What to do with 10/1 ARM resetting in 4 years

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thelonliestmonk
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What to do with 10/1 ARM resetting in 4 years

Post by thelonliestmonk »

Hello everyone,

My spouse and I have about $450,000 left on a 3.75% 10/1 adjustable rate mortgage from 2016 on our primary residence. We been paying $2000 extra towards the principal every month. I realize now both of these decisions (ARM and prepayment) were not great, but you live and learn. Principal is $1800 a month, interest is $1450.

We are in our late 40s, planning to retire at 60, have a 2 year emergency fund, and have maxed out our retirement accounts. Do we just keep on chugging away with these payments and not worry about the reset (minimum rate 2.25%, max 8.75%, change frequency every 12th month at year 10 with first change of 5% and subsequent changes of 2%)?

Until reading this forum, I was considering paying even more down each year until we were paid off at the reset, but save the peace of mind of not having a mortgage, any other reasons to change anything? (looks like we would have a negative real mortgage rate for the forseeable future, or at least until we retire).

Thanks for any suggestions!
the_wiki
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Re: What to do with 10/1 ARM resetting in 4 years

Post by the_wiki »

Are your 401k, IRA, etc. on track? You don't mention saving there.
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thelonliestmonk
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Re: What to do with 10/1 ARM resetting in 4 years

Post by thelonliestmonk »

Yes, we have made the maximum contributions to our tax-advantaged retirement accounts:

- 401k (with both pretax and post-tax contributions) and 457b at work
- Backdoor Roth IRA yearly

We also have a taxable portfolio of 80% stock (VTI/VXUS)/20% bond (VGIT). 8% of the emergency fund is cash in a checking account and the rest in 1 year treasury ladders.

Currently have about 15x yearly expenses saved in our retirement and emergency funds, bearing in mind 38% of our yearly expenses is the mortgage and 2k additional principal payment.

Thanks!
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Re: What to do with 10/1 ARM resetting in 4 years

Post by steve r »

thelonliestmonk wrote: Wed Sep 21, 2022 1:32 pm Hello everyone,

My spouse and I have about $450,000 left on a 3.75% 10/1 adjustable rate mortgage from 2016 on our primary residence. We been paying $2000 extra towards the principal every month. I realize now both of these decisions (ARM and prepayment) were not great, but you live and learn. Principal is $1800 a month, interest is $1450.

We are in our late 40s, planning to retire at 60, have a 2 year emergency fund, and have maxed out our retirement accounts. Do we just keep on chugging away with these payments and not worry about the reset (minimum rate 2.25%, max 8.75%, change frequency every 12th month at year 10 with first change of 5% and subsequent changes of 2%)?

Until reading this forum, I was considering paying even more down each year until we were paid off at the reset, but save the peace of mind of not having a mortgage, any other reasons to change anything? (looks like we would have a negative real mortgage rate for the forseeable future, or at least until we retire).

Thanks for any suggestions!
You are doing fine. Maxing your retirement contibutions is key. Paying off the house, as you are doing, is fine. I did so myself.

The question I think you are asking is perhaps "should I lock in a higher rate now, so that I have a fixed rate?" While "no knows" the future of interest rates, 3.75 percent for the next four years is good, the rate reset "may" go to the max. (5 percent seems steep). But buy that time, you balance may be half what it is now or less as more and more of your payments will go towards principle.

At that point, your payments will go up. You can do some math, but this can be offset by reducing your extra payments. Alternatively, you may have enough sideline cash / 1 year treasuries to pay the whole thing off. (I would stretch a little to do so if it means NO monthly payments as you cash will likely be build back up quickly in that case.) When the house is paid off, you will be a touch older so most would increase bond allocation. You may not want to do so, because with a home paid for you can be a touch more aggressive (and stay at 80/20).

Just one persons opinion.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by snowday2022 »

Since you are already investing well, I would try to pay it off in the next 4 years. In fact I am doing that with my supplemental ARM with similar rate. What else would you do with the money, taxable?
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Re: What to do with 10/1 ARM resetting in 4 years

Post by delamer »

Have you actually figured out what your monthly payment would be if you get the maximum reset at each anniversary? I’d look at it both with and without future prepays.

At 10 years, you’ll have paid off a decent amount of the principal. So even if the reset is at the maximum, it will be on a significantly lower balance than you started with.

The issue is whether the new payment at the anniversaries will be affordable. If that’s the case, then the actual interest rate is less significant.

I understand your concern about the unknown and wanting to minimize your total interest charges. But make sure you have all the facts, particularly before you aim to pay off the mortgage which sounds like a heavy lift.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by Weathering »

It seems like you are in a great position to arbitrage treasury rates against your mortgage. Short term treasury rates are higher than long term currently because the market believes inflation will be lower in a few years.
1) You could immediately buy $60k worth of US Treasury series I savings bonds ($20k for self&spouse for 2022, $20k for 2023 as gifts, and $20k for 2024 as gifts). Locking in the current rate of 9.6% for the first six months followed by >5% for the next six months, with only a few months at the subsequent rate before selling them in 2024.
2) You could buy short term treasuries. The one year was paying 3.9% before today, so it could be higher now.
3) You could buy short term US govt agency bonds. Usually they offer a slightly higher interest rate than treasuries because they have a smaller market than treasuries.
4) You could look into short term municipal bonds for your state. However, I know that municipal bonds for my state (CA) are still well below 4% for anything maturing in less than 10 years, so you may find the same situation in your state.
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thelonliestmonk
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Re: What to do with 10/1 ARM resetting in 4 years

Post by thelonliestmonk »

Thanks for all the replies and perspectives. The question of what I would otherwise do with the money I would use to pay off the mortgage is a good one. In the past, I held onto cash for WAY too long (didn't trust the stock market in the run up and aftermath of the housing crash) and while I have always maxed out my work retirement options, investing on my own in taxable never really felt safe to me. It's only in the last year that things really clicked and I started to understand the long game. It helps to have found the white coat investor and this forum.

