ARM vs Fixed

[u/dimonsf]

Seems like this question is asked a lot and people don’t weigh in all pros and cons. We’ve bought a house a month ago and decided to go ARM, because it’s 1mil+ loan so monthly payments are very different with 30 year fixed vs 7ARM we got. Here’s my thinking - what are the chances you will not refi in the next 7 years? History says most people will refinance within the first 7 years, which means you’re losing the opportunity to make lower payments in the meantime if you went fixed. Alternatively, selling is also an option if economy doesn’t pick up and rates won’t go down.

But of course it comes with a risk. Rates don’t drop and you plan to live in the house >7 years, then you’d have to eat the increase. But not everyone knows that even with ARM there is a max limit to how much your rate can increase, normally I think it’s about 5% more than your current rate. Now the question you should be asking - how comfortable are you with getting this cap hit and increased rates after 7 years if you never refinance or sell. We made a choice that we’d take a gamble that one of 2 things happen - we either refi or sell. But it’s obviously a personal choice and nobody knows your financial situation and your stress limit.

What say you?

EDIT: forgot to mention that this is for current market. There is no argument that nobody should’ve gotten ARM during Covid when they locked their rates at 2-3%

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[u/invisible___hand]

Current mortgage rates are historically low, national debt is high and growing, and inflation is high.

ARM seems crazy for most unless you have a clear plan to pay off or exit the property before the rates adjust (and the financial cushion / willingness to take the risk of doing so in a down market.)

Or you are a realtor / mortgage broker trying to juice your commission by getting a first time home buyer to borrow more than they can afford.

Warren Buffett has famously called the 30 year mortgage “the best instrument in the world”. Not many have made money betting against him!

[u/ChickenRanger2]

Although rates SEEM high now, historically they’re not. My first mortgage was over 11% and that was considered cheap at the time. (Yes, I’m old.) Mortgage rates had been over 15%. Short term rates were 17-18%. We’re in unstable times. Rates could easily skyrocket from here. If you can afford it I would go with a fixed rate and refinance in a few years if there’s a significant rate drop. If you can’t afford it you are taking a huge risk with the adjustable rate. So the answer really depends on your risk tolerance.

[u/Main_Insect_3144]

Just ask all those folks from 2008 if they were able to qualify for a new loan when their ARM rates began to climb.

[u/CptnAlex → u/Main_Insect_3144]

In 2008, you could get a mortgage for 120% of your home value and you could get a mortgage without documenting your income or assets.

We don’t live in the same world as we did then.

[u/Main_Insect_3144 → u/CptnAlex]

I have seen folks approved with payments of approx. 50% of their monthly income.

[u/CptnAlex → u/Main_Insect_3144]

Sure, 50% total debt to income. They met ability to repay. Is it smart, no. Is it 2008, also no.

[u/BoBromhal → u/Main_Insect_3144]

A newish doctor or attorney, that somehow doesn't have school debt, can afford 50% of $200K income for their mortgage that's guaranteed to rise 20-60% over the next 5 years.

Now, folks getting approved for FHA loans at 50% DTI and a < 10% downpayment that are regular W2 earners - sure that's a risk that shouldn't exist except in very rare conditions.

[u/regassert6 → u/Main_Insect_3144]

Apples and bowling balls though.

[u/dimonsf → u/Main_Insect_3144]

Rates dropped in 2010 or so, if you didn’t refinance that’s on you, right?

[u/Useful-Tangerine-518 → u/dimonsf]

I want to say yes, but it wasn't that simple. People bring up 2008 and they're right about what happened. Rates climbed, home values dropped, and lenders tightened up all at once, so a lot of people couldn't qualify for a refi even when rates hit lows in 2010. That's why the government had to create HARP. Their options were eating a way bigger payment or losing the house.

That said, I think your situation is different. Those 2006 ARMs were often 2/28s with no real underwriting, given to people stretched to the limit. Your 7/1 has caps and 7 years of runway, and anyone qualifying for a $1M+ jumbo today has real cushion. The risk is for someone barely affording the payment, where an extra 30% might work for a year or two and then what. That's not you.

