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There is a 0.75 diff between the two best quotes i got. While I like the stability of 30 year fixed, I fear refinancing in future would mean, i had paid more than I needed to. However I fear 7/1 is too risky considering the likelihood that rates will only go higher, not lower.  Am I thinking logical? Any tips and tricks that will help me here? 

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Sell the house, take your $42K in savings and go rent?  If your argument against it requires a collapse of the economy a... (more)

realjones (Sep. 23, 2016 @ 5:09p) |

I agree 6 K per year saving is no joke and in a normal scenario with mildly rising rates, refi can be done. I just don't... (more)

needdealsnow (Sep. 23, 2016 @ 6:27p) |

My choice was the ARM - I'm not going to stay in this house for 30 years.

camiolo (Sep. 23, 2016 @ 10:26p) |

Summary so far:

  1. Definitely go with arm if you can finish the loan quick say under 10 years.
  2. Even otherwise, one calculation below suggests you would break even at 9 years (with few assumptions). So for many,  9 years is long time and worth taking the risk.
  3. Another  suggestion is to repay each time the rate drops by 0.25 (with no closing costs), and pay any difference towards principal...reduces risk even further.
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For some people, 5/1 and 7/1 could be risky if they can barely make the current set of payments. On the other hand of the spectrum, 5/1 and 7/1 could be attractive for people who purposefully want to finish their mortgage in 5, 7, or even up to ~10 or 12 years (depending on what the 15 year rate is).

One interesting feature that may be applicable to some people is that as 5/1 and 7/1 recasts, your mandatory payments shrink with time if you've purposefully been overpaying.

Contrast that to 15 and 30, where overpaying won't spare you any payments in the mid term. Overpayments help you finish earlier, but you have to keep making your monthly mortgage payment until it is all done!

BTW have you looked at Penfed? They have some interesting mortgage products, and the rates are often competitive.

I don't remember how big the difference was a year ago, but I took a 5/1 instead of fixed. And that was a refinance of another 5/1 that had about a year left. Same rate now.

The monthly savings is pretty big and the worst case seemed unlikely and far away. Staying with the arm while it adjusts has caps on increases, so even with a big jump by then, it will take even longer than the fixed term for the total costs to even up. And I don't think I've ever held a mortgage for 5 years - there are a couple of reasonably likely scenarios where I don't keep the mortgage past 5 years anyway.

The short term benefit vs long term risk is mostly a personal judgment call - fixed may be sensible for you. But that was my general assessment for our situation.

nowadays it seems fixed term mortgage is an oxymoron, something like full-time employment.
stick with the current lowest rate possible and keep your eye on the situation.

I have Penfed's 5/5 and my first renewal will be next year. Their current Rate is 2.625% with a 2% being the maximum increase each period. So the maximum effective rate for the first 10 years would be just under 3.625%.  (If you average the 2 periods).  I'm hoping to get lucky and keep a low rate for another 5 year period.  Otherwise, I may decide to pay off my mortgage early.

The 15/15 at 3.25% I've found to be very interesting. Sort of straddles/averages the benefits when comparing a 15 year to a 30 year mortgage. 1. Better rate than 30 year mortgage. 2. 30 year amortization for cash flow benefit. 3. Can pay off within 15 years to avoid being sucked into a rate increase. - 15/15 rate is only .2% lower than the 30 year rate, so be confident you'll be able to pay off within 15 years if needed.

Note: I understand weighing the risks since I have a Variable Rate. But keep in mind to identify any "past bias' / "present bias' on these decisions.  I only chose this rate because I knew I could pay early if needed. (I also saw selling the house as likely, but decided to stay for time being.)  Sure folks have refinanced frequently over the past decade. But when rates hike over the next few years that will no longer be the case.  Perhaps an exception being a  situation where someone MUST move every few years. - Even putting a house up for sale will become a heavier decision if it entails losing a great rate and taking a bad rate. (That decision will be more neutral for someone with a variable rate.)

-  I never considered aggressively paying my mortgage would drop my payment when the recalculation comes.  I'll have to take that into consideration.   

centrifuge41 said:   
BTW have you looked at Penfed? They have some interesting mortgage products, and the rates are often competitive.

