30-Year Fixed Mortgage Loan Or An Adjustable Rate Mortgage (ARM)?

What’s the one thing I’ve told you guys to study in the markets if nothing else? Forget? Well, let me remind you. The one thing you should always pay attention to is the US government long bond yield e.g. the 10-year US Treasury yield. Rates reached a low of around 1.6% in December, 2012 and now they are hovering at 2.35% in 2H2015. As you can see from the chart below, rates have been coming down for 30+ years and will likely continue to stay low thanks to the efficiency of information transfer.

10 Year Yield Historical Chart

From this simple chart, you will understand:

* The risk free rate of return

* Expectations on interest rates

* Expectations on inflation

* Borrowing/credit costs

* Risk aversion, or lack thereof

* The health of the world

That’s right. By understanding what the latest 10-year treasury means, you will be able to save a lot of money, make a lot of money, and stop being an bozo who just follows the heard and listens to whatever people tell you to do. Think for yourself!  

The tone of the article was inspired by a response from a “mortgage specialist” who wrote a book on mortgages. I received an e-mail from her asking me to promote her book. I congratulated her and mentioned I had just refinanced a 5/1 ARM at 2.625%.  Instead of responding in a normal way, she replied, “Oh, no! You can’t refinance to a fixed rate???? That sucks!” I couldn’t be more disappointed with her response and her subsequent reasoning. I fear for the public if people are reading her books. Refinancing to a 5/1 ARM was my choice.

I’m dismayed how people are paying more in mortgage interest than they have to. A large part of it is because the media and mortgage officers continue to push people to get as long a fixed rate mortgage as possible. In America, the longest conforming standard is 30 years.

Borrowing on the long end is a suboptimal use of funds. The people who are pushing you into 30-year fixed loans: 1) Are not economics majors or bond traders, but journalists, and/or 2) Have a vested interest in you borrowing as long as possible so they can make as much money off you as possible. The higher the rate, the easier it is for them to earn a wider spread.


* Upward sloping yield curve. It’s important to understand that due to the time value of money and inflation, the longer you borrow the higher your interest rate. If you borrow money from me today to pay me back tomorrow, I won’t charge you interest.  But, if you want to borrow money from me today, to pay back over the next 30 years, you better hell believe I’m going to charge you an interest rate above inflation to counteract inflation, make some money, and bake in some risk of default.

* Average length of stay. First of all, the average duration one lives in and owns a home is 7 years. If that’s the case, what on earth are you doing borrowing a 30-year fixed rate mortgage for? A 23 year + overestimation of ownership is a serious miscalculation based on the statistics at hand. With a 5/1 ARM, your underestimation is only 2 years, but you already have baked that in.

* Match fixed rate with length of stay. If you plan to live in your house for 10 years, take out a 10 year fixed rate (amortizing over 30 years) as the most conservative loan duration. A 10 year fixed rate is cheaper than a 20 year or 30 year fixed rate.  It is only logical that you match your mortgage fixed rate with your expected duration of stay. Sure, you might stay longer, but you might also stay shorter as well. If you know you plan to stay in your house forever, it’s more justifiable to take out a 30-year fixed, but I still wouldn’t because 1) You will likely pay down your loan faster than 30 years, and 2) The spreads are unjustly high in this environment.

* Adjustable rate loans have an interest rate cap. People think, thanks to fear mongering by the media and mortgage officers, that once the adjustable rate loan period is over, your mortgage rate will skyrocket and make things super unaffordable.  This is not the case because everything is relative and rates are capped. I’m refinancing to a 5/1 ARM at 2.625% with all fees included, and after 5 years, the interest rate can reset one time to a maximum of 7.25%. Whoopdee doo!  After 5 years, if I don’t pay any extra principal, my principal mortgage amount is about 10% less. A 7.25% mortgage rate on a 10% lower principal amount is very digestable.

* If rates rocket higher, you will be celebrating. Things don’t happen in a vacuum. The 10-year yield is a reflection of inflation expectations. If the 10-year yield, and therefore mortgage rates are skyrocketing, that means inflation expectations are at the very least skyrocketing. However, you don’t have inflation expectations going higher unless demand for real goods and services going higher. Higher demand is a reflection of a stronger economy, and your real assets (property), by very definition or inflating!  So what if inflation rises from 2% to 5%, causing your mortgage to reset to 7% due to the 2% spread?  If your home is now inflating by 5%, and you have a 80% loan-to-value ratio, your cash on cash return is going up by 25%!

