Ask the Readers: Should I Stick With My Adjustable-Rate Mortgage?
Published on - April 9th, 2010 (by J.D. Roth) In February, Get Rich Slowly reader Abby wrote with questions about her adjustable-rate mortgage (or ARM, for short). She’s had an ARM for seven years now, and the rate is due to reset in 2010. She wants to know what her best course of action is. Abby writes:
In Fall 2003, I began my career as a teacher and bought my first house at 23. I shopped around for a home loan, borrowing a little over $111,000. I had good credit and picked a 7-year ARM at 6.125%. At the time, I planned to work in the City Schools for five years — so that my student loans would be forgiven. I thought that by the 7-year mark I’d be moving to a new area (back home) or be ready for a different house. Oh, how hindsight is 20/20.
I’ve moved forward in my career and am enjoying my house. I have other debts that I’m aggressively trying to pay down. In December of this year, my interest rate will adjust. The rate will adjust based on the “Index” (which, according to my paperwork, is the weekly average yield on US Treasury securities adjusted to a constant maturity of one year) with a margin of 3.410%.
With the rates being what they are, I was considering refinancing. I’ve contacted some places and, with my now excellent credit rating, I qualify for some lower 30-year mortgages, but it’s the closing costs that confuse me. My mortgage payment is about $925 a month, which makes my break-even point several years away. I know that I’ll want to continue building my career, but I imagine that I will begin to outgrow this house in the next few years.
To finally get to the question: Is it reasonable to believe that I could actually benefit from the ARM with the current low rates and that my rate could stay about the same or even lower? What are your thoughts on adjustable-rate mortgages with the rates so low?
My thoughts are: This question is way out of my league. I know there are a lot of folks who have adjustable-rate mortgages, but I’m not one of them. I have no experience with them, and I’m only vaguely familiar with the implications. To get some solid answers to Abby’s questions, I asked Tim Manni from HSH.com if he could talk about the pros and cons of adjustable-rate mortgages. Everything that follows (except the questions at the end) comes from Tim.
Are adjustable-rate mortgages evil?
Despite being around for over 25 years, adjustable-rate mortgages (ARMs) have recently begun to lose their favor in the mortgage market. There are at least a couple reasons why ARMs aren’t as popular as they once were: The housing crisis has scared many borrowers away from any home-loan product without a fixed rate, and ARMs have gotten a bad rap because they’ve been associated with other riskier mortgages like loans made to sub-prime borrowers, pay-option schemes, and no-documentation products.
While it’s true that hundreds of thousands of borrowers — who likely couldn’t properly afford an ARM in the first place — entered into default because their monthly payments increased when the rate on their ARM reset higher, ARMs certainly aren’t “evil” or “toxic”, if used correctly. While ARMs aren’t very popular at the moment, they can still be used to a homebuyer’s advantage, even in today’s low-rate market.
How do ARMs work?
ARMs start with a fixed rate for a period — sometimes as short as three months or as long as 10 years. Thereafter, the rate is tied to an economic indicator, called an Index, which governs changes in your loan’s interest rate and, thus, your payments. When the ARM rate is adjusted, the lender (or servicer) uses the value of the Index, and adds a markup, known as a Margin. (Abby’s Margin is 3.410%.) Generally, the total of your Index plus Margin equals the interest rate you’ll be charged for the next fixed period, however long that may be (just one year in Abby’s case). Such interest rate changes are governed by limits, called caps.
ARMs when rates are high(er)
Abby purchased her home back in 2003 using a 7/1 ARM (a home loan with a fixed rate for the first seven years, with the interest rate adjusting every year thereafter). At that time, the combination of current mortgage rates and Abby’s uncertain living situation made her a prime candidate for an ARM. A fixed rate for seven years was all the “fixed-rate mortgage” she needed, and it came at a better price than loans fixed for a full 30 years.
When Abby purchased her home in the fall of 2003, 7/1 ARM rates were lower than the 30-year fixed rates. ARMs were developed in a time when fixed-rate mortgages (FRMs) were extremely expensive. Rates were well into the double digits in the early 1980s, and few borrowers were interested in locking in those high rates for a full 30 years, even if they could qualify for them.
