On August 1, 2020, I took out a 7/1 Adjustable Rate Home Loan (ARM) at 2.125%. I could have taken out a 30 year fixed rate mortgage at 2.75%. However, I wanted to save 0.625% in interest.
A few years later, mortgage rates skyrocketed thanks to the pandemic, massive stimulus, the war in Ukraine, and supply chain problems. Inflation reached its highest level in 40 years in June 2022.
Do you regret choosing a variable rate mortgage over a fixed rate mortgage?
My answer is “no”. Let me tell you why.
Why ARM is OK with High Mortgage Interest Rates
Fast forward to 2020, we had just had our second baby and wanted a fully renovated home for our family to live in. We lived in a house that was undergoing a major renovation for a long time. The renovation was going to take longer than expected, so I decided to jump on a better house.
I fully admit that I did not expect inflation and mortgage rates to skyrocket to the levels we will see in 2022. But even with rising mortgage rates, I still don’t regret getting my ARM.
I know I’m in the minority, and my opinions can be heavily criticized. But listen.
1) ARM saves money
Instead of paying 2.75% for a 30 year fixed mortgage, you’re paying 2.125% for a 7/1 ARM. Nearly $10,000 in interest expense savings each year.
Over a fixed term of 7 years, you could save up to $62,000 in total mortgage interest expense. Saving money is great, but not bad.
Even if you end up paying a much higher mortgage rate after your ARM expires, you still have a $62,000 buffer before you start paying more to get your ARM.We calculate that the period starts at ARM 11th yearEven if mortgage rates remain at their current high levels.
2) House values ​​have gone up
Buying a home in mid-2020 turned out to be a good choice. Even after falling 5% to 10% in 2022, home values ​​are still rising between $300,000 and $500,000.
I feel lucky for the combination of savings in mortgage rates and rising house prices.Rising house prices child Even with an increase in mortgage payments that must be paid after the ARM expires.
Even if the value of your home has decreased, it’s still comforting to know that you’re paying less interest on your mortgage than you need to. But of course it doesn’t feel good.
3) There is a limit to the increase in ARM interest
All ARMs must put limits on how much the mortgage rate can be increased in the first year after the fixed rate period ends. There is a limit on the increase in interest from the following year onwards. It also sets the maximum mortgage interest rate increase for the life of the loan.
In my case, the mortgage rate will increase by up to 2% in year 8, and another 2% in year 9, to a maximum interest rate of 7.125%.
Below is an example of an ARM interest rate limit increased to $850,000, 5/1 ARM, 2.375%.
As you can see from the example above, your mortgage loan increase can increase each year up to your limit. So you can model potential worst-case scenarios in the future to see if you can afford to pay your mortgage.
Thankfully, most people get raises and increase their net worth over time. As a result, it will be able to accommodate higher payments in the future.
4) Mortgage principal is repaid over time
Each month, $3,450 of your mortgage payment goes towards repaying the principal. After 84 months, when my 7/1 ARM expires, I will have paid back approximately $330,000 of principal.
If the 8th year mortgage rate is higher, you will pay a higher mortgage rate of up to 4.125% for one year. However, you will still be paying interest on the mortgage balance that has been reduced by up to 20%.
As a result, the actual monthly payment will only increase by about 200,000 yen. 1 percent. Even if mortgage rates rose another 2% to 6.125%, his monthly mortgage payments would only increase by about 2%. nine percent.
A worst-case scenario of paying 1% to 9% more in years 8 and 9 hardly stands out. An average worker who receives a 2% annual salary increase would easily be able to pay these high salaries.
5) You have refinancing options
No one knows what the future holds. However, you have the option to refinance before your ARM expires on August 1, 2027.
Refinancing to the similarly low interest rate of 2.125% is unlikely. However, there is a good chance that you can refinance to another 7/1 ARM that is less than 4.125%, i.e. less than the first year adjusted maximum mortgage rate.
If you can refinance for free with low interest rates, even better. A no-cost refinance will pay a higher mortgage rate, but if the mortgage rate is attractive, it’s still an advantage. Plus, you can keep the option to refinance again without regretting the fees you paid to refinance.
