Shopping for Mortgage - Question re ARMs

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dcw213
Posts: 135
Joined: Sun Dec 16, 2012 3:04 pm

Shopping for Mortgage - Question re ARMs

Post by dcw213 » Fri Jun 28, 2019 8:25 am

I am about to purchase my first home and I am shopping for a mortgage. I had always planned to go with a 30 or 15 year fixed. However, I received some very compelling ARM offers in the process. I wanted to see if I could get some opinions about what might be best for me. Some key information:

1) I plan on getting a conventional conforming loan with at least 20% down. Loan balance likely to be 400-480K depending on purchase price. Likely price will be 600K.

2) Important to note, I have liquid assets in taxable above expected purchase price. With a toddler and a baby on the way and enormous childcare and therapy costs (special needs) I am not willing to give up the liquidity so am using a mortgage.

I am seeing 30 year fixed rates at 3.5% and 15 year fixed rates at 2.85%, approximately. I was leaning towards the 30, willing to pay the incremental 60 bps in interest to lower payment obligation and maintain more liquidity during a period of elevated expenses, but then got the ARM offers.

I got a verbal offer for a 5/1 ARM at 2.5% and a 3/1 ARM at 2.0%! The 3/1 is very tempting given the 150 bps difference vs the 30 yr with the same payment schedule. This amounts to about $20K in interest saved over the initial 3 year period. I have significant balances of CDs yielding 3.5%-4.0% so it us tempting to lock in a significant positive spread on the loan. My thought is that if the rate reset goes against me after 3 years, when my CDs mature it is likely that I can renew at a rate near the reset mortgage rate to offset the higher payment. Alternatively, I could throw a significant amount at the principal at the reset point.

However, 3 years is very short time. I'm sure it will fly by and I will barely have made a dent in the principal and I may be questioning if it was even worth it if I were forced to pay off principal or, worse, find a new loan and deal with closing costs again (have not received quotes on closing costs yet and I must admit the variation across lenders confuses me).

I'm curious what folks would do in this situation. Im happy to provide more detail. Thank you as always.

bloom2708
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Re: Shopping for Mortgage - Question re ARMs

Post by bloom2708 » Fri Jun 28, 2019 8:30 am

We did a 5/1 ARM near the end of our mortgage life. It worked well.

What is the rate for a 7/1 or 10/1? Most people stay in their first home 5-7 years.

You might keep the mortgage less than that if rates keep dipping. You might refinance 2 times during a 5-7 year period.

If you can afford the 15 year amort, that saves you the most interest. Well, 10 year would be better.

All the ARMs are amortized at 30 years, so pick the one that matches your rate timeframe. With rate pressure, I might pick the 3/1 ARM today.
"We are not here to agree with you; we are here to provoke thoughtfulness." Unknown Boglehead

chevca
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Re: Shopping for Mortgage - Question re ARMs

Post by chevca » Fri Jun 28, 2019 8:48 am

If you have taxable accounts equal to or above the purchase price, I'm not sure you have a liquidity issue to worry about. I assume you have a good monthly income and can afford the payment for any of the mortgages brought up. I think you can scratch liquidity worries off your list.

I think ARMs can be good if one plans to pay off, or is ready to pay off the mortgage at any of the reset years. That could be an option for you in the future with the CDs you have. So, and ARM could make sense for your situation.

Personally, I prefer a fixed rate mortgage just for the security part of it. If you can afford the 15 year payment easily, that's the way to go there, IMO.

If paying the least amount of interest is your main concern, put more money down or pay the mortgage down aggressively. The best way to avoid paying interest is to never or no longer pay interest on that amount. :happy

Where did you get CDs at 3-4% in recent years?? Nice deal!

Topic Author
dcw213
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Re: Shopping for Mortgage - Question re ARMs

Post by dcw213 » Fri Jun 28, 2019 9:36 am

Thanks for the replies. Most of the savings were accumulated prior to kids and reduced spouse hours and salary and high child related expenses have us not able to save much taxable anymore (still save some just at a lower rate than very aggressive pre kids). We still max out two 401ks, two backdoor roth, HSA, and contribute to 529.