The combination of Abby’s temporary living situation and the lower mortgage rate allowed her to benefit immensely from the ARM.
Things change
Abby is now the final year of the fixed-rate portion of her ARM, and is still living in her original home with plans to stay there (at least for a little while longer). With her ARM due to reset in December of this year, Abby wants to know whether or not she should stay with her ARM given how low current mortgage rates are.
Abby also asks this question because, if her ARM resets today, her new interest rate for the next year would be in the neighborhood of 4%. This (combined with her now seven-year-lower loan balance) will give her a new monthly payment substantially less than she now has — a powerful reason to consider holding onto her present loan.
ARMs when rates are low(er)
One could argue that Abby has already maximized the benefits she could get out of her current mortgage. To avoid future uncertainty about living arrangements and market conditions, and to take advantage of an even lower mortgage rate than what she has now, Abby could simply refinance her ARM to a fixed-rate product before her December reset.
When interest rates are low — at or close to historical lows (as they have been for the last year or so) — the only way rates can be expected to move is upward. By refinancing her ARM relatively soon, Abby can lock in a low, fixed-rate mortgage rate for up to the next 30 years.
Abby’s current mortgage rate is 6.125%. If she decides to refinance into a new 7/1 ARM before December, chances are her interest rate will be in the 5%-5.25% range. Abby could get rid of all the uncertainty about future rate resets by meeting herself in middle with a fixed-rate loan, currently hovering in the lower 5% range.
If Abby decides to stick with her original ARM (without refinancing), she has to ask herself whether or not she can handle an appreciable increase in her interest rate at some point down the road. Could she handle her monthly payments if her interest rate doubled? Is she prepared to potentially dedicate her savings to her mortgage if rates jump?
Final thoughts
While Abby was the perfect candidate for an ARM back when she originated her loan, she has the chance to remove all uncertainty surrounding future rate increases — even living arrangements — by refinancing to a fixed-rate loan.
If you find yourself in Abby’s situation you need to answer these questions:
- How long do you plan on being in your home?
- What are the risks of remaining in your ARM?
- If you decide to refinance today — relative to market conditions — is it a valuable choice?
What do you think? Do you have an adjustable-rate mortgage? Have you had one in the past? When does it make sense to keep an ARM, and when does it make sense to refinance at a fixed rate? What would you do if you were Abby?
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Thoughtful piece on ARM’s. I generally loathe any type of mortgage product save the fixed rate mortgage because I do not like the idea uncertainty and attendant stress that I would go through every year when my rates adjust. After giving this some more thought, especially after reading this piece – I’m not sure if any loan product is inherently evil save predatory loans. 7/1 ARM, meaning Abby had a fixed rate the first seven years-that’s a prime window where the borrower can pay extra on their mortgage bringing their principal down. (Of course, Abby cannot go back and retroactively pay money if she hasn’t but I think it is still worth noting in this discussion)-Additionally, people with ARMS should adjust their emergency funds accordingly to account for the uncertainty. Good luck with your decision, Abby!
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Hi, I purchased a home last fall using an adjustable-rate mortgage (5/1). I am in a similar situation as the letter-writer; I am in the military, and I don’t expect to be stationed at my current location for more than 3-4 years, and the rental market was disappointing. Anyway, I know the rules of my ARM, but I’m not experienced enough to know if they will apply to the letter writer.
There is a cap on my mortgage. Here’s what I mean: my mortgage rate is 4.25%, and no matter what the prime rate is at the end of my 5-year fixed-rate period, my interest rates will not increase more than 1.25% annually, and my rate will NEVER climb higher than 9.25% overall. This means that my mortgage payment will NEVER double, and it won’t climb unreasonably high on a year-to-year basis.
Perhaps I have an unusually great deal (I have stellar credit, solid employment, and have been with my bank for 15 years), but hopefully this information helps. At least, the letter writer should check to see if there are similar stipulations in her mortgage contract. If so, and she is still planning on moving out of her house within the next 5 years, it probably makes sense to keep her ARM… she won’t save money by refinancing, and the risk of her mortgage sky-rocketing is pretty much nil.