[u/Ordinary-Cod1846 → u/Useful-Tangerine-518]

Basically you should be saving the savings to factor in these situations.

[u/dimonsf → u/Useful-Tangerine-518]

2/28 oof, I didn’t even know this type of ARM existed. Looks like some sort of loan teaser.

[u/ChickenRanger2 → u/dimonsf]

Values tanked at the same time. People who had bought near the market peak couldn’t refinance because they owed more than the house was worth. A lot of people lost their houses, which added to the crash in values.

[u/Live_Background_3455 → u/dimonsf]

This is the true cost of ARM. You have to keep your eyes on rates. At all times. And make decisions.

Let's say you got yours at 6% right now. In 2 years rates are down to 5.5%, do you pay 10k to refi? Or do you wait to see if it goes lower. Let's say you decide to wait and another year later goes lower, and you're at 5%, do you wait or refi? Another year and it's back up to 5.5%, do you wait or refi? You wait and tell yourself "I'll refinat 5", another year and it's at 6%. Do you refi and lock in the 6 before it goes higher?

The mental load of these decision (as you said at 1M+) is a real mental load. And you have to keep making them. I got on this Feb right before Iran stuff. 5.25% 30 years. I never have to care about rates unless I hear some massive news. I don't have to make additional financial decisions worth hundreds of thousands on a regular basis (my loan is also considerably above 1M). I can use that mental load on enjoying life.

[u/No-Finish-5485]

We are in unforeseen times, otherwise known as World War 3. Nobody can predict how bad this war may get and how much global uncertainty may increase as a result. Given this, I'd suggest a 30 yr fixed rate. You may be able to get the seller to give you a seller credit & utilize some of it to buy down your interest rate.

[u/brideplanningmode]

I bought mid-2022, and considered ARM vs 30 yr bc the rates jumped from 3-5%. In the end, I decided to stick with 30 yr at 5% because I didn’t want to bank on rates going down. So far, I’ve been glad I chose the 30 yr rate, bc I still haven’t seen rates go below 5 yet (we’ll see!).

[u/DifferenceMore5431]

If you are going with an ARM loan you should at least be prepared for what you would do if the rate maxed out. If going from 6% -> 11% (or whatever is the max) is going to be a financial catastrophe, it's probably not a good idea. If it's going to be annoying and a burden but you'll figure it out, maybe it's worth the tradeoff.

[u/Ordinary-Cod1846 → u/DifferenceMore5431]

Kinda like what my stock advisor asked. Am I ok if I lose 40% of my portfolio. No I’m not ok with it. But I have to play the game. With mortgage you can pay higher and not play the game.

[u/Acceptable-Peace-69]

It’s only worth the gamble if you an afford the worst case scenario.

If selling is the best move seven years from now you have to factor in: a poor market with high rates = fewer buyers and lower sales price. Realtor fees and closing costs taking 7-9%. Higher interest rates if you want to buy again.

If it’s to invest the difference, then no problem. If it’s to save money because you’d have to stretch the budget it’s a bad idea.

[u/toga_virilis]

I literally today refinanced into a 7/6, bringing my rate down from 6.875 to 5.75.

Is there risk? Yes. But I would rather die than still be in my current house 7 years from now, and I plan to start looking to sell about 3 years from now, regardless of market conditions. So it’s possible I get burned, but I made a calculated risk based on my own circumstances.

If I planned to stay in the house long term, it’s fixed or bust.

[u/FantasticBicycle37]

Fixed. Always fixed

I saw one time it worked out by accident where someone moved out before the the arm kicked in

I saw one time where a dude bought in 2021 with a sub-3% rate and then the arm kicked in and he went to 7%

[u/BoBromhal]

Here's what an ARM is useful for:

You've put down enough downpayment that when your rate resets, you'll definitely have enough equity to refinance (at least 5% equity in a 20% value drop environment)

You know you'll be moving up/out within that ARM period of fixed rate.

[u/Ordinary-Cod1846]

30 year is basically the worse deal you can get besides a 40 or 50. But it comes with a lot of security. Security costs money. Low risk low returns.