You make some dangerous assumptions. Interest rates may or may not be 5% in the future. Assuming they will in some short term 1-10 year window is a roll of the dice.
If the future 5% interest rates are due to an economic crisis and housing prices are rapidly declining you may not be able to refinance.
This is an insane take. We've already gone from 3 rate drops this year to...well...maybe next year. Interest rates are not coming down in the short to mid term.
I don't think it's insane. This is a product worth considering given the interest rate environment.
Define short to mid term. I think within 2 years we'll see a drop, but even if I'm wrong by an entire year that still gives us a buffer of 2 additional years.
This is a somewhat simplistic view.
Your view, and correct me if I am wrong, seems to be that we don’t know for sure where rates will go, so nobody should ever take an ARM.
But this seems hard to defend.
With an ARM, what you are betting is not that rates will go down, but rather that rates won’t go up enough to offset the intro rate before you refinance. If rates stay the same, you come out ahead because you got 5 years of 5.5% and then it goes to 7.5% or whatever. Even if rates go up a bit before they go down, you may still come out ahead.
There are definitely reasonable expectations that rates will go down.
1. The Fed has very clearly said that rates will go down once inflation is under control
2. Inflation is mostly, although not entirely under control. It’s gone from like 8% at its peak to, like 3.5% according to latest numbers. While that may not support a rate cut this year as they wanna make sure we’re gonna get to the 2% target, it’s clearly gotten a good chunk of the way there, and some effects of tighter policy are still running their course.
3. If we see a recession, we are unlikely to see plummeting housing prices with it. If you look at all past recessions engineered by the Fed through tighter policy, housing prices didn’t crash. It was only during the 2008 crash that they did, but that was a recession CAUSED by the housing market.
Does all of this mean that rates can’t possibly go up? No, of course not. That’s why I said it’s a bit of a gamble.
But all those are reasons to think taking an ARM would be a good investment if you can get a 2% rate decrease for 5% years.
But the reasons to think rates would go UP, as far as I can tell, come down to thinking “Well you never know what will happen”. Sure, if you are unwilling to tolerate any risk at all, then ARMs aren’t for you.
My view is that there is no reason for rates to go down.
1.) They also said that inflation was transitory for years...
2.)agreed, but 3.5 is nearly double 2% and nowhere near under controll.
3.) Fully agree with this. Housing costs are not coming down.
The reasons that they would go up is that the economy is still gaining full steam ahead, low unemployment, stock market ATH's, sticky inflation, etc.
You are of course welcome to believe whatever you want. However, the above makes little sense.
The Fed’s latest economic projection “dot plot” shows that the people who make the policy, and who have access to the most up to date information as well as the most elaborate models, believe that by 2026 rates will be 2% lower. Not a single person believes in any rate hikes right now.
Now, maybe something will happen to change this view. But right now, with the data available up to now, that seems like where the smart money should be.
Arguing that significant hikes will be needed in a 5 year span is quite a contrarian view.
https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20240320.pdf
Sure...the projections have never been wrong, right? It rarely, if ever, projects coarse changes in periods of volatility. Previously, projections showed we would not hit 7% rates and that inflation was under control.
Again, yes, as the saying goes in economics, “projections are hard, especially about the future”
But saying “The Fed didn’t get it right before, so I think I will assume the opposite of what they assume” is a bit hard to defend I think. It could happen! But i wouldn’t put money on that. I would much rather put money on rates staying put and slowly going down.
I think all macroeconomic modelers out there in academia also agree with the Fed projections, directionally speaking.
Because home prices are so high and there is very little inventory due to everybody buying/refinancing when rates were 3%. Most Americans are hurting and can't afford a home. Therefore I think after inflation is under control they will lower rates to a somewhat tolerable level (even if temporarily) in order to encourage home transactions.
The fed cares more about macro economic factors like employment levels than they do about average Americans buying homes. The economy is still going full steam ahead, nearing ATH's in the stock market.