* 35 years in a row of deflation. Look at the historical 10-year treasury yield. Rates have gone down for 35 years in a row.  That’s right folks. THIRTY FIVE YEARS! Are you telling me there’s no trend here? Are you saying that we are going to see massive inflation spikes on the way (which are fine as I just wrote) all of a sudden? In these 30 years, we’ve become a much more efficient society who enacts monetary and fiscal policy in anticipation or with shorter lead times. Yes, there will be occasional upward blips in pricing, but I highly doubt there will be a 5-10 year continuous ramp in inflation, which means your 5-10 year ARM is just fine.


Insurance salesmen and mortgage officers are very skilled at evoking fear. They will paint worst case scenarios of super inflation and crushing payments so you can pay more money now than you should. Have a 30-year fixed provides a great peace of mind that your payments will never go up.  In fact, your real payments will actually go down over time given you will be paying back a fixed loan with ever depreciating dollars thanks to deflation. The question is, at what price is this worth?

Given you know the yield curve is upward sloping, you must study the spreads between each borrowing point. A 30-year fixed loan is currently around 4% vs. 2.625% for a 5/1 arm. Let’s say you borrow $1 million, the ideal mortgage amount. $1 million X 1.375% = $13,750 more in interest expense you will have to pay every year for the length of ownership.  If the average length of ownership is 7 years, that’s $96,250 more in interest expense you would have paid if you borrowed at 30 years.  If interest rates stayed the same (not down as it has for the past 30 years), then you would have paid over $420,000 more in interest during the lifetime of the 30 year fixed loan! That is just ridiculous. However, if your peace of mind is worth $96,250 or $420,000, and you can’t handle the reality of economics, don’t know your options, and don’t believe in yourself, then why not.

BenGenie has telegraphed the Fed Funds rate will stay at current levels until end of 2014. I believe him, and so should you.  Signaling low rates helps businesses invest and consumers to spend again without fear of getting railroaded.  It’s the same thing with taxes, which is why the sceptre of increasing taxes is not a good thing. If I could borrow at a 1 month floating for the next 2 years at 1.625%, I would! Alas, I can’t find a bank to loan me this type of mortgage.

The next time someone is hawking you a 30-year fixed ask them: 1) What their major was in college or grad school, 2) How many times have they refinanced before, 3) Quiz them on what the current 10-year treasury yield is, 4) Where was the 10-year treasury yield 10, 20, and 30 years ago, 5) If they are a homeowner, 6) How much more are they going to make off you.  Finally, refinancing now to a 30-year fixed from an existing 30-year fixed is a good option.  Refinancing to a 30-year fixed is just a sub-optimal good option vs. borrowing on the shorter part of the yield curve. Both are good options vs. not refinancing.

Addendum: Please not there is a BIG difference between a negative amortization loan and a adjustable rate mortgage like the ones I’m referring to here.  A Neg Am loan causes your principal to grow larger every month because it is by definition, negatively amortizing.  The Neg Am loan generally is only fixed for one year and a teaser low rate.  Hence, you have a lower than market rate + a payment that’s based on a lower amount that gets added to the principal.  This is where people get in trouble.  People who have normal ARMs have not been getting in trouble because when their ARM floats, their rates are LOWER than when they first locked!  Please understand this point.


* Shop Around For A Mortgage: LendingTree Mortgage offers some of the lowest refinance rates today because they have a huge network of lenders to pull from. If you’re looking to buy a new home, get a HELOC, or refinance your existing mortgage, consider using LendingTree to get multiple offer comparisons in a matter of minutes. The Fed is signaling interest rate hikes by 2016 due to inflationary pressures now. When banks compete, you win.

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Updated 2H2015

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship. Sam focuses on helping readers build more income in real estate, investing, entrepreneurship, and alternative investments in order to achieve financial independence sooner, rather than later.

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  1. Adam says

    Sam when I stumbled on this article I did not believe you either since it goes against everything we’ve been told over the years, “LOCK IN THESE RATES NOOOWZZ!!”

    But I did the math for myself; and even taking account rolling all costing costs and points into the refinance; I would still come out AHEAD by at least 10% on principal after 5 years AND my worst case rate increase monthly payment would be LESS than what it is now.

    The math just blew my socks off and I’m going to refinance from a 3.75 30 year fixed to a 1% APR. Infact going to refinance all my properties to 5/1 ARMs.

    This is one of those things where I need to tell all my friends and families about.

    • says

      The beauty is, you may not even have to refinance and let your rate float at current levels. A 3.75% 30 year fixed ain’t bad, but if you can get a 1% APR, then wow… very tempting!

      Doing the math always makes a lot of sense. Too much blind faith. Good luck!