Taking on the 15 year will be affordable but will leave little left over after maxing tax advantaged. I worry that given my frugal mentality I will tighten up on discretionary spending (fun activities for kids) despite having high savings. Might be a psychological hangup but the thought of the whole post tax advantaged paycheck being allocated somewhere stresses me out. I do recognize that a large chunk would be going to principal payoff and equity but that doesnt register with me as an investment. I recognize that much of this is psychological.

Topic Author
dcw213
Posts: 135
Joined: Sun Dec 16, 2012 3:04 pm

Re: Shopping for Mortgage - Question re ARMs

Post by dcw213 » Fri Jun 28, 2019 9:37 am

I got the CDs last year and early this year.

PenFed (3.5%, 5 year)
Sharonview CU (4.0%, 6 year) *brief promotion
Andrews Federal CU (3.5%, 7 year) just saw this was offered last week and pounced, think it ends today

chevca
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Re: Shopping for Mortgage - Question re ARMs

Post by chevca » Fri Jun 28, 2019 9:56 am

dcw213 wrote:
Fri Jun 28, 2019 9:36 am
Might be a psychological hangup but the thought of the whole post tax advantaged paycheck being allocated somewhere stresses me out. I do recognize that a large chunk would be going to principal payoff and equity but that doesnt register with me as an investment. I recognize that much of this is psychological.
I assume you have paid rent up until now? What's the difference?

Stop thinking of your new house as an investment... now. It's a purchase. No need to register it as anything but that.

If the 15 year mortgage would leave things feeling tight, go with a 30 year mortgage. ARM or fixed, up to you there. Would you be more comfortable with a fixed rate mortgage, or would an ARM be okay with you knowing rates could go up... or down... and/or refinances might be needed to get a fixed rate mortgage later?

My only experience with an ARM was a bad one, and one that I never should have entered into even. It was in 2005, during the sub-prime borrowing days, and a 2/1 interest only ARM. Yikes, that was learning experience when the ARM adjusted after 2 years. Wish I knew then.... Obviously, that's not what we're talking about in your case. But, it kind of scared me away from ARMs for good. Just me though. As I mentioned, they do make sense in some situations.

knowledge
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Re: Shopping for Mortgage - Question re ARMs

Post by knowledge » Fri Jun 28, 2019 10:07 am

Wow, I wasn't aware that rates for conforming loans had gotten so low. I'd definitely get quotes for a 7/1 and a 10/1. Given the rates you've quoted, I'd think you'd be able to find a 7/1 at 2.75%, and a 10/1 at 3.00 or slightly better.

Also, see what 25 or 30% down will do as well. I think you'll likely end up honing in on the 5 or 7 year ARMs.

sk2101
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Re: Shopping for Mortgage - Question re ARMs

Post by sk2101 » Fri Jun 28, 2019 10:10 am

If you have the flexibility of paying off the loan sooner in case rates go up unexpectedly I would feel comfortable with the ARM.

I did a 30 year mortgage and ended up changing my mind and paying it off in less than 5 years later. I wish I had done a 5/1 ARM and saved the interest.

lstone19
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Re: Shopping for Mortgage - Question re ARMs

Post by lstone19 » Fri Jun 28, 2019 11:19 am

Another factor you should be considering is what the maximum interest rate it can go up to is and what it's indexed to and what the maximum payment will be if it goes up to that maximum as quickly as it can.

One thing a lot of people don't realize is every rate adjustment that results in a rate lower than the maximum it could be at that point means a period where you are paying more principal and less interest. So at the next rate adjustment, there is less principal to amortize so the maximum payment is then lower than when you started. For instance, we took out a 7/1 mortgage in 2003. When we paid if off in 2017, the rate had never been higher than the initial rate (we were indexed to the 1-yr t-bill rate and much of this during the period t-bills were paying almost nothing) and the maximum monthly payment, which has started at $2,005, was down to $1,732 thanks to all the extra principal that had been paid relative to the initial amortization table.

