Author Topic: Mortgage: Fixed or ARM?  (Read 6745 times)

glorkvorn

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Mortgage: Fixed or ARM?
« on: September 29, 2014, 10:27:42 PM »
HI!  This is my first post here, I hope someone can help me out.

I'm in the process of applying for a mortgage (in the US), and I'm trying to decide what kind to get.  I've already decided on a 30 year, because I'd rather put the extra into stock investing for higher expected returns and more diversification (I'm in my late 20s, so plenty of time).

I can get a 30 year fixed rate for about 4% interest, or a 5:1 ARM for about 3% interest.  3:1 and 7:1 ARMs are also a possibility.  I can easily afford the 4% interest, that's no problem, I just want to make sure I'm getting the best deal.  I do intend to keep living in this place for a long time, but I can't be certain.  There's basically 4 scenarios I can see.

Scenario 1: For whatever reason, I'm forced to move out quickly.  Very annoying, since I lose the closing costs, but in this case it doesn't really matter what kind of mortgage I have.
Scenario 2: I live there for about 5 years, then sell the place.  In that case, the 5:1 ARM is clearly superior.
Scenario 3: I continue to own the place for the full 30 years, either living there or renting it out.  In that case, the fixed rate is probably superior, although how much better it is depends on what happens to interest rates during that time which I have no way of predicting.  I'm not opposed to renting it out, but I've never been a landlord before so I have no idea what that's like.  It's also just very hard for me to imagine what my life would be like in 30 years time.

I have to admit, part of me wants to go for the ARM just because everyone keeps saying that ARMs are always terrible and I like to be a contrarian.  But maybe the conventional wisdom is right about this one.  Any thoughts?

sideways

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Re: Mortgage: Fixed or ARM?
« Reply #1 on: September 29, 2014, 11:19:50 PM »
Back in 2009, we got the 30 year fixed (at 5%!), thinking we were being responsible. A year or so later our broker offered us a refi at something like 4.75%. We considered it, realized we were being idiots, and switched to a 5/1 ARM at 2.5% (!!) which we have to this day. We saved about $800 a month by refinancing.

The fixed-rate loan is a better deal only if rates increase substantially and you stay in the place for a long time. IMO it only makes sense for people who cannot tolerate much risk. Our only regret with the ARM is that we did not refi sooner.

glorkvorn

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Re: Mortgage: Fixed or ARM?
« Reply #2 on: September 29, 2014, 11:39:27 PM »
Back in 2009, we got the 30 year fixed (at 5%!), thinking we were being responsible. A year or so later our broker offered us a refi at something like 4.75%. We considered it, realized we were being idiots, and switched to a 5/1 ARM at 2.5% (!!) which we have to this day. We saved about $800 a month by refinancing.

The fixed-rate loan is a better deal only if rates increase substantially and you stay in the place for a long time. IMO it only makes sense for people who cannot tolerate much risk. Our only regret with the ARM is that we did not refi sooner.
Seems like 2009 was an exceptionally good time to get an ARM though.  Would you still feel the same way if rates had stayed the same or gone up slightly?

orbix

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Re: Mortgage: Fixed or ARM?
« Reply #3 on: September 29, 2014, 11:59:24 PM »
Based on what rates have done over the past year or so, it seems like this is a solid time to go ahead with the fixed rate, since chances are pretty darned good that by any point that you'd be likely to refinance, rates are going to be above the ARM rate. Heck, we snagged a 2.5% on a 15 year loan a bit over a year ago, and rates are already in the 3.5% range for an equivalent loan now.

AlanStache

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Re: Mortgage: Fixed or ARM?
« Reply #4 on: September 30, 2014, 03:54:29 AM »
just got 3.2 fixed on a 15 year, probably should have done the math on a ARM but did not, but I could have had it more or less paid off in 5-7 years (still will...)

I would suggest doing the math on what the ARM has to reset to for it to cost more than the fixed.  Then is just a matter of guess work if you think rates will be lower than that in 5 or 7 years.  The lower rate at the start of the loan will help lots especially if you can pay a bit extra to get the principle down.  Less to compound if you pay more aggressively at the start, but all this is working with small rates and the resultant dollars might be close.

