1% margin loan vs. 2.85% 30yr fixed for primary home

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FreelancerNYC
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1% margin loan vs. 2.85% 30yr fixed for primary home

Post by FreelancerNYC »

Hello Bogleheads. New home purchaser and would appreciate your collective perspective.

I'm in contract on a primary residence. My mortgage is moving along the underwriting process @ 2.85% (30-yr fixed). I have the option to draw on a portfolio-backed margin loan from Schwab at 1% interest (floating). Schwab agreed to beat Interactive Brokers' rate, so I kept my portfolio with Schwab. I don’t want to buy the property outright with the margin loan since it’s not a fixed rate. I will however use the margin loan for the ~$250k down payment and a ~$200k gut renovation. My question is: Is there an optimal way to use the margin loan to reduce interest payments on the 30-yr, while controlling for interest rate risk?

I was thinking about using the margin line (at 1%) to pay down a year’s-worth of mortgage payments (2.85%) in advance every 12 months. The 1-year horizon gives me a buffer against rising interest rate risk. I would then make monthly payments on the mortgage and margin loan. (While I theoretically could skip making payments on the margin loan until rates rise enough to warrant a lump-sum payment, I’m not sure I want to do that.)

I don’t believe I can deduct mortgage interest on any margin funds used for this purpose. A solve would be to use the margin loan to replace stocks I sell to fund the mortgage payments, but that would entail a sizable cap gains tax hit and doesn't seem practical. I itemize deductions.

My portfolio covers the margin loan many times over, so margin call risk and sleeping at night is not a concern. Again, I’m not purchasing the condo outright on margin, just looking for a way to arbitrage the lower rate to my advantage if possible. My portfolio is 90% VTI/SCHB and I'm in my early 30s. Some commenters in other threads suggested hedging rate risk with futures, but that’s beyond complexity tolerance.

Side Note: This is for a non-warrantable condo, meaning the loan can’t be sold to Fannie/Freddie. It’s very difficult to get mortgages on non-warrantable condos, let alone at market rates. Banks need to keep those loans on their books and I only found two banks out of dozens that would do the loan. I’m just glad my rate begins with a “2," since >4% is the going rate for non-warrantable loans.
alex_686
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by alex_686 »

FreelancerNYC wrote: Tue Apr 06, 2021 7:08 pm I was thinking about using the margin line (at 1%) to pay down a year’s-worth of mortgage payments (2.85%) in advance every 12 months.

Some commenters in other threads suggested hedging rate risk with futures,

90% VTI/SCHB
This is kind of my day job. Also, I use to sit on the margin desk. My short answer is to just sell the stock unless it is going to trigger a massive tax bill.

The first sentence is wrong.

The second sentence is a interesting mix of being wrong, ineffective, or perhaps interesting correct in a tangent fashion.

Third, you are thinking about this wrong. Lets start with the 3rd sentence. Why are you currently 90 stock / 10 bond. Now margin is a loan and thus a negative bond. So why are you contemplating going 125 / -25. Forget about having equities multiple times the loan. That does not matter. Why is 125 / -25 the optimal asset allocation. The one that maximizes the chance of reaching your goals with the minimum amount of risk. That is the framework you want to adopt.

Don't create a mental anchor and kid yourself you that you are getting a cheap loan. You are leveraging yourself up.

I doubt this is the best choice. As you increase leverage you increase both returns and volatility. However, the higher the volatility the lower your Compounded Annual Growth Rate. i.e., you get returns lower than 100% equities.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
corp_sharecropper
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by corp_sharecropper »

FreelancerNYC wrote: Tue Apr 06, 2021 7:08 pm Hello Bogleheads. New home purchaser and would appreciate your collective perspective.

I'm in contract on a primary residence. My mortgage is moving along the underwriting process @ 2.85% (30-yr fixed). I have the option to draw on a portfolio-backed margin loan from Schwab at 1% interest (floating). Schwab agreed to beat Interactive Brokers' rate, so I kept my portfolio with Schwab. I don’t want to buy the property outright with the margin loan since it’s not a fixed rate. I will however use the margin loan for the ~$250k down payment and a ~$200k gut renovation. My question is: Is there an optimal way to use the margin loan to reduce interest payments on the 30-yr, while controlling for interest rate risk?

