5/1 Hybrid ARMs Rock!

A New Post By Dan Melson
Mortgage Loan Broker - California
Read other posts by Dan Melson

I've been mostly dealing with issues on the real estate side in the last couple weeks.

But here's a question:  Can you persuade someone who wants a thirty year fixed that a 5/1 is a good idea?

Here's a refinance question I got this week

$600k loan at 6.25%.  LTV is between 75 and 80, and we're looking rate/term (no cash out)

Refinancing at 6.25 on a thirty year fixed (with all adjustors) would cost the client a little over $4000.

Refinancing at 5.875% would cost (mutatis mutandis) about $11,000, for a savings of about $2200 per year.

Refinancing at 5.5 would cost about $18,000, saving roughly $4500 per year.

Considering that most folks (these included) refi about every 3 years, none of these make sense.

BUT

5.875 on a 5/1 is Zero points, with me making just over a half in YSP.  Would I spend $3500 (about) to save $2200 per year in interest for up to five years?  Yes.  That makes sense, especially when most folks refinance every three years anyway.

for 5.5, it's about 0.8 points.  Spend $8-9000, save $4500 per year.  Still good!

For a point and a half ($12500) they can have 5.25%, saving about $6000 per year.  Not only are their payments way lower but if they keep it four years they're $12,000 to the good on the cost of the money, never mind the payment difference.

no matter how you slice the 5/1 here, you're paying for the loan in two years, leaving the last three to be pure profit for the client (they can keep it after adjustment, but you and I know nobody does).

There's a lot of folks out there at rates where a thirty year fixed doesn't make any sense - but a 5/1 ARM does.  And the spread between the two seems to be getting wider again.  Your client gets not only a better rate, but five years of insurance that the rate won't change.  Since this is way more than most people use, the 90% of people who are in this position really aren't giving up anything.

Not to mention you've got a tickler for when you're ready to do another loan.

(and before anyone asks, I'm not seeing 7/1s and 10/1s drop like this.  Since the spread between the thirty fixed and these is usually *much* smaller than the 5/1 spread, I find it hard to recommend either one of them.  More than once I've had to catch a thought about 10/1s being a small reward for wimps before it got out of my mouth.  Especially given that the national mean time between refinancing is still less than three years)

Comments

[Rhonda Porter]

I really like using Mortgage Coach to compare programs side by side for clients. Dan, do you use MC or a program like it?

[Dan Melson]

I wrote my own loan comparison spreadsheet about two years ago. Nothing fancy, but it gets the job done. Took me about an hour and a half one day when I had nothing better to do. It's just cut and paste of formulas, but it lets me and clients scrutinize the loans under consideration for the entire period. It's also one of the tools I use to make writing articles with large amounts of calculation easier.

Maybe one of these days I'll take my spreadsheets and pretty them all up and start selling them to people who don't understand spreadsheets.