Adjustable Rate Mortgages Are Awesome!
When shopping for a mortgage, you have many choices, including typical fixed products such as a 30 or 15 year fixed mortgage, or more aggressive programs such as adjustable-rate mortgages, option-arms, and hybrid option-arms.
Considering the average time people spend in a home is roughly three or four years, why settle for a high-priced fixed mortgage? You can get a 5, 7, or 10 year hybrid arm that comes with a significantly lower interest rate, plus the safety of a fixed period for longer than you’ll likely stay in the home.
Even if you do stay in the home for longer than anticipated, you can always refinance into another option-arm or hybrid arm program and reset the fixed period.
Be sure to include an interest-only option on your mortgage as well. It makes no sense to pay down your principal. You’ll probably move out of the home in the next five years, and with market appreciation almost guaranteed, you’ll have enough equity to part with the home and still make a decent return.
Additionally, if you make interest-only payments, you’ll be able to invest the difference in the stock market and get a better rate of return than the 6% interest rate on your mortgage. During the 1990s, the S&P 500 provided an annualized return of 17.3%.
Better yet, you could get an option-arm that comes with payments as low as 1%. Sure you’ll experience negative amortization, which will eat away at your equity, but why pay the mortgage down when you make more money investing in stocks or other securities?
If you pay 1% on a $500,000 loan amount, the monthly payment is a mere $1,600 versus a monthly payment of $3,200 on a fully-amortized 30 year fixed program at 6.625%.
And all that interest is tax-deductible, so you’ll get it back in April. Any money paid towards principal is not.
Don’t believe what Suze Orman says, the choice is simple. Invest your money at a higher rate of return than your interest rate, using your home as leverage and you won’t be sorry.
This is a guest post by Colin Robertson, a mortgage professional and chief writer for financial blogs: The Truth About Mortgage and The Truth About Credit Cards.
17 responses to “Adjustable Rate Mortgages Are Awesome!”
LAMoneyGuy responds:
Posted: May 3rd, 2007 at 10:40 am
The original premise: ARMs are awesome. There are times when they were and will be again. In periods of relatively high interest rates, and in periods with wide spreads between the fixed and adjustable rates make ARMs potentially sensible. I didn’t understand for a moment why anyone would take out an ARM in the last three years, when we were at historically low rates, and the difference was like a half a percent. Or less.
plonkee responds:
Posted: May 3rd, 2007 at 2:14 pm
Why fix for 25 years when you can fix for 2 years and then remortgage to another rate thats cheaper with a term 2 years shorter.
Or get a capped rate mortgage, or a tracker rate if you think that rates are likely to go down. You lot have plain vanilla mortgages.
fivecentnickel.com responds:
Posted: May 4th, 2007 at 6:26 am
Weekly Roundup - 05/04/07
FMF has a list of six steps to avoid foreclosure. I have just one: pay your mortgage on time and in full.
Flexo has a list of things that your body shop won’t tell you.
Jim talks about adjustable rate mortgages.
On the flipside, MBH talks about f…
Livingalmostlarge responds:
Posted: May 4th, 2007 at 10:26 am
Arms are not bad, it’s how people use them that can be bad. We have an ARM. DH is canadian, and ask any canadian they ONLY have arms for buying a house. The most common method is a 5 year Arm, then you renegotiate with the bank and get a new rate higher or lower. Hopefully lower if rates are down, but then you always get the lowest rate at that time.
My MIL screeched when she heard we were getting a 30 year fixed, she yelled why? Why? How do you know it’s the absolute lowest? Why not a 5 year arm every 5 years?
So you see it really is where you are living that highly influences what you think. People here think “Only fixed rates,” but do you think all canadians are bankrupt? Or broke? Or poor? No, but the average person there uses an Arm. Plus they also need to put down 25-30% and usually their mortgage only last 20 years.
So are Arms bad? No, it depends on circumstance and people and society.
Nigel responds:
Posted: May 4th, 2007 at 10:33 am
“And all that interest is tax-deductible, so you’ll get it back in April”
I know this is a devil’s advocate post, but are you allowed to make blatantly misleading statements?