   Penfed is much expensive now compared to the last time I used them for my first house.

Thanks for all the replieMy main issue is will the rates will ever go down? and what is the likelihood of it? Fed released a "dot plan" where they show a chart that says they want to increase the rates by 2.5 points by 2020.While I agree nothing is guaranteed and there are number of factors that can change that, but the fact that Fed already vocal about and already has a plan to increase rates that much, is it really wise to go with 7 year arm. I definitely do not have a plan to payoff early unless I hit some lottery jackpot . What do you think of this "dot plan" by Fed and how it impacts us ?

Key thing is to look at what is going to be the "adjusted rate". I had a 5/1 and when the 5 years were going to be over, I was looking to refinance. And then my bank sent me the first adjusted rate and I fell out of my chair. The adjusted rate was lower than any refinancing rate. For the last several years, I have been letting the bank adjust it every year and and now I am used to it - I no longer fear the annual adjustment.

I hear you about the interest rate fear. After that last crash relating to the financial meltdown, I put some money in bonds. And I only did "some" because the fear was that rates will go up and my bonds will go down in value (and this was in consultation with a bond consultant). But the reverse happened - the rates kept going down - the $100 face value bond has a market value of $113. [Market value is not all that relevant to me since I plan to hold until maturity]. So when the rates are low, the fear is always there - but it doesn't always materialize.

Nobody can really predict the rates - but you will be starting out with a 0.75 advantage which over 3 years is 3.75% advantage. And then you rely on the "index" rate to stay reasonable enough that your 3.75 cushion handles that. No risk, no reward. Lots of issues in the world with oil prices, wage pressures in developed countries etc. that I believe that the rates will not change drastically.

[I did 7/1 followed by 5/1 and smiling all the way to bank for the money that I have saved over the years. The 5/1 was probably not necessary but just like most people, I had the fear of variability].
 

PrincipalMember said:   Nobody can really predict the rates - but you will be starting out with a 0.75 advantage which over 3 years is 3.75% advantage. And then you rely on the "index" rate to stay reasonable enough that your 3.75 cushion handles that. No risk, no reward. Lots of issues in the world with oil prices, wage pressures in developed countries etc. that I believe that the rates will not change drastically.

 

   I do not follow the math of 3.75%? how did you get to that number?

SummerDude said:   Thanks for all the replieMy main issue is will the rates will ever go down? and what is the likelihood of it? Fed released a "dot plan" where they show a chart that says they want to increase the rates by 2.5 points by 2020.While I agree nothing is guaranteed and there are number of factors that can change that, but the fact that Fed already vocal about and already has a plan to increase rates that much, is it really wise to go with 7 year arm. I definitely do not have a plan to payoff early unless I hit some lottery jackpot . What do you think of this "dot plan" by Fed and how it impacts us ?
  

For such a small difference, I would go with the 30 year.

Rates may go down.  I got 3.25% on a 15 year term about 3-4 years ago.  I never thought it would go lower.  Right now, I wouldn't bet either way.  Too hard to say.
 

SummerDude said:   
PrincipalMember said:   Nobody can really predict the rates - but you will be starting out with a 0.75 advantage which over 3 years is 3.75% advantage. And then you rely on the "index" rate to stay reasonable enough that your 3.75 cushion handles that. No risk, no reward. Lots of issues in the world with oil prices, wage pressures in developed countries etc. that I believe that the rates will not change drastically.

 

   I do not follow the math of 3.75%? how did you get to that number?


You are saving 0.75 per year for 5 years,  i.e. 5 * 0.75.

PrincipalMember said:   
SummerDude said:   
PrincipalMember said:   Nobody can really predict the rates - but you will be starting out with a 0.75 advantage which over 3 years is 3.75% advantage. And then you rely on the "index" rate to stay reasonable enough that your 3.75 cushion handles that. No risk, no reward. Lots of issues in the world with oil prices, wage pressures in developed countries etc. that I believe that the rates will not change drastically.

