Ah, adjustable rate mortgages….the duct tape of the financial lending industry. Can’t afford that house of your dreams? Sure you can! Just put the whole thing on an adjustable rate mortgage and you’ll easily be able to make those payments you couldn’t afford on the fixed rate mortgage.
Did I say “easily make the payments?” Well, that’s right….for now.
Most financial advisors worth their salt (present company included, even though I really don’t need more salt) usually recommend against adjustable rate mortgages. Why? Simple: Unless you’re one of those awesome psychics on television, you can’t predict what’s going to happen in the next seven or eight years, let alone 30. If there’s one equation that makes sense for most people, it’s this: fixed rate mortgages relieve you from one of the bazillion worries that you have in your daily life.
Side note:….I was reading a piece recently called “Is the 30 Year Mortgage Dead.” Dead? What could be more alive than certainty? The piece argued that you shouldn’t have a 30 year mortgage because you will never stay in your house that long and will end up paying a ton of front-loaded fees. Agreed. However, there are many reasons for a 30 year mortgage beyond that simpleton thinking. A good stacker looks at the whole forest and avoids getting sucked into the single tree argument.
How Does This Adjustable Rate Mortgage Thingy Work?
For those of you new to the adjustable rate mortgage game, it’s pretty easy: your interest rate is generally lower than the current fixed rate because the bank doesn’t have to guarantee the rate for a substantial amount of time. You win because you get a lower rate. The bank wins because they’re off the hook sooner.
Don’t get it? Try this: Imagine you’re a banker and a customer walks in to borrow $200k. Would you offer a better rate on a 30 year loan where you had to guarantee the rate for 5 years or for 30? Exactly.
After the initial period (which varies from ARM to ARM…often it’s five or seven years.) your rate can change. Generally speaking your rate will float with prevailing rates and there is a cap on the amount that the rate can change per year.
Three fantastic questions to ask before you buy an ARM:
– How much can my rate change per year?
– What rate is the ARM based on and how can I track it?
– Is there a penalty to change loans early?
But just like annuities and whole life insurance have a time and place, so does the adjustable rate mortgage. Here are a few examples:
– You still haven’t refinanced from much higher rates and are close to paying off your loan. A no-point/no cost adjustable rate mortgage might leave your payments low.
– You know for certain that you’re moving in a short time. Why not bury the rate as low as possible?
– You’re working on a strategy that is short term, rather than long term.
I’m sure there are countless other reasons.
When I was practicing financial planning, I saw many studies that showed a superior strategy over long periods of time is to secure a no point/no cost one year arm and refinance constantly. Historically your mortgage rate will be lower by far than with fixed rate loans. This is an extremely aggressive strategy because:
– You have to remember to refinance every year.
– You have to be comfortable with the hassle of the yearly refinance
– Your cash flow has to be flexible enough to withstand (possibly) substantial changes in your payments
What Type of Mortgage Should You Buy?
Your mortgage search shouldn’t begin with “I love 30 years” or “I hate ARMs.” It should start with your overall plan. Remember: Successful businesses build debt strategies around their long term goals. People pay off debt willy-nilly.
Lesson of the day: Don’t do things all willy-nilly.
Today’s Workout: 6 x 1 miles @ 8 minute pace
I’ve run 350 days in a row
Best song on my iPod today: Young The Giant: My Body