Interest Rates gamble - 30 yr. fixed vs. 5-year ARM's

[nolanfan34]

Mrs. Nolanfan and I are in the process of looking to buy a house. I'm having a hard time right now deciding on what kind of financing we should go with. Any economists in the house who want to make a prediction?

One one hand, a 5-year ARM allows us to get a better rate for the short term, and a lower monthly mortgage payment. The question is, what are rates going to look like in 5 years, when it would adjust? We could refinance in that timeframe, but what are the odds we could see rates jump a point or two in the next few years, before we're able to do that?

The 30-year fixed would allow us to lock in a rate, but one that's 5/8 to 3/4 of a point higher than an ARM for the short term. So, a higher monthly payment, etc.

Which is the better gamble at this point? Having a lower monthly payment to start with is somewhat important to us, so we can try to save some money for improvements on the house we buy. But I'm wary of being socked with a higher rate later, if they go way up.

[nyc999]

I am closing on a house this month, and know exactly what you mean.

I ended up going with a 7-year ARM, which has slightly higher interest rates but with more time to refinance.

Secondly, how long do you intend to stay in the house? The national average is 7 years so if you get a 7-year ARM you will most likely be able to sell before worrying about it.

[BoogerFace]

Interest rates are near historical lows. It would be prudent to expect interest rates to rise within the next 5 years.

I vote for 30 year fixed.

[Reqtech]

If you expect to move (growing family, perhaps?) in the next 5 years, ARM.

If not, fixed. It's hard to imagine rates being lower (or the same) in five years.

[PanchoVilla]

5/8 to 3/4 seems high, the gap between a 5/1 ARM and a 30 fixed is so large. Adjustable rates have gotten hammerred in the last few weeks. I just locked a rate on a refi for a friend of mine two days ago and the difference between a 30 fixed and a 5/1 Arm was only a quarter point. I would be happy to sanity check your rate quotes if you wanted to email me at the address below.

Pancho
e-mail is
presto(dot)good(at)gmail(dot)com

[astroglide]

i think the obvious answer to this lies in how long you think you'll actually live there

[swede123]

If you are planning to stay at this house for the long haul go fixed. Interest rates right now are very low, and even if they were to get lower five years down the line you could always refinance at that time.

If you are planning to move to a bigger house or another city in the next several years (like the next seven or eight years) go for the ARM.

Swede

[hicherbie]

[ QUOTE ]

Interest rates are near historical lows. It would be prudent to expect interest rates to rise within the next 5 years.

I vote for 30 year fixed.

[/ QUOTE ]

id agree...rates over the avg of the next 30 years wont be this low. id go with a frm.

[tonypaladino]

So this thread not about how many 5 year mortgages you can take on /images/graemlins/confused.gif

[nolanfan34]

Thanks for the thoughts so far, and some more background:

Most likely, I'd anticipate we live in this place between 5-7 years. That's not set in stone though, if it turned out that we blink and it's 10 years later, that wouldn't surprise me.

We don't have kids yet, but plan to in the future. We are trying to buy something big enough to anticipate that.

[Ray Zee]

rates are on an upward trend and should continue to do so. but way out know one knows. if your financial position expects to be much better in 5 years gamble on the rates and save now. but if you are stuck in a fixed income for the future lock in now.
also you may save enough to pay it way down in those five years i hope. as its always a better feeling owning your own home outright.
i like shorter term financing as you save now and now is the best time to save. as long as you dont just blow that savings on consumer goods then go far out in years. good luck as owning a home is the start to becoming wealthy.

[SossMan]

it really depends on the index and margin and the caps (adjustment cap, life cap, floor) of the ARM. Assuming it's standard, though, I would almost always go with the 5 yr ARM in your spot. This is your first house, it won't likely be your last. You said your horizon is 5-7 years...if this is the case, then a 5 year ARM is a no brainer. You are paying soooo much more over the 5 years w/ the 30 yr fixed that it becomes much more burdensome than the small chance that
A) you are still in the house in 5 years
B) rates are significantly higher in 5 years
C) you are not only in this house, but still have this loan in 5 years (rate/term isn't the only reason to refi)
D) you won't have a non-marginal increase in pay 5 years from now
All in all, unless you are set in stone that this is going to be THE house for 10 yrs, get the ARM. If it makes you feel more comfy, get the 7/1...the yield curve is so flat right now that the 7/1 is usually only 1/8 different than the 5/1.

Think about it this way:
You are saving .75% each year. Not counting TVM, that's 3.5% over 5 years that you have saved over that time. In order for a 30 year fixed to have been a better decision, you would have to have a rate on your ARM after the 5 year period long enough to add up to 3.5% difference on the backside. With the caps that are likely in place on your ARM, it would likely take a while to do that. Again, this is discounting the fact that a few hundered dollars a month now is likely worth much more to you now than a few hundered dollars 5-7 years from now (both from an inflation and an income standpoint).

