Financing Decision

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almon_IHB

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We are getting close to buying a home. I have some financing scenarios in mind, and would like to throw my favorite out there for comments, especially from those in the mortgage industry and all of you who have interacted with me in the past.





We have excellent credit scores, 30% in down payment, and need a mortgage for $600k. After we close on the new house, we can sell our existing home for a net gain of $100k, and we can put away an additional $50k per year. I also believe rates will go down over the next 12-18 months.





Thinking of going with a 3-yr adjustable ARM to save a few bucks per month, and do this for 2 years. Then refi to a conforming loan with a 30-yr fixed.





So what did I forget and what could go wrong?





My exit strategies:


1- If I lose my job, sell the new house immediately, even at a loss.


2- If rates are higher in 2 years than now, refi to fixed anyway, even at a loss.


3- If anything occurs that threatens our ability to refi in 2 years...ummm, don't know what to do with this one.





Anyway, appreciate your thoughts please.
 
almon,





Depending on where you looking for a loan, the spreads on the 30 year and the short term ARMs, are not that big. Union Bank has the best ARM rates, and if you went with an ARM the 5 year is 6%, and is only .125% higher than the 3 year. OCTFCU has great rates for a 30 year fixed at 6.875%. You need to be a member, but there are other credit unions with great rates.





So, you are looking at a $340 a month difference between a fixed and the ARM. In two years that would be about $8k in total payments more with the fixed rate. I agree, I think rates will come down, but I don't know if the secondary mortgage market will come back down for jumbos. It is easier to get a purchase loan, and the rates are lower. So, is the $8k worth it to hedge from a rate increase? I think so, because you will have enough fees when you refi, and a rate premium if you do. If you factor in all those costs, you will see it is going to save you very little to get an ARM now.





Most in the mortgage biz would not tell you that. This is why I got out, but from their perspective, it is best to get you in an ARM. This way you are a prime candidate to refi, and make some more money from.





I know, I know we are the bears, but if your home goes down by more than 10%, then all bets are off to refi. This is a reality you have to think about.
 
<p>Why would you put 30% down and then do a short term ARM to save a few bucks? That extra 10% has to be nearly $85,000. You've nothing better to do with the $85K?</p>

<p>Also, how much will your refinance cost? Nobody is going to refi the loan for free in 18 months. You'll pay for it by either re-extending the term to 30 years or with YSP by getting a higher rate or directly. If not all.</p>
 
I would not bet on falling long term 30yr rates with a declining short term fed rate. The US dollar is in a long term decline and IMHO inflation driven by rising energy costs and the lack foreign buyers for US debt will drive mortgage rate. I would get a fixed rate.
 
<strong>Graph</strong> - Thanks for your thoughts. You pointed out that "It is easier to get a purchase loan, and the rates are lower." What's the usual spread between a purchase loan and a re-fi?





By the way, "... but I don't know if the secondary mortgage market will come back down for jumbos." My bet here is actually for us to re-fi into a conforming loan in 2 years, so I shouldn't have to worry about the jumbo rates in the future.





<strong>No_Such_Reality</strong> - Funny you said that...I know a bit about the markets, but I'm also the most undisciplined investor I know. I've been burned a few times in the past, usually doing well in the beginning, then my mind wanders and all the gains go out the window.





I really appreciated everyone's comments, please keep them coming!
 
<p>My opinion is worth less than two cents, but I'm going to chime in anyway. I think that 30 yr rates are going nowhere but up; in order to attract investment in mortgages again, banks will be forced to offer better ROI and the only way to do that is to charge more in interest. The Fed (and all the other central banks) are going to start raising interest rates again to combat inflation, which will also affect the 30yr rates. </p>

<p>Financing now using an ARM means you are betting that your property value won't drop below your current loan balance. Based on everything we've seen, read, and dicussed on this blog, I think that's a REALLY bad bet.</p>

<p>Rerun your calculations based on all of your assumptions being wrong, and see if you can still afford it. If you can survive a worst case scenario, then you don't really have much to worry about. But I would prefer to see the bottom rather than try and call it.</p>

<p>Again... my opinion is worth what you paid for it.</p>
 
What is the purpose of the move. Are you forced to move? If you are putting down 30% with a loan of 600k, that means your purchase price is roughly 857k. You are planning on plopping down 257k on a depreciating asset? You could earn 5.25% on average right now in a FDIC insured CD. The monthly interest would be over 1,100 a month. This would offset the loss of your mortgage tax breaks.