  2. Tony says

    Sam, I am on a 5/1 arm, 3% right now. I know the FED is byung the MBS now and probably will keep doing it for a while. How long this will last I don’t know. At the best the rate will stay low to the end of 2014? I am planing to stay at this new house for 10+ years. Wouldn’t it better off to lock in a 30 year fix rate while the morrtage rate stay in this kind of historical low? I am thinking there is more room or chance for the rate to go up than down now. what’s your suggestion?

  3. Moshennik says

    I was trying to do a Monte Carlo simulation for 7/1 ARM vs 30 fixed and stumbled upon your blog.
    Awesome read, btw, thank you!
    Your thinking is basically in line with my gut fill, but I was going to do some modeling to justify my choice.
    Basically, we are buying a place for 1.4M, 20% down. Two options 7/1ARM @2.5% or 30 fixed @3.5%. In both cases fractional negative points. The cap on the arm is 7.5% and maximum annual increase is 2%.
    The largest unknown is variance in LIBOR, I was thinking about using historical data, however not sure if it’s appropriate.
    Anyway, I am pretty much set with 7/1ARM for now, my rate is locked, reading your article adds a bit to my confidence level lol.

  4. HJ says

    Thank you very much for the interesting, yet very informative discussion. I just found this website yesterday night, couldn’t stop reading it.

    I am a first home buyer and in the process of buying a condo (loft). As I expecting to buy another house (with yard) before 7 years, I started to consider 7/1 ARM (370K purchase price, 30% down, 3% interest). I did math, got the number, no brainier that 7/1 ARM is the winner.

    Now I have to think about exit strategies after 7 years. I can always sell, but what if I want to keep it longer than 7 years? We know the interest rate wouldn’t stay in this low level forever. In fact, it already started to go up. My question is what would you do, when the interest rate is probably/significantly up in six years? What kind options should I prepare in my mind?

    • says

      HJ, welcome to my site. If interest rates are “significantly up” that also means the economy and likely your house’s value is also significantly up. Nothing happens in a vacuum.

      In 7 years, you have less principal to pay when your rate resets. You can rent out your place for much more than now, or you can sell. Not bad options. Sam

      • PS94555 says

        Hi Sam
        Love your articles. When you say the interest rates are high then home prices will be likely high – this seems counterintuitive because affordability will also be low and house price will either go down or stay stagnant. Please advise given current real estate market in 2015 in Bay Area. 10/1 vs 30yr interest rate delta is 0.5% or $160 per month.

  5. bruinmax says

    Hi Sam,

    I’m not sure you’ll red this as it is an old posting but I m hoping to gain some wisdom from you.

    I will fully disclose that I am fairly ignorant when it comes to financial & economic matters (I am not proud of that.) My husband and I are buying our first place. Purchase price will be about 545K (when we finalize upgrades; new construction) with 20K down (about 3.6%) and are trying to decide between a 5/1 ARM or 30 fixed. The 5/1 ARM will have a rate of 3.25% and the fixed 4.25%, so if we take the ARM we will save about $230 a month. The ARM has a cap of 5% and will go up 1%per year after the 5th year.

    I will say that I am freaked out at the thought of the “instability” of the ARM and, being a pessimist, assume that rates will continue to go up and up and we wont be able to afford our payment after the 6th or 7th year. We are planning to be there for 5 or 10 years (though you never know what will happen.) I read on another blog that what you save with the ARM you lose in closing costs should you refinance into a 30 year, which does seem like a good point.

    Our mortgage officer advised us to go for the ARM bc of the lower rates but, frankly, I don’t know that I trust her bc,….well……she works for the bank.

    Do you think the ARM is a better option?

    • says

      The 1% rate difference is significantly large. Calculate 5 years worth of dollar savings. You basically have 5 years at a 5.25% rate before the 5/1 ARM is not the ideal option. If you are only going to stay for 10 years then I would take the 5/1 ARM. You don’t have to refi at the end of 5 years and can let it float.

      You’ll have paid down some interest too. I don’t think rates are going to rise by more than 2% during this time.

  6. Daniel says

    Hi Sam,

    Thank you for the post – it certainly does challenge the conventional way of thinking! Our situation is a bit different though – we are past the 5-year period on our ARM and have been enjoying decreased rates, but now moving to a new place and intend on keeping this as a rental for a while, so to keep the cash flow more predictable and avoid yearly adjustments, considering converting to fixed, which would be 3.875 for 15 or 4.5 for 30. The current rate is 3% with a 2% annual increase and 10.25% lifetime rate caps. Would you still hold on to the ARM when there is a lot more upredictability than in a “lock for 5 years, sell in 5-7 years” scenario?

