15 vs 30 yr fixed, or 5/1 ARM

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golden7
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Joined: Sun Jul 06, 2014 8:55 pm

15 vs 30 yr fixed, or 5/1 ARM

Post by golden7 »

Age: Both early 30's
Kids: In the near future, 2
Income: $190k (10-20k bonus typical)
Debt: Student Loan $11k at 2.9%
Savings: $130k
Checking: $15k
Retirement Portfolio: $310k
Purchase Price: $390k
Mortgage Amount: $312k (20% down)

We recently reached an agreement on a house at $390k. Here are the rates I was quoted from the bank: 15 yr fixed: 3.25%, 30 yr fixed: 4.125%, and 5/1 ARM: 2.875%. I am leaning towards getting the 30 yr fixed while making the payments of a 15 yr fixed. The banker recommended the 5/1 ARM in our case, but I hadn't been considering this option and don't know a lot about it. Which option would you take in our case? We tend to be savers by nature, and will invest the difference in cash for retirement between the different options. Thank you!
NYBoglehead
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by NYBoglehead »

If could afford the monthly payment I like the 15 year. Looks like you've got significant cash savings and my math tells me a good chunk of that will remain even after making the down payment on the house. But that's just me, I try to extinguish debt in any form as soon as possible, I think the 30-year mortgage is still a pretty good deal, and you mentioned making larger payments to get an accelerated payoff. So if you can afford the monthly payment, why go for the higher interest rate?
music_man
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by music_man »

Personally, I like the 15 year if you can swing the additional monthly payment without much stress (looks to be about $2192 for the 30 vs $1512 for the 15, not factoring in taxes and insurance). I think it comes down to personal preference though, do you want to stretch it out over 30 years with a lower payment or pay it off sooner but with a higher payment (and less interest). 5/1 ARM, I would only suggest if you're pretty sure you plan on selling the house within 5 years. Can't predict interest rates, but if I were going to bet on where they'd be in 5 years, I'd guess up from where they are today, which would cause your 5/1 ARM to go up as well.
John3754
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by John3754 »

Why would you take the 30 year and pay a higher rate when you're going to make the payememt as if it's a 15 year?
music_man
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by music_man »

John3754 wrote:Why would you take the 30 year and pay a higher rate when you're going to make the payememt as if it's a 15 year?
I've heard of others (not me) doing this for the added flexibility of being able to switch back down to the smaller payment amount should some unexpected life circumstance come up. You can plan to pay it off in 15 years, but a lot can happen in that time, job loss, health issue, etc.
BogleBoogie
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by BogleBoogie »

music_man wrote:
John3754 wrote:Why would you take the 30 year and pay a higher rate when you're going to make the payememt as if it's a 15 year?
I've heard of others (not me) doing this for the added flexibility of being able to switch back down to the smaller payment amount should some unexpected life circumstance come up. You can plan to pay it off in 15 years, but a lot can happen in that time, job loss, health issue, etc.
By doing that, do you not pay for that "flexibility" by incurring a higher interest rate?
LongerPrimer
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by LongerPrimer »

DS opted for 7/1/2/5 @2-5/8, Seattle. First home. Not married/no GF-BF. Possible move if he ever got married. Location is good so it could become a rental where upon the renter will pay any increases in ownership. Purpose is to maintain his purchasing ability. He can now invest the difference in a college education fund or fully fund the 401k, so he says.
LeeMKE
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by LeeMKE »

Take the ARM, prepay with 15 yr amortization schedule and you'll get the best of both worlds. By the time you are at 5 years, the principal will be reduced to a level that the required payment will never rise above what you are already paying because the principal is reduced so drastically. However, after year 5, if something happens and you want to reduce the payment, you have that flexibility, and the required monthly payment will be quite a bit lower than the 30 year fixed.

