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Author: chopsueycp Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 126962  
Subject: FRM vs ARM debate Date: 8/19/2011 12:24 AM
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There seems to be a pretty healthy debate/disagreement going on this board between Dave D. and, well, everybody else, regarding FRM vs ARM mortgages.

Would you say Dave is an ARM-y of one?

(booooooooooo!)

Anyway... Dave pretty soundly believes that it's a no-risk, common-sense financial move to go with the ARM, while it almost seems to be more of a philosophical difference when everybody else weighs in - most people here haven't wanted to take the interest rate risk that comes with the ARM.

Dave constantly responds to that way of thinking by saying there IS no risk - and that's the part I'm not quite understanding. Dave, how can there be no risk? Sure, the spread between the ARM rate and the FRM rate is wide right now, but still - what stops interest rates from increasing more than that spread amount in a short period of time?

I haven't joined a side yet (I've been hunting for my first house this summer), but I'm certainly intrigued by Dave's position on this, if it truly is as smart a move as he is saying. I'm just not convinced.

Dave, could you summarize why it's a risk-free move? Is your stance entirely based on the fact that someone will almost certainly re-fi after a given period of time? If that is the case, I slightly understand your position. For example, if someone moves out of their home in 6-8 years and they're forced to refi, they *probably* will pay less in interest over that 6-8 yr period if they chose the ARM today. But you seem to be 100% sure that they will be pay less, no matter what.

How can you guarantee that rates stay low over that period?

Also, there's additional risk involved in the fact that maybe you THINK you're going to move 6-8 years from now, but suddenly things change. You love your house and your neighborhood and you want to stay, or instead of moving up, you just want to add a new wing to your house, or you find out you're sterile and can't have kids, and a bigger house someday never makes any sense. That additional "staying-put" risk really gets you in trouble if rates increase.

I just want to better understand how you seem to think that it's 100% the right move to go with an ARM, no matter what. Perhaps I'm not evaluating your stance correctly, either. That is possible. But I'd love to hear more on this from you.

Thanks for all the great opinions and advice from all of you - this is a great board to follow, especially for a potential new buyer like me.

I still hope to start working on that FAQ one of these days.


-CP
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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120791 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 12:53 AM
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Hi chopsueycp,

1st off, *nothing* is completely risk-free... but a properly structured and maintained equity plan using a 5 yr ARM is *LOWER* risk than the same with a 30 FRM. How can I possibly claim such a thing? Because overpaying immediately is just as much of a loss as overpaying possibly, eventually.

Here's the quick & dirty;

A) the 'guaranteed' savings for your initial 5 years, over a 30 FRM, are substantial. 35-45% per year, locked for 5 years in a row.
B) In an absolute meltdown/worst-case market scenario, those initial 5 years of savings can be dipped into to supplement the rising rate costs on the adjusting ARM... and you will still pay less with the 5 yr ARM for another 2-4 years... that's in the *WORST* case...

That gives you a better performance than the 30 FRM *GUARANTEED* with the 5 yr ARM for a MINIMUM of 7-9 years... longer if the markets wiggle up & down, or merely crawl upwards.

FURTHER, rising rate markets also reflect in rising safe money returns... so your accumulated equity savings can also potentially be growing & compounding faster, extending your 7-9 year minimum outperformance even further (again, in the worst case, at MINIMUM!)

The worst that could happen is loan rates rise "limit up" to the cap... but for some bizzarro reason, no financial institutions raise savings crediting rates. In this case, you're good 7-9 years.

If loan rates go limit-up, *and* crediting rates trail them up as is normal, your outperformance stretches further... perhaps 10-12 years.

If rates do *NOT* go "limit-up," then your ouperformance is out there somewhere in the 10-15+ year range, or longer.

THE COUP DE GRACE:
According to the financial statements of FannieMae, over 97% of *ALL* 30 year notes are turned over (paid off due to refinance or sale) by their 7th year (I typically tell people to calculate at 9 years for a maximum 30 FRM... but the historical records are under 7.)

Lastly, anyone who finances with a Debt To Income ratio of 35% or less has sufficient positive income cashflows that I can build a plan to accumulate enough of a side account (what we call a Mortgage Freedom Account) to completely cancel out (on paper) the mortgage balance by the 9th year (somewhat coincidentally.) Of course, we do *NOT* typically actually have them stroke a check to cancel the mortgage leverage... for a variety of strong financial reasons... but they have the CAPACITY to do so, which gives them the freedom & security to make other safe-but-assertive financial moves.