  7. Shaun says

    I’m actually shopping for a mortgage for my first place right now and came across this. I very much agree with you and I was leaning towards the fixed rate coming in.

    Something I hadn’t considered is if you assume mortgage rates continue their 30 year decline or stay low then I don’t see how anybody could argue the higher fixed rate is the better option since you’d always be paying a higher interest rate which makes the math easy.

    At 5 years would it make sense to refinance into another ARM if interest rates were still low or let it ride? Would it make sense to extend the terms back to 30 years and lower your payments since what’s the point of paying back the loan faster with such low interest rates?

    • says

      The answer can only be given at the end of the 5th year. I have kept refinancing into another 5-year fixed rate at no cost. My main rental property mortgage is so low now that I can’t bake in the costs anymore, and I will probably let it float.

      Depends on how much longer you plan to stay and your income outlook.

  8. Julio says

    I currently have a mortgage 3/1 ARM at 2.5% with the cap of 7% and can’t increase over 1% annual. I received a proposal from a bank to fix the rate to 4.5% on a 30 year loan. Do you recommend to go to the fix or stay? Any recommendations?

  9. Marko says


    Great post. I came across your blog as my mortgage officer wants me to refinance. Hope you help me with an advice. I bought a new house in Boston, MA for $800,000 two months ago. I put 20% down and took a 30 year fixed mortgage for $640,000. My mortgage officerr wants me now to re-finance to 5/1 ARM amortized over 30 years with the initial rate of 3.25% for the first 5 years. The amortication rate is linked to LIBOR index + 2.25 margin. It’s a 2/2/5 loan- meaning, the year 6, the rate can go to max of 5.25%. Than, at year 7, the max is 7.25%, and than 8.25% max for the rest of the loan duration. Do you think I should refinane? I plan to stay in this home for long time (it’s my primary and only residence), and I plan to put that extra ~$400 (difference between the ARM and the fixed rate) as extra payment each month twd the principal. Plus, I should also be able to afford to put another ~$800 on top of that (so, it’s $1,200 extra each month twd the principal). Do you think I should refinance? I fully follow your logic and it makes lots of sense to me- the only thing is what if the LIBOR rate doesn’t go down as it was down for the past 30 years.. I mean, the current LIBOR rate is at historical low (~0.35%), so it has no way but to go up from here.. or maybe you thing that it stay the same or even go down even more- please HELP:)!

    • says

      May I ask why the mortgage officer is asking you to refinance just two months AFTER you got the loan? Why didn’t s/he advise you then? Rates are higher now than 2 months ago. Seems opportunistic to me to try and make more money off you.

      I’m not afraid of rocketing rates. We already went from 1.6% to 3% in the past 16 months. I think the biggest move is over.

      • Marko says

        Don’t know why the morgage officer didn’t mention ARM earlier. I guess I just asked him abouth fixed at that time and we never really appoached the subject. Than, I started reading some blogs that talk about ARM and how they are making a comeback etc., and so, I called my mortgage officer again, and I ask him what would his recomendation be and he says go with ARM, the rates are great etc and youl will always be able to re-finance ie he doesn’t think it will go up… And so, here is my dilema now: go with the ARM at 3.25% or stick with 4.5%? Worth mentioning is that there is no closing cost and no points with these rates ie I always go with no points and no closing cost when I refinance (understand that I get slightly higher rate that way, but still I wasn’t able to find any better rate these days than 3.25% ARM even if I am to pay extra for closing costs..). Anyway, you think rates will not go up in 5 years or…? All I need is the first 5 years, and than being able to refinance at the same rate (or close to) or the next 5- meaning after those 10 years, I would have been very close to paying my mortgage in full as I am putting always another $1,200 more into the principal all the time ie each month. So, what do you say?

  10. Marko says

    Don’t know why he didn’t suggested ARM 2 months ago. I guess we never approached the topic as I’ve been always doing fixed and never asked for ARM. It’s only after I started reading more about it in the last 2 months that I asked him about the recomendation between the two and he said go with ARM… He also said, like you, that he doesn’t think the rates will go up.. So, you think I should go with ARM, or..? I don’t know, it’s killing me right now to make this decision:)- I have all paperwork for the refinance signed at my home and ready to go via FedEX but for some reason can’t seem to be able to make that final push:):)- it’s always the question what if what if it goes up that comes to me (and yeas – I understand what you’re saying about better economy and inflation and better rates at savings/ CD etc accounts in that case, but still…)..

