Analysis on a 7-year ARM mortgage versus 30-year fixed mortgage

All,

Through a corporate relocation I have the opportunity to secure some extremely low interest rates on ARM products as follows:

7/1 ARM - 2.25%

10/1 ARM - 2.75%

I have no idea when my next relocation will be if ever as I am in my mid-40's and have relocated to corporate headquarters.  I am inclined to go with the 10/1 ARM as if I am here longer term and have to refinance it will be on my own with no buy down from my company.  Since rates are this low and not going much lower then this then it probably makes sense to lock it up for the extra 3 years.  When that refinancing day comes or if I move I won't see rates like this again.

I am borrowing $270,000.

Which does the forum recommend the 10/1 or 7/1?  I just found this forum and I have to make the decision with my lender today.


 
alumiu said:
All,

Through a corporate relocation I have the opportunity to secure some extremely low interest rates on ARM products as follows:

7/1 ARM - 2.25%

10/1 ARM - 2.75%

I have no idea when my next relocation will be if ever as I am in my mid-40's and have relocated to corporate headquarters.  I am inclined to go with the 10/1 ARM as if I am here longer term and have to refinance it will be on my own with no buy down from my company.  Since rates are this low and not going much lower then this then it probably makes sense to lock it up for the extra 3 years.  When that refinancing day comes or if I move I won't see rates like this again.

I am borrowing $270,000.

Which does the forum recommend the 10/1 or 7/1?  I just found this forum and I have to make the decision with my lender today.
Click to expand...
Your worst case scenario with the 7/1 ARM will have a breakeven with the 30-year fixed of around 10-11 years while the 10/1 ARM will have a breakeven of about 13-14 years.  The max rate for your 7/1 ARM can be 7.25% (start rate + 5%) and your max rate for your 10/1 ARM can be 7.75% (start rate + 5%). 
 
USCTrojanCPA,

Using your speadsheet I showed the 7/1 as upside down in year 8 if the loan interest rate jumped the maximum of 5%.  I am comparing the 10/1 ARM to the 7/1 ARM and have modified your spreadsheet as such.  I am not even looking at the 30 year fixed as an option as the best rate I had on that was 3.75%.  Longest period of time I have ever been in the same home is 12 years.

 

Attachments

  • 7-1 ARM vs 10-1 ARM.xlsx
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alumiu said:
USCTrojanCPA,

Using your speadsheet I showed the 7/1 as upside down in year 8 if the loan interest rate jumped the maximum of 5%.  I am comparing the 10/1 ARM to the 7/1 ARM and have modified your spreadsheet as such.  I am not even looking at the 30 year fixed as an option as the best rate I had on that was 3.75%.  Longest period of time I have ever been in the same home is 12 years.
Click to expand...
On your schedule, you are comparing a 7/1 ARM and 10/1 ARM so yes assuming the worst case the 7/1 ARM will have a breakeven in year 8 when comparing it to the 10/1 ARM.  The 10-11 year breakeven is when you compare the 7/1 ARM versus the 30-year fixed loan.  It comes down to how long you think you'll be in the home to determine which loan you go with. 
 
Here's the updated analysis with our current low rates...it assumes 25% down with 740+ FICO scores with a loan of $400k.  Breakeven using the worst case scenario is between year 9 and 10.
 

Attachments

  • 7 year ARM calculation.xlsx
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I have a question.  At the end of year 7, when the ARM can adjust.  How does the new payment get calculated? Can you explain in excel and plain english?

So assuming worst case scenariom 2/2/5

Initial Rate = 2.75%
Adjust to = 4.75%

And the principal that has been paid down from a 400,000 loan was 75,000 from years 1-7

Do you re-amortize over 30 yrs at 4.75% with a 325,000 balance?

 
From what I have seen.  You re-amortize the 325,000 over 23 years (30 minus the 7 years that have passed).  So payment would be 1,937

I have been playing with Martin's spreadsheets (mainly his 5 year one) to try and figure out what balance I would need to be at the end of the 5 year ARM term so that my payment would be lower than the 30 year fixed payment after my 5 year adjustment.

Since this is a spreadsheet I have saved I will give you these numbers:  For a 280k loan balance.  I would need a balance of $224,606 to have a lower payment after 5 years (assuming the rate jumps the full 2%) then the 30 year fixed payment of $1296.72


That is why that payment shock was huge for those Option ARM or Interest Only loans.  They went from paying interest or less than interest on a loan but now their payment is not only including principal and probably a higher rate but it was now based on a 25 year amortization (if 5 year Option ARM)
 
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