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30yr fixed vs 7/1 ARM

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  • 30yr fixed vs 7/1 ARM

    First time homebuyer. I have two offers from the lender on a house I'm looking to purchase for $159,900. Using a physician's loan.

    30yr fixed at 4.25%

    7/1 ARM at 3.5%

    Plan on staying in the house for no more than seven years. I'll be starting my five year residency this summer. Plan on doing a one year fellowship where I'd have to move. Could possibly sell when I leave for fellowship after five years. I would like to live and work in the area where I'm doing residency, so I could potentially see myself keeping the house during fellowship and living there for a year (or more) before buying a bigger/nicer house on the attending salary.

    Doing the math:

    30 yr fixed = $786.61/mo. Would owe $145,202 after 5 years of payments.

    7/1 ARM = $718.02/mo. Would owe $143,426 after 5 years of payments.

    Difference = $4115.40 in monthly payments (60 payments) + $1,776 of less owned towards loan after 5 years for a total of $5,891.40 in savings.

    I was originally considering 7/1 as I am pretty sure I would keep the house for no more than the seven years. But seeing that the total savings amounts to just under 6k over five years (if my math is correct) I'm not so sure it wouldn't be better to just lock in a fixed rate in case anything happens (eg, trouble selling the house).

    Any thoughts on this?

     

  • #2
    Yes, why on earth are you buying if you plan to leave in 5 years?

    Rent.

    Comment


    • #3


      Plan on staying in the house for no more than seven years. I’ll be starting my five year residency this summer. Plan on doing a one year fellowship where I’d have to move. Could possibly sell when I leave for fellowship after five years. I would like to live and work in the area where I’m doing residency, so I could potentially see myself keeping the house during fellowship and living there for a year (or more) before buying a bigger/nicer house on the attending salary.
      Click to expand...


      I'm not actually sure you should be buying a house, but given the uncertainty you have about it I would lean towards the 30 year fixed.  Granted I'm not qualified to predict what will happen with the economy, but it would be hard for rates to drop below what they are now in the next 5 years.  If you end up stuck with the house at least you don't have to freak out about rising interest rates.

      Of course you should really be looking into a 15 year fixed.  5 years of making those payments and you will have a ton of equity.  If you hold onto it you'll be able to pay it off within a couple years of being an attending, and if you sell it, even if you don't get a profit, you won't have only been paying interest for 5 years and can get some of your money back.

      We bought our first house 10 months into my 3-year fellowship and not sure where my attending job would be.  Pretty much goes against everything you are taught.  I bought it on a 7/1 ARM doctor loan 100% down, refinanced into a regular 7/1 ARM, then again to a 15-year fixed (rates kept dropping).

      I stayed as an attending, sold the house after 6 years at peak of housing market after buying at the bottom.  However I also had a lot of equity in the house because of making large payments, and as an attending the payment felt like nothing.

      I had a lot of things go right for it to work -- buying at the bottom of the market, rates continually dropping, having enough income from spouse to afford a 15-year fixed payment, staying as an attending (not because of house), home prices appreciating, and my area of town going from high turnover to high demand.

       
      An alt-brown look at medicine, money, faith, & family
      www.RogueDadMD.com

      Comment


      • #4
        I'd spend some time with this Rent Vs. Buy calculator, to make sure you'd still like to buy. Remember, in residency you likely won't have much time for house improvement sorts of things. If you're up for it, great. If not, consider renting, in addition to the financial aspects of the Rent Vs Buy tool. Don't forget, when you sell, you have a timing issue, fees, commissions, etc. It can work out well, and it can be a pain.

        Also, I'd go with the 30 yr fixed. Low cash flow, the ARM will "A"djust, so having something consistent with a relatively consistent salary for the next years is valuable. I'd get a lot of value from knowing the payments wouldn't change. Just my 2 cents.

        Also Also, making sure the rest of your financial house is in order. Student loans on the proper plan, emergency fund (maybe larger if you have a house!), retirement contributions, spending money for comfort food for those horrible shifts that never seem to end, etc.