I was thinking about using the margin line (at 1%) to pay down a year’s-worth of mortgage payments (2.85%) in advance every 12 months. The 1-year horizon gives me a buffer against rising interest rate risk. I would then make monthly payments on the mortgage and margin loan. (While I theoretically could skip making payments on the margin loan until rates rise enough to warrant a lump-sum payment, I’m not sure I want to do that.)

I don’t believe I can deduct mortgage interest on any margin funds used for this purpose. A solve would be to use the margin loan to replace stocks I sell to fund the mortgage payments, but that would entail a sizable cap gains tax hit and doesn't seem practical. I itemize deductions.

My portfolio covers the margin loan many times over, so margin call risk and sleeping at night is not a concern. Again, I’m not purchasing the condo outright on margin, just looking for a way to arbitrage the lower rate to my advantage if possible. My portfolio is 90% VTI/SCHB and I'm in my early 30s. Some commenters in other threads suggested hedging rate risk with futures, but that’s beyond complexity tolerance.

Side Note: This is for a non-warrantable condo, meaning the loan can’t be sold to Fannie/Freddie. It’s very difficult to get mortgages on non-warrantable condos, let alone at market rates. Banks need to keep those loans on their books and I only found two banks out of dozens that would do the loan. I’m just glad my rate begins with a “2," since >4% is the going rate for non-warrantable loans.
I don't have an answer for you but I'm glad you shared what Schwab was willing to negotiate, that's pretty awesome. If you don't end up using margin for this purpose, do you still get to keep that margin rate? What's their math, some benchmark rate + 0.XX%?
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FreelancerNYC
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by FreelancerNYC »

alex_686 wrote: Tue Apr 06, 2021 7:39 pm
FreelancerNYC wrote: Tue Apr 06, 2021 7:08 pm I was thinking about using the margin line (at 1%) to pay down a year’s-worth of mortgage payments (2.85%) in advance every 12 months.

Some commenters in other threads suggested hedging rate risk with futures,

90% VTI/SCHB
Why are you currently 90 stock / 10 bond. Now margin is a loan and thus a negative bond. So why are you contemplating going 125 / -25. Forget about having equities multiple times the loan. That does not matter. Why is 125 / -25 the optimal asset allocation. The one that maximizes the chance of reaching your goals with the minimum amount of risk. That is the framework you want to adopt.
I never said I was 10% bond. I'm 100% stock. The other 10% is comprised of 5 individual stocks I've held and added to for over a decade. The margin loan I'm contemplating using would be about 6% of my portfolio. I'm curious what the math reasoning is behind your answer to sell the stock and take the tax hit. At what point is that not worth it? Based on long-term historical market returns, leveraging a loan for 1% seems ideal if you can get it (as long as I'm realistic about the rate eventually increasing).

Why do you say the "first sentence is wrong"?

Thanks
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FreelancerNYC
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by FreelancerNYC »

corp_sharecropper wrote: Tue Apr 06, 2021 7:41 pm
I don't have an answer for you but I'm glad you shared what Schwab was willing to negotiate, that's pretty awesome. If you don't end up using margin for this purpose, do you still get to keep that margin rate? What's their math, some benchmark rate + 0.XX%?
I almost didn't share this because I felt like it was a betrayal of sorts, ha. I came across a Barrons article a couple weeks ago that mentioned the major brokerages can be flexible on margin rates if competing for assets. I'm glad Schwab was willing to compete, since I definitely would have moved money to IKBR as much as I didn't want to. I haven't made a formal commitment to use the line for the condo. Rate for the PAL is LIBOR + 0.xx%. Margin rate is based on Fed Funds + 0.xx%.
ajg189
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by ajg189 »

Maybe I’m not reading this correctly, but you said you plan to take out $450k (250+200) and this only comprises 6% of your portfolio? If you have a $7.5mm portfolio, is it really worth all this effort to save what I’m guessing is $10-20k per year. Seems like additional complexity and potential risk in your life for what is otherwise a rounding error.
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FreelancerNYC
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by FreelancerNYC »

ajg189 wrote: Tue Apr 06, 2021 9:15 pm Seems like additional complexity and potential risk in your life for what is otherwise a rounding error.
You might be right, and I considered this. At the same time, it seems easy enough to execute if the math case can be made. I tend to seek to maximize portfolio returns and don't consider this too stressful compared to say, real estate investing/landlording. I will likely use the margin loan for the down payment, renovation, and closing costs (~$450-$475k). Perhaps I should be thankful I at least have the 1% margin option for those expenses, but I wanted to hear other perspectives on the 30-yr angle. The real rate on the 30yr fixed is likely <2% after accounting for the mortgage interests deduction, so that's something.
learntoinvest123
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by learntoinvest123 »

You have too many things going on here. From what I gather, it is equivalent to taking a 1 year ARM type loan on your down payment + renovation. There is always arbitrage between short term and long term rates (this situation is not unique now), you are fortunate to have access to short term rates.

