5/1 ARM vs 30 yr fixed

Your worst case scenario is high rates and property prices down which will increase the probability of you not selling the apartment. If you think you will pay down your mortgage a bit more over the next five years, it is hard to justify 30 year. Realize you were looking for justification for 30 years.

F'k. Why don't you just structure a 5 year lease above mkt rents whereby the next sucker, I mean buyer will earn a 3% yield kicking the crap out of the .25% savings yield. I guarantee you your unit will be cheaper in 5 years.

Geitner is giving you huge line to make a noose. On the other side of the line is an underwater fool choking and dying.... Oh if you didn't get the memo, by refinancing you are in effect swapping out lines, but still choking on it.

The general answer is to treat the 30 year fixed in your mind as a combination of your 3.75% 5 year plus an option to extend for 25 years at a fixed rate of 4.75%. The option to extend (put) is costing you $50,000 (pretax).

If someone on this board trades fixed income futures/options for a living, he/she could tell you if that option is priced correctly....To my mind, the option seems pretty pricey especially since you only have a 50-50 chance that you'll need it (and it's non-transferable).

Is it a coop or a condo? What are the reset terms on the ARM? What is the LTV on the loan?

Your spread to 5-year treasuries is 2.38%; your spread to 30-year treasuries is 0.96%.

It would not be unreasonable to expect refi into new 5/25 of 30 year fully amortizing in five years at rates of around 7%.

Let's throw in another possibility: it may not be worth it for you to refi at all.

The calculation should be about more than when your interest savings cover your refi costs (i.e. your "breakeven point"). Depending on how long you've already been in your place and what happens, the enticing immediate interest savings might be wiped out by the extended loan term.

Systematic prepayment might be a better long-term option.

ali r.
DG Neary Realty

Have to agree with Ali, The 4.75% should be placed in the context of your savings rate. If you don't need the liquidity and wind up hundreds of basis points less on savings parked in a CD, savings or checking account, the prepaying is the better option..and you avoid refinancing costs and points.

UES: First of all, why go to the extremes of only comparing a 5yr Arm and a 30yr Fixed? One of which is amongst the shortest periods of rate protection available and the other being the absolute longest? Neither of which seem to suit your needs all that well. There are 7 and 10 year Arms available.

The 30yr Fixed should be viewed as an insurance policy. It will protect you from potential rate increases beginning in year 6, but at a cost of $50,000. Do you need that type of insurance policy? I'd say highly unlikely.

Assuming you stay beyond 5 years, your 5 year Arm would likely go to 5.75% in a worst case scenario in year 6 and to 7.75% in the 7th year due to your caps. This means that theoretically your 5 year Arm, when accounting for worst case scenario of rate increases, would break-even with the 30yr Fixed sometime in the 7th year when applying the $50,000 in savings. In essence you're self-insuring your own loan for 2 years by pocketing the savings and taking on the rate risk in years 6 and 7.

The rates you quoted above are generally available today without points, and somewhat lower on the 5YR depending on LTV, property type, etc... You may want to get a second opinion.

nycmortgage@gmail.com

Here's a thought. Suppose you really are done with the place in 5 years, but interest rates have gone up to 6.75% for the 30-year loan. If you do get the 30-year loan now, the value of the difference will be something like $300K, so you may end up hanging onto the place to realize this $300K (i.e., rent it out). My point is that your plans with the place may change depending on which loan you have and how interest rates pan out.

If you can handle the payments at 7% interest then pick the ARM, if not, pick the 30yr fixed. You'll sleep better.

Thank you all for the helpful comments. A few additional facts to respond to the above. (1) Terms of the 5/1 ARM are 2% cap on rate increases in years 6-7, with an overall cap of 5% over the initial fixed rate; (2) I am currently 3 years into a 10/1 ARM at 6.5%, so this refinance is definitely value add to me; (3) LTV on new loan is no greater than 80%, and I may need all of that 80% given current property values; (4) I am also interested in 7/1 and 10/1 ARMS but am finding that those rates look almost identical to the 30-year fixed.

