Choosing a Low Down Payment Mortgage: ARM or Fixed?

5 Replies

Hi Everyone, 

I am in the process of purchasing my first deal, a duplex in Exeter, NH, for $265K. My plan is to house hack by owner-occupying one side with a roommate and (hopefully) living for free. I have just enough money for a 15% down payment and I have been approved for several first time homebuyers' programs, of which I have found the following two options to be the best offers.

Option 1: 30-Year Fixed Rate @ 3.875%, 15% or $39,750 Down Payment, ~$2,500 in loan-associated closing costs (origination fees, appraisals, etc.), $160/month of PMI that can be removed at 78% LTV, $1,219 monthly payment w/ PMI and $1,059 without it.

Option 2: 30-Year 3/1 ARM @ 2.875% to start, 3% or $7,950 down payment, no loan-associated closing costs (origination fees, appraisals, etc.), no PMI, 7.875% interest rate cap with increases of no more than 1% per year, $1,066 monthly payment for the first three years.

I understand that the interest rate risk of an ARM can be very dangerous and that, with interest rates on the rise, it might be more prudent to lock in at a 3.875% fixed rate. However, I want to hear from others how this ARM (Option 2) compares to my best fixed rate offer (Option 1). First, the 3% down payment and lack of loan-associated closing costs would keep $34,300 in my pocket at closing for me to fund another deal in the short-term. Second, the low interest rate and lack of PMI would make for a monthly payment that is $154/month cheaper than Option 1 while I am above 78% LTV and a monthly payment roughly the same as Option 1 once PMI is removed.

If it is relevant to this financing decision, I am fortunate enough to have a W2 job that, combined with a frugal lifestyle, lets me save $3,000/month currently. If I live in this duplex with a roommate, I should be able to save $3,800/month. This would allow me to pay down my mortgage early under either of these two financing options, something that would enable me to remove PMI quite soon or minimize my exposure to interest rate increases.

Which option would each of you choose were you to be in my position? Should I take the up-front savings and additional leverage in exchange for interest rate risk or pay an upfront premium for long-term rate stability? 

Thanks for the help!

I had an arm and its stressful. You always think about it. Do the fixed. 

@Nicholas Gray

Awesome! For my personally, I’d first ask what my cushion is for paying a higher mortgage. A wholistic picture of the deal (ie what are rents and expenses) would better gauge if the risk of higher leverage is worth the upfront savings.

@Nicholas Gray It sounds like your being quoted on a Fannie Mae 30 year fixed with 15% down because its an owner occupied duplex. 2 other programs you can consider that will have a lower down payment are an FHA with 3.5% down with permanent MI. or you can look at a Freddie Mac Home Possible with 5% down & MI that can be removed at 78% LTV. Call your lender and ask about these programs and the rates, & MI on both. If you dont get competitive rates, call a mortgage banker or broker.

I tend to be financially conservative, so I would go the fixed rate route almost every time. The only time I wouldn't go fixed is if I knew for sure I was selling within a specified period of time. 

Rates are generally at their lowest in history right now, so that only leaves one direction for them to go.......UP, and the FED is projected to have a rate increase in December. Lock in this month!!!

If you are leaning towards arm, take a quote on 5 and 7 year arm also. 7 year arm will give you more time and less interest rate  compare to 30 year fix, you can take your decision whether to keep this property or sell in future. 

Hey Nicholas,

Congratulations on finding a property - Exeter is a great place to buy. I would personally opt for the fixed rate.. interest rates will continue to rise and who knows when they will return to the low rates that borrowers are being offered now. If the lender will remove MI from the loan at 78% LTV and you are putting 15% down, then you should reach that threshold rather quickly if you are buying the property for any amount that is under market. One of my personal goals is to secure as much debt as I can while interest rates are low as well, which may further bias me to the fixed rate product

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