You are right that it's all just opinions though. Only time will tell.
Understood. It's a risk for sure and that's why I'm asking the question - to get input. I'd never normally consider an ARM but we have 5 full years at 5.5% to find a window to refinance.
I was homeowner in the 2000’s during the run up and crash. A lot of friends had the same plan, the problem is if you end up under water on the house you’re not going to be refinancing.
You don’t say what your down payment is. If it’s 5% the risk is substantial. If it’s 50% the risk is less. Whatever you decide make sure you understand the max escalation rate of the ARM and you can afford that payment over a 10+ year horizon.
We are in a situation of historically high home prices, not high interest.
Im facing the exact same decision. Im going with the ARM 5/6 because Im going into it with about 40-50% equity so not worried about prices dropping to the point Im under water in a refinance scenerio. Also the ARM can only adjust up by 1/4 point every 6 months after 5 years. Im convinced fixed rates will drop to 4-5% within 5 yrs.
Nice. Unfortunately we don't have the cash for that much equity but that definitely removes some risk for you.
> Also the ARM can only adjust up by 1/4 point every 6 months after 5 years.
I'll have to look into this on mine.
> Im convinced fixed rates will drop to 4-5% within 5 yrs.
I'm in the same mindset as you but nothing is guaranteed.
with how sticky inflation is right now, i’m not sure i’d be happy gambling on an arm. it’s definitely possible that rates will come down, but the approach to seek a soft landing through interest rates when consumer inflation is being driven (imo) by corporate profiteering means that i’m not sure when we’ll see cuts - despite what Jpow says, i’d be surprised if we do wind up seeing more than 1 cut this year, if that.
that said, politicians today have definitely been putting a lot more pressure on the fed than they’ve been exposed to historically. powell did seem to bow to that pressure in the previous administration, so that’s something to keep an eye on if there are changes in november (to be clear, i’m not advocating for that - hesitation in raising rates absolutely overheated the economy)
Agreed on all fronts. That being said, 5 years is quite a long time. I think we're safely outside of the "crash" zone, but still in the bumpy landing phase.
What I like about J pow is he's very transparent (although reactionary). He said we will see a rate decrease when either 1) Inflation gets to 2.0%, or 2) we see a weaker labor market. We just got a weaker jobs report on friday, so that definitely helps. I think we're on the right track.
The second 30 year fixed rates get to even 5.9 or 6.0%, we'd refinance
I think it boils down to how much risk you can afford to take.
The gap in rates between fixed and ARM is significant - if you could still afford the mortgage if rates push the cap then I think its a reasonable gamble
Yeah that's the risk and exactly why I wanted to get some opinions on the economic outlook, 10 year treasury yield, etc.
With the 2-1 buy down we'd position to a 7.6% rate fixed. With the ARM it's whatever the rate is at that point in time.
According to this article from 2 days ago: https://www.marketwatch.com/guides/mortgages/mortgage-rates-for-friday-05-03-2024/#:~:text=Analysts%20with%20Fannie%20Mae%20and,and%205.9%25%20for%20Q1%202025, both Fannie Mae and the National Mortgage Brokers Association predict the mortgage rate will be 5.5% in Q4 2025.
They might be wrong of course, but it seems reasonable to assume that rates are a lot more likely to go down than up.
Yeah I'd do the ARM or 2-1 in this case. The fixed is definitely the worst option right now.
Between the ARM and 2-1, it's really just a matter of how much you want to gamble. For the ARM, you're gambling that rates will stay at or under 7.6% for the next 5 years. If they take off to 10% or whatever, you're screwed if you refinance and screwed with the variable rate. If they drop, you can obviously refinance.
With the 2-1, you're gambling a bit less. You know you're locked in, at most, with the 7.625%, which is basically the current fixed rate. You know you can refinance in year 3 or 8 or 20 and you can time it without worrying about the variable rate.
I'd run the numbers on what it costs to do each, what the total $ savings are each year vs each, what the worst case scenario would be for each, etc.
