The mortgage rates dropped again. I'm refinancing my home mortgage again. It's incredible it hasn't been even a year considering that 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 don't know. Maybe the market is anticipating a QE3.

This time, rather of following my typical Stepping Down the Ladder script, I'm refinancing my mortgage to an ARM with a squander. Before you call me insane for choosing an ARM when rates are lower than ever, bear with me and read to the end.

Stepping Down the Ladder

Stepping Down the Ladder indicates re-financing to a fixed rate somewhat above the marketplace rate, with adequate credit from the lender to cover the closing cost. Rinse and repeat whenever the rates go lower again.

It's a no-lose proposal. You begin benefiting from the lower rate on day one. As the rates go lower, you keep locking in to a lower rate, and never pay any closing expenses. Repeat this process up until the rates reach the bottom. Because the rate is repaired, your rate will remain at the bottom.

10-Year and 15-Year Fixed Rate Mortgages

When I looked at re-financing this time, I started with the same technique. Because I have a 15-year set rate home mortgage now, I looked at 15-year repaired and 10-year set alternatives.

If I choose another 15-year fixed, the very best rate I can get is 3.625% without any closing expense. It's barely beneficial because my existing rate is 3.75%. If I go with a 10-year fixed, I can get 3.25% without any closing expense.

Between these 2 choices, I would choose the 10-year repaired. I've had a 15-year set mortgage for a couple of years now. I wish to pay it off in 10 years.

5-Year Adjustable Rate Mortgage (ARM)

I typically do not take a look at ARMs at all, because the entire concept of Stepping Down the Ladder is about securing the most affordable rate for the life of the loan. But given that I was thinking about a 10-year fixed, I also looked at ARMs.

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

If I opt for a 5/1 ARM, I can get 2.75% without any closing cost.

Squander Refi

A cash-out refi suggests obtaining more than the present loan balance. Usually you will pay a greater rate and/or greater fees 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 sustaining a penalty for cash-out.

Why take cash out? Because the loan provider credit is connected to the loan quantity. Within specific limits, the greater the loan quantity, the greater 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 cost loan.

For instance, expect the loan provider credit for a $100k loan is $1,000 at 2.625% and the total closing cost is $2,000. It means the net closing cost 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 lending institution credit will be $2,000, enough to cover the closing expense. Then the $200k loan will be no charge at 2.625%.

If I increase the loan total up to the maximum 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 using the very same lender I utilized last time: First Internet Bank of Indiana ("FirstIB"). For the loan I desire, FirstIB provides the best deal amongst a list of lending institutions I looked at: PenFed, National Mortgage Alliance, and AmeriSave.

Won't obtaining more increase the overall interest paid? Yes, if you only pay the minimum. Because the loan has no prepayment penalty, you can pay the cash-out right back in the very first month. The only effect of a greater loan amount will be a higher needed month-to-month payment amount. Since I'm going to follow a 10-year benefit 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 anyway.

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

Borrow More to Invest?

I thought of keeping the cash-out and investing it. After all, it's hard to see how I can't make more than 2.625% a year from my investments. A five-year CD from Melrose Credit Union pays 2.90% a year. If I only pay the needed minimum regular monthly payment and put the cash-out and the additional 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 deduction on the mortgage interest will be a wash.

If I put the money in an internationally varied portfolio of stocks and bonds, the return needs to be greater - if I don't think that I need to simply liquidate whatever, pay off my home mortgage, and put the rest all in CDs. Everybody who is bring a home mortgage and investing at the very same time is betting the financial investments will earn more, or else they would not invest before the loan is paid off.

But anticipated returns are just that - anticipated. You can bet and anticipate all you want. The real returns may come greater or lower than your expectation.

Although the thought of earning money with other individuals's money is appealing, I'm not yet that comfortable with it. I may still do the CD however that's about it. I do not wish to take more threat with this cash.

Rates Have Nowhere to Go But Up?

You may think rates have nowhere to go but up which it's shortsighted to get an ARM now when rates are the most affordable. You may think five years from now interest rates will be much greater.

I believed the exact same whenever I refinanced in the last 10 years but rates keep coming down, reaching one historical low after another. I truthfully thought it was the last possibility to re-finance in March 2010. That was two refinances earlier.

The market has defied all predictions of greater rates. I will stop stating this will be my last re-finance. It will not surprise me if rates go either method: considerably greater or substantially lower. If rates go down again, I will re-finance again with an ARM and extend my 5-year fixed rate duration.

When you are within ten years to paying off your home mortgage, re-financing to an ARM can conserve you cash compared to a 10-year set rate home loan. The rate is lower. So are the closing expenses (for instance PenFed charges a 1% origination charge on all fixed rate home mortgages, however not on ARMs).

Taking a money out and paying it right back will reduce the closing expenses. You might even make money for doing the refinance. If you are going to settle in ten years anyway, it's totally free money.

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Comments

1. Money Beagle states

June 13, 2011 at 5:50 am

I would re-finance in a heartbeat if it were possible, however the equity in our home is well listed below what the banks would consider in offering us a PMI-free loan w/o escrow (which is what we have today due to the reality that we put 20% down at the time). If I were able to re-finance I would definitely consider an ARM. Even if rates were higher a couple of years down the road, the quantity of principle I 'd be able to pay for in the mean time would more than likely well balance out any possible uptick down the road.

