Maximizing the Benefits of Adjustable-Rate Mortgages: A Personal Reflection
When it comes to purchasing homes with mortgages, I’ve always had a soft spot for adjustable-rate mortgages (ARMs). The allure lies in securing a lower interest rate compared to a traditional 30-year fixed-rate mortgage. Additionally, aligning the fixed-rate duration with my intended homeownership period just makes sense.
The average duration of homeownership spans about 12 years, making a 30-year mortgage with higher interest rates less than ideal. Opting for a 30-year fixed-rate mortgage in such a scenario is akin to purchasing a bus for a family of four.
Despite the logical reasons behind selecting adjustable-rate mortgages, they often face significant opposition. A majority of new or refinanced mortgages, around 90% to 95%, tend to fall under the 30-year fixed-rate category. It’s understandable to push back against something you may not fully grasp or have direct experience with.
Embracing the Benefits of Adjustable-Rate Mortgages
Having weathered the storm of the most substantial and fastest Federal Reserve rate hike cycle in history, I’ve come to realize there’s no urgency in paying off your adjustable-rate mortgage before it resets. Let me share a personal case study based on my own experiences with ARMs.
1) You will pay down mortgage principal during your ARM’s fixed-rate period
Take, for instance, my decision back in 2014 to purchase a fixer-upper in Golden Gate Heights for $1.24 million with a 5/1 ARM at a 2.5% rate. Despite the option to secure a 30-year fixed-rate mortgage at 3.375%, I opted for the lower rate to avoid unnecessary higher interest costs.
Fast forward to October 2019, where I refinanced the remaining mortgage balance to a new 7/1 ARM at a 2.625% rate. By making regular mortgage payments and occasional extra principal payments over the years, I successfully reduced the principal by $291,289, marking a significant 29.3% decrease from the original mortgage balance.
This approach to paying down the mortgage didn’t strain my liquidity or cause undue stress; instead, it followed my FS-DAIR framework, which outlined how to allocate cash flow towards investments or debt repayment as interest rates fluctuated.
2) Your mortgage pay-down momentum will continue
Since refinancing in 2019, I’ve further reduced the principal loan balance by an additional $284,711, bringing the current mortgage balance down to $416,000 today. Factors contributing to this steady pay-down include a lower mortgage rate, consistent payments at the same level, and occasional additional principal payments.
As we navigate through economic uncertainties, the potential for lower mortgage rates in the future alongside prudent financial management remains a strategic advantage for ARM holders.
3) Elevated inflation rates will likely recede by the time your ARM resets
Recent economic indicators point towards a potential slowdown in inflation, with jobless claims exceeding expectations and the Producer Price Index coming in lower than forecasted. This suggests a recalibration in mortgage rates and a favorable environment for ARM holders.
For individuals with a 5/1 ARM set to reset in the coming years, there’s a high probability of savings due to lower rates and significant principal pay down achieved during the fixed-rate period.
4) There’s a mortgage rate reset cap and lifetime cap
Understanding the interest rate caps on your ARM provides peace of mind amidst rate fluctuations. By knowing the maximum allowable rate adjustments and lifetime caps, you can plan accordingly for possible rate hikes while benefiting from the initial reduced rates.
5) Your property likely appreciated in value
Property appreciation during the fixed-rate period can offset potential mortgage rate hikes post-reset, offering a buffer against increased monthly payments. Real estate investments, complemented by mortgage affordability, remain a reliable wealth-building strategy.
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