patrick.net

What if you are stretched out and just assume on prayer that rates will not be up to 6% (ARM rate) on Year 6? That could be dangerous if you choose a 5/1 based on what you can afford -now-.

chip_designer says

In the high income, there is also a cap on how much mortgage interest you could deduct. So if deducting less mortgage interest(using adjustable rate), you might pay more federal tax, but lower AMT.

There is a cap, but it's $1M for acquisition loans + $100K in equity loans. The old cap on ALL itemized deductions is gone as of 2010 -- it was phased out in the years before. Under the 2010 tax extension, this cap will not apply for 2011 and 2012 either.

You might also consider a 5/5 ARM as I've mentioned on Patnet before, as it might fit your profile:

https://www.penfed.org/productsAndRates/mortgages/mortgageCenter.asp

Pentagon Federal's ARM is limited to a 2% increase every 5 years and a 5% max increase over the life of the loan. The current listed rate is 3.25%, so at 5 years, the max would be 5.25%, at 10 years, the max would be 7.25%, and at 15 years, the max would be 8.25%. Both 7.25% and 8.25% are reasonable by historical standards, and lots of people move before 10 years anyway.

If you can deal with the risk of the payment going up, the ARM makes sense. The problem during the boom was two-fold: 1) people took ARMs with maximum size loan, so they were on the margins to begin with; 2) some of the ARMs had other "innovations" such as recasts which structurally increased the size of payments, as opposed to resets which change the interest rate. If you live within your means and can deal with the interest rate risk, it can be a good option.

corntrollio says

There is a cap, but it’s $1M for acquisition loans + $100K in equity loans. The old cap on ALL itemized deductions is gone as of 2010 — it was phased out in the years before. Under the 2010 tax extension, this cap will not apply for 2011 and 2012 either.

Hi Corntrollio, can you elaborate more on above. What is the old CAP. And which cap that is will no longer apply for 2011 and 2012, is this good or bad?

Thanks

chip_designer says

What is the old CAP. And which cap that is will no longer apply for 2011 and 2012, is this good or bad?

It's not really a cap, so much as a phase-out. I think it works something like this:

80% of itemized deductions are subject to the phase-out
3% of the amount over a threshold (something like $165K in 2009) was the amount that could be phased-out before the phase-out was changed

In 2006 and 2007, the phase-out was 2%. In 2008 and 2009, the phase-out was 1%. In 2010, 2011, and 2012, the phase-out is 0%. After 2012, who knows?

It's good if you make over $170K or so because you get to take all of your itemized deductions. But there is no advantage under the AMT with respect to mortgage interest, as there was before.

By the way, I believe mortgage interest from an equity loan is not deductible under the AMT -- only a purchase-money loan.

In addition, refis are deductible, but only to the extent that they do not exceed the original principal amount. Under the AMT, this means that interest cash-outs is not deductible, but under regular taxes, cash-outs count as equity loans and are deductible up to $100K.

what if mortgage adjusts and you are stuck at a point where you cant refinance? Even the people who started/created ARM's thought they were a terrible financial idea.

corntrollio says

Both 7.25% and 8.25% are reasonable by historical standards, and lots of people move before 10 years anyway.

If you are moving in less than 10 years then all you are doing is renting the money. You might as well rent the house and let the landlord take all the risks. The cost of buying and selling a house will be far higher than what you deduct on your taxes for interest.

bob2356 says

corntrollio says

Both 7.25% and 8.25% are reasonable by historical standards, and lots of people move before 10 years anyway.

If you are moving in less than 10 years then all you are doing is renting the money. You might as well rent the house and let the landlord take all the risks. The cost of buying and selling a house will be far higher than what you deduct on your taxes for interest.

chip_designer says

bob2356 says

corntrollio says

Both 7.25% and 8.25% are reasonable by historical standards, and lots of people move before 10 years anyway.

If you are moving in less than 10 years then all you are doing is renting the money. You might as well rent the house and let the landlord take all the risks. The cost of buying and selling a house will be far higher than what you deduct on your taxes for interest.

chip_designer says

chip_designer says

bob2356 says

corntrollio says

Both 7.25% and 8.25% are reasonable by historical standards, and lots of people move before 10 years anyway.

