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The mortgage rates dropped again. I'm refinancing my home loan once again. It's incredible it hasn't been even a year because I did it last time.

The rates were low in 2015 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, instead of following my normal Stepping Down the Ladder script, I'm refinancing my home 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 indicates refinancing to a fixed rate a little above the market rate, with sufficient credit from the lending institution to cover the closing expense. Rinse and duplicate whenever the rates go lower again.

It's a no-lose proposal. You begin gaining from the lower rate on day one. As the rates go lower, you keep securing to a lower rate, and never ever pay any closing costs. 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 took a look at re-financing this time, I started with the very same method. Because I have a 15-year fixed rate home loan now, I took a look at 15-year fixed and 10-year fixed alternatives.

If I opt for another 15-year fixed, the very best rate I can get is 3.625% without any closing cost. It's barely rewarding due to the fact that my present rate is 3.75%. If I choose a 10-year repaired, I can get 3.25% without any closing expense.

Between these two choices, I would select the 10-year repaired. I've had a 15-year fixed home loan for a couple of years now. I want to pay it off in ten years.

5-Year Adjustable Rate Mortgage (ARM)

I normally don't take a look at ARMs at all, since the whole concept of Stepping Down the Ladder is about locking in the least expensive rate for the life of the loan. But since I was considering a 10-year repaired, I also looked at ARMs.

A 5/1 ARM has a set rate for the very first five years. The rate begins adjusting every year after 5 years. If I'm going to pay off in 10 years, by the sixth year the staying balance will be small enough that I can settle if I wish to. If I don't like the rate at that time, I will simply pay it off. Meanwhile I will have conserved rather a bit of interest in the first 5 years.

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

Cash Out Refi

A cash-out refi means obtaining more than the current loan balance. Usually you will pay a higher rate and/or greater charges if you re-finance 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 money out? Because the lender credit is associated with the loan amount. Within specific limits, the greater the loan amount, the greater the lender credit. When the lender credit is high enough, it will be able to bump the rate down a notch and still make it a no closing cost loan.

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

If I increase the loan total up to the optimum permitted, 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 exact same lender I used last time: First Internet Bank of Indiana ("FirstIB"). For the loan I want, FirstIB offers the best offer amongst a list of lenders I looked at: PenFed, National Mortgage Alliance, and AmeriSave.

Won't borrowing more increase the overall interest paid? Yes, if you just pay the minimum. Because the loan has no prepayment penalty, you can pay the cash-out right back in the first month. The only impact of a higher loan quantity will be a greater required month-to-month payment quantity. Since I'm going to follow a 10-year reward schedule and the 5/1 30-year amortization, the higher needed month-to-month payment is still lower than what I'm going to pay anyway.

For example, to pay off $100k in ten years at 3.25%, I will need 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 obtain $200k, repay $100k right away and keep paying $977 a month, the remaining $100k will still be settled 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 earn more than 2.625% a year from my financial investments. A five-year CD from Melrose Credit Union pays 2.90% a year. If I only pay the needed minimum month-to-month 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 reduction on the home loan interest will be a wash.

If I put the money in an internationally varied portfolio of stocks and bonds, the return has to be greater - if I do not believe that I ought to simply liquidate whatever, pay off my home loan, and put the rest all in CDs. Everybody who is carrying a home loan and investing at the exact same time is betting the financial investments will earn more, otherwise they wouldn't invest before the loan is paid off.

But anticipated returns are simply that - anticipated. You can wager and anticipate all you desire. The real returns might come greater or lower than your expectation.

Although the thought of generating income with other people's cash is appealing, I'm not yet that comfy with it. I might still do the CD however that has to do with it. I don't wish to take more risk with this money.

Rates Have Nowhere to Go But Up?

You may believe rates have nowhere to go but up which it's shortsighted to get an ARM now when rates are the most affordable. You may believe 5 years from now rates of interest will be much greater.

I thought the same every time I re-financed in the last 10 years however rates keep boiling down, reaching one historic low after another. I honestly thought it was the last possibility to re-finance in March 2010. That was 2 refinances back.

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

When you are within ten years to settling your home mortgage, refinancing to an ARM can save 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 mortgages, but not on ARMs).

Taking a cash out and paying it right back will lower the closing expenses. You may even earn money for doing the refinance. If you are going to pay off 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, however the equity in our house 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 fact 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 few years down the roadway, the amount of concept I 'd have the ability to pay down in the mean time would most likely well offset any possible uptick down the roadway.

2. David says

June 13, 2011 at 7:39 am

Very interesting analysis. Did you consider the PenFed 5/5 ARM? If so I wonder about your ideas on that. I've taken a look at that over the last couple of years whenever there was a dip in rates however I always wound up choosing the "more secure" fixed rate loan.

