The mortgage rates dropped again. I'm re-financing my mortgage once again. It's remarkable it hasn't been even a year since I did it last time.

The rates were low last year due to the fact that of the anticipation for QE2. Once QE2 started, rates went up. Now rates are low again. Why? I do not understand. Maybe the marketplace is expecting a QE3.

This time, rather of following my normal Stepping Down the Ladder script, I'm re-financing my mortgage to an ARM with a squander. Before you call me crazy for picking an ARM when rates are lower than ever, bear with me and check out to the end.

Stepping Down the Ladder

Stepping Down the Ladder means refinancing to a fixed rate a little above the marketplace rate, with sufficient credit from the lender to cover the closing expense. Rinse and duplicate each time the rates go lower once again.

It's a no-lose proposal. You start gaining from the lower rate on the first day. As the rates go lower, you keep locking in to a lower rate, and never pay any closing expenses. Repeat this procedure till the rates reach the bottom. Because the rate is repaired, your rate will stay at the bottom.

10-Year and 15-Year Fixed Rate Mortgages

When I took a look at re-financing this time, I began with the exact same approach. Because I have a 15-year fixed rate mortgage now, I took a look at 15-year repaired and 10-year fixed options.

If I choose another 15-year fixed, the finest rate I can get is 3.625% with no closing expense. It's hardly worthwhile because my present rate is 3.75%. If I opt for a 10-year fixed, I can get 3.25% without any closing expense.

Between these 2 choices, I would pick the 10-year repaired. I have actually had a 15-year set home mortgage for a few years now. I want to pay it off in ten years.

5-Year Adjustable Rate Mortgage (ARM)

I usually do not take a look at ARMs at all, because the whole idea of Stepping Down the Ladder has to do with locking in the most affordable rate for the life of the loan. But considering that I was considering a 10-year repaired, I also looked at ARMs.

A 5/1 ARM has a set rate for the very first 5 years. The rate begins adjusting each year after 5 years. If I'm going to settle in 10 years, by the 6th year the staying balance will be little enough that I can pay off if I desire to. If I do not like the rate at that time, I will just pay it off. Meanwhile I will have saved a fair bit of interest in the first 5 years.

If I go with a 5/1 ARM, I can get 2.75% with no closing cost.

Squander Refi

A cash-out refi means borrowing more than the existing loan balance. Usually you will pay a greater rate and/or higher costs if you refinance with a cash-out. However, if your loan-to-value ratio (LTV) is low enough, there is a ceiling you can go to without incurring a charge for cash-out.

Why take squander? Because the loan provider credit is connected to the loan quantity. Within particular limits, the higher the loan quantity, the higher the loan provider credit. When the lending institution credit is high enough, it will have the ability to bump the rate down a notch and still make it a no closing expense loan.

For instance, suppose the loan provider credit for a $100k loan is $1,000 at 2.625% and the overall closing expense is $2,000. It implies the net closing expense is $1,000 for the 2.625% rate. To make it no expense you will need to go to 2.75%. However, if you increase the loan total up to $200k, the lender credit will be $2,000, enough to cover the closing cost. Then the $200k loan will be no cost at 2.625%.

If I increase the loan amount to the optimum allowed, I can get a 5/1 ARM at 2.625% with a net $900 paid to me at closing in addition to the cash-out. I got this offer.

I'm utilizing the same lending institution I used last time: First Internet Bank of Indiana ("FirstIB"). For the loan I want, FirstIB offers the finest offer among a list of lenders I took a look at: PenFed, National Mortgage Alliance, and AmeriSave.

Won't borrowing more increase the total interest paid? Yes, if you just pay the minimum. Because the loan has no prepayment charge, you can pay the cash-out right back in the very first month. The only result of a higher loan amount will be a greater needed regular monthly payment amount. Since I'm going to follow a 10-year payoff schedule and the 5/1 ARM uses 30-year amortization, the higher required month-to-month payment is still lower than what I'm going to pay anyhow.

For instance, to settle $100k in 10 years at 3.25%, I will have to pay $977 each month. The required month-to-month payment on a $200k 5/1 ARM at 2.625% with a 30-year amortization is $803. If I borrow $200k, repay $100k right away and keep paying $977 a month, the remaining $100k will still be paid off in 10 years.

Borrow More to Invest?

