Is Refinancing 5/1 Year Arm With a 30 Year Frm Worth It?
Scenario:
I am about to shift to a place 55 miles east of my current home which I intend to sell. I wanted to sell the sell the home before I could get the new home as I have sufficient equity ($30,000) in the old house which I could put into the new home when the former sells. But the market isn’t going great in the county where I live and it doesn’t seem that I will be selling it fast. I am thinking of going for a 5/1 year ARM on the new home while the old property is up for sale. I would then refinance the new home with a 30 year FRM when I am able to get the sale proceeds and hence my equity from the old home. Am I on the right track?
Solution:
If you are buying a second home with a Mortgage, you must be aware of closing costs involved in it. Such costs range from $2000-4000 and vary from one state to another and even from county to another. So, once you are buying the home, you’ll pay the closing costs and then again when you refinance it, you’ll pay another set of the same costs. And, the costs of refinancing are worth considering. So, why pay it twice when you can use up the money on something else that can benefit you.
Instead of going for a 5/1 year adjustable rate mortgage (ARM) and then refinancing it into a 30 year fixed rate mortgage (FRM), it is better that you go directly for the fixed rate loan in order to buy your home. Moreover, considering the current interest rates on 5/1 year ARM and 30 year FRM, the difference in interest expense isn’t much.
Let's take an example to find out the difference in interest rates on 30 year FRM and 5/1 year ARM.
For 30 year FRM,
Suppose, Loan amount = $150,000
Interest rate = 5.90%
Using the FRM calculator, the monthly payment = $889.70
Loan balance at the end of 1 year = $148123.33
For 5/1 year ARM,
Say, Loan amount = $150,000
Interest rate = 5.56%
Using the FRM calculator, the monthly payment comes out as = $857.34
Loan balance at the end of 1 year = $148001.52
Thus, the difference in the monthly payments on 30 year FRM and 5/1 year ARM is around $32.36 ($889.70 - $857.34) which comes out to be $388.32 annually. And, the difference in loan balance at the end of the 1st year is around $121.81. So, the monthly payment and loan balance (at the end of 1 year) do not differ by a large number. Moreover, taking out a loan with variable payments just for the sake of saving $388 a year isn’t a good financial move. You don’t know what your rates can be each year when they adjust as per the changes in the ARM index. Therefore, it's better to go for a 30 year fixed rate loan instead of first applying for a 5/1 year ARM and then refinancing it with a 30 year FRM.
Now, when you buy the second home (with a 30 year FRM), you need to pay the closing costs and for that you can take out a bridge loan in case you aren’t able to sell the current home and use the sale proceeds. The bridge loan gives you a short term financing solution and it will be offered against your current home as the collateral. Generally it should be repaid by the time you sell your current home but you can request the lender and extend the repayment period to another 6 months. And, you can get such a loan with little documentation of your income and assets.
However, I would advise that you sell the property within a short time, and if possible, even at a lower price. This is because if you delay the sale, you may end up paying much more as rates and costs of taking the loan may get higher.
If you have any query on Refinance or loan related issues, feel free to discuss it with the community members in Forums.
(ArticlesBase SC #290383)
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