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I imagine it all boils down to the risks you are willing to take. A fixed rate mortgage is a known quantity for the life of the loan, a adjustable rate mortgage is unknown and has both upside and downside risk. I am much more comfortable with risk on my investments, than I am with risk on my living expenses, so I have a fixed rate mortgage and risky investments.
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I am not sure if this is an option for Abby, however, I bought a condo through my Credit Union with a 3-year ARM many years ago. At that time, I had the option to switch the loan over to fixed rate at any time by paying a somewhat nominal fee (around $700).
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Interest rates have nowhere to go but up from here, but they are not likely to rise rapidly. IF Abby is thinking about moving in the next few years, then I would advise to stick with the ARM. It doesn’t make sense to pay closing costs to get a 5% rate for 2 years, when she can get a 4% rate for the next year and not pay closing costs. If she decides to stay in her current house longer than a few years, she might have lost out by not locking in a lower rate.
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I would check with ING Direct. They are offering a great product now…she could refinance into another 5 or 7-yr. ARM, and at a much lower rate than she is currently paying (ING lists their ARM at around 3.5-4.0%). They also have very LOW closing costs; they also offer a FREE bi-weekly payment option as well as the option to ‘renew’ the loan at the end of the fixed period for a modest fee (with good credit).
Sounds like a great product (wish I had known about it when I refinanced in 12/08).
Another option is to call the current mortgage company and discuss a refinance.
Finally, I think that if she’s not sure what to do, I would simply do nothing and enjoy the rate drop that seems likely in Dec.
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I, too, have an ARM mortgage that is set to reset this year, September to be exact. I have been keeping a very close eye on the LIBOR rate as that rate + 2.5% in my case is what my new mortgage rate will be for the next year. At this time, having an ARM could benefit me, like it will Abby, in that my interest rate could go down when it resets. Unfortunately, I’m not in the same position that Abby is in. I don’t have the option to refinance. We’re too underwater on our mortgage (above the typical 105% loan to value ration most lenders require) so we’re stuck for a while until we can 1 – pay down our mortgage to get us to the 105% or 2 – hope home values rise enough to get us to the 105% or less mark (or a combination of both most likely). We’re keeping a very close eye on it though so we can refinance to a fixed rate mortgage as quickly as possible and hopefully the rates on those won’t have risen too high by then.
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Decades before the rest of the world had a housing crisis, I lived in a part of Texas that had a real estate crash. Entire neighborhoods that had been financed on ARM loans turned into deserted wastelands.
So, yes, I think ARM’s are inherently evil. I saw it in the 1980′s, and I’m seeing it again now.
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No. Those people would have been underwater in the same way as if they had ARMs or not. The payment only goes up if the LIBOR rate goes up. In the past 30 years it has gone down consistently. That is not to say that it will continue to go down. Like another commenter pointed out there is a cap rate. You know what that cap rate is going in. Sit down and do the math assuming the worst case. Save the difference and get rich slowly.
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Usually closing costs are a function of how great of a rate you lock in. If closing costs are too high for a 30-year fixed rate of 5%, inquire about what the costs would be if you accept a fixed rate of 5.5%. You might even be able to get a cost-free refinance (or even cash-back) if you refinance at 6%. Definitely check out rates on the internet. You don’t have to “know” or trust the bank particularly well to use their money
Check out a website like http://www.amerisave.com to quickly compare rates vs costs.
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I disagree that rates are likely to stay low.
The US govt stopped backing mortgage loans in the last couple of weeks, and rates have already jumped a half percent or more.
Since rates have nowhere to go but up and the writer has no plans to move, I urge her to go apply for a fixed rate mortgage now. Don’t wait until December. If there are any issues which will need to be addressed, better to know now than wait until the last minute.
Home values have fallen so much she may find the bank thinks she has no equity.
Good luck to her!
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Don’t buy into all of the media HYPE. ARMs are not “inherently evil”. If you finance with an ARM, and have good credit, you will be laughing all the way to the bank for the next several years. Your rates will be below 4%. The poster will never make up the costs of the refi because she will be moving in a few years.
Why would you give the bank thousands of of dollars to refinance when you will be out of the house in a few years? Save the money or use it to pay down the principal!
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I don’t have enough information to guess at a good answer.
How would you “outgrow” a house? Do you mean you might have more people living there, like after getting married and having kids? Or do you just think you have a “starter house” and will deserve a better house? If you still like your house now, what would be changing?
