It really disheartens me to see people go from some of the best kind of debt to have to some of the worst kind, at the worst possible time.
Someone over at Basically Money was planning to do a mortgage refinance from a 30-year fixed-rate at 5% to a 5/1 adjustable rate mortgage at 2.7%.
As I read this, some baby koalas were dismembered.
A 30-year fixed-rate mortgage at anything close to today's rates (5% counts as close) is a great inflation hedge, and it puts all of the interest rate risk on the lender (where it belongs). Adjustable-rate mortgages, on the other hand, do just that: they adjust with the market, which takes into account price rises due to inflation just by its nature.
The person asking the question already has the good mortgage, and is looking to trade it in for one that in most cases is not nearly as good. To boot, he's trading this good mortgage in at a time when mortgage rates are at multi-decade lows. Mortgage rates have almost no more downside, and plenty of upside.
He can come out ahead with this deal if he gets rid of the mortgage close to the time the teaser rate expires. Then he will have paid back the refinance costs (which, frankly, sound atrocious) and maybe saved a bit on interest. But if he holds on to it after the five years, the rate can float and sink with the market, and since the level now is somewhere between low tide and drought, it will do a lot more floating than sinking.
In short, if he holds on, he'll be really sorry that he has the ARM.
I and another user tried to explain this to him. I hope he listens. This could end up being a very expensive mistake.
Have you consider the possibility that this person only intends to stay in the house for 5 years?
If that was the case I would go with the 5/1 ARM over the 30-year fixed anytime.
Switching from 5% to 2.7% is almost 40% interest payment savings. This is a lot of money over 5 years.
Also your are likely relocate or decide to move to a bigger house during that time.
Serg, Tony: If he times the exit correctly, then yes, he can come out ahead. This assumes that he can find a seller at around five years, or refinance favorably at about that time. Doing either of these is far from a sure thing.
For my 7/1 I will go into losses only after ~11 years (worst case scenario)