Honestly, if you are contemplating doing a 3/1 ARM in this environment, that tells me you probably shouldn't be buying. If you are spending more than 35% of your gross wages on the PITI payment of a 30 year fixed, it's too much for you. Prices matter much more than rates. The IO payment on 600k @6.5% is $3,250. Now let's say prices fall 20% in the next 2 years. This house value will be $685,600. Now 30% down is only 205k and your loan will be $479,920. The IO payment @ 8.0% would be $3,199 a month. This is still less than the payment on 600k even though rates increased by 23% to 8.0%. IMHO you can only benefit by waiting.
 
My concern with the original post is this:





<em>After we close on the new house, we can sell our existing home for a net gain of $100k





</em>Are you certain about that? Do you have a bona fide buyer lined up? What you're planning on offering you might <em>think</em> is fair, but if there aren't any buyers out there interested, it won't matter.





Just sayin', prepare for the worst and anticipate that you could wind up sitting on the old place for a while until you find a buyer, unless you already have one.
 
<strong>lendingmaestro</strong> - i'm with you and the other bears on this forum, that right now is not the right time to buy economic-wise. there are reasons for us: my wife like our little neighborhood a lot. we also place a premium on the convenience of walking our kids to school and not having to transfer them to another school. also, our oldest son went to 5 different schools in less than 18 months when we re-located to california, and watching his being miserable and having difficulties adjusting wasn't fun.





also because the neightborhood is small, there aren't many homes with the size + price + floorplan combos that fit us. in this respect, we limit ourselves needlessly. but each of our moves in our history has been so painful, we want to avoid moving into a home that we don't really like, just to move again later when something "better" comes along.





i sometimes think my wife and i value convenience too highly, to the point that we're willing to pay too much for proximity to work, ease of schooling, etc. but, every time we look back, we still nod at each other and say we would do it again.





anyway, getting off track...my original thoughts on getting a 3/1 ARM was because our savings (as downpayment) brings the loan down to ~600k, not enough to qualify as a conforming loan. since we expect to have another 200k incoming over the next 2 years, i was trying to come up with a way to lower monthly payments while saving enough to re-fi as a conforming loan later.
 
almon, check out pedfed.org. They have a 5/5 arm jumbo for 5.375% with very little fees. Best deal out there and might even cheaper than your 3/1 arm. Just donate $20 to some military charity and you will be a member.
 
<strong>rtlguru</strong> - i can't find the link that shows you how to become a member.





it looks like a bulletin board that takes you to lenders like countrywide, wells fargo, etc. do members get preferential treatment?





thanks
 
look at doing a 5 year arm at minimum. Contact some banks directly. Make sure you do a loan with a zero to one year Prepayment penalty at most. Do not do any rate buy downs since you'll need to refinance again.





You'll want to do an Interest only ARM and here is why. You have the option of paying extra principal on the loan every month, and once you do, you'll reduce the monthly payment. If your mortgage is traditionally amortized, lump sums will not affect your payment schedule. Seriously consider a 7 year IO if you need to buy.
 
<em>>>i sometimes think my wife and i value convenience too highly, to the point that we're willing to pay too much for proximity to work,</em>





Personally, I think living close to work is priceless. You can always make more money, but you can't make more time.
 
The stability for your kids is also priceless. Changing schools and houses is hard on kids. Renting doesn't provide the same piece of mind that owning a home--one that you can actually afford that is--provides.



We cannot afford to buy right now and I fear that at the end of our lease, our landlord may decide to put the home on the market and we will have to move again. Once we can afford to buy a house in the area we want we will, regardless if we think the housing market has reached the bottom.
 
<strong>lendingmaestro</strong> - you're right, wonder why i didn't think of that before! like you said, might as well depend on myself to make extra principal paydown.
 
HOC-





On the bright side, if he lists his house, it probably won't sell immediately. Also you can tell him that you are requesting a 10% or more discount for living in a listed property
 
Once you have a conforming loan amt the best loans are:





1.) 30 year fixed w/10 year IO (only if pricing is relatively equal to 30 year fixed)





2.) 30 year fixed





3.) 10 year IO
 
A word of caution on IO loans...I have two of them, one on my principal home and one on my rental property (duplex). This shows a negative impact on my credit report (where they make comments about your score being postive/negative). I was shocked when I saw this recently. Whats up with that?
 
sell now for whatever you can get, and rent for a few years. Then buy that house for a 10 year fixed rate loan, pay it off and start saving seriously for retirement. That is my plan,and I'm sticking to it (house already sold... thank god).
 
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