    • says

      Weird. Well, if all the costs are baked in, I’d rather pay 3.25% for 5 years than 4.5% for 5 years. I don’t think rates will be much higher in 5 years. If they are, you have 5 years of savings on paying less in the bank, and your house probably inflated much higher too.

      • Marko says

        I wonder if anyone has done a MonteCarlo analysis or something like that to tell us from a probability vs risk perspective what the odds are that the rate will go up/down (and by how much) or will it stay the same based on the historicals. It all comes down to a probability of success/ or loss at a certain risk. Haven’t been able to find anyone that have done such an analysis online- I would expect that someone must have done it…

  11. kate says

    Eye opening article and great discussion here. We are under contract on a house, and my gut too,was thinking 30 yr but was still seriously looking into the 7/1. I’m so glad I found this article. I have since looked at the 5/1 as well. Rates quoted to me: 30 yr 4.125%, 7/1 3.125%, 5/1 2.5%. High closing costs but paid by seller at close. Payment difference $300, $180 respectively bt 1st 2 options and 2nd 2 options. After reading this article, that 5/1 is looking fantastic- almost $6K savings per yr! We do plan on being in the home for a while – definately 7, and hopefully many more yrs. I do feel like our income level will be higher in those years than now. I must add that I do not intend on putting the extra savings back toward paying down the house. I feel like that’s silly (but I am not as schooled as most of you here, so I could be wrong) at such low borrowing costs. Also because I flip houses on the side and could put the $$ there instead. I do believe rates are going higher and will sit in the 5% range starting sometime in 2014 for the duration. So, with that said, and the fact that I DO NOT intend on putting the extra savings back toward paying down the house, is it still wise to do the 5 or 7 and if so, which one given the spreads? Advice welcome…..

    (it is worth mentioning that about 2 yrs ago I FRETTED about our 5/1 ARM coming up as adjustable on our old home that we now have as an unplanned rental due to the market/being underwater/not selling. I was freaking out. Low and behold we let it go adjustable, and guess what, I’ve enjoyed what I think is 2% rates for almost 24 mos so far. In THAT case, I am actively paying down that loan with the savings I’m enjoying only bc we are underwater and I want to get it to a point where it’s at least break even or better, so that I can refi or sell before int rates go up too much. And, incidentally, I am kicking myself on refi’g our other 2 rental properties 2 OTHER TIMES to 30 yr fixed during this time, only to see interest rates at historic lows during the period)

  12. Shabnam Zaidi says

    Hi Financial Samurai-

    I am pretty impressed by your initial article. I am in a fix right now, I would like you to help me.

    I have a mortgage of $495,000 at a 3% adjustable (i had it for 7 year arm in 2005)). My arm currently is at 3% since interest rates went down. The arm is expiring in March of 2014.
    My interest rate can go up to 9% max (initial interest rate +5%).

    I am not sure how long I will live in the house, in next 6 years my youngest will be going to college, I do feel we would then like to move into a smaller house but you never know, I want to keep my options open. I do want to pay most of my mortgage by the time I sell the house so I can build equity and retire with more cash.

    I am now looking to refinancing…as interest rates are going up and I missed getting it done around Sept Oct of last year when the rates were lower.

    When I look at the 30 yr fixed, I am getting a 4.625% on a jumbo conforming. 5/1 arm is 3.625 and 7/1 offered is at 4.0%. The 15 year at 3.75.

    When i look the interest I will pay for the life of the loan, there is a significant difference in the interest we will pay in refi for 15 year fixed verses again a 30 year…. The total interest paid for next 30 year with 4.625% apr is approx 430,000 and for 15 year fixed is approx 160,000.
    Since I have almost lived in the house of 10 years my term has reduced and so is my mortgage principal, now when i plan to refi, its going back to 30 year which means the loan will be paid of in techically 40 years since originiation.

    What can happen if i don’t refinance? What is the worst that can happen year after year…?

    The 15 year is scary a bit as the P and I will high for that.

    Should i take another 5/1…

    the problem with again going with an arm is the interest rate is NOT very low (3.725), and i may be in the same situation after 5 years. Plus when you refi you do pay some cost …that too will be there.

    I just cannot figure out what I should do….

  13. Sleeping Easy In Seattle says

    Hey Samurai:
    Thanks for the information. We’re looking at buying a $750K new construction here in Seattle this month (more house than we need, but it’s sweet), and we’re going to forego the 30-year fixed and go with a 7-year ARM based on your information. Makes complete sense to me, considering my wife and I have moved 3 times in 4 years :) We make over $250K annual household income, so we’re pretty well protected if we stay 7+ years, and rates increase.

