Want to refinance: 7-year ARM, 30-year fixed, or 15-year fixed?

Question

We want to refinance; currently at 6% on a 30-year fixed. We are unsure how long we will be in the house but assuming at this time we will want to move within 7 to 10 years. We are offered a 3.75% variable (7-year ARM) with low closing costs. We have a relatively low mortgage (under 175k). I am the sole breadwinner and had originally thought to keep monthly costs low. However, I know in refinancing we will be paying off less of the principal. Would it be more advisable to do a 15-year fixed given how low the rates now are and try to pay it off more quickly? I realize of course our monthly payments will be higher. Or would I be just as well off by overpaying on the variable rate. Am I correct on assuming a 30-year fixed doesn't make sense if we plan to move within 7 to 10 years?

Much thanks for any advice.

Answer 1

I'd avoid that ARM like the plague because rates are lower than they've ever been, practically.

You stand to gain quite a bit better rate in a refinance (more than a percent). If your goal is a lower monthly payment, then going with a 30-year fixed at today's rates should save you a couple hundred a month on your payment.

If you want to knock the crud out of your principal you'll go for a 15-year. Getting one at 4.5% fixed you'll only be looking at $1,340 principal and interest per month. But once you get yourself into that, you're stuck paying at least that per month until it's done. With the 30-year you have the flexibility to pay about $400 less than that per month.

Again, stay away from the ARM. Interest rates have little place to go but up.

Answer 2

As the previous responders have said, throw out the ARM. Rates have nowhere to go but up, so it's far better to lock in stable cost-of-living with a fixed rate.

To choose between the 15 and 30-year, compare your monthly payments with both terms. Refinance to the one that won't push you beyond 30-35% of your monthly take-home pay. If it's too much of a stretch to get the 15-year, take the 30-year and just add an extra payment each year that goes just to principal if you want to build equity faster.

I've thought about refinancing too, but since I refinanced from 30-year to a 20-year mortgage in 2003,refinancing now would actually delay me in paying off my house.

Answer 3

Think about how long you want to stay in the house. If there are factors like work, quality of schools, size of your family that are going to lead you to move in less than 10 years, the ARM may be the best value. Study the loan carefully and understand what the ARM rate is tied to and how much can it go up per year.

If you a 7 year ARM at 3.75%, and the escalation in rate is capped at 1.00%/year, than in 10 years you're looking at a worst case scenario 6.75% rate -- not so shabby.

If you don't feel strongly about moving, go for the 30 year and use bi-weekly payments to pay down the principal on an accelerated basis. Bi-weekly takes 8-9 years off a 30 year loan. The problem with a 15 year loan is that you're going to have a high payment, and life events (sickness, job loss, overtime loss, etc) may force you to refinance to a higher rate loan down the line.

Don't use an ARM if you're in the house of your dreams.

Answer 4

First - Was it Hippocrates who suggested "do no ARM"? Perhaps not, but I say avoid them.

Now, as far as 15/30. It's curious that 20/25 isn't as common, and that banks won't write mortgages for any term. The way I look at it, if you have say 27 years left, take the rate of the 30 yr mortgage, but use 27 as the term, then calculate the payment with those numbers. This is the apples to apples way to calculate your savings. If you only look at the payment based on the 30 yr mortgage, the "savings" from where you are now is nonsense, but my term-adjusted payment takes care of that. After the refi, make the payment you calculated, the higher payment, not the one the bank gives you, now you've kept the same final payoff date. For those with 18 or fewer years left, the jump down to the 15 year mortgage may make sense.

Answer 5

Rule of thumb is - ARM is good if planning to sell or move out within the end of period. As average person in USA stays in a home for approx. 7 years, it is good to go with 7/1 ARM with low interest rate. Also, with most ARM plans, pretty much there is no penalty if you prepay the mortgage. However, if you liked the location a lot and do not want to move out in next 10 years at least, then it makes sense to go for 15 year fixed if you can bear the monthly payment or 30 year fixed if not. And, if you are going to 7/1 ARM then pay a little more to principal as much as you pay to 15 year fixed, then by the end of 7 years, you would have paid more than half of your mortgage and with remaining mortgage less than $80K ($175/2) and in that case, even if the interest rates go to 6%, they will make only few more dollars.

Answer 6

Personally I would avoid an ARM for that long of a time. Rates just seem likely to go up because they are so low, and your low rate (in my opinion) won't be low for long.

If you can afford the 15 year, go with that especially if 15 years is fewer than the number of years you have left. You should get a lower rate on a 15 year, which means more of your money is going towards your home instead of the borrower.

That also gives you to the option to rent out the home in 7 to 10 years instead of selling it. With the best case in your numbers, you would only have 5 years left on your mortgage, get someone else's rent money to help you pay the mortgage and after 5 years you keep all the rent (minus expenses) There are lots of nuances to being a landlord, so consider that part carefully, and it might not be something you are interested in.

I still personally lean heavily towards a 15 year fixed if you feel you can do it. I like the ability to budget for the long term and owning your home in 15 instead of 30 years seems like the way to do it.

Answer 7

Definitely stay away from the ARM. My suggestion would be go with the 30-yr fixed. That will help you keep your monthly payments lower than the 15-yr rate. But at the same time, if you feel more confident about your financial situation, then you could make extra payments for every year. It gives you flexibility to adjust your payments according to the monthly situation.