Mortgage Options - What would you do?

[Farmer123]

My wife and I will be building a house this fall, which means we will not be locking in a rate until near the end of the year. Here are all of the different options we have to pick from. With interest rates rising quickly, I am trying to decide if it makes sense to try to lock something in now or let it ride until the end of the year. Also we plan on staying in this house for a long time.

Option 1: Start construction loan within next few months at 2.625%, then roll into a 30 year mortgage at end of year. Current rate is about 4.65%

Option 2: Start construction loan within next few months at 2.625%, then roll into a 15 year mortgage at end of year. Current rate is about 4.15%.
I did the math on this one and the mortgage payment would be about $600-700 more per month. If I invested that month over the 15 years instead of paying towards the mortgage I would get about $200,000. I also calculated how much interest I would save on a 15 year loan and it is about $190,000. Therefore, somewhat of a wash.

Option 3: Start a 7 year ARM right now at 4.375%. This would obviously lock in this rate for 7 years, but who knows where rates will be in 7 years...

Option 4: Start a 10 year ARM right now at 4.625%. This would obviously lock in this rate for 10 years, but who knows where rates will be in 10 years...

The mortgage officer I have been talking told me most people refinance within 7-10 years anyway so the arm might be worth it to get the lower rate now. But we do plan on being in this house for a long time. I feel like if we wait until the end of the year to lock in a 30 year loan, the rates are going to be over 5%.

Other positives of the arms is that I can lock in those rates now and at the end of the year, I still can change to a 15 or 30 year loan if we want. But of course the big negative is having to deal with rates in 7 or 10 years. But we can also refinance anytime within the 7-10 year period.

What would you do?

[boarder42]

based on staying in the house for a long time and the current interest rate climate is for rates to rise. 

your math on option 2 is likely flawed the diffference at the end of 30 years is likely much higher for the 30 year loan.  the breakeven point is about 6-7 years - this is a cool calculator http://michaelbluejay.com/house/15vs30.html  but if long time is your goal the the 30 year loan will likely win.

i'm not a fan of ARMs in a rising rate environment but a 10 year lock is a pretty good deal that you could lock in now and then if rates stay flat to down you could change to a 30 ... seems like the best option is likely to do option 4 with the caveat that if rates are still 5% or less swap to the fixed 30 year loan.

[Catbert]

I would not go with an ARM unless:   you could and would pay it off within the ARM period OR you will be selling within the ARM period.

I believe that interest rates won't be going back to the historic low rates where they've been for the past few years.  The 10 year ARM is ridiculous since the interest rate is even higher than the 30 year fixed.  The fact that most people move within 10 years doesn't mean anything is this is your dream/forever home.

[boarder42]

I would not go with an ARM unless:   you could and would pay it off within the ARM period OR you will be selling within the ARM period.

I believe that interest rates won't be going back to the historic low rates where they've been for the past few years.  The 10 year ARM is ridiculous since the interest rate is even higher than the 30 year fixed.  The fact that most people move within 10 years doesn't mean anything is this is your dream/forever home.

did you read the post... the 10 year ARM is lockable now the 30 year rate is just what rates are today - all indications are that rates will be higher in dec/jan when the OP needs to get the loan.  So locking in a 4.625% for the next 10 years today with the option to go 30 year when the house is done if rates are still around 5 or less is probably a good bet - locks in a rate at today's prices for basically 10 years vs rolling the dice on what it will be at the end of the year.   

[Farmer123]

I just talked with the other bank we were thinking about using. Their 10 year arm is 3.875% and going up to 4.125% on Monday.
I can lock in the lower rate this week if I sign some paperwork. Don't have much time to make the decision.

With being able to still convert to 30 year once the house is completed, I think signing up for the 10 year arm is the best decision at this point.
Who knows where rates will be in 10 years but the 3.875% is a good rate right now.

Doing some quick math... over the first 10 years going with the 3.875% 10 year arm I would save just over $25,000 in interest compared to a 30 year loan with a 5% rate.
If I get to the 10th year and rates are 8%, I can adjust in year 7,8,9 first of all but I will also have that $25,000 that I already saved.

[boarder42]

that sounds pretty great assuming their closing costs arent higher in relation to the rate.  much better situation i'd lock in the 3.875%.   the re evaluate at year end.  if rates go lower you can always REFI.

[Farmer123]

Thank you Boarder42. The closing costs will be about $1,000 more but that doesn't change my mind when I will be saving $25k over the first 10 years.
Who knows where interest rates will be in December or 10 year from now!
Guess I should have built last year...

[Dicey]

Just saw this thread, but I see B42 has fielded your questions expertly. Good on you for making a swift decision to lock in a great rate. Hope the home building project goes well, Farmer Al!