I considered keeping the cash-out and investing it. After all, it's tough to see how I can't earn more than 2.625% a year from my investments. A five-year CD from Melrose Cooperative credit union pays 2.90% a year. If I only pay the required minimum month-to-month payment and put the cash-out and the extra primary payments in a CD, as long as the CD rate is greater, I will come out ahead. The tax on the CD interest and the tax reduction on the mortgage interest will be a wash.

If I put the extra money in an internationally varied portfolio of stocks and bonds, the return has to be higher - if I do not think that I ought to just liquidate everything, settle my mortgage, and put the rest all in CDs. Everybody who is bring a mortgage and investing at the very same time is wagering the investments will make more, or else they wouldn't invest before the loan is settled.

But anticipated returns are simply that - anticipated. You can bet and expect all you want. The real returns might come greater or lower than your expectation.

Although the thought of making cash with other individuals's cash is appealing, I'm not yet that comfy with it. I might still do the CD but that has to do with it. I don't wish to take more threat with this cash.

Rates Have Nowhere to Go But Up?

You may think rates have no place to go however up which it's shortsighted to get an ARM now when rates are the lowest. You may think 5 years from now rates of interest will be much greater.

I thought the exact same each time I refinanced in the last 10 years but rates keep boiling down, reaching one historical low after another. I truthfully believed it was the last opportunity to refinance in March 2010. That was two refinances earlier.

The marketplace has defied all predictions of greater rates. I will stop saying this will be my last re-finance. It won't shock me if rates go in any case: significantly higher or substantially lower. If rates decrease again, I will re-finance again with an ARM and extend my 5-year fixed rate period.

When you are within 10 years to paying off your home mortgage, refinancing to an ARM can save you money compared to a 10-year fixed rate mortgage. The rate is lower. So are the closing expenses (for example PenFed charges a 1% origination fee on all fixed rate mortgages, but not on ARMs).

Taking a squander and paying it right back will reduce the closing costs. You may even get paid for doing the refinance. If you are going to settle in ten years anyhow, it's complimentary cash.

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Comments

1. Money Beagle states

June 13, 2011 at 5:50 am

I would re-finance in a heart beat if it were possible, but the equity in our home is well listed below what the banks would consider in giving us a PMI-free loan w/o escrow (which is what we have today due to the fact that we put 20% down at the time). If I were able to re-finance I would absolutely consider an ARM. Even if rates were higher a few years down the road, the amount of principle I 'd have the ability to pay for in the mean time would more than likely well offset any possible uptick down the road.

2. David says

June 13, 2011 at 7:39 am

Very intriguing analysis. Did you think about the PenFed 5/5 ARM? If so I'm curious about your ideas on that. I've taken a look at that over the last few years whenever there was a dip in rates however I always ended up going with the "more secure" repaired rate loan.

3. Harry Sit says

June 13, 2011 at 9:27 am

@David - Yes I thought about PenFed's 5/5 ARM. It's currently 3.25% for the very first 5 years, versus 2.625% on the 5/1 ARM from FirstIB. If I'm going to pay 3.25%, I might as well get the 10-year fixed at 3.25% from FirstIB with no closing expense. For my loan, the PenFed 5/5 ARM isn't as great as the deals from FirstIB.

4. Mike says

June 13, 2011 at 10:46 am

Interesting method. What is limit. LTV ratio you can cash out without being penalized?

5. Harry Sit says

June 13, 2011 at 10:47 am

@Mike - 60%.

6. TJ states

June 13, 2011 at 6:00 pm

Has teh no closing expense ended? I do not appear to see that alternative ...

7. Harry Sit says

June 13, 2011 at 8:30 pm

@TJ - FirstIB just lists rates with closing expense. The next greater rate will have no closing expense. For example if the greatest rate (most affordable costs) noted is 3.5%, 3.625% will have no closing expense.

8. enonymous states

June 14, 2011 at 11:08 am

great analysis

obviously 60% LTV, and small enough balance to be able to benefit the loan with a balloon payment at the end of the 5 years is the crucial

the Penfed 5/5 is an incredible offer at 3.25% (if that is stll there) particularly for those with jumbo home mortgages. however it is not a good deal for those in TFBs specific circumstance ...

I remain in a 15 year repaired, doing the refi thing yet once again (always no closing expenses), and the 5/5 or 5/1 or even 7/1 ARMs didn't make good sense to me, largely due to the fact that I hesitate to to make the large balloon payment required to be safe with a 5/1 or 7/1, and since the 3.25 5/5 ARM isn't low enough to attract me from my 3.75% 15 yr repaired ...

