Why should you ALWAYS get a one year ARM rather than "locking" into a 30 year fixed rate loan? The easiest
answer is that you will NEVER be able to accurately predict interest
rates. Did you know that Wall Street gurus are wrong over 60% of the
time with their interest rate projections over a 3-5 year timeframe? What makes you think you know better than them ?
Did you know that over a five year period of time, the one year ARM has always outperformed a 30-year fixed rate loan? That statistic has held true for over 40 years. What that means is that your average interest cost for a five year period was less with a one year ARM, than with a traditional 30 year fixed-rate loan.. Let's look at the last five years and compare a LIBOR plus a 2.25% margin ARM to a 30 year fixed rate loan:
Let's assume a customer secured a 30 year fixed rate loan in October, 2001. They would have gotten a rate of 6.75% for a $200,000 loan. Now let's assume they refinanced in the summer of 2003 to a 5.5% rate and paid out $3,000 in closing costs. How much interest (and costs) would they have paid until today? $1125/month times 20 months PLUS $3000 closing costs PLUS $916/month times 40 months. A total of $62140 in interest and costs. Good thing they refinanced because if they hadn't that figure would be closer to $67,500.
Now,
let's look at the one year ARM: They would have had a rate for the
first year at 5.0% or paid $10,000 in interest. The second year, their
interest rate would have jumped to 5.75% costing them $11,500. The
third year would have been nice, they would have been at 4.5% costing
them $9,000 in interest. The fourth year at 5.50% costing them
$11,000. Finally, this year, their rate would have climbed to 6.75%
costing them $13,500 (the inverted yield curve, while temporary, was
brutal this past year). Total costs...$55,000.
Will this trend continue? Absolutely. Their rate will be set around 7% this year and that will be difficult. Inverted yield curves don't last forever, in fact, they usually precede a period of rapidly declining interest rates of 2% or more in a 6-12 month period. This means we start the cycle all over again at a sub 5% rate next year.
How about for jumbo loans? Here's where it gets even more advantageous to have a one year ARM. You see, ARMs favor big borrowers. It is possible to get a LIBOR plus 1.75% margin loan for a jumbo where the 30 year fixed has a "jumbo premium" of .25% higher to the rate.
Why don't people borrow with annual ARMs then? People always compare the annual ARM rate to their last one year period; that context is unfair. It makes sense to analyze a loan for the average holding period (3-7 years) rather than compare over a one year timeframe. Check with me about how an Annual ARM might save you lots of money. I'll show you the 40 year charts, explain how ARMs are priced, and give you some great advice.
