On August 1, 2020, I took out a 7/1 adjustable rate mortgage (ARM) at 2.125%. I could have gotten a 30-year fixed-rate mortgage for 2.75%. However, I wanted to save 0.625% in interest.
Years later, mortgage rates have zoomed higher thanks to the pandemic, massive stimulus spending, a war in Ukraine, and supply chain issues. Inflation reached a 40-year high in June 2022.
Do I regret my decision to get an adjustable-rate mortgage over a fixed-rate mortgage?
My answer is “no,” and let me tell you why.
Why I'm Fine With An ARM Despite Higher Mortgage Rates
Back in 2020, we just had our second baby and wanted a fully remodeled home to house our family. We had been living in a home that was in the middle of a long gut remodel. Given I thought the remodel would take longer than expected, I decided to pounce on a nicer home.
I fully admit I did not anticipate inflation and mortgage rates surging to the levels we saw in 2022. However, despite higher mortgage rates, I still have no regrets getting an ARM.
I know I'm in the minority and will likely get heat for my views. But hear me out.
1) I'm saving money with an ARM
Instead of paying 2.75% for a 30-year fixed mortgage, I'm paying 2.125% for a 7/1 ARM. Every year that goes by, I'm saving almost $10,000 in interest expense.
Over the seven-year fixed duration, I will likely end up saving ~$65,000 in gross mortgage interest expense. Saving money feels great, not bad!
Even if I were to pay a much higher mortgage rate after my ARM expires, I have a $65,000 buffer before I start paying more due to getting an ARM. I calculate that break even period will start in the eleventh year of my ARM, even if mortgage rates stay at current elevated levels.
2) The house has appreciated in value
Buying the house in mid-2020 turned out to be a good move. The value of the house is up between $300,000 – $500,000, even after a 5% – 10% slump since 2022.
The combination of saving money on mortgage interest expense and experiencing home price appreciation feels lucky. The home price appreciation dwarfs any amount of increased mortgage payments I will need to pay after my ARM expires.
If the house depreciated in value, then I would still feel better knowing that I'm paying a lower mortgage interest than I had to. But of course, I wouldn't feel as good.
3) ARM interest increases have limits
All ARMs should have a limit on how much the mortgage rate can increase the first year after the fixed-rate duration is over. Subsequent years also have interest increase limits. There is also a maximum mortgage interest rate limit increase for the life of the loan.
In my case, my mortgage rate can go up a maximum of 2% in year eight, another 2% in year nine, and up to a maximum interest rate of 7.125%.
Below is an example of an ARM interest limit increase of an $850,000, 5/1 ARM at 2.375%.
As you can see from the example above, the mortgage increases can go up every year up to a limit. Therefore, you can model out potential worst-case scenarios in the future to see if you'll be able to afford your mortgage.
Thankfully, most people get raises and grow their net worths over time. As a result, they will be better able to handle higher payments in the future.
4) Mortgage principal gets paid down over time
Every month, $3,450 of my mortgage payment goes to paying down principal. In 84 months, when my 7/1 ARM expires, I will have paid off around $330,000 in principal.
If mortgage rates are higher in year eight, then I will pay a higher mortgage interest rate of up to 4.125% for one year. But I will also be paying interest on a ~20% lower mortgage balance.
As a result, my actual monthly payment will only increase by about one percent. Even if my mortgage interest rate increases by another 2% to 6.125% in year nine, my monthly mortgage payment will only increase by about nine percent.
The worst-case scenario of paying one percent to nine percent more in years eight and nine will be hardly noticeable. The average worker who receives two percent raises a year will easily be able to afford these higher payments.
5) Have the option to refinance
Nobody knows the future. However, before my ARM expires on August 1, 2027, I have the option to refinance.
It's unlikely I can refinance to a similarly low rate of 2.125%. However, there's a good chance I could refinance to another 7/1 ARM that's under 4.125%, i.e. less than my first year adjustment's maximum mortgage rate.
If I can do a no-cost refinance at a low rate, even better. Although you pay a higher mortgage rate in a no-cost refinance, if the mortgage rate is attractive, you're still winning. Further, you retain the option to refinance again without feeling bad that you paid fees for refinancing.
I believe the long-term trend for inflation and interest rates is down. We've already seen inflation peak in June 2022 and come down every month since. I'm confident that sometime between now and August 1, 2027, I'll have another window to refinance at an attractive mortgage rate.