Are there risks in the above? SURE... but not so much market risks. There are risks of employment/income loss (which having lower interest costs actually helps,) and other capacity risks (all of which are generally slightly higher with a more expensive 30 FRM.)

UNDERSTANDING how to build a personal hedged-equity strategy is the key. It is safer and cheaper than using an unstructured 30 FRM strategy... but the difference is that one requires know-how, the other not so much. As is typical, knowledge results in safer & more certain benefits.

SO... I do not "guarantee rates will stay low forever." Quite to the contrary, I am positioned to exploit rising rates to my advantage *IF* and *WHEN* they occur. If I thought rates were going to the moon in the nearterm, then I'd still stay the strategic course (as long as the savings spread on the 5 year ARM is there.) All I need is that 7-9 year edge in the "worst case" environment... but I do not believe we are likely to get that worst-case meltdown situation.

Make sense?

Cheers,
Dave Donhoff
Leverage Planner

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120794 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 1:35 AM
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According to the financial statements of FannieMae, over 97% of *ALL* 30 year notes are turned over (paid off due to refinance or sale) by their 7th year

I think this is a factoid. That is, it is literally true, but implies something that isn't generally true at all.

Example: In 5 years in our present house we had 5 mortgages (one original and 4 refi's). I 4 years in our previous house we had 4 mortgages (1 original and 3 refi's). The shortest loans we had for only 4 months before refi'ing.

But this happened *only* because rates were dropping. We refi'd specifically to get a lower rate.

But if rates had stay stable or risen, we would not have refi'ed at all.

I suspect that if you talk about sales rather than refi's the same thing happens. When the economy is good, people sell and move up after a few years, but then the economy is bad, people will not (or can not) sell.

So....it's probably more accurate to say that mortgages average 7 years when the economy is good and when rates are falling. But when rates are rising and the economy is bad, the average mortgage duration is going to be more than 7 years.

The only reason that rates are low now is that the economy is bad. The Fed is holding rates down specifically because it's bad. Eventually rates will be going back up--and that's just about the time that today's 5/1 ARMs will be seeing their first reset.

Actually, people who got a 5/1 ARM in 2006 are already at the first reset, and now they'll get a reset every year. But for many of them, the savings that they got in the ARM vs. FRM is long gone. They spend that for groceries after they got laid off.

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120795 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 1:43 AM
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Hi Ray,

So....it's probably more accurate to say that mortgages average 7 years when the economy is good and when rates are falling. But when rates are rising and the economy is bad, the average mortgage duration is going to be more than 7 years.

Irrelevant in any case... even if it is nothing but a mere "factoid." If 100% of 30 FRMs remained in place for the duration, my strategy still outperforms.


Actually, people who got a 5/1 ARM in 2006 are already at the first reset, and now they'll get a reset every year. But for many of them, the savings that they got in the ARM vs. FRM is long gone. They spend that for groceries after they got laid off.

For those whom this is the case, they survived longer *BECAUSE* they had the 5 yr ARM, than had they paid-up for the pricier 30 FRM.

5 yr ARM strategy still prevails.

Cheers,
Dave Donhoff
Leverage Planner

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120796 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 10:23 AM
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my strategy still outperforms

Hmmm, now we're talking about much more than ARM vs. FRM. Now we're talking about a wider investment strategy that includes your house as a major component. Fair enough, I guess. And you openly say that you want to manage your client's entire financial situation and not just their mortgage.

But: a) I don't like it. A house is primarily a consumption item and a place to live (ha! made a typo and typed "love", but that's valid, too. A house is a place to live in, to love in, and to raise a family.)
b) Most people don't ponder the alternatives of ARM vs. FRM as an investing question. They ponder it as a matter of monthly cost.

The thing about an ARM is that the risks/costs of rising interest rates fall on the homeowner. The thing about a FRM is that the risks/costs of rising interest rates fall on the bank.
I always figured that *they* can handle that risk easier than *I* can, so it's better to let them have it. If things go pear-shaped, I don't care if the risk kills them. I care a lot if the risk kills me.

IIRC, your solution is to marry the ARM with another investment which is expected to offset the risks/costs of the ARM when things turn bad. But they are not really tied together. They are two independent things that you've chosen to mentally tie together.

