I spent a lot of time in the past few weeks reading about sub-prime mortgages. You see, I’ve just entered into a mortgage, and I wondered what my risk was. Was I in danger, in some way, because of all of this financial foolishness? Well, of course: everyone on the block around me could loose their shirt, and my home purchase would be devalued. I don’t think that’s going to be the case, however, so lets just say that my largest risk is probably general economic collapse.
But what if I were in a different situation? Say I had purchased a condo for around $200K. I purchased it with a short-term ARM (perhaps a 5-year) about four years ago, and I now need to decide what to do. The rate is about to jump, I don’t want to sell just yet, but at the same time, I don’t want to watch my monthly payments double in the next few years. Because I’m in a good financial position (right now), I decide to refinance. There are two ways I could do this.
It’s fine!
I used to live at 3 Woodland Way in Canterbury, England. In this house, we had a saying: “It’s fine!” Usually, this is said forcefully while something is on fire. Typically, that particular thing (whether it is a microwave or a coffee machine) should not be on fire. It was an assertion, not an assessment, intended to calm any housemates who may be witness to the unfolding disaster.
I could look around at my local economy, and declare “It’s fine!” I might, then, refinance with another 5-year ARM. Doing a bit of reading:
Under this model, an ARM that starts at 5.75 percent can increase to 7.75 percent in the second year, to 9.75 percent in the third year, and 11.75 in the fourth year. This means monthly payments will nearly double.
So, if I believe that my local economy will outshine the global economy, and that I will be able to refinance and sell within five years without substantial loss, then I should go ahead with the 5/1 ARM. Why? Because I pay less interest now, offload my property in three years, and save money in the process.
We’re screwed, Cap’n
I heard my housemate Ed say this more than once: this was often stated in aftermath of declaring “It’s fine!” The US economy is fcuked. We are in recession. We are getting hit hard on jobs, oil, and the ongoing debacle that is the subprime crisis. Hell, people have even stopped buying Hum-Vees.
No economy in the US will weather this well. I take that back: small, isolated micro-economies (rural towns, etc.) will continue to do as poorly as they ever have. In other words, they won’t be effected by large wiggles in the economy, because they run on a lower baseline and the ripples aren’t felt as fiercely. So, arguably, small economies will do better as the fecal matter hits the rotating blades.
Large economies (cities) cannot fare well. Cleveland is already being gutted (charts and graphs) by the subprime scandal, and we haven’t yet seen the fallout from this. To claim that any one market will do better than another is crazy-talk; certainly, I’d want data to support such crazy-talk, but… oops! That data comes from the future. So, I guess I won’t be seeing that data.
Snark aside, there would seem to be only one option: financial conservatism. The safest move is to refinance on a stable, 30-year mortgage. A 30-year fixed at 6.25% will involve a monthly payment of roughly $1200. This is a bit higher than the ARM, and yes, you pay $250K in interest over the life of the loan. However, the life-of-loan figure is a lie. We can refinance later if the rate comes down—not to buy a new car, but to jump from a 30-year to a 15-year mortgage, thus saving substantial cash. (We avoid the 15-year now because of the higher monthly payments; the 30-year gives us more breathing room right now.) Or, we can pay on a bi-weekly basis to cut the 30-year to a 22-year mortgage… if we’re making a steady flow of serious cash. (Remember the golden rule: the bank will always take your money.)
But again, if the goal isn’t to keep the property forever, it is simply a matter of “when” we are going to sell, not “if”. Hence, we shouldn’t care about the interest, or refinancing, or anything else for that matter. Instead, we should just care about getting into the safest financial position we can find now, and make sure that it is a position from which we can weather any coming crisis. If we manage to sell in three years, we paid a relatively small amount more (per month) for the safe 30-year loan over the unsafe 5/1 ARM. If the economy is in such dire straits in three years we cannot sell, and we’re lucky we’re employed and still have a place to live, then we want to make sure that our loan doesn’t yank that stability out from under our feet—which a 5/1 could easily do.
Keep in mind, I don’t actually know anything about long-term finance, but I am having a hard time finding ways to argue for the higher-risk strategy unless you’re prepared to loose. I, myself, would not be in a position to see base housing costs double.
Of course…
The safest-est move is to dump the property while/if there is a local economy that is in the mood to buy. Then, the whole discussion becomes moot, and the financial burden is covered by an SEP field… it becomes Somebody Else’s Problem.
If this were me, selling right now would mean I’d have to move in with my parents for a while, and it would be inconvenient… but I’d sleep better knowing that a clean, empty condo sells better than one with people in it. However, prepping a property for sale so that prospective buyers want to buy it as soon as they see it is another post entirely.