Below is a chart that shows the historical trend of the average 30-year fixed-rate mortgage. Rates have been going down since the 1980s.
6) Fixed-rate duration of an ARM more closely matches my ownership duration
If I thought I was really buying a forever home in mid-2020, I would have been more inclined to lock in a 30-year fixed-rate mortgage and pay it down sooner. Instead, I got a 7/1 ARM partially because we will unlikely live in the house for much longer than seven years.
Based on my homeownership track record, we move every two-to-ten years given I'm an avid investor in real estate. My holding period is lower than the median homeownership tenure of roughly twelve years today.
I believe in buying a primary residence, updating it, living in it for at least two years to get the tax-free profits up to $250,000/$500,000 in profits, renting it out, and then buying another home. Over the course of a regular lifetime, a typical household could amass a four rental property portfolio by age 60 and retire comfortably off rental income.
Since 2003, I've been buying middle-class homes because that's what most households can afford. I believe this is a smart way to invest in real estate. Investing in luxury property does not give as high of a return on investment.
Below is the average homeownership tenure from 2005 to 2022 according to Redfin. At about 12 years today, getting a 30-year fixed-rate mortgage is a big 18-year overshoot for the average homeowner. I've only owned my current home for three years and I'm already itching to upgrade homes. Know thyself!
Although I love our current house, I will likely be disappointed if we are still living in it seven years from now. This means we will have not relocated to Oahu. It will also mean we lived too frugally. In seven years, the house will likely decline to less than ten percent of our net worth.
As someone who has entered into his decumulation phase of life, my goal is to try and spend more money, not less. And one of the easiest ways to spend more money is to own a nicer house.
7) The worst case of paying more isn't so bad
With principal paydown and the savings I'm accumulating from having a seven-year adjustable-rate mortgage, I will have a large buffer in case mortgage rates skyrocket in year eight and beyond. But let's say mortgage rates do surge long after my savings buffer is exhausted. Not a big deal.
Chances are high that ten years after I first took out the 7/1 ARM, my net worth will be higher. That's usually what happens when you continuously save and invest.
In an high inflation, high mortgage rate environment, we also get to earn higher risk-free income through Treasury bonds, CDs, and money market funds. For example, today we can all earn over 5% risk-free in one-year Treasury bonds. We can ride the inflation wave too.
Even if your absolute mortgage amount goes up, if the mortgage payment as a percentage of your income goes down, you will feel fine. There's a reason why I encourage everyone to follow my 30/30/3 home buying rule.
8) An ARM keeps me motivated to grow more wealth by a particular time
Having an ARM motivates me to pay down debt quicker. When you have a shorter time horizon to get something done, you tend to be more focused.
If I had a 30-year fixed-rate mortgage, I wouldn't work as hard, pay as close attention to my finances, or pay down debt as intentionally. With a 5/1, 7/1, or 10/1 ARM, I treat the introductory fixed-rate period as a deadline to earn as much as possible and/or pay down as much mortgage debt as possible.
One of the key tenets of a Financial Samurai is to achieve financial independence sooner, rather than later. Taking thirty years to pay off a mortgage is not the way. An ARM motivates me to take more action to secure my financial future.
Congrats To All Who Refinanced Or Got A New Mortgage At The Bottom
Refinancing or taking on a mortgage in 2020 or 2021 is one of the all-time great financial moves. It's hard to see mortgage rates getting back to those levels again.
Whether you got a 30-year fixed-rate mortgage or an adjustable-rate mortgage, feel good knowing you got a historically low rate. The double benefit of living cheaply while experiencing property price appreciation is wonderful.
Although paying off your home might not provide joy long-term, when you finally do, you'll appreciate that you were able to borrow so cheaply.
Despite an increase in mortgage rates, my preference towards adjustable rate mortgages has not changed. Based on my 20+ years of investing in real estate, I don't want to pay more money on debt than I have to.
Reader Questions And Answers
Does anybody regret getting an ARM? If so, why? Does anybody regret getting a 30-year fixed-rate mortgage? If so, why? Do you think mortgage rates and inflation will stay elevated in 2027 and beyond?
If you're looking to refinance or get a better mortgage rate, shop around online at Credible. Credible has multiple lenders who will offer personalized prequalified rates and compete for your business. Also contact your existing bank to see what it has to offer. If you have good credit, you should get a lower rate than the national averages.
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