If you are moving in less than 10 years then all you are doing is renting the money. You might as well rent the house and let the landlord take all the risks. The cost of buying and selling a house will be far higher than what you deduct on your taxes for interest.

Since i am the original poster, I just want to say that this post is about which loan package is better.

Lets not talk about the merits of buying or renting. There are enough of this in 90% of this forum.

ChrisLA says

Even the people who started/created ARM’s thought they were a terrible financial idea.

Only in this country and only for mortgage loans. In other countries, mortgage loans often have adjustable rates. For other types of loans, e.g. student loans and credit cards, an adjustable rate is quite common (except for consolidations of government-subsidized loans).

bob2356 says

If you are moving in less than 10 years then all you are doing is renting the money. You might as well rent the house and let the landlord take all the risks. The cost of buying and selling a house will be far higher than what you deduct on your taxes for interest.

I don't disagree, but you'd actually have to do the math on this to make sure. It's possible that you'd be ahead after 10 years, but it's also possible that transaction costs could kill it.

corntrollio says

It’s possible that you’d be ahead after 10 years

Not the immediate 10 years that is going to follow.

bubblesitter says

Not the immediate 10 years that is going to follow.

I'd probably agree with that because we are post-housing bust. I'm just talking about any random 10 years.

wait, wait, I don't get it.

Interest rates are record low NOW. So why get a loan that is going to reset in 5 yrs, when rates would be most probably HIGHER, and home prices are likely to be flat, so can't refinance.

permanent_marker says

wait, wait, I don’t get it.
Interest rates are record low NOW. So why get a loan that is going to reset in 5 yrs, when rates would be most probably HIGHER, and home prices are likely to be flat, so can’t refinance.

Cash is the King. Enjoy the lower rate for 5 years and pay it off at the reset. It is also a best case scenario for deadbeats to walkout at reset, or stay for free for who knows how long at that time?

permanent_marker says

wait, wait, I don’t get it.
Interest rates are record low NOW. So why get a loan that is going to reset in 5 yrs, when rates would be most probably HIGHER, and home prices are likely to be flat, so can’t refinance.

It really doesn't matter whether rates are high or low. The important part is the spread between arms and fixed, and the specific reset terms of the ARM. With that data you can do a pretty easy spreadsheet to tell you which product is better.

corntrollio says

ChrisLA says

Even the people who started/created ARM’s thought they were a terrible financial idea.

Only in this country and only for mortgage loans. In other countries, mortgage loans often have adjustable rates. For other types of loans, e.g. student loans and credit cards, an adjustable rate is quite common (except for consolidations of government-subsidized loans).

I don't think we are discussing buying property in Bulgaria.

tatupu70 says

The important part is the spread between arms and fixed,

Yes!, why the spread is so much >1% ? If there were not much spread, I think it would efficient to go to fixed products, like 30 year or 15 year fixed. Before the bubble , the spread use to be around 0.5%.

ChrisLA says

I don’t think we are discussing buying property in Bulgaria.

No need to add strawmen. My point is germane to the discussion at hand. People elsewhere have ARMs all the time, and it doesn't lead to mass destruction. It isn't uncommon in the UK to have a variable rate loan -- you don't have to resort to Eastern European EU members to find an example.

The reason the US has fixed rate mortgages is more about government subsidies and general government intervention in the mortgage market than it is about market forces deciding it was the best thing to do. It's not like we always had fixed rate mortgages and someone decided to invent the ARM.

The US is just about the only country in the world that has long term fixed rate mortgages. As Chrisla points out this is due to government subsides. A fixed rate mortgage in Europe is only fixed for 3-5 years. What they call variable rate varies as often as 6 months or less.

I experienced high fixed interest rate before, back in 1999, I had 6.85% 30 years fixed.

Right now, 30 years fixed is 4.5%, 5/1 ARM 2.75%

If rates starts to rise in 5 years or less time, and suppose rates go up to 1999 levels, and the spread between fixed and ARM is close, people will not be able to get refinance rates that match today's 30 year fixed.

That is the only option when ARM is not a good deal.