SovereignInvestor
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Re: Shopping for Mortgage - Question re ARMs

Post by SovereignInvestor » Fri Jun 28, 2019 10:10 pm

ARM is great for low payment of 30 year ammortization with low rate of shorter loan.

If you have cash to pay it off any time you can take the risk here. Remember, one can always refinance an ARM into another ARM.

3/1 rate seems super low in rate but 3 years is pretty short.

In your situation you can afford to just see the lowest rate and if the reset makes rates spike high enough that it's onerous you can always just pay a lot down.

NYCguy
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Re: Shopping for Mortgage - Question re ARMs

Post by NYCguy » Sat Jun 29, 2019 6:56 am

You need a safety valve and you may have one.

I faced a similar analysis and chose a 3/1 ARM.

Additional key factors for me were after three years what is the maximum reset (I think mine was 75 basis points) per year).

What is the lifetime rate cap? I think mine was 7%.

I planned to pay off my mortgage in 3 to 5 years based on my personal financial projections at the time. That of course meant that even if I had maximum resets I would be repaying the higher rates on a much lower balance.

Your safety valve if rates move against you is your CDs.

I do not think I would’ve pursued it 3/1 ARM if I planned to keep my mortgage for 10 or more years.

As it turned out, I paid off the mortgage in 4 1/2 years and save myself about $75,000 in interest.
If your out-go is greater than your income, your upkeep will be your DOWNFALL.

veindoc
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Re: Shopping for Mortgage - Question re ARMs

Post by veindoc » Sat Jun 29, 2019 7:46 am

I would do the 5/1 ARM. 3 years goes by very fast. We have a 5/1 ARM now. Got it in 2011, re-locked our rate at 4.5 years in for another 5 years at same rate and will likely re-lock again when the time comes. Interest rates will likely be higher but probably not that much higher (I hope). Even though we have five years it goes by so fast. Just now I got some junk mail from quicken loans and had to recalculate in my head when our term ends and realized it is only 18 months away!

At 3 years you buy house, put some furniture in, celebrate baby’s arrival, first birthday, toddler going to pre-K and boom time to think about the mortgage again.

I would also pay attention to what your options are after year 5. With third fed we can re-lock a rate for five more years for whatever the prevailing rate is. In other words, not simply re-setting every two years up to 2 basis points till we hit 8. I am hoping the next one is our last re-lock and home will be paid off.

SovereignInvestor
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Re: Shopping for Mortgage - Question re ARMs

Post by SovereignInvestor » Sat Jun 29, 2019 8:14 am

veindoc wrote:
Sat Jun 29, 2019 7:46 am
I would do the 5/1 ARM. 3 years goes by very fast. We have a 5/1 ARM now. Got it in 2011, re-locked our rate at 4.5 years in for another 5 years at same rate and will likely re-lock again when the time comes. Interest rates will likely be higher but probably not that much higher (I hope). Even though we have five years it goes by so fast. Just now I got some junk mail from quicken loans and had to recalculate in my head when our term ends and realized it is only 18 months away!

At 3 years you buy house, put some furniture in, celebrate baby’s arrival, first birthday, toddler going to pre-K and boom time to think about the mortgage again.

I would also pay attention to what your options are after year 5. With third fed we can re-lock a rate for five more years for whatever the prevailing rate is. In other words, not simply re-setting every two years up to 2 basis points till we hit 8. I am hoping the next one is our last re-lock and home will be paid off.
The re locking oprion seems helpful to avoid a harsh reset. But isn't refinancing another option too?

Bacchus01
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Re: Shopping for Mortgage - Question re ARMs

Post by Bacchus01 » Sat Jun 29, 2019 9:40 am

Where are you seeing rates like that? Lowest I’m seeing on 15 year is around 3.125% and I’m seeing ARMs actually higher.