"It is difficult to get a man to understand something when his salary depends upon his not understanding it." - Upton Sinclair

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120797 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 10:48 AM
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Dave, could you summarize why it's a risk-free move? Is your stance entirely based on the fact that someone will almost certainly re-fi after a given period of time? If that is the case, I slightly understand your position. For example, if someone moves out of their home in 6-8 years and they're forced to refi, they *probably* will pay less in interest over that 6-8 yr period if they chose the ARM today. But you seem to be 100% sure that they will be pay less, no matter what.

How can you guarantee that rates stay low over that period?


There is a risk.

Dave will cite statistics that say that 95% of mortgages are paid off within 7 years, and so the odds are in your favor, and then show that even if you keep a 5 year ARM for 7 years, you will likely break-even. But 5% is not 0%, so there is a risk.

To ensure that you feel comfortable with the risk that you will be in the 5% that keep your mortgage more than 7 years, you should ensure that you are comfortable making what the payment would be at the maximum interest rate. If you are comfortable with that maximum payment, then you need to weigh what you think the odds that you will pay off your mortgage (either through refi or sale of the home) within the next 7 years.

Personally, my lean is to use an ARM in times when I think it is likely that rates will go lower and an FRM in times when rates are low, and are likely to increase. Over the last 2 years I my lean has cost me some money. But I'm still happy with my choice, and because of refi costs in Texas, haven't yet found a refi that has a payback of less than 2 years, so I'm probably going to be sticking with my 4.25% mortgage for long enough that it will be cheaper than the ARM.

AJ

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120802 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 12:36 PM
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Hi Ray,

a) I don't like it. A house is primarily a consumption item and a place to live (ha! made a typo and typed "love", but that's valid, too. A house is a place to live in, to love in, and to raise a family.)

You're letting emotion cloud logic. I agree that your home (regardless owned or rented) is a consumption item, but deciding to own gives you liabilities that renters aren't burdened with, *AND* compensating equity benefits that renters don't enjoy. Ignoring either of these ownership features is a recipe for greater risk and expense.

b) Most people don't ponder the alternatives of ARM vs. FRM as an investing question. They ponder it as a matter of monthly cost.

"Most" people do a whole lot of other dumb things too... over eat, under exercise, buy lotto tickets, swallow Dave Ramsey's average 12% returns claims, and on & on. If anything, your #B supports *ME*.


The thing about an ARM is that the risks/costs of rising interest rates fall on the homeowner.

This is too simplistic of a view, and artificially black & white. Rising rates are *ONLY* a *POTENTIAL* risk in relationship to several factors;
A) the offsetting guaranteed savings accrued initially,
B) the RATE of increase of the interest rate costs,
C) the effects of rate volatility (markets tend to rally & fall back, rarely increasing in a straight line,)
D) the offsetting returns on the accrued savings,
E) the RATE of increase of the interest rate credits,

The thing about a FRM is that the risks/costs of rising interest rates fall on the bank.

The bank is over-padding/over-charging their compensation for carrying that risk (which can be more effectively privately managed.) The guaranteed up-front loss from the premum paid for the FRM, *PLUS* the ongoing loss of the returns that money would have made, *PLUS* the compounding effects lost, are calculable & significant risks unavoidable with the costlier FRM as well.

I always figured that *they* can handle that risk easier than *I* can, so it's better to let them have it.

THIS is a rational enough reason to pay up on the premium. If you can't manage it yourself, pay those who can.

IIRC, your solution is to marry the ARM with another investment which is expected to offset the risks/costs of the ARM when things turn bad.

Not necessarily, but that certainly adds to the performance. If you use a 5 yr ARM, have a 35% or less Debt-To-Income ratio, and accumulate your Mortgage Freedom Account separately (even in a coffee can buried in the back yard,) you can stroke a check to the mortgage company by your 7-9th year to wipe out the loan entirely before you ever pay a dime more than you would have in a 30 FRM.

If you grow the money you save, you simply do better. And after all, better is.... better!

Cheers,
Dave Donhoff
Leverage Planner

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Author: spinning Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120803 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 1:13 PM
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If you use a 5 yr ARM, have a 35% or less Debt-To-Income ratio, and accumulate your Mortgage Freedom Account separately (even in a coffee can buried in the back yard,) you can stroke a check to the mortgage company by your 7-9th year to wipe out the loan entirely before you ever pay a dime more than you would have in a 30 FRM.