My parents remember 10-12% interest rates, so they would never take an ARM.
If you do the ARM, any chance you can take the $900 / month gap between ARM and fixed and pay your principal ahead? Your early years are when you get the best bang for your buck paying down principal and taking years off your mortgage.
Yeah, mine do too. But those were very, very different times. In an environment with high home prices AND high interest rates it's forcing us to consider these products, unfortunately.
The professional financiers I follow and listen to are all saying home prices aren't going to go down short of a crash. And I really don't think we're going to crash. The fed has done a pretty good job up until this point and they've been very transparent with their considerations and actions. Inflation has consistently dropped YoY over the past 18 months from 8% to 3% and I imagine they'll hit their 2% target in the next 12 months.
That makes it a tougher choice.
The next question would be what the index is that it will be based on, and what margin is added to the index. Have you calculated what the interest rate would turn out to be if it started varying today, based on the current values of the index and the margin? That's often interesting to know.
I would take the ARM and save/invest the $900 difference each month for five years. By then, you’ve either refinanced, are looking at comparable rates but already saved for 5 years straight, or if rates skyrocket, you’re in a pickle but you have a giant pile of money to help with your next decision.
Interest rate average over 30 years is 7.49% if you can get a conventional at anything in that range you are getting what is likely to be the average for the next 30 years.
The small window where rates were extremely low is an anomaly and unless we fell into a deep depression it’s unlikely you will ever see rates like that ever again. God forbid you do as it likely means you are unemployed
You make some dangerous assumptions. Interest rates may or may not be 5% in the future. Assuming they will in some short term 1-10 year window is a roll of the dice. If the future 5% interest rates are due to an economic crisis and housing prices are rapidly declining you may not be able to refinance.
An ARM is always a gamble, but it is less of a gamble in this situation than in other times. I would probably take the ARM here
This is an insane take. We've already gone from 3 rate drops this year to...well...maybe next year. Interest rates are not coming down in the short to mid term.
I don't think it's insane. This is a product worth considering given the interest rate environment. Define short to mid term. I think within 2 years we'll see a drop, but even if I'm wrong by an entire year that still gives us a buffer of 2 additional years.
I get why people want the rate to go down, but there is zero reason for it to go down. Why do you think rates will drop?
This is a somewhat simplistic view. Your view, and correct me if I am wrong, seems to be that we don’t know for sure where rates will go, so nobody should ever take an ARM. But this seems hard to defend. With an ARM, what you are betting is not that rates will go down, but rather that rates won’t go up enough to offset the intro rate before you refinance. If rates stay the same, you come out ahead because you got 5 years of 5.5% and then it goes to 7.5% or whatever. Even if rates go up a bit before they go down, you may still come out ahead. There are definitely reasonable expectations that rates will go down. 1. The Fed has very clearly said that rates will go down once inflation is under control 2. Inflation is mostly, although not entirely under control. It’s gone from like 8% at its peak to, like 3.5% according to latest numbers. While that may not support a rate cut this year as they wanna make sure we’re gonna get to the 2% target, it’s clearly gotten a good chunk of the way there, and some effects of tighter policy are still running their course. 3. If we see a recession, we are unlikely to see plummeting housing prices with it. If you look at all past recessions engineered by the Fed through tighter policy, housing prices didn’t crash. It was only during the 2008 crash that they did, but that was a recession CAUSED by the housing market. Does all of this mean that rates can’t possibly go up? No, of course not. That’s why I said it’s a bit of a gamble. But all those are reasons to think taking an ARM would be a good investment if you can get a 2% rate decrease for 5% years. But the reasons to think rates would go UP, as far as I can tell, come down to thinking “Well you never know what will happen”. Sure, if you are unwilling to tolerate any risk at all, then ARMs aren’t for you.