    I have another question. We currently own a condo in Chicago – we just paid off a second mortgage a year ago (7.5% rate) and refinanced our primary (5.25% rate) at the same time – we did a 30-year fixed at 3.875% (I didn’t read your blog soon enough, don’t comment on that please). Our payments are roughly $1800 a month, and we’re getting $2000 in rental income. We pay about $5000 in taxes a year. My question is – do we sell it this spring (at a loss, bought it in the height of the 2007 market, will expect to lose roughly $50K), or do we keep it as a rental property, and manage it remotely? That last point doesn’t worry me as my work takes me to Chicago at least quarterly, the property is managed by a HOA group, and I have maintenance folks on call.

    I appreciate your thoughts…

  14. Helen Chambers says

    Advice sought: I purchased my $198,000 condo with 20% down when I was working in business and had a decent salary. The loan I selected was a 5 year ARM at 3.75% and it has since adjusted downward. It can never be adjusted more than 2% a year, and is capped at 8.75%. At the time I also took out a 104,000 equity line of credit. The interest for that is prime rate minus .5. I used the line of credit to finance a career change to teaching (year off going back to school), and to supplement a significantly lower salary for many sequential years. My cash flow has since improved (I make about $70000 now between the salary and a roommate’s income, ) but I will need to pay off the 104,000 beginning April 2015 (over five years); my mortgage at that time will be about $125,000. My condo is probably worth about 275,000 at this point.

    I’ve been running the numbers and am leaning to keeping everything I have in place, and just figuring out how to make that equity line of credit payment. I look at it as forced savings. My question is would this be too risky? Should I go to the bank as quickly as I can now and refinance both loans into the 30 year 4% that would be a safe bet to pay…. but MUCH more expensive over the long run.

  15. Helen says

    Additional info: My ARM rate is currently 2.875 (adjusting every April). I do plan to stay in the condo for at least another 10 years, and would probably then rent it when I move out of the area.

  16. Pk2538 says

    Hi Samurai,

    My wife and I have a contract on an investment property (Foreclosure). We paid $136,500 for the single family home and are putting 25% down, which put our principal on the loan at $102,000. Wondering if it makes sense to go the route of a 30-year fixed (4.6% interest) or a 5/1 ARM (3.375%). Closing costs are essentially the same $3000 vs $2800. There are minor repairs to do before putting the property up for rent. Current rent for similar homes in the area are falling in the $1300 – $1500/Month range. we plan on owning the property for at least 10 years and are looking to essentially just build equity. Your thoughts on what might be the best financing option?

    Thanks for your help in advance!

  17. Larry says

    I am 75 years old and I purchased a condo for $180000 cash. I need to cash refinance $100000.
    I plan to stay in the condo for the rest of my life or if I go into assisted living. I want to pick a mortgage plan with a low payment. Would a seven or ten year ARM be my choice?

  18. Gwen says

    Hi Samurai, looks like you haven’t responded to comments in this post for some time, but I’ll give it a try. I’m buying a house for 1.1M which I plan to stay in until my kids go off to college (my youngest is 3…so I have some time). Putting 80% down, so getting a mortgage for $880K. I could go for the 30 year fixed at 4.25% or the 7/1 ARM 5/2/5 LIBOR rates with 2.25 margin at 3.125%. The ARM will net me a savings of almost $50,000 over the course of the 7 years if I pay what’s due. My biggest concern is that the 1 yr LIBOR rate is at .535 right now. How much lower can it go before it starts to climb. It has to “normalize” at some point, doesn’t it? I’m worried that as my 7 years draws near, interest rates will be on the move back up. What do you think is my best option, considering I will be in this home for about 15-20 years? Thanks in advance!

  19. says

    It amazes me how turned off people are of ARM loans. I recently refinanced out of a 30 year 3.75% fixed rate mortgage that was an FHA loan with PMI ($370/month) and into a 5/5 arm with no PMI.

    The fixed rate on my new ARM for the first 5 years is 3.675% with no PMI. So I am spending about $430 less a month.

    Like you mentioned in the post above, not only are rates at all time lows, I expect they will remain low for sometime. You look at Japan that has essentially had zero % interest rate for over 20 years now. The central banks around the world have embarked on an experiment that is unprecedented and its going to be hard for interest rates to rise.

    Even if they do rise, like you said I have a cap that allows the interest rate to adjust 1-time every 5 years for a maximum of 2% up or down and a lifetime cap of 5%. So even in the worst case scenario I would be looking at 8.675%. The worst case scenario isn’t that bad. It ends up averaging out to be pretty close to my original loan.

