Would a 7 arm mortgage work in thus economy

Question

My bank said that a 7 arm rate would work very good for me.  The rate is 6.8 now and will stay the same for 7 years then it will change every year based on the rates.  What is your opinion on this? I already have a house this would be a 2nd home. It's less then 90 miles from my property so they can't use a 2nd house. It's only 65k and the closing cost is over 7k.

Jack Tulloch · Answer

Hey Zach - I think Doug hit the nail on the head, it really depends on your goals and strategy.

Doug Smith · Answer

There are a couple of things in your post of note.

ARMS AND INVESTING: Most of the newer investors that we get are fixated on doing a 30 year fixed product, but the more savvy investors do opt for a 5/6 or a 7/6 ARM where the rate is fixed for the first number and then it adjusts every 6 months after that. It depends on the rate difference between the fixed and ARM rate and where the break even lies. For instance, if the 5/6 ARM rate is 0.25% less than the fixed rate, then over that 5 year period, in basic terms (yes, I know, the calculation is much more complex than this), you've saved 1.25% over that 5 year period. Then, you'll have to make an assumption as to where that rate will be for year 6 and beyond. Most investors don't plan on holding the property much past 5-8 years, so the ARM makes sense. If you think rates will drop, the ARM makes sense. The same thought process goes into choosing prepayment penalties. Many rental lenders will give you a better rate if you'll add a prepay. If you are holding the property as a rental for less than a couple years anyway, you probably shouldn't be getting a long term loan. A short prepayment penalty might offer a discount that makes sense for an investor. You just have to do that math.

BANKS AND INTEREST RATE RISK: Banks and Lenders like us have a different source of capital to lend. Neither is necessarily better...they are just structured differently. We get our money from longer-term Wall Street investors, so our rates are tied to the bond market, particularly the Treasury (watch the 10-Year Treasury...rates will move in that direction). A bank, on the other hand, gets their money from depositors and from short-term borrowing from the Fed, so they are quite rate sensitive after a loan is made. That is why they want to go variable later in the term or even, more commonly, balloon the loan at 5 years. I will tell you that the 6.8% for a 7 year ARM isn't bad at this moment. They aren't taking advantage of you with that rate.

CLOSINGS COSTS: I can't say whether or not the closing costs are high without seeing the breakdown of those costs. They will usually issue an estimate of those costs...if not, ask for one. A lot of those "costs" might be in transfer taxes, title costs, insurance costs, prepaying the escrow for taxes and insurance, and other costs that you're going to have anyway whether you borrow or pay cash. Watch the fees like the origination fee, discount fee, underwriting fee, processing fee and other "junk fees" that go into the bank's pocket. I'm not saying they shouldn't charge them. We do it too. I have to pay my staff and my processor gets paid on a per-file basis. No one goes into business to break even. They are providing you a valuable service and deserve to be compensated, but see if those fees make sense. Here's the kicker for a $65K loan. That's a super small loan. I won't do loans below $100K because when you charge a fee on a percentage basis, the dollars and cents that we're actually getting might not be enough for us to make sense doing the loan. 1% of $65K is only $650 where 1% of $300K is $3000. I wouldn't get stuck on the percentages for a small loan like that as much as I would look at the reasonableness of the fees in dollars and sense.

I hope that helps a bit. Good luck to you with your project.

Eric Mcginn · Answer

Great advice above. I’m about to close @8.65% so your 6.8 sounds pretty great to me! Rates are a bit high now so not going with a 30 year fixed might be a good idea if it saves a little $ now.

Zackery Smith · Answer

@Doug Smith wow that was such a good response! 5 starts to you!

Would a 7 arm mortgage work in thus economy

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