Do you like your neighborhood? If so, another way to handle outgrowing a house is to renovate.
When will your other debts be paid off? After that, would you start paying down your house? Maybe the whole house could be paid off in another five or ten years before your interest rates have a chance to go through the roof.
If you’re pretty sure you’re really going to move this time, you could refinance to another 30-year loan and your payments would probably be a lot smaller.
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In general, I would never ever get an adjustable mortgage when rates are at historic lows. And unlike the person who replied, I don’t think rates have been at historic lows for one year—I think they’ve been at historic lows for a decade. Adjustable mortgages are for when interest rates are crazy, like 18%, so you’re pretty sure they’re going nowhere but down.
On the other hand, refinancing also sucks because of the closing costs. If you’re paying PMI, that might disappear with your new mortgage. And if there’s anything else icky about your current mortgage (like pre-payment penalties), you could get rid of that, too, with your next mortgage. I refinanced to reduce my interest rate, and switching from a 30-year mortgage to a 15-year mortgage (after only two years, but I had been adding enough extra principal that it was as if I were 5 years into the mortgage), my payment went up only very slightly (even with closing costs rolled in). So that’s another strategy.
And you should try shopping around for mortgages before making your final decision. Start at other companies, getting good-faith estimates, and then see if your current company is willing to beat your favorite one. If you’ve been paying on time, they shouldn’t want to lose you.
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Rates do indeed have no where to go but up and economic growth pressures will probably push them up sooner rather than later. I would lock in a 15 year fixed rate and start building equity before the reset. Her calculations are faulty given an expectation that rates could climb substantially over the next 3 years. The US Treasury Yield Curve is pricing in growth and recovery. That will mean higher rates in the next 18 months.
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Wow…great, informative article.
I personally do not like ARMs. The uncertainty of what the future brings can hamper anyone’s productivity. If I was Abbey, I would re-finance at the low rates that are available now. This secures the low rate, and she can focus her attention on other important things in her life.
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If I were in Abby’s shoes, I would refinance to a 15 yr. fixed loan. You will get a lower interest rate with a 15 yr. loan than with a 30 yr. loan. If I couldn’t afford the payments on a 15 yr. fixed, then I would get a 20 year fixed. I wouldn’t get another 30 year loan when I’ve already made payments for 7 years. If the value of your home has declined since taking out your interest only loan, then that could be an issue. (It’s my understanding with interest only loans that one will never own the home).
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I would add that I have been watching rates for a while, to refinance at a shorter term, and unlike the previous commenter (#10), I have not notice rate go up in the past month (they are up .125% – normal fluctuation). The federal reserve stopped by mortgage backed securties, but fannie, freddie, FHA and the FHLBs still back mortgage loans.
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my 2 yr ARM reset in February of this year. my loan for my house which I now rent dropped 3% and cut over $120 off each payment. It’s set to renew every six months so I am keeping a close eye on things and hope to refinance when the time is right. Until then, I’m sticking with my ARM and researching fixed options.
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Good comments all around, so maybe these thoughts are not needed now, but I would just concur with Tim that when the rates are this low, the logical conclusion is that they will go up. And, while many people will think “but I plan on moving soon,” most don’t. Life continues to happen and transpire and before you know it, you have lived there 3-7 years. When we bought our house back in 1994, I can promise you that my wife and I WERE DETERMINED to move out within 3 years.
Our excellent realtor promised she could move the house quickly and we’d make a killing. And SHE WAS RIGHT. The house value did soar. But, due to a lot of unforeseen events with our lives, nothing that anyone could plan for, we found ourselves still there in 2000. Before long, we realized that God was having us stay in this town, and that we loved the neighborhood and area.
The point of the story is just that things happen. If you move our story from buying in 1994 to buying in, say 2005, with plans to move in 3 years, but then the same “life happens” stuff went on, then we’d be fools to not convert.
For what its worth, we have refinanced two different times to get absurdly low rates in the 4% range (I have a great credit score, so that helps too). And I still remember my parents rate of 23% in the late ’70s.
