Monday, December 1, 2008

From Fixed To Variable - Smart or Stupid?

Great move
I recently decided to switch from a 30 year fixed mortgage to a variable 5/1 ARM. It does sound a little counter-intuitive since the variable rate ARM has been blamed for many of the current housing issues. So here was my thinking when making this call

Lower Payment
This was obviously a big component in the decision process. Due to the reduced rate with the ARM I could lower my monthly payment by about $300/month. $300/month is significant savings and could be used to pay down the mortgage or invest in the market.

New Term
My current mortgage was only 2 years old so even though I ended up increasing the overall term of my mortgage to 32 years - in the end I still came out ahead. Basically the higher rate on the 30 year fixed was going to cost me more in total interest compared to a 32 year mortgage at a lower rate. I used an amortization calculator from to figure out the total interest.

Closing Cost
The new loan has no closing cost. Yup - no out of pocket expense, which means my payment reduction is money in the pocket from day one. Generally, closing expenses are offset by the monthly reduction in loan payment amount and the borrower breaks positive over a period of time.

The Bad Part
There is the risk that rates will sky rocket in the next few years and I will be stuck with a 10/11% rate (the maximum cap on possible rate increases). Five years is a long time and a lot can happen in that time horizon - so in some sense this is a calculated risk.

As a business decision - it makes sense to borrow money at the lowest possible interest rate but at an emotional level can you live with the uncertainly of an ARM. That is a call you have to make!

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