So what happens when rates go up? Your ARM rate will rise and when it goes over 2.85% you will want to pay it down. How do you plan on doing that?
You can't sell stocks to do that, they could be way down. If you have cash to do that, why are you taking a 1% loan today?

I think it will take 2 or 3 years for rates to get that high assuming inflation stays low, but that is the gamble. You could get a free ride till then.

You can deduct interest payments on margin loans if you itemize.
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FreelancerNYC
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by FreelancerNYC »

learntoinvest123 wrote: Tue Apr 06, 2021 10:02 pm So what happens when rates go up? Your ARM rate will rise and when it goes over 2.85% you will want to pay it down. How do you plan on doing that?
You can't sell stocks to do that, they could be way down. If you have cash to do that, why are you taking a 1% loan today?

I think it will take 2 or 3 years for rates to get that high assuming inflation stays low, but that is the gamble. You could get a free ride till then.

You can deduct interest payments on margin loans if you itemize.
Right, a few years is all I was expecting to get away with. You're correct, that is the gamble. It's the reason I would not pay more than 1 year in advance on the mortgage, if I go through with that part. You make a good point about the potential snafu when in a down-market if rates go up past 2.85% (if I needed to wait out a route, the rate could actually move a bit higher before negating the advantages of when the spread was favorable, but that's splitting hairs). Actually, your post makes a better case for using the margin loan for the 12-months or mortgage pre-payments while practical. Those annual payments would be a fraction of the lump-sum I would need to use for the down payment + renovation. Maybe I'll just choose one of those. Something to consider.

You sure about your last sentence? I thought you could only deduct interest on loans that are secured by the purchased property, which a portfolio margin loan is not. From the Internet:
...to qualify for this favorable tax treatment, the IRS requires that the loan be secured by the properties it purchased. Therefore, you cannot deduct interest on margin loans for these purposes, though you can deduct the interest to the extent the properties were investment properties rather than personal property
Last edited by FreelancerNYC on Wed Apr 07, 2021 12:54 am, edited 1 time in total.
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FreelancerNYC
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by FreelancerNYC »

alex_686 wrote: Tue Apr 06, 2021 7:39 pm
My short answer is to just sell the stock unless it is going to trigger a massive tax bill.
Still curious why you think this is the best route, and if others disagree on this point. Taking a long-term cap gains hit (20% on say $50k of gains) from the $450k withdrawal (plus the opportunity cost of taking that out of the market) feels worse than the risk of the floating rate on the margin loan rising past 2.85% before I pay it down, either with future income or selling at a potentially sub-optimal time.
LeftCoastIV
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by LeftCoastIV »

Worth checking your mortgage docs to see if you are allowed to fund your downpayment with a second loan (the margin loan). I suppose they may not care if the house is not collateral and your income to debt ratios are still fine.
quantAndHold
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by quantAndHold »

One of the Boglehead principles is to use risk to meet our financial goals according to our need, willingness, and ability to take risk. With a presumed $7.5M portfolio, I doubt that you actually *need* to lever stocks up to >100% in order to meet your financial goals. I’m usually pretty pro risk, but this just seems like you’re adding gratuitous risk and complexity. Just sell some stock and get on with enjoying your new home.
Yes, I’m really that pedantic.
coffeeETF
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by coffeeETF »

You can use the margin loan to buy the home and then refinance against the value of the improved home after your renovations, thus locking in the rate and giving you the tax deduction
MeanVarianceOptimal
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by MeanVarianceOptimal »

I don't think 1% floating is actually a good deal compared to 2.85% for a 30y fixed mortgage. The current fed funds rate is at 0.1% and the 20y bond is at 2.4% (a 30y mortgage has a lower duration than 30 years due to repayment, hence the 20y comparison). So your markup for the margin loan actually seems larger than the markup for your 30y mortgage. If you want to borrow at a floating rate you would actually be better off taking the mortgage and buying an interest rate swap or a futures contract on a long term bond.