         

        Comment


        • #5
          I wish I had rented during residency.

          Picking up and moving to your final practice destination without having to sell is so nice. Also, if you do stay in your training town to practice full time, you should stay in your residency rental house until you can save a down payment and pay off student loans.

           

          As for the debate of 7/1 ARM vs 30 fixed, I tend to lean on the 7/1 ARM. The odds of staying in a house 30 years are pretty low.

          WCI had a nice write up here:

          https://www.whitecoatinvestor.com/10-reasons-why-residents-shouldnt-buy-a-house/

           

          You can read about my residency home buying experience here:

          https://www.highincomeparents.com/investing-mistakes/

          Comment


          • #6
            Thanks for the advice!

             

            Big part of buying is based on emotion (surprise!). We could absolutely stay in our 2br apartment for about what our monthly mortgage payment will be -- at least until we start having kids.

             

            But looking at the numbers, the rent vs buy calculator tells us it's basically a wash either way. My wife has a good income and I've budgeted ~$6000/yr towards maintenance and selling costs, plus another $900 towards a good home warranty (at least until we can get a good emergency fund going). If we don't outgrow the house (kids), I would definitely stay put for a few years as an attending to save and pay off student loans for a couple years. I anticipate outgrowing the house after 7 years however -- hence the 7/1 ARM option. And I would almost certainly not stay in it longer than 9-10 years.

             

             

             

             

            Comment


            • #7
              I would definitely do the 7/1 arm. $6000 is nothing to sneeze at, even for a doc. If interest rates rise it's not like they will all of a sudden jump to 10%. These things are capped yearly and it will take many years for you to lose that $6000 in saved interest. You will have sold the home my then. Also you will not be a resident. Your income will make it easy to pay off a 140k note in a couple of years. I can't see the upside to a 30 year fixed.

              Comment


              • #8




                I would definitely do the 7/1 arm. $6000 is nothing to sneeze at, even for a doc. If interest rates rise it’s not like they will all of a sudden jump to 10%. These things are capped yearly and it will take many years for you to lose that $6000 in saved interest. You will have sold the home my then. Also you will not be a resident. Your income will make it easy to pay off a 140k note in a couple of years. I can’t see the upside to a 30 year fixed.
                Click to expand...


                Fair enough - I see your logic in that.

                Comment


                • #9
                  If you are going to buy, take the better interest rate.

                  Renting has headaches but selling a house can be quite costly.

                  I had plenty of classmates take a beating when they left after 4 years and we were selling in the 2012-14 range. It is hard to predict markets. Who knew a large company was going to put up 100 houses across the street just as we were all selling...

                  My wife and I just barely broke even at 5 years and most of my classmates lost at least 10-15k and had months of anxiety.

                  Comment


                  • #10
                    Location Location Location - is the mantra of housing ownership.   From neighborhood to the corner vs cul-de-sac to the barking dog next door -- it all matters. Only you will know the pro/cons to ownership vs renting and tolerance of landlord if RE asset is in your future.

                    All of these play a role into deciding ownership and holding house duration and if converting to rental afterwards.-- then it'll clear up the pro/cons of 7/1 vs 30yr.  If you KNOW for certainty moving in 7; why not get 7 year interest only?  that's make the most sense.  If you're in a sensitive market, renting perhaps maybe better as others have pointed out.

                    It all really depends on your local market  .  My guess since 160K for home, somewhere in midwest and college town. Check back in 2008-2012 on the realty market (realtor.com or redfin or zillow) and see valuations compared to 2005-2007 and Days On Market for sales.  That'll give you an idea of worse case scenarios.  Also look at rental market now and during that time as the alternative to sell on down market as backup unless you're ready to take a loss on forced sale on relocation.

                    To me, the 30year decreases a lot of anxiety on the unknown of costs for ownership.  You're not at the mercy of the Fed Reserve in 7 years and yearly ARM.   Who knows, in 7 years interest rates could be 10%.   in 2000, we would never guessed interest rates dip from 8% to sub 4%

                     

                    Comment


                    • #11




                      Location Location Location – is the mantra of housing ownership.   From neighborhood to the corner vs cul-de-sac to the barking dog next door — it all matters. Only you will know the pro/cons to ownership vs renting and tolerance of landlord if RE asset is in your future.