9. ChrisCD says

June 17, 2011 at 7:59 am

Forgive me, but I am uncertain how the no-closing costs deal works. Every time I have looked they have wished to wrap the expenses into the loan which isn't what I am aiming to do.

In addition, our home value has actually dropped low enough to make it the alternative seem out of reach.

cd:O)

10. Heidi states

June 18, 2011 at 4:54 pm

Money Beagle - I was in a similar situation. After calling numerous banks (due to the fact that their site calculators regularly concluded that I would not get approved for their mortgage due to my LTV), I discovered Connexus Cooperative credit union. They let me do an 80/20 to prevent PMI simply last December and I saved over a $1,000 a month on my incredibly jumbo mortgage. I have given that settled the HELOC and am settling the 25 year 3/3 ARM over a 10 year amortization. You may wish to attempt providing them a call.

11. Madison says

June 22, 2011 at 6:38 am

I keep reducing our 5/5 ARM at penfed with a strategy to settle in 5-10 years. And much like you, I believed every time it couldn't go lower. We're at 3.375% on our 5/5, and now naturally, I see rates are even lower once again!

I'll have to have a look at FirstIB, I had not checked out their ARMs lately.

12. TJ states

June 23, 2011 at 9:26 pm

@TFB - I see an alternative with no points, however this choice still has $2k in costs (origination charge, appraisal, credit report, flood cert, title insurance coverage, government recording charges)

13. Harry Sit states

June 23, 2011 at 10:59 pm

@TJ - If you desire the no expense option, add 0.125% to the greatest rate noted. You have to call them.

14. TJ states

August 7, 2011 at 4:08 pm

@TFB do you have any experience with boxhomeloans. com?

I got much better rates for a 30 year than any other websites. I locked it however since it was "after hours" (the weekend), they can't confirm until Monday, if it is lower than what i locked, my own will be the lower rate, if rates go on monday, they will overlook my request and I have to resubmit a lock demand.

15. Harry Sit says

August 7, 2011 at 6:16 pm

@TJ - Sorry, I do not have any experience with Box Home Loans. Maybe inspect the FatWallet thread?

16. extremely costs states

February 19, 2012 at 7:27 pm

First IB looks appealing for a 5/1 ARM. However, I reside in Maryland and it appears that they do not provide here. Do you understand if this is true and if so, could you recommend other organizations? I am seriously considering the PenFed 5/5 at 3.125% without any closing ... Thanks for an excellent website.

17. Harry Sit states

February 19, 2012 at 8:12 pm

@super bill - Several other readers also reported the very same thing. You can always call their 800 number to validate if it's still the case. If so, choose PenFed then. Maryland has a transfer tax. It'll be very tough to beat the PenFed rate when you consist of the transfer tax, which PenFed says it covers.

"5/5 Adjustable Rate Mortgage (ARM) Promotion: We will pay closing expenses as much as $10,000 per loan, to include: Appraisal cost, Tax Service Fee, CLO Access Fee, Title Fees, Transfer Tax Fees, Credit Report Fee, Flood Cert Fee, Recording Fee, Survey if required and Work Verification Fee."

18. very bill says

March 12, 2012 at 10:55 am

TFB - simply wished to follow up on my posting. I appled for the PenFed 5/5, which appeared great, but their appraisal was available in method low - about 120k under what our last appraisal was one year back. Therefore, our loan quantity exceeds their limit provided the valuation. I am attempting to appeal but in the meantime, wanted to see if you or others had other recommendations for a 5/1ARM or interest just product with no closing costs? (BTW, I contacted FirstIB, and they do not lend to MD) Thanks once again.

19. Harry Sit says

March 12, 2012 at 12:55 pm

@super costs - Regrettable the PenFed appraisal was available in low. I hope you will have the ability to effectively appeal it. Maybe they can ask for another one? The other 2 lenders on my short list to examine are NMA (nmaloans.com) and AmeriSave (amerisave.com). Also examine the [long] FatWallet thread.

Reply

20. Jc says

July 6, 2012 at 8:52 am

If my lyv is 50% and I refi from a 30 to a 15yr fix, and money out 50,000 and then pay back the 50,000 towards the principal, it seems i will be conserving a big quantity of interest monthly. Exists a draw back to this besides a greater month-to-month payment?