I am fortunate in that we will be fine even if it resets to the highest rate. We could continue to ladder treasuries and did get several years of I-bonds through the gifting method this year that we can use towards paying it off, so I think we'll probably stay on the current track and make a final decision based on how the interest rates are doing.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by smithers »

Resets in 4 years?! Wake me up in 3.5 years to ask this question again. No one knows what rates are going to do in that time frame, so it's not worth wasting any time wringing your hands about it.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by Silverado »

smithers wrote: Thu Sep 22, 2022 12:32 am Resets in 4 years?! Wake me up in 3.5 years to ask this question again. No one knows what rates are going to do in that time frame, so it's not worth wasting any time wringing your hands about it.
Disagree. There are actions one can take over the next 3.5 to optimize the situation. Waiting until the last couple months to think things through is suboptimal.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by harikaried »

thelonliestmonk wrote: Wed Sep 21, 2022 1:32 pmMy spouse and I have about $450,000 left on a 3.75% 10/1 adjustable rate mortgage from 2016 on our primary residence. We been paying $2000 extra towards the principal every month. Principal is $1800 a month, interest is $1450.
thelonliestmonk wrote: Wed Sep 21, 2022 6:28 pmWe also have a taxable portfolio of 80% stock (VTI/VXUS)/20% bond (VGIT). Currently have about 15x yearly expenses saved in our retirement and emergency funds, bearing in mind 38% of our yearly expenses is the mortgage and 2k additional principal payment.
Sounds like about $2.5M liquid assets, so 20% bonds (assuming same AA across other accounts) means you have around $0.5M currently yielding 3.45% while at the same time you have $0.5M costing you 3.75% interest.

Is it worthwhile for you to keep both the bonds and mortgage for the extra liquidity? Otherwise, you could sell bonds to pay off the mortgage. But maybe if you expect bond yields to keep going up within 4 years, it could be better to hold the bonds and sell if the mortgage interest rate ends up significantly higher than yields.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by WestCoastPhan »

I have a similar situation. A 5/1 ARM that resets in Jan 2027. It's at 2.25%. I plan to ride it out.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by smithers »

Silverado wrote: Thu Sep 22, 2022 7:38 am
smithers wrote: Thu Sep 22, 2022 12:32 am Resets in 4 years?! Wake me up in 3.5 years to ask this question again. No one knows what rates are going to do in that time frame, so it's not worth wasting any time wringing your hands about it.
Disagree. There are actions one can take over the next 3.5 to optimize the situation. Waiting until the last couple months to think things through is suboptimal.
My point is that any decision to optimize should not be based on current interest rates, since they won't matter for another 4 years and that is far too long to predict where they'll be.

By all means, make optimizations that make sense given that interest rates are equally likely to be way higher as way lower in 4 years time when they actually matter. When the reset date is closer (about 6 months out) then the OP can actually start considering current rates in their decision because then they're a useful estimate of what rates will be when the reset hits.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by JackoC »

smithers wrote: Thu Sep 29, 2022 12:21 pm
Silverado wrote: Thu Sep 22, 2022 7:38 am
smithers wrote: Thu Sep 22, 2022 12:32 am Resets in 4 years?! Wake me up in 3.5 years to ask this question again. No one knows what rates are going to do in that time frame, so it's not worth wasting any time wringing your hands about it.
Disagree. There are actions one can take over the next 3.5 to optimize the situation. Waiting until the last couple months to think things through is suboptimal.
My point is that any decision to optimize should not be based on current interest rates, since they won't matter for another 4 years and that is far too long to predict where they'll be.

By all means, make optimizations that make sense given that interest rates are equally likely to be way higher as way lower in 4 years time when they actually matter. When the reset date is closer (about 6 months out) then the OP can actually start considering current rates in their decision because then they're a useful estimate of what rates will be when the reset hits.
You can though gauge what level the 1 yr rate is 'equally likely to be way higher or lower' than in 4 yrs by looking at the forward rate now. Which isn't vastly different than the 1 yr rate now but is lower. The spot 1 yr rate yesterday was 3.99%, the 1 yr rate 4 yrs forward ('4x5') was ~3.52% (3 yr rate 4.12, 5 yr 3.92, interpolating linearly to get rough 4 yr rate). And as a general rule historically the market's true expectation of the 1 yr rate X yrs from now tends to be lower than the forward rate for the same calendar period now (IOW the term premium tends to be positive, though probably less true now than historical average). OP didn't mention what spread the mortgage rate is to the 1 yr treasury but it would usually be something in mid to upper 2's say it's 2.75% hypothetically. Then 'over/under bet' on the reset in today's market would be something like 6.25%. Of course where it actually comes out is unknown but that's roughly the expected value (meaning of 'expected value' in a Stats 101 textboook, not 'what I say is going to happen').

But even if you could guess the actual reset rate, the prices of assets (like stocks) you'd invest in instead of paying down the mortgage are also going to be influenced by rates. You can't easily say 1 yr treasury+275 is a great rate to borrow to invest in stocks when 1 yr T =2.5 but it's a terrible rate to finance stocks when 1 yr T is 5%. The expected return on stocks also depends on the risk free rate. But that doesn't summarize in my mind as 'let's get into all kinds of more complicated analysis', but rather 'don't worry about this a great deal as long as you could afford to pay high resets on the balance outstanding by then'. It isn't too soon to think a bit about it now, but mainly floating rate debt is only a big risk if the balance is so much that high resets would drive you into default. Doesn't sound like that's likely here with loan already partly paid down. Beyond that, paying down mortgages or not is largely a matter of preference.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by EnjoyIt »

4 years away, the rate can be anything. Although I personally did not pay off my mortgage until we were close to being financially independent, there is nothing wrong with adding $2k extra a month. Honestly, what I would do is invest that $2k a month in a mortgage payoff fund. I personally am willing to make the bet that your return in 4 years will be way better than your current mortgage rate and that includes 15% capital gains tax. Then, in 4 years you can decide if you want to throw it into the mortgage as you refinance or continue to invest.

