10-year ARM vs. 30-year fixed on a coop

option 1.

I would go with Option 1 too

I like option 1

See if you can find an ARM with a lower cap on the rate.

Are you sure the co-op allows ARMs?

I've been quoted with the same for 10/1 ARM and same % deposit. I've decided to go with that option as well... 65 bps is significant. I would have enough money to pre-pay a good portion of the principal if rates do spike up significantly in 10 years and can afford to refinance at the higher rate at that point if necessary. I don't see myself living in the same apt for more than 10 years... self diagnosed case of ADD.

Why wouldn't a co-op allow an ARM?

unlimited subletting. option 2.

dc -- good catch. They indeed have unlimited subletting, albeit for a monthly fee projected at ~$300 for this unit. My calculation for ROI (with fixed mortgage) looks like this at year 10:

(4189-1370-1.25*(654+538)-126-1887*.25+.85*611-.15*500)*12/341521 = 4.13% annual return on equity

(4189=projected amortized rent, 1370=interest, 654+538=maintenance and sublet fee, 126=misc, 1887*.25=amortized depreciation recapture tax, 611=property appreciation, .15*500=amortized capital gain from appreciation that happened before I began subletting; 341K=projected equity at yr10).

Do these projections justify getting the fixed mortgage at the higher rate?

Option 1
Subletting is being a landlord but governed by the coop. Rules change.
You will be ready to move in 10 years and use the equity.

NYCMatt is correct on this. Coops would shy away from ARM's. Boards want certainty. The volatility in the market scares coops should rates ever rise. They do not want to worry about the cost of ownership increasing, oh except only when they want to raise the maintenance.

What a surprise, are you saying ARM is not even an option with coops? No bankers or mortgage brokers ever told me this (and my agent hasn't encountered this problem, either). Thanks!

Option 1

some coops. i have friends that had IO' for coops.. regretfully

"are you saying ARM is not even an option with coops? No bankers or mortgage brokers ever told me this (and my agent hasn't encountered this problem, either)."

They're going to encounter this problem more and more, as long as the economy remains on shaky (at best) legs.

he is just saying some boards don't like arm, understandable

but the thing is, the mortgage application process begins after board approval, so it doesn't matter at all

An ARM is just one of the items the Board weighs in its decision. Some have issue with Interest Only loans.
Our Board packages contain a copy of the loan application and Loan Commitment so it occurs before the Approval process.

I've never seen a oo-op that didn't require to see the loan application and commitment before the approval process. But even if a co-op would not require this before approval, a co-op always has to approve a co-op loan before the bank can move to fund. A document known as the recognition agreement has to be signed by the co-op,otherwise there's no loan. This holds true for co-op refinances. As far as getting an arm, it shows you may not intend to be there too long. I would say an arm is a minus in the approval process. Certainly an interest only one is.

Ellen Silverman
Licensed Real Estate Broker
Licensed Mortgage Broker

Are coops in GV really that restrictive? (Perhaps on Lower Fifth?) I think that they look at the whole financial package and there is rarely a hard restriction on ARMs. Obviously they take this into account when considering your application, but it's within the larger context.

"Are coops in GV really that restrictive? (Perhaps on Lower Fifth?"

LOLOL!!!

Are you kidding?

There is one co-op on Lower Fifth that I know of personally whose board *cough cough off the record* flatly turns down single divorced female applicants. I kid you not.

Yes, I'd have to apply for a loan first. Thanks.

OP is just over 30 years old who is buying a 1 br and will likely need more space before the 10yr ARM resets. If s/he is going to be rejected, it wouldn't be b/c of the 10yr ARM; a 5yr ARM could be an issue.

On a separate note, I would like to remind people that co-ops make up less than half of the sales in Manhattan for quite a few years now.

I've never heard of a co-op with unlimited sublets. I wouldn't expect that will last forever. Not to be rude, but based on the purchase price you've said it's not really a meaningful difference. Do yourself a favor (as well your fellow shareholders) and go for stability

Out of the dozens of coops I saw, at least 6-7 had unlimited subletting, and this coop had this policy since its conversion. Of course, you still must live there 2 years and there is a monthly fee which makes it less attractive to investors.