3. Harry Sit states

June 13, 2011 at 9:27 am

@David - Yes I considered PenFed's 5/5 ARM. It's currently 3.25% for the first five years, versus 2.625% on the 5/1 ARM from FirstIB. If I'm going to pay 3.25%, I may as well 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 good as the deals from FirstIB.

4. Mike states

June 13, 2011 at 10:46 am

Interesting method. What is the max. LTV ratio you can squander without being punished?

5. Harry Sit states

June 13, 2011 at 10:47 am

@Mike - 60%.

6. TJ says

June 13, 2011 at 6:00 pm

Has teh no closing expense expired? I don't seem to see that choice ...

7. Harry Sit says

June 13, 2011 at 8:30 pm

@TJ - FirstIB only lists rates with closing cost. The next greater rate will have no closing expense. For example if the highest rate (least expensive costs) listed is 3.5%, 3.625% will have no closing cost.

8. enonymous states

June 14, 2011 at 11:08 am

good analysis

naturally 60% LTV, and small enough balance to be able to reward the loan with a balloon payment at the end of the 5 years is the key

the Penfed 5/5 is a significant deal at 3.25% (if that is stll there) especially for those with jumbo mortgages. but it is not a good deal for those in TFBs precise scenario ...

I remain in a 15 year repaired, doing the refi thing yet once again (constantly no closing costs), and the 5/5 or 5/1 or perhaps 7/1 ARMs didn't make good sense to me, mainly due to the fact that I hesitate to to make the large balloon payment needed 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 year repaired ...

9. ChrisCD states

June 17, 2011 at 7:59 am

Forgive me, however I am unclear how the no-closing costs deal works. Whenever I have actually looked they have wished to wrap the costs into the loan which isn't what I am aiming to do.

In addition, our home worth has dropped low enough to make it the alternative appear out of reach.

cd:O)

10. Heidi says

June 18, 2011 at 4:54 pm

Money Beagle - I was in a similar situation. After calling numerous banks (since their site calculators regularly concluded that I would not certify for their mortgage due to my LTV), I found Connexus Cooperative credit union. They let me do an 80/20 to avoid PMI simply last December and I conserved over a $1,000 a month on my extremely jumbo mortgage. I have considering that paid off the HELOC and am settling the 25 year 3/3 ARM over a ten years amortization. You might want to attempt providing a call.

11. Madison says

June 22, 2011 at 6:38 am

I keep decreasing our 5/5 ARM at penfed with a plan to pay off in 5-10 years. And similar to you, I thought whenever it couldn't go lower. We're at 3.375% on our 5/5, and now obviously, I see rates are even lower once again!

I'll have to check out FirstIB, I hadn't checked out their ARMs lately.

12. TJ states

June 23, 2011 at 9:26 pm

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

13. Harry Sit states

June 23, 2011 at 10:59 pm

@TJ - If you want the no charge choice, add 0.125% to the greatest rate noted. You have to call them.

14. TJ says

August 7, 2011 at 4:08 pm

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

I improved rates for a 30 year than any other sites. I locked it however since it was "after hours" (the weekend), they can't confirm up until Monday, if it is lower than what i locked, mine will be the lower rate, if rates go on monday, they will disregard my request and I need to resubmit a lock request.

15. Harry Sit states

August 7, 2011 at 6:16 pm

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

16. very 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 seems that they do not provide here. Do you understand if this is true and if so, could you recommend other organizations? I am seriously thinking about the PenFed 5/5 at 3.125% with no closing ... Thanks for a terrific site.

17. Harry Sit states

February 19, 2012 at 8:12 pm

@super expense - Several other readers also reported the same thing. You can constantly call their 800 number to verify if it's still the case. If so, opt for PenFed then. Maryland has a transfer tax. It'll be extremely challenging 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 approximately $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 needed and Work Verification Fee."

18. super expense says

March 12, 2012 at 10:55 am

TFB - just wished to act on my publishing. I appled for the PenFed 5/5, which appeared terrific, 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 limitation offered the assessment. I am attempting to appeal however in the meantime, wished to see if you or others had other suggestions for a 5/1ARM or interest only product without any closing costs? (BTW, I consulted FirstIB, and they do not provide to MD) Thanks once again.

19. Harry Sit states

March 12, 2012 at 12:55 pm

@super bill - Regrettable the PenFed appraisal was available in low. I hope you will be able to effectively appeal it. Maybe they can ask for another one? The other two lenders on my list to examine are NMA (nmaloans.com) and AmeriSave (amerisave.com). Also inspect 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 repair, and squander 50,000 and after that repay the 50,000 towards the principal, it appears i will be saving a huge quantity of interest on a monthly basis. Exists a draw back to this besides a greater month-to-month payment?