I have one loan on a 15 at 2.5%, 7 years left. If I could get a 3/1 ARM at 2% I’d jump. I also have a 15 year at 3.25% with 13 left. If I could get 2.75% on 5/1 ARm or another 15 I’d jump.

veindoc
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Re: Shopping for Mortgage - Question re ARMs

Post by veindoc » Sat Jun 29, 2019 1:12 pm

SovereignInvestor wrote:
Sat Jun 29, 2019 8:14 am
veindoc wrote:
Sat Jun 29, 2019 7:46 am
I would do the 5/1 ARM. 3 years goes by very fast. We have a 5/1 ARM now. Got it in 2011, re-locked our rate at 4.5 years in for another 5 years at same rate and will likely re-lock again when the time comes. Interest rates will likely be higher but probably not that much higher (I hope). Even though we have five years it goes by so fast. Just now I got some junk mail from quicken loans and had to recalculate in my head when our term ends and realized it is only 18 months away!

At 3 years you buy house, put some furniture in, celebrate baby’s arrival, first birthday, toddler going to pre-K and boom time to think about the mortgage again.

I would also pay attention to what your options are after year 5. With third fed we can re-lock a rate for five more years for whatever the prevailing rate is. In other words, not simply re-setting every two years up to 2 basis points till we hit 8. I am hoping the next one is our last re-lock and home will be paid off.
The re locking oprion seems helpful to avoid a harsh reset. But isn't refinancing another option too?
Refinancing is, but it only costs $295 to relock and no paperwork other than a signature. No appraisal, income verification or credit check.

autolycus
Posts: 260
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Re: Shopping for Mortgage - Question re ARMs

Post by autolycus » Tue Jul 02, 2019 10:17 am

veindoc wrote:
Sat Jun 29, 2019 1:12 pm
SovereignInvestor wrote:
Sat Jun 29, 2019 8:14 am
veindoc wrote:
Sat Jun 29, 2019 7:46 am
I would do the 5/1 ARM. 3 years goes by very fast. We have a 5/1 ARM now. Got it in 2011, re-locked our rate at 4.5 years in for another 5 years at same rate and will likely re-lock again when the time comes. Interest rates will likely be higher but probably not that much higher (I hope). Even though we have five years it goes by so fast. Just now I got some junk mail from quicken loans and had to recalculate in my head when our term ends and realized it is only 18 months away!

At 3 years you buy house, put some furniture in, celebrate baby’s arrival, first birthday, toddler going to pre-K and boom time to think about the mortgage again.

I would also pay attention to what your options are after year 5. With third fed we can re-lock a rate for five more years for whatever the prevailing rate is. In other words, not simply re-setting every two years up to 2 basis points till we hit 8. I am hoping the next one is our last re-lock and home will be paid off.
The re locking oprion seems helpful to avoid a harsh reset. But isn't refinancing another option too?
Refinancing is, but it only costs $295 to relock and no paperwork other than a signature. No appraisal, income verification or credit check.
One note of caution on these re-lock type features: PenFed had a similar program but has stopped offering it at different times when rates were rising or fluctuating too much. Unless it's in the mortgage contract itself, you cannot completely rely on it being an option.

Topic Author
dcw213
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Joined: Sun Dec 16, 2012 3:04 pm

Re: Shopping for Mortgage - Question re ARMs

Post by dcw213 » Tue Jul 02, 2019 6:16 pm

Thanks all for the replies. The resets can be pretty harsh - can move 200 bps is each year with a ceiling of 7%. I have since learned that in order to get this rate it requires 30% down payment, something I had not been told originally so there definitely are some strings. As discussed in a great response above, I feel like if things continue with work and life I would be in a good position to pay down significant principal after year 4 if rates move against me and that this would be a good bridge during a high expense period in my life with lots of personal life volatility that goes into raising infants and toddlers. The thing I am most concerned about is regretting paying the closing costs if I do pay off after 3 years but I think the peace of mind at this stage is worth it.

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