Or,

keep doing what you are doing and in 3 years re-evaluate what your options are. I definitely would not refinance today. 3.75% on $450k for the next 4 years and then 8% on the remaining $250k after the 4 years are up is way better than 6.5% on 450k today.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by Artsdoctor »

Try using a decent mortgage calculator to see what a worse case scenario might be. For example, figure out what your balance will be if you continue making your extra payments at the end of the 10 year period. Then, figure out what your monthly payment might be if the rate increases maximally (not just the first year but the second and third). Don't forget to take taxes into consideration (are you itemizing, etc.).
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Re: What to do with 10/1 ARM resetting in 4 years

Post by KlangFool »

thelonliestmonk wrote: Wed Sep 21, 2022 6:28 pm
Currently have about 15x yearly expenses saved in our retirement and emergency funds,
thelonliestmonk,

That means you are not financially independent yet. So, why is it safer to pay down a 3.75% mortgage than investing in your portfolio? Do you think that your portfolio would return less than 3.75% per year over the next 4 years? If that is true, you want even more liquidity. Not more money inside your house.

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Re: What to do with 10/1 ARM resetting in 4 years

Post by Artsdoctor »

^ I'm going to respectfully disagree with KlangFool on this one. The current rate of 3.75% is excellent so that's not the problem. If I'm reading the OP's terms correctly, the rate could potentially reset above 8% in 4 years; with rates being around 6.5% now for a 30-year, it's not an unreasonable concern. He's trying to hedge his bets against this now as opposed to waiting. While it's true that we would normally think that making 3.75% per year on our investments would be a relatively reasonable goal, this year alone has shown us that that's not always a given.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by EnjoyIt »

Artsdoctor wrote: Thu Sep 29, 2022 3:39 pm ^ I'm going to respectfully disagree with KlangFool on this one. The current rate of 3.75% is excellent so that's not the problem. If I'm reading the OP's terms correctly, the rate could potentially reset above 8% in 4 years; with rates being around 6.5% now for a 30-year, it's not an unreasonable concern. He's trying to hedge his bets against this now as opposed to waiting. While it's true that we would normally think that making 3.75% per year on our investments would be a relatively reasonable goal, this year alone has shown us that that's not always a given.
Your comparison is off. The comparison is:

$450k mortgage @ 6.5% today which is a rate one probably should be paying the extra $2k a month into principal which is something OP currently is doing.
vs
a $450k mortgage at 3.75% for the next 4 years while also paying $2k a month and then in 4 years the mortgage is about $250k at 8%

comparing the above it looks like a no brainer.

Then, Klangfool adds in that maybe paying the extra $2k a month into the mortgage over the next 4 years isn't that great of an idea compared to investing as per their asset allocation. If this was my money and my life at 15x expenses saved I would invest that cash and not consider adding anything extra into the mortgage until closer to 25x or the rate adjusts to something unbearable such as 8% and I would throw as much money at it as fast as possible.

Can we predict what the markets will do in the next 4 years. Probably not, but, considering equities are depressed and most drops last well under 4 years, OP has a very high likely hood of coming out significantly ahead investing $2k a month as opposed to paying extra into a 3.75% mortgage. But, at a rate of 3.75% plus a high likelihood of the interest rate being higher in the future, since OP is already maximizing all tax advantaged accounts, putting that extra into the mortgage is a reasonable option.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by KlangFool »

EnjoyIt wrote: Thu Sep 29, 2022 4:36 pm
Artsdoctor wrote: Thu Sep 29, 2022 3:39 pm ^ I'm going to respectfully disagree with KlangFool on this one. The current rate of 3.75% is excellent so that's not the problem. If I'm reading the OP's terms correctly, the rate could potentially reset above 8% in 4 years; with rates being around 6.5% now for a 30-year, it's not an unreasonable concern. He's trying to hedge his bets against this now as opposed to waiting. While it's true that we would normally think that making 3.75% per year on our investments would be a relatively reasonable goal, this year alone has shown us that that's not always a given.
Your comparison is off. The comparison is:

$450k mortgage @ 6.5% today which is a rate one probably should be paying the extra $2k a month into principal which is something OP currently is doing.
vs
a $450k mortgage at 3.75% for the next 4 years while also paying $2k a month and then in 4 years the mortgage is about $250k at 8%

comparing the above it looks like a no brainer.

Then, Klangfool adds in that maybe paying the extra $2k a month into the mortgage over the next 4 years isn't that great of an idea compared to investing as per their asset allocation. If this was my money and my life at 15x expenses saved I would invest that cash and not consider adding anything extra into the mortgage until closer to 25x or the rate adjusts to something unbearable such as 8% and I would throw as much money at it as fast as possible.

Can we predict what the markets will do in the next 4 years. Probably not, but, considering equities are depressed and most drops last well under 4 years, OP has a very high likely hood of coming out significantly ahead investing $2k a month as opposed to paying extra into a 3.75% mortgage. But, at a rate of 3.75% plus a high likelihood of the interest rate being higher in the future, since OP is already maximizing all tax advantaged accounts, putting that extra into the mortgage is a reasonable option.
EnjoyIt,

Let's assume that the portfolio cannot return 3.75% per year over the next 4 years. Then, we are in a recession over the next 4 years. The worst thing that someone can do is to tie up more of the person's money into the house during a recession. That is not very safe.

In summary, for both cases

A) Portfolio return less than 3.75%

Or

B) Portfolio return much more than 3.75%

It is not safer to pay down the mortgage.

For every 1% interest rate increases, the house price has to drop 10% to keep the monthly payment the same. It does not take much interest rate increase to wipe out the home equity if we are in a recession.

