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Need a mortgage - fixed or ARM?
Old 03-23-2013, 10:15 PM   #1
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Need a mortgage - fixed or ARM?

Renting currently, need a mortgage for a house. Price is low $400s, we'll put 20% down so financing ~$325k. Rates quoted today:

30y fixed: 3.5%
15y fixed: 2.75
7y ARM: 2.125
5y ARM: 1.875

We have enough cash in the bank to pay cash for the whole thing if we wanted to, but would leave us a little light on liquid assets so want to finance. Base case, we would pay off the house within the next 5 years. However, job loss or other events could derail that.

I have surprised myself by favoring the ARMs. I figure every dollar not spent on interest is an extra dollar that can be applied to principal in the next 5 years. Initially the interest expense savings between 3.5% and 1.875% is ~$400/month.

DW does not like the ARM. Says the rate change stresses her out even though our financials are in great shape for our age (early 30s). Only other debt is $40k of student loans at 2%.
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Old 03-23-2013, 10:24 PM   #2
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Depends on your plansand rsik tolerance. If you really expect to pay off the house in 5 years, then perhaps something like Pen Fed's 5/5 ARM would be areasonable middle ground. The big risk with ARMs is that rates spike and you get nailed on the reset. The 5/5 product doesn't adjust more than 2 points at once, which is a lot less risky than a 5/1, which can adjust up to 5 points a year.
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Old 03-23-2013, 10:32 PM   #3
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Arb that 30 year fixed mortgage. You can probably beat the 3.5% by a few basis points. I still can't figure out why banks would be foolish enough to offer these rates long term. I guess only because they can sell them to Fannie and Freddie. JMO, of course.
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Old 03-23-2013, 10:49 PM   #4
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Take the 15 year fixed.
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Old 03-24-2013, 01:18 PM   #5
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If you just have to pay it off super early go with the ARM that fits your payoff timing.

If you can live with investing the excess cash go with the 30 year.
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Old 03-24-2013, 01:27 PM   #6
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DW does not like the ARM. Says the rate change stresses her out even though our financials are in great shape for our age (early 30s). Only other debt is $40k of student loans at 2%.
I would take the 30 year mortgage at 3.5% (in fact that is what we actually did). You can always pay it off early if you want to, but I preferred the flexibility of the 30 year since you don't know what the future may bring.
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Old 03-24-2013, 04:01 PM   #7
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I would stay away from ARMs as interest rates will surely go up so they are wildcards. However, I would choose the 15 year amortization due to its low rate and the fact that I would simply not be comfortable with a 30 year debt. In fact, you can't even get a 30 year mortgage in Canada now; the maximum is 25. Here's one perspective on amortization periods:

Why homebuyers should go short on amortizations | Mortgages & Real Estate | Personal Finance | Financial Post

The fly in the ointment is that mortgage terms in Canada are not the entire amortization period. The term is commonly 5 years or less. There are no guarantees as to what the interest rate might be at the time of renewal. So it makes sense to put spare cash towards the principal during the term and pay it off ASAP.

People in the US have a great advantage currently in the ability to lock in very low interest rates for the entire term of the mortgage. During periods of high interest rates it would obviously be wiser to go with the variable rates.
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Old 03-24-2013, 08:13 PM   #8
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I would stay away from ARMs as interest rates will surely go up so they are wildcards. However, I would choose the 15 year amortization due to its low rate and the fact that I would simply not be comfortable with a 30 year debt. In fact, you can't even get a 30 year mortgage in Canada now; the maximum is 25. Here's one perspective on amortization periods:

Why homebuyers should go short on amortizations | Mortgages & Real Estate | Personal Finance | Financial Post

The fly in the ointment is that mortgage terms in Canada are not the entire amortization period. The term is commonly 5 years or less. There are no guarantees as to what the interest rate might be at the time of renewal. So it makes sense to put spare cash towards the principal during the term and pay it off ASAP.

People in the US have a great advantage currently in the ability to lock in very low interest rates for the entire term of the mortgage. During periods of high interest rates it would obviously be wiser to go with the variable rates.
That's certainly a different way of doing it. So there's no such thing as a long term fixed rate mortgage in Canada? A 25 year mortgage gets renewed at a different rate every five years? If that's truly the case then getting the lowest rate no matter what the term makes sense.

One thing I noticed in the article that I see all the time in US conversations about mortgage terms is the "if you get a shorter term you'll pay less in interest" argument. What they never take into consideration is the effect of inflation on that interest debt. At these low rates it won't be long before the interest becomes meaningless compared to the return on however you choose to invest the mortgage money. As far as 30 years of debt instead of 25 or 15 or whatever, odds are you'll move before the term is up, so who cares?
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Old 03-24-2013, 09:01 PM   #9
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That's certainly a different way of doing it. So there's no such thing as a long term fixed rate mortgage in Canada? A 25 year mortgage gets renewed at a different rate every five years? If that's truly the case then getting the lowest rate no matter what the term makes sense.