UESResident, let me ask you, have you looked at other units w/in your price range. Maybe a desperate seller situation? Or maybe looking to do a 3 year lease w/ 2 one year options? Seems to me you are at a crossroads, it is at times like these financial geniuses re-look at everything... not just 50bps difference btwn arm and fixed... IMHO... well not so humble...

Take the 5/1.

ali

I think you're missing how much relatively cheaper that 30-year mortgage is, UESResident. According to bankrate.com, exactly 3 years ago the 5/1 jumbo ARM was at 6.45%, about 2.25% higher than 5-year treasuries. The 30-year fixed jumbo was at 6.91%, about 1.9% higher than 30-year treasuries. Today, you're looking at a 2.38% spread on the 5/1 ARM vs. a 0.96% spread on the 30-year fixed.

Of course, it takes some planning to monetize the relatively cheaper 30-year money depending on circumstances. Obviously, if you're going to sell in 5 years no matter what, profit or loss paid out of pocket, then the 5/1 ARM is the right choice. However, you should think through the possibilities if that's not the case.

Right now, the market is pricing 5-year treasuries at 1.37%, and you're getting dangled a 2.38% spread on top of that leaving you with a 3.75% rate on your 5/1 ARM. However, the market also is giving a price for what it expects the 5-year treasury rate to be 5 years from now: something in the 3.75% to 4.0% range. Let's call it 3.75% for the sake of argument. Assuming the future also puts a 2.25% spread on top of this for the future 5/1 ARM, the market is telling you that the 5/1 ARM in 5 years will be at 6%.

So, if you go with the 5/1 ARM, then you will be faced with one of two options in 5 years. The first option is that you keep the place for another 5 years and refinance with something like a 6% rate, or you just have the ARM track LIBOR + 2.25% or whatever, which still leaves you at 6% expectted since the market is putting future LIBOR at 3.75% or so expected. In that case, your 1% gain in the first 5 years will be offset by a 1.25% loss for the next 5 years. The second option is that you sell. Needless to say, if prices are where they are right now with 3.75% 5/1 ARMs, it might look a whole lot less pretty with 6% 5/1 ARMs.

I'm not saying you should definitely go with the 30-year fixed, but rather that you look at expectations (yours, as well as the market's) of where things are going to be in 5 years when the honeymoon period of the 5/1 ARM is over.

Spread analysis is not appropriate here. If treasuries represented cost of funds or an alternative investment then maybe...Dangling spreads to benchmark only makes you look smart..you might as well bring out OAS.

I don't understand why dangling irrelevant spreads would make a person look smart, RS. Perhaps you could provide us with your analysis, seeing how you have opinions on what is and is not appropriate in this circumstance. What do you think is representative of cost of funds for a lender if not treasuries?

Your quotes are off.

I was quoted (in the last 3 weeks):
1) 4.125, 7/1 jumbo, no points, no fees (just closer's "tip")
2) 3.375, 5/1 jumbo, no points

p.s. and instead of going through the bother of refi, ask your lender for a loan mod, I was also quoted the same 4.125 rate for a loan mod.

Was the huge difference between the 5/1 and the 7/1 just because of the fees? How big were the fees?

Typo no fees for 5/1 either, just the tip.

Got it. My initial thought was that the difference was nutty, but it looks like there's a 0.65% rate differential between 5-year and 7-year treasuries as well (1.37% vs. 2.01%).

Still think treasuries are not appropriate, RS?

@NYC10023 - where did you get that rate? and was it for condo or co-op?

We are about to refi through citi - $488k of $700k valuation (valuation was done last week).
725 credit rating on $240k income

its for 2 co-join apts in a small 8 apartment brownstone.

Best rate we've been offered is 4.55%

If i'm missing something then i'd love to hear where i should be looking.