    I don’t actually plan to keep the loan for 30 years anyways. I have a plan to pay off my mortgage in the next 7 years.

    So many people I talked too couldn’t believe or understand why I would go from a fixed rate to and adjustable rate. The savings in PMI was worth it alone, especially since the ability to write that off as a tax deduction was only extended through 2014.


  20. Investment nomad says

    I’m not making any predictions where interest rates are going – because no one can predict the future. You can make arguments for rates to go either way – but it boils down to this:

    With a fixed rate mortgage – if rates drop – you can refi. If rates go up, your cost is fixed. All the risk is transferred onto the lender – which is why banks try to get the vast majority of these loans off their books as soon as the ink is dry!

    With an ARM – if rates stay flat or drop – you save on interest vs. a fixed rate loan. If rates go up, your costs will go up – the question is how much. Look at the last 30 years of interest rates to see how much things can change in 30 years.

    Everything boils down to one question – can your budget handle higher rates? What if rates double? What if rates triple? Do you have a flexible budget that could handle these scenarios? Or do you have little wiggle room?

    ARMs are particularly attractive for people on tight budgets because they see that lower payment – meanwhile – those are the same types of people that will get crushed if rates go against them. Don’t expose yourself to risks that you can’t handle.

  21. Tom says


    I am at a dilemma. I used to work in mortgages and bought my first home in February of 2013, when we were at the lowest point of mortgage rates. I consider myself an opportunist. The only thing is my 3.5% 30 year fixed has PMI over 150$/mo which is insane to me. I have been doing some research and am very interested in a 5/1 ARM so I can also get rid of my PMI as my home value has increased substantially since purchase. Do you feel it is worth giving up an amazing 30 yr fixed rate to pay down principal faster with the risk of rates rising in the future?

    I feel rates overall would not rise more than 5.5% as this will significantly decrease future homebuyers interest, therefore negatively impacting the economy. Yes I understand that 5.5% is significantly low compared to historical rates, but back in those days gas was less than 1$ a gallon. We are in a changed world. What are your thoughts to my dilemma?? Thanks so much, I really enjoy your articles.


  22. Positive Carry says

    Sam, I’m a faithful reader and agree with most of your posts, but I really think this topic needs more balance on your blog. By the way, I would have been super annoyed by the ignorant response of that “mortgage specialist” too! While ARMs might make sense for many people, I don’t think you give the fixed-rate mortgage (FRM) the credit it’s due. My argument is below, but first, in a feeble attempt to give my argument some more weight, here are my credentials: 1) I have worked in bond markets and housing finance for 11 years (NOT for a mortgage broker or lender), 2) I was an Econ major in undergrad and have a MBA 3) I have refinanced, 4) my job requires me to follow interest rates real-time, and I read financial history for fun, so I can tell you where a lot of markets were 10, 20, 30 years ago 5) I am a homeowner, 6) I don’t make any money from people going into a FRM versus an ARM.
    Here are seven reasons why FRMs can be a great product for today’s borrowers:
    1) The obvious one: the FRM provides payment certainty and stability. This can help with consumer budgeting and can reduce the likelihood of default through payment shocks. A rate increase from 2.625% to the 7.25% ARM cap may not be “very digestible” for the average American family! Let’s say Johnny Risk has a $200,000 mortgage balance with a 2.625% rate. His monthly payment is $803. At year 5, his rate resets to 7.25%, which increases his monthly payment by 60% to $1,277. The $473 payment increase equates to ~15% of his after-tax income (assuming he makes $50,000/yr). Just like your example, his principal is down 10% after 5 years, but it’s hardly a “whoopdee doo” scenario for Johnny.

    2) While ARM borrowers have done much better since the 1980s, the 30-year FRM borrowers who locked rates in the 1950s were better off. The Federal Funds increased from 1% in the mid-1950s to 19% by the early 1980s. No one can predict exactly what interest rates will do in the future. However, the longer the Federal Reserve remains accommodative (keeps rates lower), the higher the likelihood of higher rates in the future. In a more normal economy, the Federal Reserve forecasts rates to rise by 2-4%. If rates rocket even higher because of a stronger economy, you’ll be celebrating even more with a 30-year FRM. The FRM is a nice inflation hedge

    3) As you know, the yield curve is not always upward slowing. In 2000 and 2005, it inverted, which usually happens when the Fed raises rates. So, borrowing on the long-end is not always a suboptimal use of funds.