One thing I noticed in the article that I see all the time in US conversations about mortgage terms is the "if you get a shorter term you'll pay less in interest" argument. What they never take into consideration is the effect of inflation on that interest debt. At these low rates it won't be long before the interest becomes meaningless compared to the return on however you choose to invest the mortgage money. As far as 30 years of debt instead of 25 or 15 or whatever, odds are you'll move before the term is up, so who cares?
That's not an overly different way to do it - that's the way most businesses finance their commercial real estate. Fannie/Freddie are the only reason 30 year fixed rates are offered, the noble cause of "affordable housing"
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Old 03-24-2013, 09:05 PM   #10
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You are cashed up, so I would take the lowest interest rate option.

That way you pay off the loan quicker saving more in interest. If rates move against you, you can always rebalance eg chose to pay off more of the loan, or do part fixed part variable
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Old 03-25-2013, 12:23 AM   #11
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You have the cash and expect to pay off in 5 years anyway. Do a 5/1 or 7/1 and save money.

Only exception is if you want to delay payoff for arbitrage and do a 30 year FRM and not pay extra and actually take the 30/15 years.
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Old 03-25-2013, 06:10 AM   #12
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Take the 15 year fixed.
+1
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Old 03-25-2013, 10:56 AM   #13
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I think the question is how 'light' you will be if you had to pay off the mortgage after 5 years

Also, where is this money being kept

Say that you have the money in a bond fund.... if interest rates go up, you will have to pay higher amounts on your mortgage for sure... but, your stash of money you have set aside to pay off the mortgage has declined in value... IOW, it might cost you MORE money in total to pay off the mortgage than you think....

Now, if the money is in CDs all that time... well, I would say you might not be investing your funds wisely... cannot know for sure as we do not have enough info....

Me, I went with 15 year fixed (at a higher rate to keep closing cost down) as I do think rates will go up... I also plan on not paying it off early for any reason...
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Old 03-25-2013, 01:47 PM   #14
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5y ARM: 1.875
Where did you find that rate? I just closed a Pen Fed 5/5 Arm at 2.625%, but I'd have to think about that one if the closing costs were low.

My last three loans have been ARMs. I did this without the cash on hand that you have, but rather based on my restricted stock vest schedule which would put me in a similar spot as cash on hand. Next year is the big one for me, which would make me mortgage optional.
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Old 03-27-2013, 01:52 PM   #15
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Where did you find that rate?
Wells Fargo just locked me a 5 year ARM at 1.875%. I think this includes one point (my employer will pay it as part of relocation).
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Old 03-27-2013, 02:50 PM   #16
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Congratulations! This is an excellent deal. I suggest that you put all the savings against the principal.
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Old 03-27-2013, 03:38 PM   #17
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Originally Posted by soupcxan View Post
Renting currently, need a mortgage for a house. Price is low $400s, we'll put 20% down so financing ~$325k. Rates quoted today:

30y fixed: 3.5%
15y fixed: 2.75
7y ARM: 2.125
5y ARM: 1.875

We have enough cash in the bank to pay cash for the whole thing if we wanted to, but would leave us a little light on liquid assets so want to finance. Base case, we would pay off the house within the next 5 years. However, job loss or other events could derail that.

I have surprised myself by favoring the ARMs. I figure every dollar not spent on interest is an extra dollar that can be applied to principal in the next 5 years. Initially the interest expense savings between 3.5% and 1.875% is ~$400/month.

DW does not like the ARM. Says the rate change stresses her out even though our financials are in great shape for our age (early 30s). Only other debt is $40k of student loans at 2%.
If you do an Amortization on the 5 yr ARM and the fixed in 5 yrs you will see
much lower balance with the ARM and a lot less mandatory payment.
I would get the ARM and make an extra payment each month and then
do the worst case on 5 yrs from now with the much lower balance because of the lower rate and extra payments. Will make the ARM look great.
On our last loan we got the lowest rate and just made large extra payments
each month, knowing if something happened we could skip the extra payments.
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Old 04-01-2013, 03:00 PM   #18
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Take the 15 year fixed.
+1

We've owned 2 houses and both had fixed rate, 15 year mortgages. They pay off fast (i.e. 15 years goes by like that!) and you always know exactly what to budget.

In the early 80's I ran mortgage closing departments for bank lawyers. We were closing loans at ~15% IIRC. The people who had 4% loans at that time, we sittin' pretty!
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