Interest expense per $1000
30 year @ 4% $719
15 year @ 3% $243
The mightiest Oak is just a nut who stayed the course.
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TheTimeLord
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by TheTimeLord »

I started with a 30 year but made the 15 year payment that way if I hit a rough spot I could fall back to the 30 year payment. A couple years in I refinanced to a 15 year but made 12 year payment. Now I just pay property tax.
IMHO, Investing should be about living the life you want, not avoiding the life you fear. | Run, You Clever Boy! [9085]
music_man
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by music_man »

BogleBoogie wrote:
music_man wrote:
John3754 wrote:Why would you take the 30 year and pay a higher rate when you're going to make the payememt as if it's a 15 year?
I've heard of others (not me) doing this for the added flexibility of being able to switch back down to the smaller payment amount should some unexpected life circumstance come up. You can plan to pay it off in 15 years, but a lot can happen in that time, job loss, health issue, etc.
By doing that, do you not pay for that "flexibility" by incurring a higher interest rate?
Correct, that is the premium you pay for that flexibility. Kind of like insurance in a sense, up to you if you want to pay for it.
music_man
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by music_man »

StarbuxInvestor wrote:I started with a 30 year but made the 15 year payment that way if I hit a rough spot I could fall back to the 30 year payment. A couple years in I refinanced to a 15 year but made 12 year payment. Now I just pay property tax.
I think that's reasonable strategy. I did same exact set up - - started in 30 years, refinanced down to 15 years after a few years but made payments at a 12 year pace, though I still have about 10 years to go on mine.
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TheTimeLord
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by TheTimeLord »

John3754 wrote:Why would you take the 30 year and pay a higher rate when you're going to make the payememt as if it's a 15 year?
Same logic as an emergency fund. Why take lower returns. In some ways yuou could probably rationalize the ability to drop your payment by 1/3 is part of your emergency fund or at least your emergency plan.
IMHO, Investing should be about living the life you want, not avoiding the life you fear. | Run, You Clever Boy! [9085]
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TheTimeLord
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by TheTimeLord »

music_man wrote:
StarbuxInvestor wrote:I started with a 30 year but made the 15 year payment that way if I hit a rough spot I could fall back to the 30 year payment. A couple years in I refinanced to a 15 year but made 12 year payment. Now I just pay property tax.
I think that's reasonable strategy. I did same exact set up - - started in 30 years, refinanced down to 15 years after a few years but made payments at a 12 year pace, though I still have about 10 years to go on mine.
Ended up paying the whole thing off in approximately 10 1/2 years. Also originally I had an 80/10/10 to avoid PMI and concentrated on paying off the higher interest 2nd mortgage first.
IMHO, Investing should be about living the life you want, not avoiding the life you fear. | Run, You Clever Boy! [9085]
Topic Author
golden7
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by golden7 »

music_man wrote:John3754 wrote:
Why would you take the 30 year and pay a higher rate when you're going to make the payememt as if it's a 15 year?


I've heard of others (not me) doing this for the added flexibility of being able to switch back down to the smaller payment amount should some unexpected life circumstance come up. You can plan to pay it off in 15 years, but a lot can happen in that time, job loss, health issue, etc.
This was my thinking. I work in a strong industry, but for a small company, so I feel I have a slightly higher than average chance of layoff. I believe that I would not have a problem finding another job locally, it just may take a couple of months. Under that scenario, the flexibility of going down to the 30 year payment may be nice to have? But now that I think about it, perhaps we should just carry another $10k in the emergency fund to cover this scenario and get the 15 yr fixed? Wife's job is very stable at 90k / yr.

One other idea I struggle with in terms of taking the 15 yr, is the thought that if we took the 30 yr and paid at the 30 yr rate, while investing the difference in our portfolio, that the portfolio investment would likely outgrow the mortgage savings. Particularly with our time horizon of 25-30 yrs. Perhaps I am not as debt averse as most here, but this sounds viable to me with a 30 yr rate of 4.125%?
LeeMKE wrote:Take the ARM, prepay with 15 yr amortization schedule and you'll get the best of both worlds. By the time you are at 5 years, the principal will be reduced to a level that the required payment will never rise above what you are already paying because the principal is reduced so drastically. However, after year 5, if something happens and you want to reduce the payment, you have that flexibility, and the required monthly payment will be quite a bit lower than the 30 year fixed.

Interest expense per $1000
30 year @ 4% $719
15 year @ 3% $243
Here are some additional details I received about the 5/1 ARM:

Your interest rate can change yearly after 5 years.
Your interest rate can not increase or decrease more than 2 percentage points at the first interest rate change date.
After that your interest rate cannot increase or decrease more than 2 percentage points per year.
Your interest rate cannot increase more than 5 percentage points over the term of the loan.