Right now fixed rates are still stupid low.  Bird in hand and all that.  Also the market only wins in long term historical averages, it can do crazy bad stuff over the short term, and home loan rates have been in the teens not to long ago.

http://www.freddiemac.com/pmms/pmms30.htm


chasesfish

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Re: Mortgage: Fixed or ARM?
« Reply #5 on: September 30, 2014, 04:04:28 AM »
I'd go with the 15 year fixed if you can afford the payment.  Its around 3.25% verses 4.25% for the 30 year.  The ARM doesn't give enough of a discount for the risk in my opinion.

glorkvorn

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Re: Mortgage: Fixed or ARM?
« Reply #6 on: September 30, 2014, 07:58:31 AM »
just got 3.2 fixed on a 15 year, probably should have done the math on a ARM but did not, but I could have had it more or less paid off in 5-7 years (still will...)

I would suggest doing the math on what the ARM has to reset to for it to cost more than the fixed.  Then is just a matter of guess work if you think rates will be lower than that in 5 or 7 years.  The lower rate at the start of the loan will help lots especially if you can pay a bit extra to get the principle down.  Less to compound if you pay more aggressively at the start, but all this is working with small rates and the resultant dollars might be close.

Right now fixed rates are still stupid low.  Bird in hand and all that.  Also the market only wins in long term historical averages, it can do crazy bad stuff over the short term, and home loan rates have been in the teens not to long ago.

http://www.freddiemac.com/pmms/pmms30.htm

The math is a bit hard, since it depends on not just the absolute rate but on how quickly it rises and how much time value you put on money.  I found this thread though: http://www.talkirvine.com/index.php/topic,1588.0.html where someone calculates that in nominal terms, even in the worst case (maximum rate adjustment), the 30 year fixed doesn't beat a 7:1 ARM until year 11.

I know the rates are low by historical standards.... but the spread between ARM and fixed rates is also historically high.

AlanStache

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Re: Mortgage: Fixed or ARM?
« Reply #7 on: September 30, 2014, 08:19:37 AM »

The math is a bit hard, since it depends on not just the absolute rate but on how quickly it rises and how much time value you put on money.  I found this thread though: http://www.talkirvine.com/index.php/topic,1588.0.html where someone calculates that in nominal terms, even in the worst case (maximum rate adjustment), the 30 year fixed doesn't beat a 7:1 ARM until year 11.

I know the rates are low by historical standards.... but the spread between ARM and fixed rates is also historically high.

Yeah look at a worst case, if goes max at 5/7 years and stays there, and maybe max minus 1,2,3 percent would give you a good idea what the bad out comes could be, ignoring the rate changing.  Also if it did max out prepaying starts to look better relative to market investments.


HawkeyeNFO

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Re: Mortgage: Fixed or ARM?
« Reply #8 on: September 30, 2014, 08:40:18 AM »
People are looking at this wrong.  In your late 20's, this is not really a math problem.  At that age, you are likely to have a reason to move within 5 years (new job, marriage, kids, etc.).  So I vote for the ARM.  Only thing that would change that is if you knew you would try to rent it out at some point in the future, or had another positive reason that you know that you won't be selling within 5 years.

windypig

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Re: Mortgage: Fixed or ARM?
« Reply #9 on: September 30, 2014, 09:11:30 AM »
I would go with the ARM (I have a 10/1 ARM at 3.375 - probably should have done a 5/1) anyways, if mortgage rates rise and therefore your ARM rises its because you are in a financial climate where your investments are going to be earning a high return - since you have a mustache I presume you will be staching all the money you are saving by having an ARM over a fixed rate, you can use those returns to pump into your principal to mitigate your new higher interest rates.

Most mortgages last 7 years! So statistically your best bet is to get a 7/1

Use this tool: http://mortgagemavin.com/mortgage/mortgage-calculator.aspx

to compare mortgages. This tool assumes worst case scenario on ARMs. Keep in mind you will almost never have the worst case.

frugaliknowit

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Re: Mortgage: Fixed or ARM?
« Reply #10 on: September 30, 2014, 01:51:11 PM »
Do NOT get an ARM!!!