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My 5/1 ARM is LIBOR + 2%. It adjusted for the first time last year from the initial rate of 4.5% to … 4.5%! No change last year. This year it is adjusting down to 2.5%, saving me $100/month. My ARM has an annual adjustment cap of 2%, so at most it’ll go back up to 4.5% next year. I don’t need to refinance until 2012 at the earliest, at which time I may decide on another ARM.
These aren’t complicated concepts for anyone with a grade-school education. The fact that it’s “scary” or “anxiety-inducing” for many people doesn’t change the math.
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Can someone please clarify something for me? In a 7/1 ARM, are those first 7 years interest-only by design?
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I wish I could figure out what we should do. We had a 5/1 ARM, because we didn’t know if we wanted to stay here (we still aren’t sure). That was at 3.875% for 5 years, then last year went to 3.5% for a year, and now I got the letter for this year, and it’s 3.125%. Basically it’s 2.75 + the Index (average weekly yield for US Treasury securities adjusted to a constant maturity of 1 year, as made available by the Federal Reserve Board), rounded to the nearest .125%.
Unfortunately, and this is one of the reasons I read this site, I don’t know that our home value is enough to even get a refi. And I don’t know if it’s worth it. The 5/1 can’t go up or down more than 2 pts per year, and can never go higher than 8.875 (that’s the 2/2/5).
I don’t know if I should try, or if it’s not even worth it. I wish someone could tell me. It would take three years of rates increasing (from .39 up to 6.125) to get to our maximum rate. Next year if it went up two points, it would increase our payment $154. Easily doable. If it went up the next year by two, and then the following to the max, the payment would go up by about 568. Obviously not ideal… If I refinanced (not accounting for closing costs, because I don’t know what they’d be) with a fixed 15 year rate, it would go up about 488.
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6.125% doesn’t sound very good these days on an ARM. I’m surprised she didn’t refinance to 4.75% 30 year fixed back when rates were truly low. If she didn’t have perfect credit at the time, maybe it has improved in the past 7 years? I agree with everybody who says that rates will be going up… even at ~5-5.5% they’re historically low and the Fed can’t do much of anything to cut them further.
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Sunny–not all ARMs had the interest only feature.
Regarding what Abby should do with her ARM depends on what her plans are AND what her home might appraise for in this market (if it’s too underwater or not).
Odds are with a 7/1 ARM, her caps are 5/2/5 meaning that the lowest (or highest) her ARM can adjust during this first adjustment is 5 points.
Her index (1 year CMT) is so low right now at 0.4%, that her new rate would be 3.41 (her margin) plus 0.4 = 3.8 (rounded to 3.875%).
I’m assuming it’s a 7/1 ARM meaning that the mortgage will adjust annually? If this is the case, on the next adjustment 12 months following the first adjustment (if the caps are 5/2/5) the most her rate can adjust up or down next year is 2 points. So worse case her rate is 5.875% even if the going rate at that time for a 30 year fixed is 10%.
Your reader may be doing better than her existing rate for at least two years if she allows the rate to adjust (assuming my caps are correct).
She will also have the benefit of avoiding the cost of a refinance…and hopefully have two years to have her home gain in some appreciation.
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REFI!!! Get rid of that ARM. Rates are near zero for government lending which is what dictates the prime rate. The only place rates can go is UP UP UP! You don’t want to be caught holding an upward adjusting ARM when you could have gotten the lowest fixed rates your likely to ever see.
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ElysianConfusion, you can use a site like Zillow to get a real rough estimate of your home. Even if your home value is negative, you might qualify for a HARP refi except the rate may not be better than what you have now.
So much depends on what your long term goals are.
I’m not a huge fan of the 15 year amortized mortgage in this economy only because should you need the extra $$ per month, you’re left without options. If you opt for a 30 year fixed mortgage, you can pay additional towards the principal and effectively pay off your mortgage in 15 years. The 30 year amortized mortgage provides flexibility where the 15 year has none.
Of course if you have plenty of reserves and no debts–then the 15 year is probably fine.
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I’m not a big fan of debt, but in order to own the property you live on its a near requirement. With that in mind I wouldn’t want to group my debt with an uncertain rate. I’d either lock in a very long period before adjustment, or go fixed. Rates can’t go much lower right now without a government program. Lock it in. Always buy low sell high, that includes debts.
