4.99 to 2.25 ARM: Did I do the right thing?

Question

So, I just closed on my home, again, yesterday and started to doubt whether I actually made the right decision. Here is some of the back story.

I was moving cross country on military orders and stayed in a hotel until closing. I was ready to close on my home until the appraisal came back way under (VA Loan sometimes do this). So I sat in my little hotel room with wife, my new born, my 10 week old puppy and a UHaul parked outside trying to figure it all out. Luckily, I had the best realtor who actually allowed us ALL (yes, even my NOT potty-trained puppy) to move in with her. She quickly found us another home which we fell in love with although it was above our price range.

The deal was made and we got into our $150,000 house (plus the VA funding fee) with only $2,500 in closing costs. However, that stuck a big ol' 4.99% interest rate on my 30 year mortgage. I was paying over $600 in interest and under $200 in principle. This seemed like NONSENSE so I looked for alternatives. My wife and I quickly found a 2.25% 3-year ARM which is backed by the VA. This loan lowered our payments significantly and almost doubled our previous principle payments while reducing our interest payment by more than half!

Here's the catch. I had to take a few steps back. Or, I should say, 10,000 steps backwards. After paying for all the closing costs (Florida has ALOT) It turned out to be about $163,000. Although I do plan to sell within the next 3 years (military orders) I want to make sure I didn't make a terrible mistake by lowering my payments now just to save a few hundred dollars but increasing my total loan. Any advice?

I also want to know what anyone things about this if I do decide to keep it and rent it. Do I refinance it again to a 30 year? Is it safe to wait and see what the rates change too after the 3 year period. Please offer any advice. Thank you.

Rainiel De La Nuez · Answer

I went ahead and did a little bit of digging and pretty much came up with the following:

In 36 Months ( just before the 1st ARM adjustment) the two loans will reach the same amount.

At this point the loan can jump up to a max of 3.25 for another year. (still better than 4.99).

At year 5 it can jump up to a max of 4.25 for a year (still better than 4.99).

If i were to keep this loan and rent out the house for those few years then it seems to make sense. However, if I don't then I am just right back to where I started but saving some cash monthly. Thoughts?

Joel Owens · Answer

Purchase price going in. You look at the numbers today. Any number of factors can change the outcome in the future.

You want a deal to work going in not IF this,and this, and this happens . That is speculating and not investing.

Numbers work going in and the rest is icing on the cake if it happens and if not you hit your goals anyway.

It seems the primary reason you are buying is for a home for the family to live in so the investment portion seems like a much less important detail than the emotional component from what you have said so far.

Maybe just view this property as a happy family home purchase and then if you like the area once you live there look around for properties where you buy just off of investment from the additional cash flow with the low mortgage payment. Just do not over improve the house you live in. That is a clear way to lose money.

I get stuff all the time to replace windows on my house when nothing is wrong with the ones I have. They are older but wood and in great shape. Put the money to work in investments so that you build cash flow that grows over time.

You might want to look into investments with smaller amounts such as tax liens etc. Things to invest in so in case you are busy the burden doesn't fall on your wife to deal with an unruly tenant not paying the monthly rent etc. People underestimate how tough and stressful an impact that can have on a family dealing with a house rental with a tenant in it. That takes a special type of investor to deal with that day in and day out.

I have dealt with residential tenants before and it's not my thing.

Rainiel De La Nuez · Answer

@Joel Owens

Thank you for that response. I have one question for you. If by the time I go to rent the home I only owe $145,000 on the property instead of $163,000, do I now make that my new price on which to base that 1%-2% off of., or the original purchase price?

Joel Owens · Answer

If your family loves the house then that is a very important factor. You might put more value in financial and your wife is thinking emotionally for the happiness of the family etc.

In future years on an ARM if you see that rates are rising past the threshold of the ARM then you might want to refinance for a long term fixed rate at that time if you want to keep the property long term. The question would be if you do not live there does the property have a good rent ratio to hold onto? Typical minimum is 1% rent to sales price so if you paid 163,000 you want to see 1,630 a month rent. Most investors want 1.5 to 2% rent to purchase ratio. If this house would only rent for say 900 or something then really no cash flow there versus what you paid etc. Some areas and price points are meant to be home owner only and not many rentals because of what you can get per month for it.

It usually takes about at least 2% of the purchase price a year to properly maintain a property you live in.

I wouldn't really think of the house as much of an investment as a place to live. If you wanted equity growth buying in a new subdivision for phase zero where dirt lots are just being built with little to no houses tends to have the best pricing. By stage 4 when the subdivision is almost finished you tend to have the least equity gain buying then.

Rainiel De La Nuez · Answer

@Dax Gurr

Thank you for that advice. I do need to hear that! The main reason I posted this response is because I still have a day to cancel the whole transaction and pretend like it never happened. I guess I will hold what I go and hope for the best.

Rainiel De La Nuez · Answer

@Christopher Brainard

I extremely appreciate the solid advice. I did not consider the external economic factors that could easily throw my evaluation out the window. If there is an increase in interest rates within the next years (which is likely) then maybe my 4.99% will have been a better and significantly less volatile option for the long term. Thanks for that input.

I am assuming that you would have stuck it out with the higher rate for now and played it safe?

Dax Gurr · Answer

My advice is don't beat yourself up!  You made a solid decision based on what was available when you made it.  If you refinance it you will be playing closing costs again and will be even more under water.  Work on paying the principle down and don't look back.

Christopher Brainard · Answer

@Rainiel De La Nuez

The advice you seek greatly depends on what you plan to do five plus years from now.

If you plan to keep the house as a rental and move when you get relocated, the fixed rate would have been a much safer solution. Nobody knows when the rates will go up, but it will eventually happen and 30 years is a long time.

If you do sell within the next three years, you'll probably come out even, as you added the additional loan costs to the principal you need to pay down and your house will may be underwater (assuming you bought at market and there isn't crazy appreciation where you bought your house).  There is probably some sweet spot somewhere down the road where you come out ahead, but that depends on what happens with interest rates. If they stay low a long time and you take the money you save and use it to pay down the principal, you may have made an excellent choice.

My opinion is most people are better off with fixed rate loans. They're safe, easy to understand, and not reliant on external economic factors.

-Christopher

4.99 to 2.25 ARM: Did I do the right thing?

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