REFI Question - 15 Year Fixed or 5/1 ARM !

[NikD300]

Folks... Couldn't decide which is the way to go:

I am trying to refinance my mortgage and I was offered 2 options.

1. Keeping the current 15yrs fixed @ 4.75%, I can refi to a 0.25% points lower to 4.5%.
2. Go on a 5/1 ARM with 30 year duration, I can refi to 3.8%.

While the 5/1 ARM rate is very tempting, and considering my duration of the current home might be less than 5 year stay, does it still make sense to have 15Yr fixed (where I could pay my principle more aggressively) or take the 5/1 ARM option (I still can pay more as additional). Not sure taking a 5/1 from 15yr fixed is financially savvy move. I could afford either payment, how ever 5/1 would give lower payments.

Please advice. What is your take on this.

Regards,
NikD

[rajubiztech]

Folks... Couldn't decide which is the way to go:

I am trying to refinance my mortgage and I was offered 2 options.

1. Keeping the current 15yrs fixed, I can refi to a 0.25% points of 4.5%.
2. Go on a 5/1 ARM with 30 year duration, I can refi to 3.8%.

While the 5/1 ARM rate is very tempting, and considering my duration of the current home might be less than 5 year stay, does it still make sense to have 15Yr fixed (where I could pay my principle more aggressively) or take the 5/1 ARM option (I still can pay more as additional). Not sure taking a 5/1 from 15yr fixed is financially savvy move. I could afford either payment, how ever 5/1 would give lower payments.

Please advice. What is your take on this.

Regards,
NikD

The risk with 5/1 ARM is that, the rate will reset(every year rates are set based on the rates at that time) after 5 years and if you happen to stay in the same house for longer period and if the interest rates go up, you might end up paying more interest after intitial 5 year term.

[NikD300]

Hi raju...I understand the risk of the rate reset. I was more focused on the other unknown factors and more so on if its financially smart move to readjust the balance from a 15yr to 30yrs.

[rajubiztech]

Hi raju...I understand the risk of the rate reset. I was more focused on the other unknown factors and more so on if its financially smart move to readjust the balance from a 15yr to 30yrs.

Its financially smart move or not depends on how much money you will be able to make it with the difference of the lower payments. Since the interest rates are so low,most people think they can earn more with little risk than the interest payment.

[sanjosedesi]

Hi raju...I understand the risk of the rate reset. I was more focused on the other unknown factors and more so on if its financially smart move to readjust the balance from a 15yr to 30yrs.

What are the other unknown factors you can think of? Maybe they will work to your advantage.

#1. Check the ARM contract. Many of them have a balloon payment at the end of year 5 (when it resets). I think it depends on whether you are paying only interest or principal. If the contract has it, is that something you will be able to afford?
#2. What is the maximum percentage the rate can change by every year? The smaller it is the better. Again, check the contract. When I had a mortgage, this was 2.25 which I thought was high, but other people said it was not so bad.
#3. Assume that the market will not be to your liking for 2-3 years. So if the you are forced to make a call to refi or sell at 3 year mark (taking 2 years before reset), or forced to hold the 5/1 ARM until year 7 (taking 2 years after reset) ... how will your calculations look? Would they still show 5/1 to be better?

I do not see an issue with 15 or 30. If you sign up for 30, you can always pay more and get it out of your way faster.

[NikD300]

What are the other unknown factors you can think of? Maybe they will work to your advantage.

#1. Check the ARM contract. Many of them have a balloon payment at the end of year 5 (when it resets). I think it depends on whether you are paying only interest or principal. If the contract has it, is that something you will be able to afford?
#2. What is the maximum percentage the rate can change by every year? The smaller it is the better. Again, check the contract. When I had a mortgage, this was 2.25 which I thought was high, but other people said it was not so bad.
#3. Assume that the market will not be to your liking for 2-3 years. So if the you are forced to make a call to refi or sell at 3 year mark (taking 2 years before reset), or forced to hold the 5/1 ARM until year 7 (taking 2 years after reset) ... how will your calculations look? Would they still show 5/1 to be better?

I do not see an issue with 15 or 30. If you sign up for 30, you can always pay more and get it out of your way faster.

Nice summary Sanjoedesi. Yea, I do see a baloon payment as high as 5% jump at the end of 5/1 ARM. I guess this is way high than expected but I am seriously considering moving out of this house with in next 5 years (already spent 5+ in the same home). So, taking this into consideration, yes there is a risk factor that jumps up to 8+% at the end of rate reset.

I was more speculative of how the 15 vs 30 would play out as i saw the jump from 15 to 30 as backwards even though its lower payment on a 30yr.

[sanjosedesi]

I was more speculative of how the 15 vs 30 would play out as i saw the jump from 15 to 30 as backwards even though its lower payment on a 30yr.

I think you should compare fixed 15 vs fixed 30 rather than comparing against an ARM 30.
Only thing I can say about 30 vs 15 is that you have "locked in a right" to pay in 30, so if things go wrong, you can take a step back.
On the other hand, you are building equity at a much slower rate, but I guess you already know that.

[direstraits88]

I think you should compare fixed 15 vs fixed 30 rather than comparing against an ARM 30.
Only thing I can say about 30 vs 15 is that you have "locked in a right" to pay in 30, so if things go wrong, you can take a step back.
On the other hand, you are building equity at a much slower rate, but I guess you already know that.

Did you take closing cost into factor? IMO, if you are positive about moving in 5 years, then go with ARM. Your plan to move in 5 years is also speculative to some extent.. Your job/RE mkt are unknown factors.