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Re: What to do with 10/1 ARM resetting in 4 years

Post by EnjoyIt »

KlangFool wrote: Thu Sep 29, 2022 4:44 pm
EnjoyIt wrote: Thu Sep 29, 2022 4:36 pm
Artsdoctor wrote: Thu Sep 29, 2022 3:39 pm ^ I'm going to respectfully disagree with KlangFool on this one. The current rate of 3.75% is excellent so that's not the problem. If I'm reading the OP's terms correctly, the rate could potentially reset above 8% in 4 years; with rates being around 6.5% now for a 30-year, it's not an unreasonable concern. He's trying to hedge his bets against this now as opposed to waiting. While it's true that we would normally think that making 3.75% per year on our investments would be a relatively reasonable goal, this year alone has shown us that that's not always a given.
Your comparison is off. The comparison is:

$450k mortgage @ 6.5% today which is a rate one probably should be paying the extra $2k a month into principal which is something OP currently is doing.
vs
a $450k mortgage at 3.75% for the next 4 years while also paying $2k a month and then in 4 years the mortgage is about $250k at 8%

comparing the above it looks like a no brainer.

Then, Klangfool adds in that maybe paying the extra $2k a month into the mortgage over the next 4 years isn't that great of an idea compared to investing as per their asset allocation. If this was my money and my life at 15x expenses saved I would invest that cash and not consider adding anything extra into the mortgage until closer to 25x or the rate adjusts to something unbearable such as 8% and I would throw as much money at it as fast as possible.

Can we predict what the markets will do in the next 4 years. Probably not, but, considering equities are depressed and most drops last well under 4 years, OP has a very high likely hood of coming out significantly ahead investing $2k a month as opposed to paying extra into a 3.75% mortgage. But, at a rate of 3.75% plus a high likelihood of the interest rate being higher in the future, since OP is already maximizing all tax advantaged accounts, putting that extra into the mortgage is a reasonable option.
EnjoyIt,

Let's assume that the portfolio cannot return 3.75% per year over the next 4 years. Then, we are in a recession over the next 4 years. The worst thing that someone can do is to tie up more of the person's money into the house during a recession. That is not very safe.

In summary, for both cases

A) Portfolio return less than 3.75%

Or

B) Portfolio return much more than 3.75%

It is not safer to pay down the mortgage.

For every 1% interest rate increases, the house price has to drop 10% to keep the monthly payment the same. It does not take much interest rate increase to wipe out the home equity if we are in a recession.

KlangFool
Klangfool, I do not disagree with you. I think in general putting more cash into a 3.75% mortgage is a mistake vs building a taxable investment account. For OP it isn't a horrible mistake since they maximize all tax preferred accounts, have a significant nest egg and can always tap that (at a penalty) if there is a job loss or some other travesty that will require OP to continue paying their mortgage. But yeah, all in all I would definitely be investing that money.

Allow me to ask you this question. Let us consider OP who has 15x expenses saved, has a $450k mortgage, maximizes all tax advantaged accounts, has a reasonable emergency fund, and has an extra $2k a month. At what mortgage interest rate would start paying down the mortgage sooner? How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%? Where do you draw the line?
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Re: What to do with 10/1 ARM resetting in 4 years

Post by KlangFool »

EnjoyIt wrote: Thu Sep 29, 2022 5:07 pm
Allow me to ask you this question. Let us consider OP who has 15x expenses saved, has a $450k mortgage, maximizes all tax advantaged accounts, has a reasonable emergency fund, and has an extra $2k a month. At what mortgage interest rate would start paying down the mortgage sooner? How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%? Where do you draw the line?
EnjoyIt,

1) I do not pay down my mortgage until I am financially independent.

2) I only buy a house at a price when the PITI is significantly (20% to 30%) cheaper than renting.

3) I only use 30 years fixed rate mortgage.

Under my set of rules, the actual mortgage interest rate does not matter. I make money from imputed rent.

"How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%?"

In general, the inflation rate is significantly higher than those rates. So, it is a good inflation hedge not to pay those down until the person is financially independent.

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Re: What to do with 10/1 ARM resetting in 4 years

Post by Artsdoctor »

^ Perhaps we may be just looking at things differently and there are probably some intangibles that can't be quantified.

I bring some baggage to the table because I generally imagine the worst case scenario and work backwards from there (too many years in medicine).

The OP has a lot of emergency money and doesn't appear to have any liquidity problems. He's making extra payments and saving money, and there is no threat in the immediate term.

No one knows where interest rates are going to go and I asked him up-thread to do an analysis of how much his mortgage payment would increase if the ARM adjusted to maximal rate increases. I don't have that information and it sounds as if he doesn't either.

Some people prize predictability and some people are more flexible. While it's true that unemployment can happen to anyone, it appears to me that the OP has plenty of reserve assets to weather that problem. What I think I personally would like to avoid is having my mortgage rate go from 3.75% to 8.75% overnight and then to 10.75% the next year. However, I'd like to translate those percentage into dollars; it may or may not be a hardship if rates increased that much.

I personally would not feel comfortable with an ARM in the current environment and would try to stabilize the uncertainty a bit by either getting rid of the mortgage or decreasing my risk by paying down the mortgage provided I had a reasonable buffer of financial stability elsewhere. It's entirely possible that rates will stabilize next year and the OP's job will remain secure. However, it's also possible that everything will go in the opposite direction. Much of this will depend on what priorities the OP has: how much emphasis is on predictability and how much flexibility might there be.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by Sprucebark »

Just curious- did you consider a refinance back when rates were at historic lows?
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Re: What to do with 10/1 ARM resetting in 4 years

Post by EnjoyIt »

KlangFool wrote: Thu Sep 29, 2022 5:55 pm
EnjoyIt wrote: Thu Sep 29, 2022 5:07 pm
Allow me to ask you this question. Let us consider OP who has 15x expenses saved, has a $450k mortgage, maximizes all tax advantaged accounts, has a reasonable emergency fund, and has an extra $2k a month. At what mortgage interest rate would start paying down the mortgage sooner? How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%? Where do you draw the line?
EnjoyIt,

1) I do not pay down my mortgage until I am financially independent.

2) I only buy a house at a price when the PITI is significantly (20% to 30%) cheaper than renting.

3) I only use 30 years fixed rate mortgage.

Under my set of rules, the actual mortgage interest rate does not matter. I make money from imputed rent.