The interest rate makes a difference to the tune of $155/month (lower payment & more equity on the payment). If selling at 10 years, that's maybe ~10% of total ownership cost depending on market.

$155/month isn't going to make or break the vast majority of Manhattan buyers these days, but I still wouldn't voluntarily piss that amount away "as a favor to [my] fellow shareholders."

Besides, that extra cash will cover part of the following year's maintenance increase. See, it's a favor to the fellow shareholders after all!

"property appreciation" is half of your return on equity. Take that out and the ROE (even if you used average equity instead of future equity) is bad, and the cash-on-cash return (ROIC) is even worse (like 1.2%).

Asset prices are so high in this town that it's pretty hard to find a satisfactory return- people aren't living or buying here for the cash returns. They want to live in Manh or bet on asset appreciation. You can do far far better in other cities.

option 2, make one extra payment a year all towards principle and you will knock it out in 15, check for prepayment panalties. If you don't mind being a landlord, I would just rent it out the day you need more space or sell it. Even at 4% interest we are currently in a historic low, lock it in for as long as possible. We will never see these rates again...or at least until the next recession...

Is that 3.5% 10/1 ARM with no points? What bank? Citi is quoting much higher numbers on a similarly sized refi.

I see this board is as torn as I am. But the consensus seems to be:

Fixed:
+ Lock in historic low, longer-term stability, become a landlord later, slightly better odds of board approval.
- Expensive bet on unlikely stay beyond 10-13 years, subletting is not guaranteed & not really a great deal.

ARM:
+ Better deal when I hold 1-13 years; have the option to refi or prepay anytime (no fees) if I intend to stay longer.
- Worse when I keep >13 years if rates go up and I stay; long-term subletting may become impractical.

After all the thinking and building probabilistic financial models (which slightly favor ARM, but close to break even) I'm getting close to tossing a coin. I will check tomorrow at contract signing time where the rates are, and if it's still 65bps difference I'll get ARM. If it's 3.5 vs 4 I'll probably get fixed.

nyc_sport: Wells Fargo. Rates depend on many factors, I don't know about their refi options.

angeloz, Making "one extra payment a year" towards principal will not allow you to pay off a 30-year mortgage in 15 years. With a $500k loan, you'd have to kick in $15k a year to make that happen.

The verdict is in.

Today's rate quotes: 4.0% fixed, 3.375% 10yr ARM. Going with ARM. Change is inevitable, and the premium for trying to avoid it (by using fixed) is not justified for me. Subletting is a weak justification for fixed in a coop, which (like all coops) doesn't like it & could always change its rules. Betting on the certainties.

Thanks everyone for the invaluably insightful feedback!

Forgive my ignorance, but why would anyone want an ARM with historically low interest rates in the first place? Is there any possibility of them going anywhere but UP??

how's this, i know i will move in 7-10 years and in that timeframe I will be paying 1.125% per year lower interest rate. so on 1mm mortgage that is $11k per year or $110k for 10 years.

bec one has the option of not paying it when they do go up or reset

go with the 10/1. The amt difference in principal paid in plus the lower total overall payment per month over the next 10 yrs will more than suffice to pay the adjustment after the 10th. Also, you have the option to refi at that pt. Also, if life circumstances change and you had to sell, paying the lower rate within the next 10 yrs saved you a bundle.

Somebody might choose a 10-year ARM for the same reason other people pick 15-year fixed. Not everybody needs 30 years to pay down a mortgage. Lots of people won't be living in the same place for more than a decade.

What's funny is that I remember reading comments on here two years ago about how people were stupid for picking ARMs since rates had nowhere to go but up. Some shiny crystal balls there.

The fed has a huge incentive to keep rates low at the moment, and they've explicitly stated so. With mortgage rates rising, the marginal rate difference between risk free and mortgage rates will probably rise in lockstep, no?

