Thoughts on ARM given pending FIRE

[ysette9]

I’ve been hearing of some pretty good refi deals people at work are getting with current interest rates. Naturally ARMs are lower than fixed rate mortgages. I’m wondering about the idea of a 7- or 10-year ARM if we plan on quitting work in the next year or two?

I know the WCI thinks that a fixed rate mortgage is a variable plus the cost of insurance baked in, and prefers the variable. I can also see based on our lives that it is hard to predict whether we will be in the same place with the same mortgage ten years from now.

Is it better to go with the lowest rate possible and then figure out the future later? That could be selling or paying down/off ten years from now or being stuck with a resetting rate that we can’t refinance due to lack of employment income.

[affordablehousing]

If you're fireing, the prospect of a mortgage payoff shouldn't be a big deal. Probably all depends on specifics but with 30 yr fixed jumbos at about 3.125% (friend locked last week in Long Beach, First Republic) not sure how much lower an ARM would be. How much is the cost of your stress? Presumably, come time to refi, mortgage debt will still be cheaper than investment returns.

[ysette9]

Someone at work mentioned 2.875% for a 7/1 ARM. My 30-year fixed is at 3.625%, so that is something.

[affordablehousing]

if I was choosing between a 30 yr at 3.125 and an arm at 2.875 i'd do the 30 yr for peace of mind if I wanted to stay in the house long-term but your horizon might be different.

[ysette9]

I like the peace of mind as well, but I should probably pay attention to the fact that we never seem to stay in one place, despite our best intentions. I should probably shop around and then do the calculations of how much we would save in each scenario and estimate the downside risk of an ARM going up after the 7- or 10-year lock period. Hell, it is possible we will be in another house or even another country by then; life seems to be so difficult to predict!

[seattlecyclone]

My thinking is that with an ARM you're taking a risk that 7 or 10 years down the road, if interest rates have gone up a bunch and you're still staying in the same home, you'll have to be prepared to pay that loan off at that point. Doing so would likely require you to sell a bunch of investments and forego any ACA subsidies for that year. My gut feeling says that particular risk isn't worthwhile...unless you expect you'll probably have moved houses anyway by that point, in which case you might as well take the lower rate from the ARM.

[ysette9]

I was trying to build a hierarchy of risk and responses. If rates go up after the lock period expires the first line of defense seems to be to just pay the higher rate. I would need to look into the details of the ARM to understand by how much it could ho up each year. I know they are pegged to something, like LIBOR+x%, so I need to see what the max amount it could go up each year.

I certainly have no crystal ball, but it seems like the Fed doesn’t have the appetite for 1980s-style high interest rates anymore. Do you feel otherwise?

Second line of defense would be to pay it off and/or move and/or see what could be done to refi (go back to work for a bit? Find an institution willing to be more creative?). I think I need to do more homework and some math.

[seattlecyclone]

I don't think the Fed's current appetite for high interest rates is really predictive of what might occur 7-10 years from now. Just 12 years ago I had an online savings account that paid 5%. 30-year mortgage rates were over 6% and had been over 5% for a very, very long time. Who's to say that the current low rates aren't a historical anomaly and we'll revert to higher rates over the next decade?

I agree that the terms of your ARM might make it advantageous to ride out a rate increase for a few years. Perhaps the loan says the interest rate can't increase by more than 1% in a given year. Even if prevailing rates are 10% in a decade you'll still have a full year at 4%, another year at 5%, and so on until you hit the prevailing rates. That could give you plenty of time to pay off the loan in a gradual manner if that's what you decide you want to do.

[Zamboni]

Personally I wouldn't go for a ARM unless I was certain I would be selling the home well before the run away interest rate could happen. YMMV

[norajean]

ARMs have nothing to do with FIRE and everything to do with how long you plan to need the loan.  Most people eschew mortgages during retirement because they prefer a predictable, low constant monthly living cost rather than one which is high during the  payment years then lurches abruptly lower at some point in the future.

Only you know what your risk is moving might be. Nobody knows what way interest rates will go.  We have all been saying they can only go higher for a decade but right now they look to be headed lower.

[Goldy]

I have had a couple ARMs and it has always worked out well for me.  When I was shopping the rate difference between a 30yr vs a 5/1 was just over 1% so it made sense to me.  Mine have always had a capped increase of 5% and can only go up or down 2% each year after year 5.

I had calculated a 9yr breakeven between the 30yr and 5/1 assuming worst case interest rates.  I wouldn’t recommend an ARM to help you afford a property but if you can swing a 30yr and just want to reduce the interest then it’s a good tool.

Side note, mine will adjust in about a year and i’m actually considering switching to a 30yr due to a shift in my thinking in the pay off mortgage vs invest debate.

[Rdy2Fire]

My 5/1 ARM helped me pay off my house in under 10yrs but that was when rates were continuing to go down which seems like it could be happening again. The ARM doesn't have much to do with FIRE really but I wanted to be debt free which would eventually help so I guess I can see the tie in.

My advice to people I know and based on what I did, if you can save some points and $$ but are willing to make the same payment you have been making then it should work out very well. I'd also think about what your plans are for the future in regards to how long you'll be in the house (will you be gone before the adjustments in case it goes up??), the total cost of refinance and recouping that cost etc.

[ysette9]

You folks are giving me a lot of good ideas for calculations to do to frame the question. I’ll look into how much faster we could pay it off if we just kept the payment the same but lowered the interest rate for 7 or 10 years. I’ll also look into the max downside payments and see when that crosses over eating up the savings from the earlier part of the loan.

If only the future were less murky this would be much easier.