"How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%?"

In general, the inflation rate is significantly higher than those rates. So, it is a good inflation hedge not to pay those down until the person is financially independent.

KlangFool
What if in 3 years, inflation is down to 2.5% and the mortgage is still 7.5% but OP is not yet financially independent? OP is still maximizing all tax advantaged accounts. OP still has an extra $2k a month which they can do whatever they want. Is now a good time to pay down the 7.5% debt? You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?
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Re: What to do with 10/1 ARM resetting in 4 years

Post by EnjoyIt »

Artsdoctor wrote: Thu Sep 29, 2022 6:00 pm ^ Perhaps we may be just looking at things differently and there are probably some intangibles that can't be quantified.

I bring some baggage to the table because I generally imagine the worst case scenario and work backwards from there (too many years in medicine).

The OP has a lot of emergency money and doesn't appear to have any liquidity problems. He's making extra payments and saving money, and there is no threat in the immediate term.

No one knows where interest rates are going to go and I asked him up-thread to do an analysis of how much his mortgage payment would increase if the ARM adjusted to maximal rate increases. I don't have that information and it sounds as if he doesn't either.

Some people prize predictability and some people are more flexible. While it's true that unemployment can happen to anyone, it appears to me that the OP has plenty of reserve assets to weather that problem. What I think I personally would like to avoid is having my mortgage rate go from 3.75% to 8.75% overnight and then to 10.75% the next year. However, I'd like to translate those percentage into dollars; it may or may not be a hardship if rates increased that much.

I personally would not feel comfortable with an ARM in the current environment and would try to stabilize the uncertainty a bit by either getting rid of the mortgage or decreasing my risk by paying down the mortgage provided I had a reasonable buffer of financial stability elsewhere. It's entirely possible that rates will stabilize next year and the OP's job will remain secure. However, it's also possible that everything will go in the opposite direction. Much of this will depend on what priorities the OP has: how much emphasis is on predictability and how much flexibility might there be.
Klangfool works in absolutes of his making. In general what he preaches is very sound advice. But he neglects the nuances and those nuances sometimes matter as you so well described above.

In this particular situation I would invest the extra $2k/month and in 3.5 years re-evalaute the situation. By then OP will have a decent amount of invested capital, a mortgage which is lower, and if interest rates are indeed 5% in year one and 8% in year 2 followed by 10% in year 3, I would be throwing every penny I have into that mortgage to make it go away. If OP continue to send that extra $2k a month to the mortgage company, in 4 years that $450k mortgage will be closer to $250k. Another 4 years of the same and the mortgage will be just about gone.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by Artsdoctor »

^ Actually, I'm going to go out on a limb here and do some back-of-the-envelope figures. The OP can provide his own numbers.

If the principal now is $450,000 and the mortgage rate is 3.75%, the monthly payment might be around $2,000 or so. If he makes $2,000 in extra payments each month, after 4 years the principal might be around $315,000. If the rate resets at 8.75%, the monthly payment would then be about $2,500.

If there are no extra payments made, the principal after 4 years might be around $415,000 or so. If rates increased maximally, the monthly payment might increase to around $3,300.

These numbers are just ball park estimates. It's hard to know the payoff date without knowing more information.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by KlangFool »

EnjoyIt wrote: Thu Sep 29, 2022 6:09 pm
KlangFool wrote: Thu Sep 29, 2022 5:55 pm
EnjoyIt wrote: Thu Sep 29, 2022 5:07 pm
Allow me to ask you this question. Let us consider OP who has 15x expenses saved, has a $450k mortgage, maximizes all tax advantaged accounts, has a reasonable emergency fund, and has an extra $2k a month. At what mortgage interest rate would start paying down the mortgage sooner? How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%? Where do you draw the line?
EnjoyIt,

1) I do not pay down my mortgage until I am financially independent.

2) I only buy a house at a price when the PITI is significantly (20% to 30%) cheaper than renting.

3) I only use 30 years fixed rate mortgage.

Under my set of rules, the actual mortgage interest rate does not matter. I make money from imputed rent.

"How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%?"

In general, the inflation rate is significantly higher than those rates. So, it is a good inflation hedge not to pay those down until the person is financially independent.

KlangFool
What if in 3 years, inflation is down to 2.5% and the mortgage is still 7.5% but OP is not yet financially independent? OP is still maximizing all tax advantaged accounts. OP still has an extra $2k a month which they can do whatever they want. Is now a good time to pay down the 7.5% debt? You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?
EnjoyIt,

That means the portfolio is returning much more than 3.75% per year over this 4 years stretch. So, why is that not a good thing?

"You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?"

No. Only pay down the mortgage when OP is financially independent.

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Re: What to do with 10/1 ARM resetting in 4 years

Post by Artsdoctor »

The OP is not even 50 and his portfolio is 15X annual expenses. He's in terrific shape. It almost makes no difference what he decides to do because he'll probably be fine. If he's perfectly happy to ride the interest rate rollercoaster, then no extra payments are necessary. If it makes him antsy, pay it down.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by Goal33 »

You didn’t refinance during the major rate drops in 2020 or 2021. I assume you weren’t worried about it then, why worry about it now?

I wouldn’t change a thing. Bring the thread back up in 4 years.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by EnjoyIt »

KlangFool wrote: Thu Sep 29, 2022 6:40 pm
EnjoyIt wrote: Thu Sep 29, 2022 6:09 pm
KlangFool wrote: Thu Sep 29, 2022 5:55 pm
EnjoyIt wrote: Thu Sep 29, 2022 5:07 pm
Allow me to ask you this question. Let us consider OP who has 15x expenses saved, has a $450k mortgage, maximizes all tax advantaged accounts, has a reasonable emergency fund, and has an extra $2k a month. At what mortgage interest rate would start paying down the mortgage sooner? How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%? Where do you draw the line?
EnjoyIt,

1) I do not pay down my mortgage until I am financially independent.

2) I only buy a house at a price when the PITI is significantly (20% to 30%) cheaper than renting.