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Lots of good advice, but the dominant issue is how long she intends to stay in the house. If she intends to move within 3 years, it’s unlikely she will realize any benefit from refinancing (nor are interest rates likely to rise so fast that she won’t be able to afford the new payments – right Abby?)
Go to the Mortgage Professor’s website and run the calculators based on differing assumptions, and you’ll see what will happen if she chooses to keep her ARM vs. refinancing to a different loan.
The one wild card is that if interest rates really do rise very fast, buyers may not be able to afford mortgages to buy her house and she may be staying in the house longer than she expected. If that happens, then converting to a fixed rate mortgage would clearly have been the best choice.
But if she refinances to a fixed rate, and then moves in two years… Sigh. Chasing our tails here.
Choose a scenario (how much longer before moving, speed of interest rate increases) and run the Mortgage Professor’s calculators. Making this decision is not black and white, it’s based on what she believes in her heart is most likely to occur regarding her move date – and then tempered by prudent “what if” scenarios regarding interest rates and security of her income.
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My wife and I did an ARM back in 1997, before every lender and their brother was jumping on the adjustable rate mortgage bandwagon. Our ARM allowed us to lock into a rate after the second year. It was about our third year that we locked in at around 5.8 or 6.4 or so. We did this because our comfort level wasn’t high for uncertainty. We went with the ARM because of initial costs and the fact that the agreement guaranteed that our mortgage would not be sold to another bank or institution. At the time we both knew of families that had their mortgages sold by their banks, which created unnecessary headaches for the borrowers.
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I’d never be comfortable with an adjustable rate. I just locked in for a 5 year fixed at 4.64% and I’m happy with that. (Would have been 3.95% but I still had a year left on my last fixed term, so they blended the rate)
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Refinancing to a fixed-rate mortgage may be a “bird in the hand” move but I’m not sure it reduces uncertainty. If the OP ends up moving too soon, Abby has wasted money refinancing for nothing.
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Deciding to refi in this situation would be an emotional choice, rather than a fiscal one. Minderbender has it right, and this article doesn’t address two very important points: rate caps and closing costs. She needs to re-assess how long she thinks she will stay in this house. 30 years? Refi. 2 or 3 years? Stay with the ARM. If she cannot stand the emotional uncertainty then refi is the way to go, but it is not the best financial path unless she will be in that house for the rest of her life.
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One factor that has been overlooked in this explanation is that Abby now has only 23 years left to pay on her original loan. When considering this refinance, especially since Abby is now expecting to stay in her home for the foreseeable future, she should be less concerned with the interest rate (and the monthly payment) and more concerned with the total cost over the life of the loan.
The total cost of an ARM after the fixed period can only be estimated, but the total cost of the conventional mortgage can be determined exactly. Because of this it is easier to run a comparison backwards; determine how bad the ARM index would have to get before the total cost of the ARM going forward would be more than the total cost of the conventional. Look only at the future cost of the ARM. Any interest already paid is water under the bridge and shouldn’t be part of the refinancing decision.
When making these comparisons, any short term payment reduction on the ARM due to a low index should be taken as an opportunity to build equity, not to increase the monthly household budget. After Abby runs these comparisons and determines that sticking with the ARM beats the 30-year fixed in all but the most extreme fluctuations of the index she should do the same comparison against a 20-year fixed, she may decide that is the best wealth building option (except maybe a 15-year fixed), especially since she has been able to allocate more than the minimum payments to her total monthly budget for servicing debt.
If your goal is to build wealth over time you should be looking at the top right of a truth in lending statement (total cost) instead of the top left (interest rate). You will make much better financial decisions with respect to long term debt.
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If Abby decides to move (especially since it sounds like it would be within the same area) she should take into account that the interest rates she will be paying on her ARM will be dictated by the same standards governing the mortgage on her new house. Thus, if mortgage rates rise on her current loan, they will have risen on all new home loans.
The bigger question I think we’re all raising is if Abby is actually going to move. The simple answer to her financial question since that hasn’t been answered is “it depends”. That variable needs to be taken care of before she can really make a wise decision, or there needs to be a realistic appraisal of how likely and desired that possibility is.