I'm based in Europe myself and have financed my house via a 5 year box spread at -0.45% interest (in Euro's). In your case you could also lower your borrowing cost by using box spreads instead of a margin loan, to about 0.4%-0.5% p.a. floating currently. However, since the markup on your mortgage is so low compared to bonds I would just take the mortgage in your case.
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by White Coat Investor »

I think I'd probably sell the assets rather than take out a long term loan. A margin loan would be a convenient bridge loan though, especially if basis is low.
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alex_686
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by alex_686 »

FreelancerNYC wrote: Tue Apr 06, 2021 8:01 pm Why are you currently 90 stock / 10 bond. Now margin is a loan and thus a negative bond. So why are you contemplating going 125 / -25. Forget about having equities multiple times the loan. That does not matter. Why is 125 / -25 the optimal asset allocation. The one that maximizes the chance of reaching your goals with the minimum amount of risk. That is the framework you want to adopt.
I never said I was 10% bond. I'm 100% stock. The other 10% is comprised of 5 individual stocks I've held and added to for over a decade. The margin loan I'm contemplating using would be about 6% of my portfolio. I'm curious what the math reasoning is behind your answer to sell the stock and take the tax hit. At what point is that not worth it? Based on long-term historical market returns, leveraging a loan for 1% seems ideal if you can get it (as long as I'm realistic about the rate eventually increasing).
[/quote]

I am going to break this up into 2 parts.

I assumed that when you said you were 90% VTI/SCHB that meant 90 stock / 10 bond. But lets say you are currently 100% stock. Why are you 100% stock? Why not 106%/-6%?

The point of a asset allocation is to create a portfolio with the maximum return for the minimum amount of risk. At 100% equities you certainly have a optimistic Market Expectations. Which - o.k., many people have. But why modify your portfolio from 100/0 to 106/6? From a rational perspective it can't be that you are buying a house. The fact that you are buying a house is not going to have any impact on stock returns, and thus should not change your market expectations. Rationally speaking you should already be at 106/-6.

I suspect, from reading Behavioral Economics, that you are engaged in some type of cognitive error. Maybe Anchoring, maybe Fear of Losing Out. I am not sure. It is why I think you are thinking about this backwards. It does not matter if you have the capacity to take out a margin loan, what matters is your asset allocation.

This would be a different post if this were to handle a short term cash flow issue or if you have low cost bias stock.

However, anything above 85% equity allocation gets problematic. Long term performance takes a hit. Anything above 100% gets dicey. From my experience on the margin desk people stop acting rationally and will resist selling their stock even if they should from a rational perspective.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
alex_686
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by alex_686 »

FreelancerNYC wrote: Tue Apr 06, 2021 8:01 pm I was thinking about using the margin line (at 1%) to pay down a year’s-worth of mortgage payments (2.85%) in advance every 12 months.
...
Why do you say the "first sentence is wrong"?
Well, how can it be right? I am not exactly sure what your exact method is but I can't think of any that makes sense.

Consider your portfolio. 100% equities, a negative long duration bond (a.k.a. the mortgage), a negative short term duration bond (margin)

Under what circumstance will shuffling cash from one pocket (margin) to another pocket (mortgage) make sense?

The mortgage will always require a monthly payment. Even if you drop 12 months of payments on January 1st the bank is going to expect a payment on February 1st. Maybe March 1st. So no advantage to cash flow. Maybe you bank would let you do annual payments. I have never heard of something like that for a retail client but I know next to nothing about NY condos. So maybe.

