OT: Mortgage Question

[EDS]

My wife and I are in the process of purchasing our first "home" (home in quotes because we are in NYC and it is an apartment in a co-op building, so we are actually purchasing shares).

The mortgage options that have been presented to me don't seem all that great. We have great credit scores, plenty of liquid assets and will be putting 25% of the purchase price down. The three mortgage options are:

(1) 5 year ARM (interest and principle) at 5.375% (total term is 30 years, rate increased is capped at 2% over LIBOR after expiration of ARM per year, with maximum lifetime increase of 6%);
(2) 7 year ARM (interest and principle) at 5.75& (total term is 30 years, rate increased is capped at 2% over LIBOR after expiration of ARM per year, with maximum lifetime increase of 6%); and
(3) 30 year fixed at 6.5%.

Being naturally risk adverse, I had always imagined we would get the 30 year fixed, but that 6.5% seems high (again, we are in NYC so this is a jumbo mortgage). There is a very high likelihood that we will move again in 4-6 years (we hope to have children).

Would you roll the dice and take the 5 year ARM since it saves you some serious coin per month and chances are you will be out of the apartment when the rate resets or will attempt to refinance?

[sloji]

Loans can be confusing and it's the lenders job to educate you on the choice of a loan and it's merits. If you don't feel comfortable call them and ask, if they don't respond then get another lender.

[93legendti]

Take this one:

(3) 30 year fixed at 6.5%.

[rwsaunders]

If you're moving in 5 years, go for the ARM. If not, go for the fixed and refinance down the road. Have you shopped online? With high credit scores and 25% down, you're a lender's dream in this market.

[Louis]

Rent and invest the 25%

[WadePatton]

Dave Ramsey has great answers for every personal finance question. daveramsey.com

ARMs adjust up every time, guaranteed.

[SoCalSteve]

Rent and invest the 25%

Just curious, where would you invest the 25%?

Steve

[EDS]

Rent and invest the 25%

The problem with that is that we need to move. The rent on our current apartment is very reasonable but it is a 4th floor walk-up that just won't work when we have kids (not to mention when my wife is pregnant). To rent an apartment the size of the one we are purchasing will cost us almost the same amount on a per month basis without factoring in the tax savings.

The other thing is my wife really wants to be able to decorate a little bit so owning the place will give us some more flexibility to get her what she wants (i.e., we are gutting and redoing the bathroom on the apartment we are buying).

[Hardlyrob]

I've been playing the ARM game for years - if you keep track of the various options, it is a great way to save money.

If you plan on moving in 4-6 go for the five year ARM. If at the end of five years you decide to stay in the condo - refinance the ARM before it adjusts - either into a fixed, if the rates are good, or into another ARM to keep the lower rate for the next five or seven years.

5.375 is pretty good on a 5/1 ARM. For fun, calculate the interest difference over five years on the 5/1 ARM vs. the fixed - I think you'll be surprised how much money it is. Remember that as you are amortizing the first five years of a 30 year loan, the vast majority of what you are paying is interest.

Cheers!

Rob

[neverraced]

No brainer. 30 yrs at 6.5 is money in the bank in these inflationary times.

[Ken Robb]

I've been a real estae broker for 35 years (now mostly retired) and there will be many times in the uture that you will be thankful to have a fixed loan at 6.5%. CO-OPS are very hard to finance at any rate in California due to the owners all being mutually liable for the payment of property taxes and some or all utilities. Typically the board apportions the gross bill among the shareholders by a predetermined formula in the by-laws but if one person doesn't pay hsi neighbors have to pay his share and take steps to recover rom the non-payer. You can see where this makes lenders nervous because they can evaluate your credit but they don't know if any of your co-owners are in financial difficulty and might be shifting some of their bills onto you.

Be sure you do all appropriate investigating of the HO rules, deed restrictions, and financial reports for the CO-OP. Pay close attention to the reserves vs. estimated remaining useful like of components such as roof, heat/ac, elevator, etc. Try to chat with a couple of your future neighbors as to potential problems or feuds that don't appear in the minutes of board meetings.. You will want to read those for a few years back. Buying is usually a smart thing in the long run. Good luck!

As an ex-New Yorker I have to ask: where's the unit?

[SoCalSteve]

I've been playing the ARM game for years - if you keep track of the various options, it is a great way to save money.

If you plan on moving in 4-6 go for the five year ARM. If at the end of five years you decide to stay in the condo - refinance the ARM before it adjusts - either into a fixed, if the rates are good, or into another ARM to keep the lower rate for the next five or seven years.

5.375 is pretty good on a 5/1 ARM. For fun, calculate the interest difference over five years on the 5/1 ARM vs. the fixed - I think you'll be surprised how much money it is. Remember that as you are amortizing the first five years of a 30 year loan, the vast majority of what you are paying is interest.
Cheers!

Rob

And, is 100% a tax write off (interest part, not principal).

[slowgoing]

There is a very high likelihood that we will move again in 4-6 years (we hope to have children).

You never know what your situation will be in 4-6 years and whether you be in a position where you can comfortably sell and buy another. What if you are not in such a situation and then the market drops so you lose some of your equity or you're stuck with your ARM while rates are increasing?

Take the fixed. If rates go down, you can always refinance.

[EDS]

No brainer. 30 yrs at 6.5 is money in the bank in these inflationary times.

