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Refinancing a bad ARM


mattandallismom
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I've spoken with a few lenders and I'm even more confused. We purchased our condo in 2005. Our credit wasn't so good and were financed with a loan that increases in July, oh to about 11.50%!!! Obviously we're going to refinance. One of the lenders I spoke with proposed 3/1,5/1, or 7/1 ARM vs a 30 year fixed with no prepayment penalties. He said the ARM would be better for us because we plan on selling in 2-3 years. I don't really know the difference and how it would benefit us to take the ARM over the 30 year. I feel so stupid for not being more informed the first time and want to make sure we do this right.

Thanks in advance!

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I would go with a fixed rate. You don't want to end up in the same situation 3 years from now, do you? And no one knows what the market will do in the future.

He said the ARM would be better for us because we plan on selling in 2-3 years

You may want to sell in 2-3 years, but how do you know if you will be able to? What if the market takes a dive and you can't? A fixed rate will give you peace of mind in case something happens and you chose/have to stay in your home a little bit longer than you like.

________

Club Royal Condo Pattaya

Edited by kevin3344
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I've spoken with a few lenders and I'm even more confused. We purchased our condo in 2005. Our credit wasn't so good and were financed with a loan that increases in July, oh to about 11.50%!!! Obviously we're going to refinance. One of the lenders I spoke with proposed 3/1,5/1, or 7/1 ARM vs a 30 year fixed with no prepayment penalties. He said the ARM would be better for us because we plan on selling in 2-3 years. I don't really know the difference and how it would benefit us to take the ARM over the 30 year. I feel so stupid for not being more informed the first time and want to make sure we do this right.

Thanks in advance!

The difference is primarily rate. You are locked at x rate for the amount of years specified in an ARM. At that point, it readjusts to market rate + a specificed margin. So in a 7/1 ARM, you are locked at x rate for 7 years, then after that point, once per year your loan readjusts to a market rate (possibly LIBOR) + an agreed upon margin.

In a 30 year fixed, you are locked for the life of the loan at an agreed upon rate, thus the payment of principal and interest will never go up (although your taxes and insurance will likely make your payment go up a bit over time if you escrow).

There was a time when ARM rates were advantageous over 30 year rates due to the way the bond markets were discounting short terms bond yields over long term yields. When my fiance and I went to get a mortgage in May 2005, we were looking at close to 6.0% for a 30 year fixed, but ended up in a 5/1 ARM locked at 5.125%. The difference in payment was significant AND we are 100% sure that we will be out of the house by 2009, so it was an easy decision.

However, today there is a flattened "yield curve" meaning there is no discount given to short-term bonds over long-term. The result is that rates for ARMs are very close to 30 year rates. Since rate is the only upside to an ARM, there is little reason to take on an ARM even if you are 100% sure you are leaving a few years. The downside is that if, for example, you take on a 3/1 ARM, and three years from now you can't get out of your home, your rate will readjust (most likely higher) and your payment must rise to cover the payment at the new rate. If your broker is putting you into a 3/1 Interest Only ARM, your payment will rise even more because now the amortization schedule to pay back the principal has been compressed from 30 years to 27 so you pay higher interest AND start paying chunks of principal on your loan. These are the loans that are breaking people's backs when they readjust.

In summary, there is little upside and plenty of downside to ARMs at this point.

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Thank you so much for your replies. It helps a lot in our decision making. I know we will sell within the next few years. Our family has grown and our kiddos need some yard. I'm thinking the 5/1 - 7/1 might not be too bad of a plan taking into consideration what Kevin was saying. It would all depend on the rate difference we would receive. If it isn't a significant difference then we'll push for the 30. Thanks again.

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The two previous posters are right on the money.

There are several reasons why someone would accept an ARM in today's market, but your situation may not fit the scenario for an ARM. Conventional rates do not offer enough monetary savings to make an ARM a good decision at this time.

It does make sense for the lender, because he/she can "get you back in three years to refinance your way out of the ARM before the rate adjustment takes effect."

Since you are active on this thread I am going to post and then come back and explain the last segment.

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It does make sense for the lender, because he/she can "get you back in three years to refinance your way out of the ARM before the rate adjustment takes effect".

Some brokers prefer to sell them for that reason. Buddies of mine sold subprime 2/28 ARMs for just that reason. People would lock in for 2 years, pay off their credit cards, and then 23 months later, the brokers were calling them and saving them from disaster by refinancing again into another 2 year ARM. Most of the time, the clients were living above their means and rang up consumer debt again, so their scores put them into high margin loans. Clients were asking to be fleeced and brokers were willing to deliver. When appreciation was ridiculous, everyone made out okay. Times have changed!

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