Maybe you are talking about making 1 large extra principle payment per year. Or maybe you are going to pay the mortgage with margin. Your margin rate will always be lower than the current long term bonds. It should be lower than your mortgage for the next 10 years. So once a year you are going to increase your short term loan to pay down your long term loan. o.k., playing the interest rate spread. Playing with fire but a valid choice. But how are you going to pay off your margin loan? Or are you going to let you margin loan grow like cancer? Working on the margin desk I have seen this happen.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
alex_686
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by alex_686 »

FreelancerNYC wrote: Wed Apr 07, 2021 12:48 am
alex_686 wrote: Tue Apr 06, 2021 7:39 pm
My short answer is to just sell the stock unless it is going to trigger a massive tax bill.
Still curious why you think this is the best route, and if others disagree on this point. Taking a long-term cap gains hit (20% on say $50k of gains) from the $450k withdrawal (plus the opportunity cost of taking that out of the market) feels worse than the risk of the floating rate on the margin loan rising past 2.85% before I pay it down, either with future income or selling at a potentially sub-optimal time.
Paying down the margin loan with future income is a bit of a red herring. You want to compare apples to apples. You plan on saving and investing $X per month.

In Case #1 you go on margin for $X, pay tax T0 now, and $Y goes towards paying down your margin loan for Z time.

In Case #2, you sell $X dollars, and you purchase $Y in new stock for Z time, and pay tax at time Tz. You have to pay tax at time Z to compare apples to apples. Maybe.

This is going to require some spreadsheet work and assumptions about market returns and volatility.

Under most assumptions, Case #1 is going to win. Probably around 60% of the time. However, for Case #1 the dispersion of results is going to be much greater. Often significantly lower. Leverage is great until it blows up, and then it really blows up.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Count of Notre Dame
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by Count of Notre Dame »

alex_686 wrote: Wed Apr 07, 2021 10:43 am
FreelancerNYC wrote: Tue Apr 06, 2021 8:01 pm I was thinking about using the margin line (at 1%) to pay down a year’s-worth of mortgage payments (2.85%) in advance every 12 months.
...
Why do you say the "first sentence is wrong"?
Well, how can it be right? I am not exactly sure what your exact method is but I can't think of any that makes sense.

Consider your portfolio. 100% equities, a negative long duration bond (a.k.a. the mortgage), a negative short term duration bond (margin)

Under what circumstance will shuffling cash from one pocket (margin) to another pocket (mortgage) make sense?

The mortgage will always require a monthly payment. Even if you drop 12 months of payments on January 1st the bank is going to expect a payment on February 1st. Maybe March 1st. So no advantage to cash flow. Maybe you bank would let you do annual payments. I have never heard of something like that for a retail client but I know next to nothing about NY condos. So maybe.
I think it makes sense to shuffle between a margin loan and an ARM since the margin loan rate will always be ~1% lower than an adjustable rate mortgage, due to margin accounts being more liquid than homes. If the OP has a fixed rate mortgage then the potential is there for the margin interest rate to rise above that.

Additionally, a margin loan provides for more cash flow as the margin interest payments are not required, but the mortgage payment is. Agree with everyone's comments about balancing risk, and not needing to take unnecessary risks when you've already "won" the game of financial independence.
inbox788
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Re: 1% margin loan vs. 2.85% 30yr fixed for primary home

Post by inbox788 »

FreelancerNYC wrote: Tue Apr 06, 2021 7:08 pm
is: Is there an optimal way to use the margin loan to reduce interest payments on the 30-yr, while controlling for interest rate risk?

I was thinking about using the margin line (at 1%) to pay down a year’s-worth of mortgage payments (2.85%) in advance every 12 months. The 1-year horizon gives me a buffer against rising interest rate risk. I would then make monthly payments on the mortgage and margin loan. (While I theoretically could skip making payments on the margin loan until rates rise enough to warrant a lump-sum payment, I’m not sure I want to do that.)
2.85% (30-yr fixed) vs 1% interest (floating)

It's not clear to me the cash flow payments compared are the same, which may add to perceived differences.

There's some accelerated payments going on that may not be reversible. Are you making more principal payments or paying monthly payments thru 12 months in advance. The latter doesn't save interest, and pre-paid principal isn't easily undone (requires a refi).

I don't think there is an optimization to the finance question (fixed vs floating). It seems more a risk management question of how you want to manage your cash flows, liquidity, loan durations, interest costs, etc. and that mostly depends on your preferences.

My preference would be to eliminate the loan ASAP, and if the cash to pay it off is tied up or coming later, pay the least interest today and deal with any future cost increases down the road (bird in the hand). If you save 2% today, floating rate can go to 5% before you un-break even. That would be a bigger problem if you're doing an interest only loan, so in that case, the higher fixed rate is worth the "insurance" and you wouldn't bother with floating.
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