 

   I do not follow the math of 3.75%? how did you get to that number?


You are saving 0.75 per year for 5 years,  i.e. 5 * 0.75.


Actually, I am wrong. You are doing 7/1 - the math is 7 * 0.75 - it is 5.25% cushion.

I did some extensive math on this using spreadsheets to model worst case rate increases etc. As a general result, a 7/1-ARM will "break even" with a 30 year rate in about 9 years assuming 2% rate cap per year and 5% cap life-time. I have always gone for 7/1 ARM since the worst case model doesn't look terribly bad and 9 years is a long time. The other thing I have been doing is re-fi every time rates drop by more than a 1/4 point. In doing so, I make sure that I make payments as if my loan end date hasn't changed. That way, I am actually extending my low-interest window further and further into the 30 year window and not moving the original 30 year window out - thereby reducing risk even more.

Adding my 2 cents. I previously took out a 5/5 arm on a previous property (navy fed and pen fed) but as another poster alluded to the rates on those products from both credit unions haven't been as attractive lately.

I just closed in July on my new house and had a choice between a 30 yr fixed at 3.625% or 7/1 arm at 2.875%. I took the 7/1 arm. My savings was over $400/mo so it was a no brainer.

I took a 5/1 jumbo loan and I am right on track to pay the whole thing in 5 years. Don't care if rates go up or down. Rate is 2.25 by US bank.

PrincipalMember said:   Actually, I am wrong. You are doing 7/1 - the math is 7 * 0.75 - it is 5.25% cushion.
   Still confused. What does this cushion mean?  Does it mean - after 7 years, even if the rates go up by 5.25%, it is no worse than the scenario of picking up the 30 year from the day one ? Looks too optimistic - Im missing something fundamental.

Those who are paying off the whole loan in 5 years are really lucky. I'm in hot bay area market , Im talking about 1M in the loan amount.

SummerDude said:   
PrincipalMember said:   Actually, I am wrong. You are doing 7/1 - the math is 7 * 0.75 - it is 5.25% cushion.
   Still confused. What does this cushion mean?  Does it mean - after 7 years, even if the rates go up by 5.25%, it is no worse than the scenario of picking up the 30 year from the day one ? Looks too optimistic - Im missing something fundamental.

It just means that you have saved 5.25% over 7 years compared to 30year mortgage. Assuming 2% cap in rate increase, you are looking at starting to lose out in year 9.5.But that is in the worst case scenario. Is there a guarantee that 7/1 will be better than 30 years? Hell no. At the end of the day, you need to decide - do you want to have some risk or no risk? No risk means that you are guaranteed to not save the 5.25%. But if you take the risk, you might.

One of the guys above mentioned that he would pay off the mortgage in 5 years. That is also all about risk and I would NEVER-EVER do that. I have enough funds to pay off my mortgage balance 20X - but I refuse to do so. I love the loan at 3% rates and I invest those funds. And the math for some of this stuff is very interesting - the 3% mortgage rate gets deducted at tax bracket rate but if you can generate long term gains, then the gains get taxed at a lower rate. So even with mortgage at 3% and long term investment return of 3%, you win. Obviously, the goal is to do better than 3% but just illustrating the math.

thanks man I get it now.

One other thing I notice when we compare arm vs 30 yr is, your pushing off the loan by few years when you refinance. If I refinance say after 7 years, the loan will end after 37 years, not 30 years. Even though the rate may be low in the 8th year, you may actually be paying more interest overall.

So do you recommend to pay the difference ( gained by going with arm) , towards the principal ? This way, looks like you may actually end up closing the loan earlier than 30 years (if you are lucky and get the arm rate low at each reset time).

Update: Never mind. One of the above posts suggests you should pay towards principal so you can finish the loan fast.

SummerDude said:   So do you recommend to pay the difference ( gained by going with arm) , towards the principal ? This way, looks like you may actually end up closing the loan earlier than 30 years (if you are lucky and get the arm rate low at each reset time).

Update: Never mind. One of the above posts suggests you should pay towards principal so you can finish the loan fast.