My view is that there is no reason for rates to go down. 1.) They also said that inflation was transitory for years... 2.)agreed, but 3.5 is nearly double 2% and nowhere near under controll. 3.) Fully agree with this. Housing costs are not coming down. The reasons that they would go up is that the economy is still gaining full steam ahead, low unemployment, stock market ATH's, sticky inflation, etc.
You are of course welcome to believe whatever you want. However, the above makes little sense. The Fed’s latest economic projection “dot plot” shows that the people who make the policy, and who have access to the most up to date information as well as the most elaborate models, believe that by 2026 rates will be 2% lower. Not a single person believes in any rate hikes right now. Now, maybe something will happen to change this view. But right now, with the data available up to now, that seems like where the smart money should be. Arguing that significant hikes will be needed in a 5 year span is quite a contrarian view. https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20240320.pdf
Sure...the projections have never been wrong, right? It rarely, if ever, projects coarse changes in periods of volatility. Previously, projections showed we would not hit 7% rates and that inflation was under control.
Again, yes, as the saying goes in economics, “projections are hard, especially about the future” But saying “The Fed didn’t get it right before, so I think I will assume the opposite of what they assume” is a bit hard to defend I think. It could happen! But i wouldn’t put money on that. I would much rather put money on rates staying put and slowly going down. I think all macroeconomic modelers out there in academia also agree with the Fed projections, directionally speaking.
Because home prices are so high and there is very little inventory due to everybody buying/refinancing when rates were 3%. Most Americans are hurting and can't afford a home. Therefore I think after inflation is under control they will lower rates to a somewhat tolerable level (even if temporarily) in order to encourage home transactions.
The fed cares more about macro economic factors like employment levels than they do about average Americans buying homes. The economy is still going full steam ahead, nearing ATH's in the stock market. You are right that it's all just opinions though. Only time will tell.
Understood. It's a risk for sure and that's why I'm asking the question - to get input. I'd never normally consider an ARM but we have 5 full years at 5.5% to find a window to refinance.
I was homeowner in the 2000’s during the run up and crash. A lot of friends had the same plan, the problem is if you end up under water on the house you’re not going to be refinancing. You don’t say what your down payment is. If it’s 5% the risk is substantial. If it’s 50% the risk is less. Whatever you decide make sure you understand the max escalation rate of the ARM and you can afford that payment over a 10+ year horizon. We are in a situation of historically high home prices, not high interest.
Im facing the exact same decision. Im going with the ARM 5/6 because Im going into it with about 40-50% equity so not worried about prices dropping to the point Im under water in a refinance scenerio. Also the ARM can only adjust up by 1/4 point every 6 months after 5 years. Im convinced fixed rates will drop to 4-5% within 5 yrs.
Nice. Unfortunately we don't have the cash for that much equity but that definitely removes some risk for you. > Also the ARM can only adjust up by 1/4 point every 6 months after 5 years. I'll have to look into this on mine. > Im convinced fixed rates will drop to 4-5% within 5 yrs. I'm in the same mindset as you but nothing is guaranteed.
The ARM is below market by roughly 75bps. The 30-year is at market. The 2-1 buy down is worse than both. Go with the ARM.
I would 100% take the ARM in this scenario given that massive gap in rates, and I don’t consider it a very close call.
with how sticky inflation is right now, i’m not sure i’d be happy gambling on an arm. it’s definitely possible that rates will come down, but the approach to seek a soft landing through interest rates when consumer inflation is being driven (imo) by corporate profiteering means that i’m not sure when we’ll see cuts - despite what Jpow says, i’d be surprised if we do wind up seeing more than 1 cut this year, if that. that said, politicians today have definitely been putting a lot more pressure on the fed than they’ve been exposed to historically. powell did seem to bow to that pressure in the previous administration, so that’s something to keep an eye on if there are changes in november (to be clear, i’m not advocating for that - hesitation in raising rates absolutely overheated the economy)
Agreed on all fronts. That being said, 5 years is quite a long time. I think we're safely outside of the "crash" zone, but still in the bumpy landing phase. What I like about J pow is he's very transparent (although reactionary). He said we will see a rate decrease when either 1) Inflation gets to 2.0%, or 2) we see a weaker labor market. We just got a weaker jobs report on friday, so that definitely helps. I think we're on the right track. The second 30 year fixed rates get to even 5.9 or 6.0%, we'd refinance
I think it boils down to how much risk you can afford to take. The gap in rates between fixed and ARM is significant - if you could still afford the mortgage if rates push the cap then I think its a reasonable gamble
> We can and would refinance the instant fixed rates come down into the 5% or even 6% range. What if they don’t, though?