I would love to see more details on the zero-interest savings plan. How much do you have to save to accomplish this? Certainly not just the savings of going to an ARM.

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120805 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 1:41 PM
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Dwdonhoff: "If you use a 5 yr ARM, have a 35% or less Debt-To-Income ratio, and accumulate your Mortgage Freedom Account separately (even in a coffee can buried in the back yard,) you can stroke a check to the mortgage company by your 7-9th year to wipe out the loan entirely before you ever pay a dime more than you would have in a 30 FRM."

I would like to see the math that supports your proposition. It sounds incorrect, unless there is an unstated assumption (or are unstated assumptions).

Regards, JAFO

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120806 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 3:06 PM
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"The thing about an ARM is that the risks/costs of rising interest rates fall on the homeowner. "
This is too simplistic of a view, and artificially black & white.


Maybe. But when it comes to your home I'm kinda a black&white type of guy. I've seen too many sad stories.

The bank is over-padding/over-charging their compensation for carrying that risk ... significant risks unavoidable with the costlier FRM as well.
Well, I'd more say that they are *charging* for taking the risk, not over-charging.

We have a different view of the risk of an ARM. I see a rate that can rise from 3.75% to 8.75% in just a few years. Yes, it might not go that high. Yes, there are things you could do to offset some of that more-than-doubling cost -- but they don't eliminate it, they merely offset it (Lord willing and the creek don't rise). You can handwave all you want, but defining a risk away doesn't actually make it go away. The only thing you know for sure is that it won't be more than 8.75%.

"I always figured that *they* can handle that risk easier than *I* can, so it's better to let them have it."
THIS is a rational enough reason to pay up on the premium. If you can't manage it yourself, pay those who can.

You still don't get it. It's not "fear" amd it's not "can't manage the risk". It's chosing to COMPETELY AVOID the risk. I'll let *them* bear the risk and pay slightly more for the fact that I don't bear *any* of the risk.

--------------
the offsetting guaranteed savings accrued initially,
You have more confidence in "guarantee" that I do. Considering that giants like Lehman, Bear Sterns, AIG, GM, Chrysler, etc. have blown up in the last couple of years, I'd say that a high degree of confidence is completely unwarranted.
The only guarantee I'd say you could arguably depend on would be US T-bills. And they are currently paying 0.14%.

-----------

See, I view your Mortgage Freedom Account idea as an illusion to fool the rubes. It's a trick that works on & for people who are (incorrectly, IMHO) narrowly focussed on paying off their mortgage. A superior focus, IMHO, is on one's entire financial picture, including house, mortgage, investements, etc. But a lot of people need to do that trick because they otherwise will blow the money.

--------------------
And interestingly enough, we are in general agreement in the most everything else.
I don't have an MFA or any account earmarked for paying off my mortgage. What we do have is a well-diversified investment portfolio. Nor do I have to wait for 7-9 years to be able to wipe out the mortgage. (BTW, I don't believe your 7-9 years. There is no low-risk investment that will grow that fast.)

That global, non-earmarked portfolio gives me the option to direct it however I want. If I want to pay off the mortgage, I can. If I want to keep my cheap mortgage (even though it could be even cheaper if I chose to take a bit more risk on it), I can. And in that case I can instead redirect that money into investments that will give me a higher return (on average) than the cost of the mortgage.

======================
And if anybody thinks *this* debate is never-ending, you should go to the FIRE board at early-retirement-dot-com and see the "Should I take Social Security at 62 or wait until 66 or 70" threads.

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Author: PSUEngineer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120807 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 3:29 PM
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Would you say Dave is an ARM-y of one?

(booooooooooo!)

Anyway... Dave pretty soundly believes that it's a no-risk, common-sense financial move to go with the ARM, while it almost seems to be more of a philosophical difference when everybody else weighs in - most people here haven't wanted to take the interest rate risk that comes with the ARM.


I'm going to respond before even reading the rest of the thread.

Dave has done a good job providing the reasoning behind his approach and the facts to back it up. On a facts, he is correct. I've run some of the numbers myself. I do not believe he says there is no risk with the ARM. A lot of posters, myself included, think they're going to stay in their house for decades like our parents did. My mother is still in her first house after 54 years. Therefore, a 30 year mortgage looks like a good product for this type of thinking.