I believe the long-term trend in inflation and interest rates is declining. Inflation has already peaked in June 2022 and has been declining every month since. I am confident that between now and August 1, 2027, he will find another opportunity to refinance at an attractive mortgage rate.
Below is a graph showing historical trends for the average 30-year fixed rate mortgage. Interest rates have been falling since the 1980s.
6) ARM’s fixed fee term is more consistent with my ownership term.
If I was really going to buy a permanent home in mid-2020, I would be more likely to take out a 30-year fixed-rate mortgage and pay it off sooner. I bought a 7/1 ARM instead because I’m unlikely to live in this house for more than 7 years.
According to my homeownership track record, I’m an avid real estate investor, so I move every two to ten years. My tenure is shorter than the current median home ownership of about 12 years.
I believe it’s better to buy a home, renew it, live in it for at least two years, tax-exempt housing up to $250,000 or $500,000, rent it out, then buy another. Over a typical lifetime, a typical household will be able to retire comfortably on her rental income by the time she is 60. He has accumulated four rental property portfolios.
Since 2003, I have been buying middle-class homes. Because that’s what most households can afford. I believe this is the smartest way to invest in real estate. Investing in luxury real estate does not provide a very high return on investment.
I like my house now, but I might be disappointed if I still live there in seven years. This means we will not be relocating to Oahu. It would mean that we lived too frugally. In seven years, this house could be worth less than 10 percent of your net worth.
As someone who has entered the savings stage of life, my goal is to try to spend more, not less. And one of the easiest ways to spend more money is owning a better home.
7) Worst case of paying extra isn’t so bad
The principal repayments and the savings you’ve been saving by taking out a 7-year floating rate mortgage will give you a big buffer in case mortgage rates spike after year 8. But let’s say mortgage rates spike long after the savings buffer has been exhausted. No big deal.
Ten years after my first 7/1 ARM, my net worth will likely be even higher. This is what usually happens when you keep saving and investing. I am confident that for most workers, the majority will have higher incomes and net worths in the future as well.
In a high inflation, high mortgage rate environment, we can earn higher risk-free income through government bonds, CDs and money market funds. For example, today anyone can make him 5% or more profit on his one-year treasury bond without risk. Not a bad way to ride the wave of inflation.
Even if the absolute amount of the mortgage increases, it is safe if the percentage of the mortgage repayment amount in the income decreases. There’s a reason I encourage everyone to follow my girlfriend’s 30/30/3 home buying rule.
8) ARM keeps me motivated to get richer by a certain time
One of the reasons I like ARM is that it motivates me to pay off my debt faster. We tend to be more focused when we have less time to get things done.
If I had a 30-year fixed-rate mortgage, I wouldn’t be working so hard, paying close attention to my finances, and intentionally paying off my debt. For 5/1, 7/1 or 10/1 ARMs, the introductory fixed rate period deadline To earn as much money as possible and/or pay off as much of the mortgage as possible.
One of the key tenets of the Financial Samurai is to achieve financial independence sooner or later.It will take 30 years to pay off the mortgage not that way. Thanks to ARM, we are now doing more to secure our financial future.
Congratulations to those who have refinanced or taken out a new mortgage
Refinancing or borrowing a mortgage in 2020 or 2021 is one of the greatest economic moves of all time. It’s hard to imagine mortgage rates going back to that level again.
Whether you took out a 30-year fixed-rate mortgage or a variable-rate mortgage, rest easy knowing you’ve earned historically low interest rates. The double merit of being able to live cheaply while feeling the rise in real estate prices is wonderful.
Paying off a home may not be a joy in the long run, but when it finally pays off, you’ll be grateful that you got it so cheap. Your home can also increase in value over time.
Despite the rise in mortgage rates, my preference for variable rate mortgages hasn’t changed. With my 20+ years of real estate investment experience, I don’t want to borrow more than I need to.
Reader Questions and Answers
Anyone regret getting ARM? If so, why? Does anyone regret taking out a 30-year fixed rate mortgage? If so, why? Do you think mortgage rates and inflation will stay high beyond 2027?
If you’re looking to refinance or want to get a better mortgage rate, shop online at Credible. Credible has multiple financiers who provide real quotes and compete for your business. Also, contact your existing bank to see what they have to offer. If you have good credit, you should be able to get interest rates that are lower than the national average.
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