    4) To your point about mortgage officers pushing people to get as long a fixed rate mortgage as possible. Lenders actually charge higher margin on ARMs, meaning they make more on them. Part of the housing boom leading up to 2007 was due to lenders pushing tons of people into ARMS. In 2006, ARMs made up ~25% of mortgage applications compared to 7% today. I do think there is some truth to lenders pushing more fixed rate product today, but that’s because the FRMs are simpler to originate than ARMs. Also, if bankers/lenders find FRMs so profitable, why are almost all FRMs (over 80% of origination) sold to and backed by the government or government sponsored enterprises like Fannie Mae and Freddie Mac? The government subsidizes that FRM rate.

    5) The FRM borrower has protection against lower rates because he/she can refinance into a lower rate with no pre-payment penalty. Yes, I know it’s not an entirely free option (due to closing costs), but you should be able to take advantage of lower rates if you’re financially responsible and keep 3-6 months’ worth of expenses in your bank account. With an ARM, there is no protection against higher rates.

    6) Long-term interest rates are at all-time lows. Sophisticated CFOs at firms like Apple and AT&T are taking advantage of the borrowing at low long-term rates. Why shouldn’t you?

    7) You said you pay $13,750 more in interest per year in a 2.625% ARM versus a 4% 30y FRM. However, adjusting for the mortgage interest tax deduction, it’s ~$5,300 lower than that figure. Moreover, you say you pay $420,000 more in interest during the 30 year life of the loan, but factoring in the time value of money, the present value of that interest difference is ~$237,000 (discounting at 4%). So, almost half as bad as the picture you paint.
    I love my 30-year mortgage. It’s locked at a rate of 3.375%, allowing me to leverage up at an after tax borrowing rate of 2.35%. Unless the global economy goes into a very, very dark place, the money I’m investing instead of putting towards my mortgage principal has a really low hurdle rate. Also, with some wage inflation, my fixed monthly payment will get easier and easier over time. Here are two reputable financial professionals who discuss the merits of a FRM, one young, one old.
    Ben Carlson – http://awealthofcommonsense.com/pros-cons-of-a-30-year-fixed-rate-mortgage/
    Ric Edelman – http://www.edelmanfinancial.com/education-center/articles/1/11-great-reasons-to-carry-a-big-long-mortgage

    • says

      Thank you for your rebuttal and detailed analysis.

      The question I always ask people is this: after 34 years of declining rates, why do you think now is the rear where rates rocket? And if rates rocket higher, your assets and income are also rocketing higher.

      3.375% is a great 30-year fixed rate. One of the best I’ve seen. But I prefer my 2.5% ARM I got be id rather pay less guaranteed up front.

      The average homeownership is 7 years. The average person doesn’t take 30 years to pay off a loan either. To take a 30 year and actually pay the higher interest for 30 years in a row is not a wise use of money.

      Will you be paying for 30 years?

      • Positive Carry says

        Not sure if this is the year that rates sky-rocket. I can make just as many, if not more arguments, for the 10y Treasury dropping even over the next year. One of my arguments for lower long-term rates would be a rise in short-term rates, leading to a flatter yield curve. This makes the FRM trade look better than the ARM trade. Also, your assets will not necessarily sky rocket higher if rates sky rocket higher – historical data shows that when inflation is too high, the market starts to worry about growth and the loss of purchasing power. It’s all about your personal risk tolerance and ability to absorb payment shocks.

        My whole point is that it’s not fair to knock the FRM so much. Everyone’s financial situation is unique and no one can predict the future.

        Do I plan to stay in my home for 30 years? I certainly hope so but I have no idea. Once you factor in the all-in cost of ownership versus renting, you probably shouldn’t buy if you don’t plan to stay there for at least 5 years. What if I decide to stay for 12 years instead of 5? Today, neither you nor I can say whether or not the ARM is better in this situation. That’s absolutely impossible. However, we can say for certain that my risk is highly reduced with the FRM, especially if I decide to stay longer.

        Lastly, I’d argue that levering up and paying interest for 30 years is wise if the return on your investments is higher. This decision looks even wiser if short-end interest rates move higher over those 30 years.

        • says

          Yes, starting from this point on, nobody knows for sure whether and if or when rates will rocket. But I’ve run this site for 6 years, and have been encouraging people to not waste money on a 30-year fixed during this time period, and I’ve been right. Before I started this site, I had endless discussions with clients in finance since 2001 with the same advice, which means I’ve been right for the past 14 years.

          And today, I’m still telling people in the year 2015 that they are much better off taking out a 5/1 ARM than a 30-year fixed if they want to save money. Only time will tell. And people are free to do as they wish. Everybody does have different comfort levels, and that’s fine.

          Let’s check back in 5 years!

          Related: How To Profit In A Rising Rate Environment


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