The standard (I think sensible) advice for a low interest rate fixed mortgage is to not pay down early and instead invest that money elsewhere.
What about an ARM at 3% with 4 years until adjustment to prime (LIBOR plus ~2%)?
I see some differences for this case compared to the standard advice for a 4% 30yr fixed:
- Money put into an ARM isn't lost "forever" in the same way, at each adjustment period the loan is re-amortized so prepaying actually does lower your payments.
- In this case the yield is quite favorable, it acts much like a 4-yr bond yielding 3% while even 5-yr single A corporate bonds are only yielding a bit over 2%.
- If you already max your retirement contributions the mortgage interest tax deduction is irrelevant since your alternative investment will also be taxed (if alternate returns capital gains and qualified dividends then tax rate is a bit lower though).
- Once you are past the fixed portion you are essentially borrowing money at prime to invest elsewhere, not something one would normally recommend I think.
- 4 yrs is a reasonably short window, you'd be gambling a little bit on returns from something like equities before your loan became "unfixed". Of course perhaps rates will still be really low four years from now, so of course there is uncertainty in either course of action.
- In most investment portfolios medium term bonds are one of the best things to mix with equities (short term too low return, long term too risky) so the concept jives with many portfolio recommendations if paying down the ARM is thought of as a medium term bond.
So to me it seems that this case is much less obvious than the 30yr fixed. I'd consider it pretty reasonable to pay down this ARM early (assuming of course adequate emergency funds and liquidity elsewhere).
Thoughts? Am I missing something?