I'll PM you my phone # if you want to discuss. (I'm in real estate finance)

[MtSmalls]

It largely depend on the structure and caps on the ARM. Take a look at the MAX shift on the arm (how often? how much?). Ask your bank/mortgage broker to show you the annual payments on both mortgages assuming a substantial shift up in rates over the next year...

Interest rates are likely to be a point or so higher this time next year, over five years, who knows. Mtg rates are still near all time lows, so I don't think you can go too wrong with the fixed....

[SomethingClever]

Just out of curiosity, are you buying in Seattle proper or in the burbs?

I was in about the same boat about a year and a half ago, and we went with a 5-year ARM.

The breakeven point versus a 30 year fixed is actually like 7 years on our loan, and we're pretty sure we'll move by then.

Congrats and don't let the housework drive you crazy.

[nolanfan34]

[ QUOTE ]
Just out of curiosity, are you buying in Seattle proper or in the burbs?

[/ QUOTE ]

Burbs.

Thanks again to all for the additional feedback.

[rohjoh]

Another consideration is how much you are putting down, and how much you expect the house to appreciate in the next 5-7 years. I bought a house 4 years ago, and put 50% down. My income can vary month to month, and I wanted to have the security of low payments, and I knew my house would appreciate over the next 5-7 years. I went with a 5 year interest only loan. you really do not pay off much of your loan in the first 5 years, and if you know the house is going to appreciate, you are still building equity in the home. The other nice thing about interest only is 100% of your payment is tax deductable, since 100% of your payment is going to interest.

[ISF]

Unless you can predict interest rates better then the market it shouldnt matter assuming the probability at any point in time you move is the same as the average person(i.e if you move more they variable less then fixed). That being said most hedge funds that do this sort of thing are betting that the yield curve flattens so maybe a variable would be better, but in the end the market is pretty effeceint so it really shouldnt matter.

[guller]

There is no gamble here. Get the fixed, it will only go up from here and fast.

[david050173]

[ QUOTE ]
There is no gamble here. Get the fixed, it will only go up from here and fast.

[/ QUOTE ]

Sure there is a gamble. If he moves in 5 years, he will have paid a premium for the fixed rate but gained no advantage.

[chunk]

what are the odds we could see rates jump a point or two in the next few years?

100%

[Hiding]

[ QUOTE ]
Sure there is a gamble. If he moves in 5 years, he will have paid a premium for the fixed rate but gained no advantage.


[/ QUOTE ]

I also went through this a year ago. I took the 5 year ARM. But, I also bought a new house, the builder bought down my rate. Talk to builders, housing is looking too/has slowed some and deals are being made. Just a suggestion, but I ended up with 2x the house for the same mortgage at half the payment.

[Pinlifter]

Don't get your loan through Mortgage Lending Direct. Those guys are theives.

Pinlifter.

[dcasper70]

I took a 5/1 arm last July at 4.somethingorother%, don't remember exactly. My whole thought process was a little different.

We budgeted 2k/month before we started looking (southwest CT). I planned on paying that amount every month regardless of what the actual payment was, and just put the remainder towards principle. My goal is to pay it off in 20 yrs or less.

I don't recall the precise numbers, but a 30yr mtg would have put my payment around $1700, while the 5/1 is around $1450. That extra $250/month that I put to principle will end up knocking off an additional $15k over 5 yrs.
When the 5 years is up, this difference may make it very possible for us to fit into a 15 yr fixed mtg, which usually beat the 30 year rate and the payments aren't drastically different. House paid in full in 20 or less!


Another way to think about this:
How much would you'd save over 5 yrs with the 5/1 arm?
How much would the 30 yr rates have to rise in that 5 year period in order to eat through this savings when you refinance?


Good luck

[jackdaniels]

In Canada here.

I just bought two homes which I plan to keep for the next 5-7 years. As such I locked in to a 5 year mortgage (@ 4.39%) - betting that rates will go up (I could have chosen a variable rate of Prime + half). One thing my accountant told me was to try and have your mortgage opening time coincide with the presidential election in the US, as historically rates have been kept low during this period.

Good luck with the purchase of your new home.

[stoxtrader]

sit down and run the numbers on both deals, take a 5 year, 10 year, and 15 year occupancy scenario and see which is best for what.

I think you will find that the 5 or 7 year ARM is best.

[4_2_it]

My 5.25% 30-year looks pretty good now. The Fed will raise rates at least 3 more times times before next summer, so your ARM is gonna go up. If there is a remote chance you will be in that house in 5 years, go with the fixed rate. Rates will not stay low forever and they are not going down anytime soon.

This really boils down to your risk tolerance. Will you be kicking yourself if your arm goes up to 7.5% and you re-fi to a 7.25% 30 year when you could have had a much lower rate a year earlier?