Fking retards. A 10% delta on a 10/1 leveraged asset means huge swings to initial investment. Now I know if you put on your big financial brains you will understand what w67 is takingz about..... Go on find that big brain. Nope. It in that closet. Keep looking

I would do 30 year and try to buy down the rate. Interest rates may not stay this low forever and when they do I doubt you'd want to be exposed. Think about what happened to arm loans just 5 years ago

rate swing up will definitely affect the mtm of the apt, however what will happen to rents? I would imagine they would stay elevated since buying was not an option of catching a knife drop. If rents stayed high (they will have to since real estate taxes will undoubtedly stay high) then the gap down in apt prices will be mitigated. The lockstep movement in base rates will probably be a factor, but not to the point of devastation. Besides, on a 10/1 ARM, he has the option to pay the loan off in 10 yrs.

"however what will happen to rents?"

What the hell does that have to do with a co-op owner's ability to pay the mortgage?

they are simply a correlated movement- what does GDP/Unemplyment have to do with the ability to pay the mortgage? And your point is?

My worst-case plan is to prepay 25-50% of the remaining principal after 10 years, depending how much interest rates increase. To prepay any sooner, though, would reduce the benefit of the low rate & deductions.

just keep in mind... if you get a rejection from the board, you'll know why.

what of the chances of your staying more than 10 years? of interest rates skyrocketing? you should do sometime of weighted probability to see if 30-year fixed or 10 ARM makes sense and see which one you feel better with.

I think those people who took out ARM loans 5-7 years ago (before rates rose/they refinanced) wished they had made a safer/less greedy decision.

Tommy, 5-7 years ago was 2005-2007 - rates were much higher than they are today. So whoever took an ARM back then made out well. Probably paid 1 to 1.5% lower than 30yr over the past 5-7yrs and is able to refi w/ a 4.5% 30 yr today.

i guess i was referring to cheap(er) mortgages around 2000- after the tech bubble and then fed lowered rates, then they started rising in mid 2000's.

http://www.bankrate.com/brm/news/fed/fedchart.asp

if you had an arm, could you sleep if you knew rates had a high probability of skyrocketing. what about if you lost your job? supposed you were stuck in ur pad after 10-12 years.

Tommy -- all good questions. I did exactly what you said, a weighted probability model assuming the worst case (rates jump, ARM resets to upper limit of 8.375% after 10 years). Took everything into account -- sublet probabilities, tax implications, etc. On average, ARM wins even if it precludes me from subletting after it resets. Should I want to keep after 10 years, the initial monthly payments are low enough that I'll continue saving at a good rate, so partial repayment should be no problem after 10 years. Job-wise, I'm a highly demanded professional and not too worried about the job situation (was getting solicitations even during the recession trough). Given all these factors combined, I'm willing to take the higher risk w/ ARM.

"was getting solicitations even during the recession trough"

Yes, but will you continue getting "solicitations" at the same rate in 10 years once your looks have faded. ;)

LOL, brilliant!

Any value in holding a 30 yr fixed at 4% in 10 years when rates are higher? If you sell the apartment, the new buyer can assume your mortgage. How much value will that add to your apartment, if any?

I believe that only FHA mortgages are assumable.

We're in the process of refinancing and almost did an ARM as well.... But then Citi offered us a 30-year fixed loan with an interest-only option for the first 10 years. It's an interesting hybrid between an ARM and a fixed rate loan. This was through law firm private banking, so I'm not sure if it's available across the board. The rate we were quoted was 3.875% v. 3.5% for the 10 year I/O loan. To me, the 0.375% difference is worth it in case we're still there at the end of the 10th year. If in the 11th year, interest rates are significantly higher, we will not want to use our free cash to pay off a resetting mortgage.

lad -- sounds like you got a good deal. In my case, the difference was .625% so I went with ARM 10/1 @3.375. My plan is to prepay/"invest in the mortgage" over the next few years while economy is bad and other "risk free" investments aren't yielding much. After 10 years, sell or pay out half or all remaining principal depending on current rates.