Here's why:

1.  Interest rates are at historic lows.  Why would you not want to lock in historic lows?  You think they're going lower?  Good luck with that!

2.  Coming from someone older and hopefully wiser:  You do NOT know how long you will live in this house.  You can try to predict.  Likely your prediction is wrong. 


Let's say you decide, "ok, I'll be outta here within 10 years..."  You get a 10/1 arm.  You get to year 9, rates are low, so you don't do anything.  Year 9.75 you lose your job.  While you are trying to find a job, rates scream up several percent.   While you are looking for work, your credit gets trashed.  By the time you find a job and repair your credit, guess what, you've reset to some astronomical rate.   Now that you finally have re-established your income and credit, rates are too high and you are stuck.

Lock it in!!!

windypig

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Re: Mortgage: Fixed or ARM?
« Reply #11 on: September 30, 2014, 02:12:31 PM »
Do NOT get an ARM!!!

Here's why:

1.  Interest rates are at historic lows.  Why would you not want to lock in historic lows?  You think they're going lower?  Good luck with that!

2.  Coming from someone older and hopefully wiser:  You do NOT know how long you will live in this house.  You can try to predict.  Likely your prediction is wrong. 


Let's say you decide, "ok, I'll be outta here within 10 years..."  You get a 10/1 arm.  You get to year 9, rates are low, so you don't do anything.  Year 9.75 you lose your job.  While you are trying to find a job, rates scream up several percent.   While you are looking for work, your credit gets trashed.  By the time you find a job and repair your credit, guess what, you've reset to some astronomical rate.   Now that you finally have re-established your income and credit, rates are too high and you are stuck.

Lock it in!!!

This is sound advice for someone that is not going to be saving the difference between a fixed and an ARM. Run the numbers in a mortgage comparison calculator. I would bet assuming worst case scenario on the ARM you still wouldnt be better off with the 30 year fix until year 20+

All of this assumes:

 1) You can afford the house. Dont buy a house that you cant afford a 15 year fixed mortgage on. Rule of thumb is if your montly mortgate payment is > 30% of your take home you are buying that which you cant afford.

2) You are saving the money that the ARM frees up, so that in case you need to pay down your principal you can do so.


Rein1987

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Re: Mortgage: Fixed or ARM?
« Reply #12 on: September 30, 2014, 02:15:39 PM »
I am looking for a mortgage and considering the ARM or Fixed problem now. I will probably go for the 5/1 ARM. Here's the reason:

- If we refinance or move within 7 years, definitely ARM win. Statistically, this is very possible.
- If we live longer than 7 years, and the interest rate raises to the worst case 8.25% or so (Our mortgage terms says the maximum increase is 5%, so for us 3.25% + 5% = 8.25% is the worst case), by math we still win if we live there for about 12 years.

The most important part:
- By our family's current saving rate, we have the choice to pay off the house in 12 years! If the interest does raise dramatically, we can pay down the principal more! Even if we cannot pay off the whole mortgage, every extra dollar put into principal earns us guaranteed 8.25% annual return. This sounds like a good deal.

That's also the reason why I may go for 7/1 not 5/1 nor 10/1, because we do not have confidence to have the ability to pay off the mortgage within 6,7 years (when 5/1 is definitely win), and we do not want to pay 10/1's extra 0.3% interest.

retired?

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Re: Mortgage: Fixed or ARM?
« Reply #13 on: September 30, 2014, 02:29:59 PM »
People are looking at this wrong.  In your late 20's, this is not really a math problem.  At that age, you are likely to have a reason to move within 5 years (new job, marriage, kids, etc.).  So I vote for the ARM.  Only thing that would change that is if you knew you would try to rent it out at some point in the future, or had another positive reason that you know that you won't be selling within 5 years.

Best post....I was busy thinking about interest rates and what the Fed might do, etc., but if I look back on the 15 years since I bought my first home, I have not lived in the same house more than 5.5 years.  Are you in a field that has opportunity around the country?  When I also think back to our first purchase, we chose a house based on what we wanted long-term, i.e. once we had kids, etc.  We chose a 4BR, 2.5 BA out in the burbs (unfortunately away from friends).  Moved into it in 1999, daughter born 2002, moved in 2003.

