Mortgage & closing costs: Decision Help

[FIREINDUS]

Hi All,

Have asked the paid experts that we interact with, the broker, agent, cpa, etc., but they seem to have hidden interest in what they recommend to us. Many of you have many properties, could you provide your thoughts on this, given that there is no one right or wrong answer to this.

Downpayment: 10 to 20% (have money for 20% down but it depends on other opportunities)

Loan Option 1: 7/1 ARM (7/2/8), 3.5% when closing cost is paid, 4% on no closing cost.

(or)

Loan Option 2: 30 year fixed, 4.25% (when one point is purchased, it is 4%); closing cost to be paid.

Age: 40 yrs, Primary home, intend to use minimum of 7 years and then continue there or rent and move on. No intention to sell but who knows. No relocation plans at this time.

Will be able to afford interest increases, but will feel bad about the extra cost, if that scenario arises.

Appreciate your help!

 

[Surewhitey]

I personally do not ever want to have to figure this kind of thing out. I just feel like I'm always taken for a ride or taken from. If I cannot understand it, I don't do it. My last loan was a loan with closing costs spelled out and paid separately (or broken & spelled out). The loan amount was fixed with a single rate & no points purchased additionally.

4% sounds pretty good, but not if you have to pay a point up front. I'd go with the 4.25% and lock it in for peace of mind.

 

[REWahoo]

I'd go with the 4.25% and lock it in for peace of mind.

+1

If you go with the ARM you're at risk of having to give the mortgage holder a LEG at some point in the future.

 

[FIREINDUS]

Thanks to posters #2 and #3. Our initial application holds the 30 year fixed (not completely locked in yet), but our tax agent (and another friend who recently purchased a home) put forth the 7/1 ARM noting lower interest rate; and given our LBYM principle we will payoff the extra amount regularly (in 20k increments) towards principal. This will result in lower loan amount if and when the interest resets.

The agent also seems to know someone who would refinance (after say 8 months or later), hence wondering if the no closing costs loan is in fact the right recommended option for us or is there a catch.

Thanks.

 

[tulak]

You should also take into consideration how long you plan to be in the house and if you plan to pay off your mortgage earlier.

A couple a years ago I refinanced into PenFed's 5/5 ARM. I did this mostly to avoid any closing costs and I'm ok with 5 years fixed interest, since I would like to pay off my mortgage within the next 10 years. If I was planning on never paying off the loan or moving, then I would have went with a 30 year fixed.

Out of the choices you presented, I'd probably go with the 30 year fixed. The 7/1 ARM is not that impressive, especially at that rate. I would also run a mortgage calculator to see which loan is cheaper.

On another note, have looked for better loans elsewhere? It seems like these loans aren't that impressive, but I haven't looked for a while so maybe they aren't that bad.

 

[MichaelB]

One nice thing about a 30 year fixed rate mortgage is it serves as an effective portfolio hedge against inflation. The value of the hedge may be greater than the potential savings from the ARM alternative.

 

[CUinFl]

I also agree with the 30 year as it is clear and a hedge.

As for paying down the loan earlier with accelerated payments with other loan types, I would think through that from an opportunity cost on other investments as well as the fact that you may decide to rent the place out in 7+ years.

Having mortgage interest as you realize rental income could be a good thing.

 

[FIREINDUS]

Thank you posters #5, 6, 7.

How long will we stay there? It depends; per current plan, about 7 years or more.

(The idea of not paying back the loan, and using that to write-off on rental income is a noteworthy point).

Did not shop around for a loan for fear of multiple credit inquiries; now that we know we can have many inquiries within a period of two weeks, will do that during refinance. So, would it be good to take the 7 year ARM now with no closing costs and refinance within that period after shopping around?

If not for the recommendation we received from the tax agent and the friend, we would have for sure opted the 30 year fixed, now with the thinking hat on, a little confused.

And since you cannot take any tax credit for closing costs, it is just fees, and if we find a better rate to refinance, there will be additional costs there.

Thanks.

 

[Senator]

I would probably go with the fixed rate, but here are some options to consider.

The ARM looks like fixed at 3.5% for seven years, and then it can adjust up to 2% annually, for a maximum of 8%. Please confirm.

Assume you are paying closing costs, no matter what. You do indeed pay them; it just depends on when and how. So you can compare a 3.5% to a 4.25% loan. Over 7 years, on a $200K loan, you save roughly .75% x $200K x 7 or about $10,500 with the ARM. You save even more if you make a larger payment.

If you make the same payment on the ARM as the 30-year fixed, your principal will go down much more rapid with the ARM. Why not, that’s your only choice in a 30-year fixed, do it on the ARM.

I think interest rates are headed up, not down. That is the $64K question in this equation. If they go up after 7 years, and only go up to 5% for the next 7 years after that (14 years into the loan), the ARM is the way to go. If my reading it is correct, the most it could go to is 5.5% after 7 years, but that only lasts a year.

I didn’t do any sophisticated analysis on interest cost cross over points, but that is a quick analysis.

 

[FIREINDUS]

I would probably go with the fixed rate, but here are some options to consider.

The ARM looks like fixed at 3.5% for seven years, and then it can adjust up to 2% annually, for a maximum of 8%. Please confirm.

You are correct Senator on the assumption above. And yes, the point you have noted is what supports the 7/1 ARM recommendation.

And the loan amount is 500k+ so it is 4.125% for fixed vs 3.5% on 7/1 ARM with closing costs incurred or 4% with no closing costs.

Thank you!

 

[daylatedollarshort]

I only have one house, but what I have done for many years now is always get a 30 year fixed at the best rate I could negotiate with no points or closing costs. Then every time rates drop, refinance with the same kind of loan.

The Finance Buff has a post on this methodology here:

http://thefinancebuff.com/cost-mortgage-refinance-stepping-down.html

 

[eta2020]

I would take 7/1 ARM and pay off loan in 7 years. You are 40 now and I don't think you want to be making mortgage payments at 65...

Now that is unless you want to treat this as a rental and buy more rentals. It takes special skills/stomach to manage rentals and if you don't already own some rentals assume you never will.

 

[pb4uski]

Have you considered a 15 year fixed? In our parts, a 30 year fixed is the same as your 4.25% but a 15 year fixed is 3.375%. If you can afford the payments (about 144% of 30 year fixed payments), that might be a good alternative.

Otherwise, go with the fixed rate IMO.

 

[meierlde]

IN addition as long as you have no prepayment penalty, you could make extra principal payments monthy and shorten the term of the mortgage (and thus the total interest paid). In the early years of a 30 year mortgage adding addition principal payments does significantly shorten the term.

 

[FIREINDUS]

Thank you posters #11, 12, 13, 14!

Paying off in 7 years is not a feasible option though.
15 years may work, but prefer to set it to a longer term and pay earlier.
There is no prepayment penalty on the loan.

Every one hour or so, toggling between 7/1 ARM vs 30 year fixed, still have a few days to make the decision.

 

[FIREINDUS]

Based on analysis, and points noted by "Senator" above, going ahead with 7/1 ARM and having the lender cover the closing costs.

If you see anything major glaring, holler!

Thanks!