3) I only use 30 years fixed rate mortgage.

Under my set of rules, the actual mortgage interest rate does not matter. I make money from imputed rent.

"How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%?"

In general, the inflation rate is significantly higher than those rates. So, it is a good inflation hedge not to pay those down until the person is financially independent.

KlangFool
What if in 3 years, inflation is down to 2.5% and the mortgage is still 7.5% but OP is not yet financially independent? OP is still maximizing all tax advantaged accounts. OP still has an extra $2k a month which they can do whatever they want. Is now a good time to pay down the 7.5% debt? You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?
EnjoyIt,

That means the portfolio is returning much more than 3.75% per year over this 4 years stretch. So, why is that not a good thing?

"You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?"

No. Only pay down the mortgage when OP is financially independent.

KlangFool
Klangfool,

3.5% is a good thing. I'm asking when interest rates adjust and OP is paying 7.5% is that not a good time to start repaying the mortgage faster even if they are not yet at 25x when they are already maximizing all tax advantaged accounts and have the extra cash? Keep in mind, OP has a good emergency fund and already 15x. They are not at risk of bankruptcy or losing the house. I would think a 7.5% return that is guaranteed something just about anyone would strive for. Wouldn't you like an investment that is guaranteed to return 7.5%? I know I would.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by KlangFool »

EnjoyIt wrote: Thu Sep 29, 2022 8:44 pm
KlangFool wrote: Thu Sep 29, 2022 6:40 pm
EnjoyIt wrote: Thu Sep 29, 2022 6:09 pm
KlangFool wrote: Thu Sep 29, 2022 5:55 pm
EnjoyIt wrote: Thu Sep 29, 2022 5:07 pm
Allow me to ask you this question. Let us consider OP who has 15x expenses saved, has a $450k mortgage, maximizes all tax advantaged accounts, has a reasonable emergency fund, and has an extra $2k a month. At what mortgage interest rate would start paying down the mortgage sooner? How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%? Where do you draw the line?
EnjoyIt,

1) I do not pay down my mortgage until I am financially independent.

2) I only buy a house at a price when the PITI is significantly (20% to 30%) cheaper than renting.

3) I only use 30 years fixed rate mortgage.

Under my set of rules, the actual mortgage interest rate does not matter. I make money from imputed rent.

"How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%?"

In general, the inflation rate is significantly higher than those rates. So, it is a good inflation hedge not to pay those down until the person is financially independent.

KlangFool
What if in 3 years, inflation is down to 2.5% and the mortgage is still 7.5% but OP is not yet financially independent? OP is still maximizing all tax advantaged accounts. OP still has an extra $2k a month which they can do whatever they want. Is now a good time to pay down the 7.5% debt? You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?
EnjoyIt,

That means the portfolio is returning much more than 3.75% per year over this 4 years stretch. So, why is that not a good thing?

"You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?"

No. Only pay down the mortgage when OP is financially independent.

KlangFool
Klangfool,

3.5% is a good thing. I'm asking when interest rates adjust and OP is paying 7.5% is that not a good time to start repaying the mortgage faster even if they are not yet at 25x when they are already maximizing all tax advantaged accounts and have the extra cash? Keep in mind, OP has a good emergency fund and already 15x. They are not at risk of bankruptcy or losing the house. I would think a 7.5% return that is guaranteed something just about anyone would strive for. Wouldn't you like an investment that is guaranteed to return 7.5%? I know I would.
When the mortgage interest rate is 7.5%, what do you think the

Inflation rate, bond interest rate, and the stock return rate would be?

You need to think in relative term.

KlangFool
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Re: What to do with 10/1 ARM resetting in 4 years

Post by EnjoyIt »

KlangFool wrote: Thu Sep 29, 2022 9:00 pm
EnjoyIt wrote: Thu Sep 29, 2022 8:44 pm
KlangFool wrote: Thu Sep 29, 2022 6:40 pm
EnjoyIt wrote: Thu Sep 29, 2022 6:09 pm
KlangFool wrote: Thu Sep 29, 2022 5:55 pm

EnjoyIt,

1) I do not pay down my mortgage until I am financially independent.

2) I only buy a house at a price when the PITI is significantly (20% to 30%) cheaper than renting.

3) I only use 30 years fixed rate mortgage.

Under my set of rules, the actual mortgage interest rate does not matter. I make money from imputed rent.

"How about 7.5% the current 30 year rate I am seeing today? What about 6%? What about 5%?"

In general, the inflation rate is significantly higher than those rates. So, it is a good inflation hedge not to pay those down until the person is financially independent.

KlangFool
What if in 3 years, inflation is down to 2.5% and the mortgage is still 7.5% but OP is not yet financially independent? OP is still maximizing all tax advantaged accounts. OP still has an extra $2k a month which they can do whatever they want. Is now a good time to pay down the 7.5% debt? You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?
EnjoyIt,

That means the portfolio is returning much more than 3.75% per year over this 4 years stretch. So, why is that not a good thing?

"You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?"

No. Only pay down the mortgage when OP is financially independent.

KlangFool
Klangfool,

3.5% is a good thing. I'm asking when interest rates adjust and OP is paying 7.5% is that not a good time to start repaying the mortgage faster even if they are not yet at 25x when they are already maximizing all tax advantaged accounts and have the extra cash? Keep in mind, OP has a good emergency fund and already 15x. They are not at risk of bankruptcy or losing the house. I would think a 7.5% return that is guaranteed something just about anyone would strive for. Wouldn't you like an investment that is guaranteed to return 7.5%? I know I would.
When the mortgage interest rate is 7.5%, what do you think the

Inflation rate, bond interest rate, and the stock return rate would be?

You need to think in relative term.