At 29, I shouldn't have considered anything "fixed" for more than 2-3 years.  Now that I am older and have kids, I still place the long-term at 5 years. i.e. I am not going to make decisions under the assumption that certain things are unchanged 5 years from now.

glorkvorn

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Re: Mortgage: Fixed or ARM?
« Reply #14 on: September 30, 2014, 08:31:01 PM »
People are looking at this wrong.  In your late 20's, this is not really a math problem.  At that age, you are likely to have a reason to move within 5 years (new job, marriage, kids, etc.).  So I vote for the ARM.  Only thing that would change that is if you knew you would try to rent it out at some point in the future, or had another positive reason that you know that you won't be selling within 5 years.

Yeah... I think this is a winning argument for me.  5 years ago I never would have imagined that I'd be doing this now, and it makes me really skeptical that I can predict 10-30 years of my life.

Renting it out does seem like a good option, but I can't really commit to being a landlord 10 years down the line when I haven't even lived there yet.

glorkvorn

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Re: Mortgage: Fixed or ARM?
« Reply #15 on: September 30, 2014, 08:35:16 PM »
Do NOT get an ARM!!!

Here's why:

1.  Interest rates are at historic lows.  Why would you not want to lock in historic lows?  You think they're going lower?  Good luck with that!

2.  Coming from someone older and hopefully wiser:  You do NOT know how long you will live in this house.  You can try to predict.  Likely your prediction is wrong. 


Let's say you decide, "ok, I'll be outta here within 10 years..."  You get a 10/1 arm.  You get to year 9, rates are low, so you don't do anything.  Year 9.75 you lose your job.  While you are trying to find a job, rates scream up several percent.   While you are looking for work, your credit gets trashed.  By the time you find a job and repair your credit, guess what, you've reset to some astronomical rate.   Now that you finally have re-established your income and credit, rates are too high and you are stuck.

Lock it in!!!

I admit I'm very tempted by the low rates.  On the other hand, the difference between an ARM and a fixed rate is *also* historically high.  And besides, I don't buy the argument that "there's no way they can go lower!"  That sounds like realtor salesmanship to me.  They were lower just a year ago, no reason they can't go back down again.

ARM mortgages are limited in both the overall rate and on how fast they can go up in a single year, so they can't all of a sudden go up to some exorbitant rate.  And if they do start to go up a lot, I'll start throwing more money at the mortgage to pay down the balance.

Prepube

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Re: Mortgage: Fixed or ARM?
« Reply #16 on: September 30, 2014, 09:50:38 PM »
I have a 7 year ARM at 2.75%. In year 8, it cannot go up more than 1 percent.  I hope to be gone by then, but if not, the increases will never be crazy huge, or they might not happen at all.  A 5 or 7 year ARM is the way to go in your age group, or in mine as I'm approaching an early retirement with hopes of getting out of here for warmer climes.  Chances are slim I will still have this mortgage at the time it switches to a variable rate.

CanuckExpat

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Re: Mortgage: Fixed or ARM?
« Reply #17 on: September 30, 2014, 11:20:16 PM »
Glorkvorn, it's good that you are considering this. We didn't, only looked at fixed rate products and went with the 15 year fixed. It has been good to us so far, but now I am considering refinancing for cash flow reasons

I can't advise you to what to do, but it is good that you are thinking about the ARM and going against the popular opinion.
That being said, I will say that when comparing lenders, it was easier to compare the rates on the 30 year fixed mortgages, as there was less variability as opposed to the variable rate products.

Edited to fix typo
« Last Edit: October 01, 2014, 08:05:13 AM by CanuckExpat »

wizofloz

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Re: Mortgage: Fixed or ARM?
« Reply #18 on: October 01, 2014, 07:04:09 AM »
I would go with a 5 or 7 year ARM. We bought our first house 8 years ago and we are currently in our third at age 32. My career moved us around but at this age life changes pretty rapidly and I can't see us being in the same house for more than 7 years in the near future.