                      All of these play a role into deciding ownership and holding house duration and if converting to rental afterwards.– then it’ll clear up the pro/cons of 7/1 vs 30yr.  If you KNOW for certainty moving in 7; why not get 7 year interest only?  that’s make the most sense.  If you’re in a sensitive market, renting perhaps maybe better as others have pointed out.

                      It all really depends on your local market  .  My guess since 160K for home, somewhere in midwest and college town. Check back in 2008-2012 on the realty market (realtor.com or redfin or zillow) and see valuations compared to 2005-2007 and Days On Market for sales.  That’ll give you an idea of worse case scenarios.  Also look at rental market now and during that time as the alternative to sell on down market as backup unless you’re ready to take a loss on forced sale on relocation.

                      To me, the 30year decreases a lot of anxiety on the unknown of costs for ownership.  You’re not at the mercy of the Fed Reserve in 7 years and yearly ARM.   Who knows, in 7 years interest rates could be 10%.   in 2000, we would never guessed interest rates dip from 8% to sub 4%

                       
                      Click to expand...


                      I had a house about that price during those times. Not much happened besides buyers drying up. House value changed hardly at all the whole time, was actually 5-8% less when sold 7 years later. Very steady. I 100% agree that with a price like that its not a desirable location and no appreciation should be baked in.

                      Buying/maintaining is a hassle, why add that to residency?

                      Comment


                      • #12


                        To me, the 30year decreases a lot of anxiety on the unknown of costs for ownership.  You’re not at the mercy of the Fed Reserve in 7 years and yearly ARM.   Who knows, in 7 years interest rates could be 10%.   in 2000, we would never guessed interest rates dip from 8% to sub 4% 
                        Click to expand...


                        Im sure plenty of people that knew about rates saw continued decline even in 2000 for longer term. Bond stuff lasts a long time. Might be hard to dredge up but would be interesting to see proclamations around those times.

                        Comment


                        • #13
                          2000 was just before then minirecession with Bush II, and drops of rates and then recovery into 2008 to fight growing inflation, then the bottom dropped out and the Great Recession.

                          http://www.tradingeconomics.com/united-states/interest-rate  can play with the rates graph years --- we're exiting out the longest, lowest interest rates in recent history.

                          I'm not that saavy in business economics to roll with Mr Greenspan and crew -- hence I'm locked into a 30yr fixed

                          Comment


                          • #14




                            2000 was just before then minirecession with Bush II, and drops of rates and then recovery into 2008 to fight growing inflation, then the bottom dropped out and the Great Recession.

                            http://www.tradingeconomics.com/united-states/interest-rate  can play with the rates graph years — we’re exiting out the longest, lowest interest rates in recent history.

                            I’m not that saavy in business economics to roll with Mr Greenspan and crew — hence I’m locked into a 30yr fixed ?
                            Click to expand...


                            Not saying anything negative, and what you say is true. Im just assuming since its easily known today that interest rate cycles are 30-50+ year cycles that some of these smart 80s bonds guys or technical traders must have seen it coming. I also like to go back and see who was looking at what and saying what and when. Its very interesting overall. More contemplative in substance.

                            Like the housing bubble/financial crisis. The prevailing theme was NO ONE saw it coming, then just those super smart guys in the big short, but no one else. When in fact there was a lot of chatter and a lot of it absolutely correct by a good amount of people. It just wasnt the prevailing narrative. As they say, its not that difficult to recognize a bubble, its just really hard to time its demise AND be positioned to profit from your brilliance.

                             

                            Comment


                            • #15
                              7/1 ARM.  Guaranteed better return within 7 years, and realistically longer than that, as a potentially lower fixed rate still takes time to break even after the 7 years is up (assuming rates go up, which they almost have to).

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