KlangFool
And?
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Re: What to do with 10/1 ARM resetting in 4 years

Post by KlangFool »

EnjoyIt wrote: Fri Sep 30, 2022 1:07 am
KlangFool wrote: Thu Sep 29, 2022 9:00 pm
EnjoyIt wrote: Thu Sep 29, 2022 8:44 pm
KlangFool wrote: Thu Sep 29, 2022 6:40 pm
EnjoyIt wrote: Thu Sep 29, 2022 6:09 pm

What if in 3 years, inflation is down to 2.5% and the mortgage is still 7.5% but OP is not yet financially independent? OP is still maximizing all tax advantaged accounts. OP still has an extra $2k a month which they can do whatever they want. Is now a good time to pay down the 7.5% debt? You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?
EnjoyIt,

That means the portfolio is returning much more than 3.75% per year over this 4 years stretch. So, why is that not a good thing?

"You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?"

No. Only pay down the mortgage when OP is financially independent.

KlangFool
Klangfool,

3.5% is a good thing. I'm asking when interest rates adjust and OP is paying 7.5% is that not a good time to start repaying the mortgage faster even if they are not yet at 25x when they are already maximizing all tax advantaged accounts and have the extra cash? Keep in mind, OP has a good emergency fund and already 15x. They are not at risk of bankruptcy or losing the house. I would think a 7.5% return that is guaranteed something just about anyone would strive for. Wouldn't you like an investment that is guaranteed to return 7.5%? I know I would.
When the mortgage interest rate is 7.5%, what do you think the

Inflation rate, bond interest rate, and the stock return rate would be?

You need to think in relative term.

KlangFool
And?
If the mortgage interest rate is 7.5% in 4 years, the portfolio return would be a lot more than that. Or, we are in a recession. The same argument of not paying down the mortgage still applies.

KlangFool
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Re: What to do with 10/1 ARM resetting in 4 years

Post by JackoC »

EnjoyIt wrote: Thu Sep 29, 2022 3:11 pm 4 years away, the rate can be anything. Although I personally did not pay off my mortgage until we were close to being financially independent, there is nothing wrong with adding $2k extra a month. Honestly, what I would do is invest that $2k a month in a mortgage payoff fund. I personally am willing to make the bet that your return in 4 years will be way better than your current mortgage rate and that includes 15% capital gains tax. Then, in 4 years you can decide if you want to throw it into the mortgage as you refinance or continue to invest.

Or,

keep doing what you are doing and in 3 years re-evaluate what your options are. I definitely would not refinance today. 3.75% on $450k for the next 4 years and then 8% on the remaining $250k after the 4 years are up is way better than 6.5% on 450k today.
I generally agree on both, though both involve matters of preference. One important objective fact is a 4 yr payoff fund now would earn more that the mortgage rate even in treasuries (pre tax, though the whole discussion depends somewhat on unstated tax situation). So the 'payoff fund' idea works better than when talking about on-market mortgage rate vs market treasury rate. I can't see the downside to a mortgage payoff fund in treasuries compared to putting that money directly into mortgage paydown now, if just comparing those two options.

One could of course put the payoff fund into stocks or 'normal allocation' presumably heavy in stocks. But IMO it's getting carried away with stock love to assume you'll get more than any positive return on stocks in as short as 4 yrs, even if they've already had a rocky patch recently. If the idea is to invest long term in stocks rather than ever pay mortgage off more quickly than the amort schedule, or to refinance the mortgage 'when rates go back down', OK but that's also taking on more risk. If the expected return on stocks is higher than treasuries (check) and higher than mortgage rates (probably generally) the 'long run' highest expected return is always achieved by loading up on stocks to the max*. Yet that's not the right answer for every person, considering risk.

*not counting where volatility drag eventually actually reduces the expected return past a certain point in leverage, though usually >3:1 so not relevant to this discussion.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by EnjoyIt »

KlangFool wrote: Fri Sep 30, 2022 6:42 am
EnjoyIt wrote: Fri Sep 30, 2022 1:07 am
KlangFool wrote: Thu Sep 29, 2022 9:00 pm
EnjoyIt wrote: Thu Sep 29, 2022 8:44 pm
KlangFool wrote: Thu Sep 29, 2022 6:40 pm

EnjoyIt,

That means the portfolio is returning much more than 3.75% per year over this 4 years stretch. So, why is that not a good thing?

"You may say refinance, but refinancing will get OP to 6%. Is that a good time to pay down the debt?"

No. Only pay down the mortgage when OP is financially independent.

KlangFool
Klangfool,

3.5% is a good thing. I'm asking when interest rates adjust and OP is paying 7.5% is that not a good time to start repaying the mortgage faster even if they are not yet at 25x when they are already maximizing all tax advantaged accounts and have the extra cash? Keep in mind, OP has a good emergency fund and already 15x. They are not at risk of bankruptcy or losing the house. I would think a 7.5% return that is guaranteed something just about anyone would strive for. Wouldn't you like an investment that is guaranteed to return 7.5%? I know I would.
When the mortgage interest rate is 7.5%, what do you think the

Inflation rate, bond interest rate, and the stock return rate would be?

You need to think in relative term.

KlangFool
And?
If the mortgage interest rate is 7.5% in 4 years, the portfolio return would be a lot more than that. Or, we are in a recession. The same argument of not paying down the mortgage still applies.

KlangFool
One can’t predict future portfolio returns. Once the interest rate hits 7.5% one has a choice. Pay down debt and guarantee 7.5% return or take a bet on the market. Even if inflation is 10% it doesn’t mean market returns will be better than the mortgage.

Right now, if I made a contract with you to borrow money from you and I will give you tax free 7.5% guaranteed return backed by the US government. Would you take it or would you put it into your portfolio? This isn’t a mortgage just a private loan backed by the US government.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by KlangFool »

EnjoyIt wrote: Fri Sep 30, 2022 2:02 pm
KlangFool wrote: Fri Sep 30, 2022 6:42 am
EnjoyIt wrote: Fri Sep 30, 2022 1:07 am
KlangFool wrote: Thu Sep 29, 2022 9:00 pm
EnjoyIt wrote: Thu Sep 29, 2022 8:44 pm

Klangfool,

3.5% is a good thing. I'm asking when interest rates adjust and OP is paying 7.5% is that not a good time to start repaying the mortgage faster even if they are not yet at 25x when they are already maximizing all tax advantaged accounts and have the extra cash? Keep in mind, OP has a good emergency fund and already 15x. They are not at risk of bankruptcy or losing the house. I would think a 7.5% return that is guaranteed something just about anyone would strive for. Wouldn't you like an investment that is guaranteed to return 7.5%? I know I would.
When the mortgage interest rate is 7.5%, what do you think the

Inflation rate, bond interest rate, and the stock return rate would be?