Oh wait, this was written by a “mortgage professional”. Nevermind.
Analyzing Wealth responds:
Posted: May 4th, 2007 at 10:53 am
I have an ARM. So what?
Jim over at Blueprint for Financial Prosperity published a devil’s advocate piece on adjustible rate mortgages
Weekend Personal Finance Review responds:
Posted: May 5th, 2007 at 2:00 pm
[...] for Financial Prosperity has a Devil’s Advocate post on why Adjustable Rate Mortgages are Awesome. I wouldn’t get one or recommend one, but I know some people who did and actually did well [...]
Scott responds:
Posted: May 5th, 2007 at 9:45 pm
You’re right Nigel, he should have made the article ten times longer with tax brackets, exceptions, IRS definitions, transaction types, property types and a disclaimer from a CPA to specify actually how much interest each homeowner could actually write-off. Because the article was titled “How Much Mortgage Interest is Deductible?”
And you certainly should never exaggerate in a devil’s advocate post. Ever.
mbhunter responds:
Posted: May 5th, 2007 at 10:37 pm
Interest-only? Why not go for the gusto and make it neg am?
Mighty Bargain Hunter » Roundup for week of 30 April 2007 responds:
Posted: May 5th, 2007 at 11:48 pm
[...] Blueprint for Financial Prosperity plays the Devil’s Advocate and argues for ARMs. [...]
Mighty Bargain Hunter » Roundup for week of 30 April 2007 responds:
Posted: May 5th, 2007 at 11:48 pm
[...] Blueprint for Financial Prosperity plays the Devil’s Advocate and argues for ARMs. [...]
Nigel responds:
Posted: May 6th, 2007 at 10:19 am
Scott,
Maybe I shouldn’t be replying to your rant, but since you have misunderstood my comment, I will clarify:
“And all that interest is tax-deductible, so you’ll get it back in April”
Someone who is not familiar with itemized deductions (as most first-time homebuyers are) may interpret this to mean than they will get back all the interest that they paid.
A non-misleading way to state this would be as follows:
“And all that interest is tax-deductible, so you’ll get to deduct it from your income when you file your taxes in April”
Now, that didn’t make it “ten times longer”, did it?
CPA1298 responds:
Posted: May 6th, 2007 at 11:55 am
The original thesis here was good - ARMs can be handy. I bought a small condo 3 years ago that I didn’t want to live in more than 5 years, so I took out a 7 year ARM for about 75 basis points less than a 30 year fixed loan. Why not?
However, the post got almost sarcastic and intentionally misleading when talking about 1% teaser mortgages; these are sinister little devices with huge prepayment penalties that can really trap people. And as mentioned previously nobody ‘gives you back the interest’ you paid; only 1/3 of people itemize, and then they only get back a fraction (around 25%) of the interest they paid.
A regular old ARM is simply a way to lock in a fixed rate for as long as you need it.
Finance Findings For Tuesday, May 8, 2007 responds:
Posted: May 8th, 2007 at 1:52 am
[...] Adjustable Rate Mortgages Are Awesome! [Blueprint] [...]
russell responds:
Posted: April 12th, 2008 at 10:00 am
wow, talk about missing the mark!
Rob Madrid responds:
Posted: May 3rd, 2008 at 4:19 am
And all that interest is tax-deductible, so you’ll get it back in April.
WRONG you get back a percentage depending on your tax rate, 25% tax rate you get back 25%. This is common myth that I often hear.
Since this posts were written before the mortgage meltdown we can pretty much assume that anyone who followed this advice is no in foreclosure.
42 responds:
Posted: May 3rd, 2008 at 1:51 pm
heh. the national refusal to learn just how the mortgage-interest deduction works still appalls me.
I got a 5/25 ARM when I bought in 2004 because I knew I would not be there longer than five years. Turns out I sold 13 months later due to relocation, right at the top of that local market, and I’ve been a happy renter ever since. houses are a money pit and a poor investment.