As I said earlier, you do not want to pay your principal early. And you mentioned something about life of loan gets extended to 37 years with refinance. That is great. Sure you pay more interest but you gain even more in investments. It is big F problem that all conventional literature only talks about "saving the interest when paying early" but does not talk about "earning returns on the money that was not used to pay the principal".

 

SummerDude said:   Thanks for all the replieMy main issue is will the rates will ever go down? and what is the likelihood of it? Fed released a "dot plan" where they show a chart that says they want to increase the rates by 2.5 points by 2020.While I agree nothing is guaranteed and there are number of factors that can change that, but the fact that Fed already vocal about and already has a plan to increase rates that much, is it really wise to go with 7 year arm. I definitely do not have a plan to payoff early unless I hit some lottery jackpot . What do you think of this "dot plan" by Fed and how it impacts us ?
The Fed talks a lot.  They has been talking about raising rates for years now and we've actually seen what, one 0.25% bump?  Nothing is guaranteed, but I wouldn't be afraid to bet on the rates staying fairly low for the indefinite future ala Japan.  

If you think you might get squeezed by rising rates on your ARM, just remember the government owes $20T with 4/1 style debt schedule and they aren't even cashflow positive.  The Fed can't afford to raise rates much as long as the government is massively overspending and I don't see any political will to reign that in.  Short term pain is easier to kick down the road until eventually you end up with a Greek style debt crisis.

I think it is a bad risk to take when the return is so small.

Consider this.. suppose you take 7 yr ARM at 3% with a lifetime cap of 8% against a 30 year fixed at 3.75%

As 7th year approaches, imagine some scenario in which rates rise rapidly (dollar loses reserve currency status) and you become unemployable (accident, sickness) thus losing your ability to refi..

Now evaluate the difference in paying 4.25% extra every year for the remaining 23 years vs saving 5.25% over the first 7 years

needdealsnow said:   I think it is a bad risk to take when the return is so small.

Consider this.. suppose you take 7 yr ARM at 3% with a lifetime cap of 8% against a 30 year fixed at 3.75%

As 7th year approaches, imagine some scenario in which rates rise rapidly (dollar loses reserve currency status) and you become unemployable (accident, sickness) thus losing your ability to refi..

Now evaluate the difference in paying 4.25% extra every year for the remaining 23 years vs saving 5.25% over the first 7 years

  
You have a whole 7 years in which you can think about refinancing, buying a new home, relocating for job reasons etc.

And not sure what you mean by small difference: 5.25% over years on a $800K mortgage is $40K!

PrincipalMember said:   
needdealsnow said:   I think it is a bad risk to take when the return is so small.

Consider this.. suppose you take 7 yr ARM at 3% with a lifetime cap of 8% against a 30 year fixed at 3.75%

As 7th year approaches, imagine some scenario in which rates rise rapidly (dollar loses reserve currency status) and you become unemployable (accident, sickness) thus losing your ability to refi..

Now evaluate the difference in paying 4.25% extra every year for the remaining 23 years vs saving 5.25% over the first 7 years

  
You have a whole 7 years in which you can think about refinancing, buying a new home, relocating for job reasons etc.

And not sure what you mean by small difference: 5.25% over years on a $800K mortgage is $40K!

  
save 42K over 7 years or possibly pay 34K extra every year for 23 years

needdealsnow said:    
save 42K over 7 years or possibly pay 34K extra every year for 23 years
 

  
Sell the house, take your $42K in savings and go rent?  If your argument against it requires a collapse of the economy and a major personal accident ....how realistic is that really?

ARMS got a bad name during the bubble, but I really think they are good for people that house jump or change jobs every ten years or less.  The penfed 5/5 ARM was 2.75% when the 30 year rate was 4.75%.  Absolute worst case scenario the breakeven was like year 13 and if the rates don't spike you end up tens of thousands ahead.

 

I agree 6 K per year saving is no joke and in a normal scenario with mildly rising rates, refi can be done. I just don't want to watch this all the time. SO I have set mine to 3.25% for 30 years and forgotten about it

My choice was the ARM - I'm not going to stay in this house for 30 years.



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