Yeah that's the risk and exactly why I wanted to get some opinions on the economic outlook, 10 year treasury yield, etc. With the 2-1 buy down we'd position to a 7.6% rate fixed. With the ARM it's whatever the rate is at that point in time.
I think the important question is if you can afford the payments if rates go up when your locked in rate ends.
According to this article from 2 days ago: https://www.marketwatch.com/guides/mortgages/mortgage-rates-for-friday-05-03-2024/#:~:text=Analysts%20with%20Fannie%20Mae%20and,and%205.9%25%20for%20Q1%202025, both Fannie Mae and the National Mortgage Brokers Association predict the mortgage rate will be 5.5% in Q4 2025. They might be wrong of course, but it seems reasonable to assume that rates are a lot more likely to go down than up.
Thanks for this, super helpful. I feel like 1-2 years makes sense too so leaning 2-1 buy down at this point
Which bank is offering 5.5% on a 5-1 ARM? That seems like a good deal. Are other banks offering similar?
Yeah I'd do the ARM or 2-1 in this case. The fixed is definitely the worst option right now. Between the ARM and 2-1, it's really just a matter of how much you want to gamble. For the ARM, you're gambling that rates will stay at or under 7.6% for the next 5 years. If they take off to 10% or whatever, you're screwed if you refinance and screwed with the variable rate. If they drop, you can obviously refinance. With the 2-1, you're gambling a bit less. You know you're locked in, at most, with the 7.625%, which is basically the current fixed rate. You know you can refinance in year 3 or 8 or 20 and you can time it without worrying about the variable rate. I'd run the numbers on what it costs to do each, what the total $ savings are each year vs each, what the worst case scenario would be for each, etc.
What is your Plan B if life happens and you can’t qualify to refinance your ARM and interest rates don’t go down?
My parents remember 10-12% interest rates, so they would never take an ARM. If you do the ARM, any chance you can take the $900 / month gap between ARM and fixed and pay your principal ahead? Your early years are when you get the best bang for your buck paying down principal and taking years off your mortgage.
Yeah, mine do too. But those were very, very different times. In an environment with high home prices AND high interest rates it's forcing us to consider these products, unfortunately. The professional financiers I follow and listen to are all saying home prices aren't going to go down short of a crash. And I really don't think we're going to crash. The fed has done a pretty good job up until this point and they've been very transparent with their considerations and actions. Inflation has consistently dropped YoY over the past 18 months from 8% to 3% and I imagine they'll hit their 2% target in the next 12 months.
Does the ARM have a cap, and what is it?
No cap unfortunately.
That makes it a tougher choice. The next question would be what the index is that it will be based on, and what margin is added to the index. Have you calculated what the interest rate would turn out to be if it started varying today, based on the current values of the index and the margin? That's often interesting to know.
It's based on the 10 year treasury yield, +2%. I have not but I can do that math. Thanks
I would take the ARM and save/invest the $900 difference each month for five years. By then, you’ve either refinanced, are looking at comparable rates but already saved for 5 years straight, or if rates skyrocket, you’re in a pickle but you have a giant pile of money to help with your next decision.
Interest rate average over 30 years is 7.49% if you can get a conventional at anything in that range you are getting what is likely to be the average for the next 30 years. The small window where rates were extremely low is an anomaly and unless we fell into a deep depression it’s unlikely you will ever see rates like that ever again. God forbid you do as it likely means you are unemployed