My suggestion with the current set of facts, get some quotes on fixed rate mortgages and then plan on holding onto it whether that entails renting it or living in it longer. Home ownership really only pays off financially for the long term. Their are other benefits, but not on the financial end. Just like renting, you’re simply paying somebody else to use their wealth; albeit with a mortgage at a lower rate if you stick with it for the long term. I’d like to know what “outgrowing” the house means?
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Does “outgrow the house” = “buy something fancier when all your other debt is gone”?
Why not move now and save some money by renting? Don’t throw good money after bad trying to get a lower rate on a home you’re going to leave in a few years anyway.
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@Rhonda Porter
My long term goal is to be debt free. I need to save for retirement and I’d like to contribute to my kids’ college expenses (they’re 4 and 6). I don’t have much flex in my budget right now. Childcare is taking up a lot of the money.
I don’t feel like Zillow is super accurate and the site Mint.com uses to estimate value shows home value 80K less than Zillow. So, that’s a huge range and really impacts what we could do. We don’t seem to qualify for a HARP, I guess my credit union owns the loan.
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My biggest question is WHY consider a 30-YEAR morgage??!!!! We have never had an ARM because I see little-to-no benefit. Abby’s initial thought seemed like an ARM was a good idea because she thought she may move, but now, she is still there and sounds not to have any immediate requirement to move. I can’t tell you how people I know that thought they would move in a few years and did not. I think that’s why some people first try an ARM. But unless you are somebody that should be renting because you get restless too much, it really only benefits the bank. They get the initial closing costs and then more when you refinance.
We have paid two sets of closing costs. We got our first mortgage as a 30-year fixed (I insisted on the 30-year but didn’t consider a 15, thinking it was too much). Rates dropped somewhat, so we could refinance with a lower rate, drop our PMI, and lowered ourselves to a 15-year fixed, although we incurred a second set of closing costs. First, the new set of closing costs was lower than the first because it was just a refinance. Second, I am SOO glad we did this b/c our 15-year mortgage was not much higher (about $75 more a month), and we saved ourselves 15 YEARS of not needing to pay a mortgage payment. I now have 9 years left and counting . . .
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It really depends on how long she’ll be in the home. If she’s going to be in this home for less than 4-5 years then don’t refinance. If she’ll live there longer then refinancing makes sense. If she’s not very sure how long she’ll be in the home then it boils down to what kind of risk she wants to take.
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What is not well understood is that fixed rate mortgages also include an element of interest rate risk. If rates plummet, you are either stuck or have to incur the costs of refinancing.
We have an ARM with which we’re very happy. Our current rate is 3 1/8% and so I’m inclined to let it ride. Our balance is low enough so that even if the rate rose to its lifetime cap (four years from now), we would only pay $732 a month. Since we’re stuck in our house in one of the worst hit real estate markets in northern Nevada, we could do worse. We could also do worse in terms of places to live.
The other consideration is if you are inclined to prepay your balance. If you have a fixed rate mortgage, your payment never changes. Anything extra goes toward principal so your loan would be paid off earlier.
With an ARM, your payment will adjust each year not only under the new interest rate, but also under the new (lower) balance. Thus, any rate increase would be offset by a lower balance. If you are really aggressive, you can reduce your payments significantly over time. Remember, however, that the term will still be the same, unless you pay it off completely.
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ARMS have one advantage I rarely see mentioned. When the interest rate is adjusted, the new payment
is based on the new rate, the remaining term, and the current balance. Which means that if you
make additional payments on the principal, your payment will go down. This doesn’t happen with
a fixed rate mortgage, and it gives you more flexibility: you can either enjoy the lower payment or
keep paying the same amount and pay it off even faster. I bought a condo in 1985 with a 30-year
ARM and paid it off about ten years later, so it worked out well for me.
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@Tom “total cost” is a red herring in this situation and is only something paid attention to by “pay off your mortgage” zealots. You are totally ignoring the time value of money. Not to mention the real question here which others have pointed out: “How likely is it that Abby will move out in the near future?”
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I think she should stick with the ARM. If she plan on refinancing it may take more than 5 years to get to the break even point with all the transfer taxes etc. that add up with a “simple refi”.
Read through your dusty old loan docs, see which index your mortgage is tied to, and then look at the history of that index, add in your margin of 3.14% and then make an informed decision.