2. David says

June 13, 2011 at 7:39 am

Very fascinating analysis. Did you think about the PenFed 5/5 ARM? If so I wonder about your thoughts 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 "much safer" fixed 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 presently 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 may also get the 10-year repaired 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 states

June 13, 2011 at 10:46 am

Interesting technique. What is limit. LTV ratio you can cash out without being punished?

5. Harry Sit says

June 13, 2011 at 10:47 am

@Mike - 60%.

6. TJ says

June 13, 2011 at 6:00 pm

Has teh no closing cost expired? I do not seem to see that option ...

7. Harry Sit states

June 13, 2011 at 8:30 pm

@TJ - FirstIB just notes rates with closing cost. The next greater rate will have no closing cost. For instance if the greatest rate (most affordable charges) listed is 3.5%, 3.625% will have no closing expense.

8. enonymous states

June 14, 2011 at 11:08 am

good analysis

obviously 60% LTV, and little enough balance to be able to payoff the loan with a balloon payment at the end of the 5 years is the key

the Penfed 5/5 is a significant offer at 3.25% (if that is stll there) especially for those with jumbo home mortgages. but it is not a lot for those in TFBs exact situation ...

I remain in a 15 yr fixed, doing the refi thing yet again (constantly no closing costs), and the 5/5 or 5/1 or perhaps 7/1 ARMs didn't make good sense to me, largely due to the fact that I'm unwilling to to make the big 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 lure me from my 3.75% 15 year fixed ...

9. ChrisCD states

June 17, 2011 at 7:59 am

Forgive me, but I am unclear how the no-closing expenses deal works. Every time I have looked they have actually desired to cover the expenses into the loan which isn't what I am seeking to do.

In addition, our home worth has actually dropped low enough to make it the option 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 a number of banks (since their website calculators consistently concluded that I would not receive their mortgage due to my LTV), I found Connexus Cooperative credit union. They let me do an 80/20 to avoid PMI just last December and I saved over a $1,000 a month on my very jumbo mortgage. I have actually given that paid off the HELOC and am paying off the 25 year 3/3 ARM over a ten years amortization. You may want to try providing them a call.

11. Madison states

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 similar to you, I believed each time it could not go lower. We're at 3.375% on our 5/5, and now obviously, I see rates are even lower once again!

I'll need to examine out FirstIB, I had not looked into their ARMs recently.

12. TJ states

June 23, 2011 at 9:26 pm

@TFB - I see an option without any points, but this option still has $2k in costs (origination charge, appraisal, credit report, flood cert, title insurance, government recording charges)

13. Harry Sit says

June 23, 2011 at 10:59 pm

@TJ - If you want the no charge choice, add 0.125% to the highest rate listed. You need to call them.

14. TJ states

August 7, 2011 at 4:08 pm

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

I improved rates for a thirty years than any other sites. I locked it but due to the fact that it was "after hours" (the weekend), they can't confirm till 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 need to resubmit a lock demand.

15. Harry Sit says

August 7, 2011 at 6:16 pm

@TJ - Sorry, I don't have any experience with Box Home Loans. Maybe check the FatWallet thread?

16. incredibly costs says

February 19, 2012 at 7:27 pm

First IB looks appealing for a 5/1 ARM. However, I live in Maryland and it appears that they do not lend here. Do you understand if this is true and if so, could you recommend other institutions? I am seriously thinking about the PenFed 5/5 at 3.125% without any closing ... Thanks for a great site.

17. Harry Sit says

February 19, 2012 at 8:12 pm

@super costs - Several other readers likewise reported the exact same thing. You can constantly call their 800 number to verify if it's still the case. If so, choose PenFed then. Maryland has a transfer tax. It'll be extremely hard to beat the PenFed rate when you consist of the transfer tax, which PenFed states it covers.

"5/5 Adjustable Rate Mortgage (ARM) Promotion: We will pay closing expenses up to $10,000 per loan, to consist of: Appraisal cost, Tax Service charge, 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 expense states

March 12, 2012 at 10:55 am

TFB - simply wanted to follow up on my publishing. I appled for the PenFed 5/5, which appeared terrific, but their appraisal can be found in method low - about 120k under what our last appraisal was one year earlier. Therefore, our loan quantity surpasses their limit offered the assessment. I am attempting to appeal but in the meantime, wanted to see if you or others had other tips for a 5/1ARM or interest just product with no closing expenses? (BTW, I talked to FirstIB, and they do not lend to MD) Thanks once again.

19. Harry Sit states

March 12, 2012 at 12:55 pm

@super expense - Regrettable the PenFed appraisal came in low. I hope you will have the ability to effectively appeal it. Maybe they can request another one? The other two lending institutions on my list to inspect are NMA (nmaloans.com) and AmeriSave (amerisave.com). Also inspect the [long] FatWallet thread.

Reply

20. Jc states

July 6, 2012 at 8:52 am

If my lyv is 50% and I refi from a 30 to a 15yr repair, and squander 50,000 and after that pay back the 50,000 towards the principal, it appears i will be conserving a substantial amount of interest every month. Is there a draw back to this besides a greater monthly payment?