I don't know about money in the bank. The 6.5% fixed will end up being close to $500 per month more per month then the 5.375% 5/1 ARM.

I guess since I have never owned a place before I am having a hard time getting over the difference in monthly costs.

[EDS]

You never know what your situation will be in 4-6 years and whether you be in a position where you can comfortably sell and buy another. What if you are not in such a situation and then the market drops so you lose some of your equity or you're stuck with your ARM while rates are increasing?

Take the fixed. If rates go down, you can always refinance.

The good thing about where we are buying is that there is a very small chance we will lose equity. We might not make a ton on the apartment like alot of people who have sold in the past 5 years, but it will take a much worse economy then we have now to really reduce manhattan real estate prices.

I agree that there is a chance we may want to stay. Maybe we don't have kids for some reason and then the place will be plenty big enough for the two of us.

[Louis]

Just curious, where would you invest the 25%?

At least 50% of it in Vanguard 500 Index or SPDRs, or something like that, more if not comfortable with risk, less if you like to "play the market." The rest in various sectors that you think have underperfomed recently and will turn up. Some in staggered maturity CDs Depends on where the money is right now - presumably it is not in a coffee can in the pantry. Some might stay right where it is today. Also depends on when you think you would need the cash (to buy Meivicis (sp?) for your buddies on the forum or something like that.)

PS I'm hardly an expert at this. If I were, I would be sleeping on a Virgin (Island).

[CNY rider]

The good thing about where we are buying is that there is a very small chance we will lose equity. We might not make a ton on the apartment like alot of people who have sold in the past 5 years, but it will take a much worse economy then we have now to really reduce manhattan real estate prices.

I agree that there is a chance we may want to stay. Maybe we don't have kids for some reason and then the place will be plenty big enough for the two of us.


If there's a decent chance of NOT moving on after 5 years or so then take the fixed.
It's MHO that we are already in the first inning of a highly inflationary period, notwithstanding the contortions the government goes through to remove actual inflation from their inflation statistics.
So you take the fixed, and if rates shoot up, you're sitting pretty paying off the loan with inflated dollars.
If rates go down, you exercise your embedded put option and refi to a lower rate fixed.

If your really sure about the move in 5 years (and that doesn't sound like the case) then the ARM's are more attractive.

[DukeHorn]

In 2000, there was a time when a 30 year was over 8%. 6.5% isn't anything to sneeze at.

What happens 5 years down the road and the jumbo's are over 9%, maybe you won't move.

It all depends on your current finances and your risk assessment. Good luck.

[1centaur]

This is not just about what happens in year 5 and moving. Assuming this is something close to a no points/no closing costs loan, you also have years 2,3,and 4 to have a shot at a refi to fixed at less than 6.5%. Normal mortgage rates (fixed) are 10-year Treasuries plus 120, but mortgage rates are elevated right now (especially jumbos) because lenders are trying to shed real estate loans. If the credit crisis fades and rates do not shoot up, you might have a shot at a fixed-rate loan lower than 6.5% before your ARM resets.

Second, this has a lot to do with arithmetic. Take your savings on the 5/1 ARM and add it up for 5 years. Now take a worst case re-set of 11.375% (6% lifetime cap) in five years. At the end of what month will you be even with the 6.5% starting now (a spreadsheet will help you here)? Give yourself some interest on the money you save now and add to the breakeven period. I'm guessing you are in the region of 7-8 years. Odds of moving within 7-8 years? Odds of a recession within 7-8 years that drags interest rates down (LIBOR tracks close to Fed Funds - the Fed tends to cut rates in a recession)? Odds of a reset less than the max? At the mid-point of reset possibilities are you stretching the breakeven to 10 years? Also, consider that within 7-10 years you could have much higher income or a windfall and not be crushed by a higher rate of interest.

So, the 6.5% rate is fairly expensive insurance against much higher interest rates that you would find difficult to afford but you won't be moving - three simultaneous events. I actually think inflation could be a problem so rates will rise, but the ARM vs. fixed question is about a lot more than that.

[ada@prorider.or]

well loan money in europe
at rate 4.6% (that my rate ) life time long

cheapest as you can get i guess


also get 4.2 % interest rate when saving money

[Lincoln]

Is the 30y one of the new "conforming jumbos?" When they first came out they weren't much better than the regular jumbo but just the last few weeks there have been some new loans with a lower spread between the rates for the standard and the "jumbo" here's a good article: SF Chronicle (http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/05/13/BUBV10L0PG.DTL)

Another thing in favor of the fixed is that even if you decide to move on you might decide to hold on to the condo and rent it out (if that's allowed) so having an adjustable could then become a liability.

As someone else pointed out, you can refinance if rates drop. In theory that applies to both kinds of loans. Just keep in mind that personal situations change and underwriting guidelines change so refinancing might be easier or harder for your situation in the future.

I think you've gotten good advice for both options, in the end it comes down to certain short term cash flow gain versus certain long term stability. How risk averse are the TWO of you. I'm willing to gamble some but my wife is very risk averse so we have a fixed because she sleeps better at night and I don't sleep any worse.

[cody.wms]

One thing to keep in mind is that it may be VERY hard for the person you sell too to get financing. I looked at a co-op in DC and it was apparent that none of the approved lenders were very interested in lending money. Of the seven or so lenders, the two we really talked to either required 25% down or only offered ARMs on the place. Circumstances like this might limit your options in the future.