Dave keeps up with housing market facts. He has mentioned that only "x" number of people stay in their house for longer than 10 years where x is a small number. This is due to our mobile society. He also mentions that a very high percentage of mortgages don't last longer than 9 years which is often the break even point of the 5/1 ARM versus 30 year fixed comparison under worse conditions. There are other stuff I don't remember. When you combine all the facts, there is a very small chance you are going to pay more with the 5/1 ARM. The funny thing is that many of us think we're that person.

PSU

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Author: PSUEngineer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120810 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 3:42 PM
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And if anybody thinks *this* debate is never-ending, you should go to the FIRE board at early-retirement-dot-com and see the "Should I take Social Security at 62 or wait until 66 or 70" threads.

That's an easy one. Wait until 70.

PSU

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120812 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 4:05 PM
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That's an easy one. Wait until 70.

Groan ..... Oh God, not here too.

Actually, I agree. It is an easy one. 62. Unless you're stll working. Of course, the "RE" part of the FIRE board stands for "retire early", so their presumption is that you're not still working. Or as they say, "w*rking at a j*b".

https://spreadsheets.google.com/ccc?key=0AlyWRtMroxvgdDI2MlY...

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Author: PSUEngineer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120814 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 5:41 PM
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Groan ..... Oh God, not here too.

Actually, I agree. It is an easy one. 62.


I tossed that answer in because I've read your previous responses on this issue so I know how you would respond. I did that to make a point. Just like the mortgage argument, a person can say I don't meet the averages. Even though the data says this is the correct decision, I'm making a different one since the averages don't pertain to me.

Part of the reason you say early is that you compare the SS life expectancy to the calculations that you make. Since the life expectancy is less than the break-even, you conclude it is better to start SS early. Well, in my family, there is a decent chance that I'll exceed the SS life expectancy. Several members have lived into their 100s (one to age 107) and many live into their 90s. If I expect to live to the family average, not national average, then the calculations in your own spreadsheet says I come out ahead if I wait to start collecting SS.

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120815 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 6:29 PM
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JAFO31:

Dwdonhoff: {{{"If you use a 5 yr ARM, have a 35% or less Debt-To-Income ratio, and accumulate your Mortgage Freedom Account separately (even in a coffee can buried in the back yard,) you can stroke a check to the mortgage company by your 7-9th year to wipe out the loan entirely before you ever pay a dime more than you would have in a 30 FRM."}}}

JAFO: <<<I would like to see the math that supports your proposition. It sounds incorrect, unless there is an unstated assumption (or are unstated assumptions).>>>

Loan Amount 200k, 2.5% 5-year ARM Rate, monthly P&I = 790.24 (based on 30-year amortization), loan balance after 5 years assuming no prepayment is $176,150.88.

Loan Amount 200k, 3.9% 30 year fixed Rate, monthly P&I = 943.33 (based on 30-year amortization), loan balance after 5 years assuming no prepayment is $180,601.70.

Monthly Delta: $153.09

Gross Delta after 5 years: $9,185.40.

Gross Delta plus, assuming monthly investment at 3%: $9,921.51
Extra Delta: $736.11

- - - - -

Best case scenario, interest rates stay flat

Loan Amount 200k, 2.5% 5-year ARM Rate, monthly P&I = 790.24 (based on 30-year amortization), loan balance after 9 years assuming no prepayment is $154,807.25.

Loan Amount 200k, 3.9% 30 year fixed Rate, monthly P&I = 943.33 (based on 30-year amortization), loan balance after 9 years assuming no prepayment is $162,121.70.

Monthly Delta: $153.09

Gross Delta after 9 years: $16,533.72

Gross Delta plus, assuming monthly investment at 3%: $19,001.34
Extra Delta: $2,467.62

I see no way that the $19,001.34 in the MFA after 9 years covers the $154,807.25 outstanding balance on the ARM after 9 years; in fact, even if the MFA was applied at the end of the 9th year, the outstanding balance would still be $135,805.91. And this is the best case scenario - ARM rate never rose and no income taxes due on the income from the invested delta and a safe 3% return.

What if we pay the ARM as if it was the fixed rate loan?

After 9 years, the outstanding balance would be $136,287.31.

After running the numbers, your prior statement

"If you use a 5 yr ARM, have a 35% or less Debt-To-Income ratio, and accumulate your Mortgage Freedom Account separately (even in a coffee can buried in the back yard,) you can stroke a check to the mortgage company by your 7-9th year to wipe out the loan entirely before you ever pay a dime more than you would have in a 30 FRM."