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Wow.
Tons of misinformation here.
First, how long you plan on staying in the home means ZERO.
What matters is how long you plan on keeping the LOAN.
The average person moves every 7 years, but the average person finances their home every 4.5 years.
people refinance for a variety of reasons, only one being a lower rate. And every time you refinance, the security of the fixed 15 or 20 or 30 year mortgage evaporates.
So the real question is why would you pay for 30 years of security if on average you only need it for 4 or 5?
Fixed loans serve a purpose. So do ARM’s. I know of many people who were thought geniuses for locking in at 5.75% fixed for 30 years in 2005-2007.
Then they refinanced in 2009. So much for the 30 year part. Statistics show that the average person is better off with an ARM. They recieve a lower rate for a loan they were likely to refinance or move out of anyway.
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I bought in 2007 and my primary loan was a 3 year ARM. It was due to go adjustable in June 2010 and I started getting nervous about it last year. My building is a bit unusual (more commercial than residential) so big banks were not willing to refinance. After a long search I was able to “thread the needle” and find a workaround that allowed me to refinance. I locked in at a slightly lower rate than my original ARM, but did pay closing costs. I did realize that my ARM might end up being lower, but I did not want the uncertainty.
I locked in around October of 2009 and have not regretted it for a second. Having a fixed rate makes me feel much more comfortable.
I do plan to keep this condo as long as I can, renting it out when and if I move into a larger house. While I might not keep it for 30 years, it’s a distinct possibility. It’s in a very good neighborhood so my hope is that it will grow in value as the real estate market settles back into a more predictable (if more modest) growth pattern.
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If your refi costs are reasonable, and you can adjust out of an ARM into a fixed rate mortgage which results in a monthly payment not greater than your current mortgage payment, do it.
30-year fixed rates are right around %5, last I looked. 15-year are around 4.5%. But if the costs are reasonable and you can still afford the monthly PITI afterwards, it might be worth the peace of mind to have a fixed rate.
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True, your required payment doesn’t go down, however if you’re able to pay more than the required payment anyway, that’s a bit of a non-issue. It would only come in handy if you had a sudden loss or decreas in income. Otherwise, you’re going to keep making payments that are the same or higher than the required payment.
In that regard, the fixed-rate mortgage behaves the same way, because as you pay down the principle the amount of each payment going toward interest decreases. So, regardless of whether you have an ARM or a fixed-rate, it still comes down to: paying extra on your mortgage will pay it off sooner.
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ARMS are unpopular for a good reason. The so called mortgage professionals heavily sold them because they made more money on them and they made the homes sound more affordable. The standard sales line went something like this: take the low rate now and if the rate adjusts up in a few years you can always refinance. Problem with that was when the rates adjusted up, a lot of people lost all the equity in their homes because the same banks were engaging in unethical practices causing the housing market to crash. The upshot was the people couldn’t refinance because their homes were upside down. So when the borrowers took on their loans at the time they could afford the loan at the present terms. Relying on the so called professionals they felt assured if the rates went up, they could easily refinance. When the the rates adjusted they couldn’t refinance and their payments went up hundreds of dollars.
The only way ARMs are good is if you can predict the market. You can’t.
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Is there a maximum amount per year which Abby’s adjustable rate can increase, regardless of the underlying index?
If so, this would lower the adjustable rate risk somewhat.
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“I don’t have much flex in my budget right now.”
That means get a fixed rate. ARMs are for people who can pay it off sooner if they have to.
Personally, I have a 7/1 ARM that will go adjustable in September. However, I’ve made a lot of extra principal payments and am on track to have the whole thing paid off in 2 or 3 more years. It was the right choice for me. If you can’t handle extra payments now, you’re not going to handle the forced extra payments when the rate goes up either.
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ARMs are not evil–you just have to know when to get out.
Fortunately, I have a mortgage “guy” in my life, who guided me through that perfectly. I had one for three years I think with a monthly payment of 4 something…I socked a way a bundle and am reaping the benefits from it.
Can’t give too much concrete advice, excpet for they are not evil, but you’d need to consult a prfoessional.
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I hope Abby keeps us posted with what ever she decides to do.
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