5 Reasons Why a 5 Year ARM Made Sense

By Stew

Last spring, my family and I made the commitment to purchase a home. Our new mortgage is a Adjustable Rate Mortgage that is scheduled to adjust in about five years. In my first post about this topic, many readers questioned the wisdom of getting a 5/1 ARM. The point that the readers made was solid: interest rates are at the lowest in years and likely the lowest that they will ever be, therefore, it follows that we should have locked in a 15 or 30 year rate. I understand the wisdom of that line of reasoning, yet we still chose to go with the 5/1 ARM.

Five reasons why we opted for an adjustable rate instead of long-term mortgage:

We need to save money now.

The primary motivator in moving away from our rental and purchasing a home was to save money every month on housing costs. We needed to reduce our monthly budget up front and the lower payment due to the ARM allowed us to qualify for the lowest interest rate possible. It is true that our payment will increase in five years, but we are fairly confident that we will be able to handle the adjustment at that time.

We want to pay down our balance.

A lower interest rate and a lower monthly payment means that it will be easier for us to pay down principle when we have extra money. From time to time, we will be able to send more money than is required by our minimum payment and at the end of five years, we hope to have a much lower balance with which to seek refinancing.

Our focus is on PMI.

Any of you who have taken a mortgage or refinance in recent years know that private mortgage insurance rates (or PMI) have gone through the roof. Our current PMI charge is more than $100 a month! When we get to 20% equity, the PMI charge drops off our loan, our goal is to make that happen as soon as possible by paying down principle. We will certainly qualify to remove PMI in five years meaning that even when the rate adjusts, our monthly payment will go down.

We will most likely move out before 5 years is up.

We have talked about two options for this property: sell or rent. We hope to move to a different home ( in this area) within five years. If we do not sell this place, it is highly likely that we will be able to move out and then offer this property as a rental. At minimum, we will have a higher mortgage payment, but we will be able to roll that added expense into our rental rates. The most likely scenario is that we will have to refinance anyway in order to get a mortgage suitable for rental properties.

The maximum rate is not too bad.

All of the other factors are mitigated by this provision in our loan: our rate can only go up a maximum of 2% over the life of the loan. So, relative to historic interest levels, we have locked in a pretty good rate.

I understand that many of you probably do not consider these reasons to be compelling and would have still opted to lock in a 15 or 30-year rate. We have taken a calculated risk based on our current v future cash flow and chosen savings in the short-term.

Matti Mattila


12 Responses (including trackbacks) to “5 Reasons Why a 5 Year ARM Made Sense”

  1. Bethany Says:

    I think sometimes we as people make decisions based on what’s right in our situation and to lookers from the outside it may look like an absolutely terrible decision! But I think your reasoning is solid. I just hope housing costs don’t go down more! My husband and I got similar flak when we decided to stop contributing to 401K, but when I took a solid look at predicting inflation 35 years from now, based on prices 35 years ago, it was obvious to us that we’d be better off using the money today to help us become more independent and self-sustaining, and to be able to access any liquid money that’s invested when we need to (as opposed to waiting until we’re old enough). I know too many people with enough sitting in their 401K to pay off their homes, but they still end up paying more in interest on their mortgage than they earn because they can’t touch the 401K money to pay it off.

  2. Gina Says:

    I agree w/Bethany … it seems to me that you made an educated decision. And the rate not going up more than 2% is not bad either.

    I took the “stop contributing to the 401k” route too. My company stopped matching contributions so I didn’t “leave money on the table.” We used that money to pay off our debt. Now that they are matching 2% and we are down to one debt, I’ve restarted it.

    Good post!

  3. Wendy Says:

    This all works IF you are diciplined and “life” doesn’t happen too frequently. People start off with the best of intentions, however, if they are not disciplined it can all go bad very quickly. Then “life” happens…the car breaks down, someone gets sick, a storm comes along, and then all the dicipline in the world cannot save you if you are not prepared. It all makes sense on paper but the success on this plan will be determined by how prepared you are for the unexpected.

  4. Stew Says:

    Exactly. The honest truth is that none of us can tell the future. We can only place our trust in the One who holds the future and make the best decision possible for today. “So do not worry about tomorrow; for tomorrow will care for itself. Each day has enough trouble of its own.” Matthew 6:34

  5. Holly Johnson Says:

    We just refinanced our house at 3.25% fixed for 15 years. Woohoo!

  6. Emily Says:

    Despite how much I agree with Dave Ramsey, I’ve never seen a reason not to do an ARM if you knew you were going to be out b4 the adjustment happened. I wouldn’t fault you at all. :)

  7. Moyo Says:

    Good one, good line of thinking. This definitely requires discipline. For many people it’s easier to just go with the flow after a while, rather than follow a carefully thought out plan.

    A calculated risk is always better than un-calculated risk that seems low.

  8. Jonathan Says:

    Still think you made a great decision buddy. It’s always hard to predict mortgage rate directions

  9. Money Says:

    Nice Post! Thanks for sharing this. I found your reasons reasonable enough. The most important thing is you have made a well educated decision.

    I like your boldness for taking a calculated risk.

  10. Andy Says:

    Are you sure the rate can only go up by 2% over the life of the loan? Usually, it’s 2% in an year, but 5% over the life of the loan.

  11. Drew @ EpicFinances.com Says:

    Usually these ARMS are 2% per adjustments to a maximum of 5%

    Furthermore there is usually a prepayment penalty of 3% of loan balance if you pay it off before a certain time. That means if you refinance or sell to quickly, you can suffer.

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