You need to think in relative term.

KlangFool
And?
If the mortgage interest rate is 7.5% in 4 years, the portfolio return would be a lot more than that. Or, we are in a recession. The same argument of not paying down the mortgage still applies.

KlangFool
One can’t predict future portfolio returns. Once the interest rate hits 7.5% one has a choice. Pay down debt and guarantee 7.5% return or take a bet on the market. Even if inflation is 10% it doesn’t mean market returns will be better than the mortgage.

Right now, if I made a contract with you to borrow money from you and I will give you tax free 7.5% guaranteed return backed by the US government. Would you take it or would you put it into your portfolio? This isn’t a mortgage just a private loan backed by the US government.
EnjoyIt,

" Once the interest rate hits 7.5% one has a choice. Pay down debt and guarantee 7.5% return or take a bet on the market."

And, if at that time, the treasury interest rate is 6.5%. would you pay off the mortgage? That was my point. The issue is the decision needs to be done in relative to everything else at that moment.

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Re: What to do with 10/1 ARM resetting in 4 years

Post by milktoast »

I think you are fine. I’m more inclined to payoff than others in this forum.

After maxing out tax advantaged, sounds like you have $2k a month to invest. I would look at likely yield. Ibonds are clear winners vs mortgage, so that’s first. Then we can look at bonds that mature around time of ARM adjustment. Subtract off the extra taxes and you might be slightly ahead.

After that, it’s all about your risk tolerance and expectations of returns. Personally I’d pay down.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by EnjoyIt »

KlangFool wrote: Fri Sep 30, 2022 2:27 pm
EnjoyIt wrote: Fri Sep 30, 2022 2:02 pm
KlangFool wrote: Fri Sep 30, 2022 6:42 am
EnjoyIt wrote: Fri Sep 30, 2022 1:07 am
KlangFool wrote: Thu Sep 29, 2022 9:00 pm

When the mortgage interest rate is 7.5%, what do you think the

Inflation rate, bond interest rate, and the stock return rate would be?

You need to think in relative term.

KlangFool
And?
If the mortgage interest rate is 7.5% in 4 years, the portfolio return would be a lot more than that. Or, we are in a recession. The same argument of not paying down the mortgage still applies.

KlangFool
One can’t predict future portfolio returns. Once the interest rate hits 7.5% one has a choice. Pay down debt and guarantee 7.5% return or take a bet on the market. Even if inflation is 10% it doesn’t mean market returns will be better than the mortgage.

Right now, if I made a contract with you to borrow money from you and I will give you tax free 7.5% guaranteed return backed by the US government. Would you take it or would you put it into your portfolio? This isn’t a mortgage just a private loan backed by the US government.
EnjoyIt,

" Once the interest rate hits 7.5% one has a choice. Pay down debt and guarantee 7.5% return or take a bet on the market."

And, if at that time, the treasury interest rate is 6.5%. would you pay off the mortgage? That was my point. The issue is the decision needs to be done in relative to everything else at that moment.

KlangFool
Yes, yes. If treasury interest rates are 6.5% and I can get a 7.5% tax free return I would definitely take that. Would you?
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Re: What to do with 10/1 ARM resetting in 4 years

Post by Artsdoctor »

milktoast wrote: Fri Sep 30, 2022 3:33 pm I think you are fine. I’m more inclined to payoff than others in this forum.

After maxing out tax advantaged, sounds like you have $2k a month to invest. I would look at likely yield. Ibonds are clear winners vs mortgage, so that’s first. Then we can look at bonds that mature around time of ARM adjustment. Subtract off the extra taxes and you might be slightly ahead.

After that, it’s all about your risk tolerance and expectations of returns. Personally I’d pay down.
And those are the most important words: "personally I'd pay down." Paying off a mortgage is a surprisingly complex decision because it combines all sorts of emotions with personal finance goals. Some people prize security and certainty, and others are just fine with uncertainty. There are very few places that this plays out more vividly than in mortgage discussions.
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Re: What to do with 10/1 ARM resetting in 4 years

Post by KlangFool »

EnjoyIt wrote: Fri Sep 30, 2022 6:03 pm
KlangFool wrote: Fri Sep 30, 2022 2:27 pm
EnjoyIt wrote: Fri Sep 30, 2022 2:02 pm
KlangFool wrote: Fri Sep 30, 2022 6:42 am
EnjoyIt wrote: Fri Sep 30, 2022 1:07 am

And?
If the mortgage interest rate is 7.5% in 4 years, the portfolio return would be a lot more than that. Or, we are in a recession. The same argument of not paying down the mortgage still applies.

KlangFool
One can’t predict future portfolio returns. Once the interest rate hits 7.5% one has a choice. Pay down debt and guarantee 7.5% return or take a bet on the market. Even if inflation is 10% it doesn’t mean market returns will be better than the mortgage.

Right now, if I made a contract with you to borrow money from you and I will give you tax free 7.5% guaranteed return backed by the US government. Would you take it or would you put it into your portfolio? This isn’t a mortgage just a private loan backed by the US government.
EnjoyIt,

" Once the interest rate hits 7.5% one has a choice. Pay down debt and guarantee 7.5% return or take a bet on the market."

And, if at that time, the treasury interest rate is 6.5%. would you pay off the mortgage? That was my point. The issue is the decision needs to be done in relative to everything else at that moment.

KlangFool
Yes, yes. If treasury interest rates are 6.5% and I can get a 7.5% tax free return I would definitely take that. Would you?
No.

KlangFool
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