The 5/1 ARM at 2.875% would require paying 0.125 points. They said there were other options where the bank would cover closing costs, but I didn't ask about that. Are the above rate caps standard? Do they change anything in terms of making the 5/1 ARM a better or worse option vs. fixed? Thank you.
chead
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Joined: Fri Jul 26, 2013 2:08 pm

Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by chead »

One thing you haven't mentioned is how long you intend to stay in the house. If you get a 30 year mortgage and move out in 15 years, you're paying for duration that you won't use. This might not be a factor in your case, but something to consider for first time home owners.

I personally think you should go with the 15yr. The added flexibility you get with the 30 year mortgage is pretty expensive. Your monthly payments would be $2192 for the 15 year and $1,512 if you pay down on the 30 year schedule. I would tighten your belt a little this year and add ~10K to your emergency fund if you're worried about being able to make the payments in a downturn.
music_man
Posts: 150
Joined: Mon Apr 28, 2014 12:22 pm

Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by music_man »

golden7 wrote:
music_man wrote:John3754 wrote:
Why would you take the 30 year and pay a higher rate when you're going to make the payememt as if it's a 15 year?


I've heard of others (not me) doing this for the added flexibility of being able to switch back down to the smaller payment amount should some unexpected life circumstance come up. You can plan to pay it off in 15 years, but a lot can happen in that time, job loss, health issue, etc.
This was my thinking. I work in a strong industry, but for a small company, so I feel I have a slightly higher than average chance of layoff. I believe that I would not have a problem finding another job locally, it just may take a couple of months. Under that scenario, the flexibility of going down to the 30 year payment may be nice to have? But now that I think about it, perhaps we should just carry another $10k in the emergency fund to cover this scenario and get the 15 yr fixed? Wife's job is very stable at 90k / yr.

One other idea I struggle with in terms of taking the 15 yr, is the thought that if we took the 30 yr and paid at the 30 yr rate, while investing the difference in our portfolio, that the portfolio investment would likely outgrow the mortgage savings. Particularly with our time horizon of 25-30 yrs. Perhaps I am not as debt averse as most here, but this sounds viable to me with a 30 yr rate of 4.125%?
LeeMKE wrote:Take the ARM, prepay with 15 yr amortization schedule and you'll get the best of both worlds. By the time you are at 5 years, the principal will be reduced to a level that the required payment will never rise above what you are already paying because the principal is reduced so drastically. However, after year 5, if something happens and you want to reduce the payment, you have that flexibility, and the required monthly payment will be quite a bit lower than the 30 year fixed.

Interest expense per $1000
30 year @ 4% $719
15 year @ 3% $243
Here are some additional details I received about the 5/1 ARM:

Your interest rate can change yearly after 5 years.
Your interest rate can not increase or decrease more than 2 percentage points at the first interest rate change date.
After that your interest rate cannot increase or decrease more than 2 percentage points per year.
Your interest rate cannot increase more than 5 percentage points over the term of the loan.

The 5/1 ARM at 2.875% would require paying 0.125 points. They said there were other options where the bank would cover closing costs, but I didn't ask about that. Are the above rate caps standard?
Yes, rate caps are pretty standard with ARMs. The reset of ARM rates was one of the contributing factors to the mortgage meltdown as the Fed increased rates from 2003 all the way to 2006 after just about every meeting - - http://www.newyorkfed.org/markets/stati ... drate.html, causing homeowners in ARMs to not be able to afford their payments.
LeeMKE wrote: Do they change anything in terms of making the 5/1 ARM a better or worse option vs. fixed? Thank you.
I wouldn't suggest this route unless you plan on moving from the house within the 5 year period. What you get with the ARM is an initial lower rate compared to the fixed rates, but the trade off is the rate adjusting annually after that 5 year period. Who knows where rates will be in 5 years though, maybe up, maybe down, my guess is likely up given the low rate environment we're in. Though, with the 2 percentage point rate cap at the first initial change date, your worse case at the 5 year point would be 4.875%, but could continue up annually after as well depending on the direction of interest rates. If you go with the ARM, As an exercise, it's good idea to calculate the payment you might have if rates went up 1%, 2%, etc, all the way to the max cap and evaluate if you want to take that risk.
LikeWise
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Re: 15 vs 30 yr fixed, or 5/1 ARM

Post by LikeWise »

Here is a tool to look at the cost differences b/w the options you're considering:
http://www.bankrate.com/calculators/mor ... lator.aspx
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