Seems to be a ton of fluff. Sorry.

Thus, I repeat "I would [surely] like to see the math that supports your proposition".

Regards, JAFO

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120820 of 126962
Subject: Re: FRM vs ARM debate Date: 8/19/2011 11:19 PM
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If I expect to live to the family average, not national average, then the calculations in your own spreadsheet says I come out ahead if I wait to start collecting SS.

Yup. If you are comfortable with such a long break-even period, go for it.

'course, no matter how long your familial average is, an 18-wheeler running a stoplight and plowing into your car makes that a non-factor. But that's why the mortality tables don't take cause of death into account.

Too, I wonder how many people have factored the risk that their non-early benefit will only be 78% of what they were expecting. Or received full payment only 9 months of the year. http://lieberman.senate.gov/assets/pdf/crs/socsecfunds.pdf

Which none of this has anything to do with buying a house.

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120822 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 12:45 AM
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Hi Spinning, & JAFO,

I would love to see more details on the zero-interest savings plan.

Here's an older recorded presentation on our cashflow system.

TRIQUEST Equity Accumulator
http://www.leverageplanners.com/vid_triquestequityaccum.php

This presentation shows the savings being paid directly to the mortgage balance.
Instead, we have our clients build a separate Mortgage Freedom Account.
After e-reserves are accounted for, our accounts average 6-8% tax-free.
Our asset accounts have the ability to borrow funds at a max rate of 5-6% (tax-deductible when applied to home equity leverage)... so the leveraged equity at 2.75% in the 5 yr ARM is effectively capped at the 5-6% access of funds in our accounts.

Yes, its software built on the same principal as the mortgage accelerator systems.
Yes, it is basically an automated snowball system.
Yes, it can be done DIY for anyone so itnerested & disciplined,
No, it doesn't conjure any magic... its just basic math applied,
No, its neither expensive to acquire from me, nor profitable (but the results put my clients in a position of strength were opportunities open up,)

*THIS* recorded presentation is on a 30 FRM at 6% on $200,000, with a borrower earning $5,000 gross, having $1,000 discretionary cashflow after all expenses & debts initially.

Here's the graph of the loan-life results on the system, versus traditional payments;
$200,000 30 FRM @6%, PIF on paper by 7.5 yr.
http://screencast.com/t/lHY01KCTv

Shifting variables shifts the results....
Lower rates pay off faster, higher rates, slower,
Considering credits/returns on savings create a faster payoff,
More discretionary income pays off faster, less slower,
Higher existing costing consumer debt generates quicker momentum as paid off, accelerating results.
... and on.

Again... not rocket surgery (very little in finance actually is.)

Cheers,
Dave Donhoff
Leverage Planner

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120823 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 8:58 AM
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*THIS* recorded presentation is on a 30 FRM at 6% on $200,000, with a borrower earning $5,000 gross, having $1,000 discretionary cashflow after all expenses & debts initially.

Here's the graph of the loan-life results on the system, versus traditional payments;
$200,000 30 FRM @6%, PIF on paper by 7.5 yr.
http://screencast.com/t/lHY01KCTv


I still want to see a spreadsheet of the math, not just a graph that doesn't show the calculations.

From my own spreadsheets, it appears to me that the only way that one can 'have a 30 FRM @6% PIF on paper by 7.5 yr.' is if one applies the discretionary savings each month toward the mortgage payoff fund. In that case, assuming a $150 - $175/month savings on P&I between the FRM and the ARM (varies based on actual rates - but it's in the ballpark), one is actually devoting $825 - $850 more toward paying off the house (either through the mortgage payment or the payoff fund savings) than they would be by paying just the FRM. What would the payoff time on the FRM mortgage be if you put that money toward the FRM instead (ignoring all the arguments on how locking up the money in the house isn't a good idea)?

And about that 'on paper' payoff - is the mortgage payoff fund savings REALLY all available to 'write a check and pay off the mortgage'? You say that the savings rate that you are getting is in the 6% - 8% tax-free range. In order to get those rates and tax treatments, are the savings REALLY available for anyone, of any age, to write the check in 7.5 years, without any surrender charges or taxes due? If not, then, even the the mortgage is paid off 'on paper' - you couldn't REALLY pay it off. So the concept looks really nice, but the practice gets messy if someone were to actually want to pay off the mortgage.

Locking up money into an investment that has tax consequences or surrender charges can be just as bad as locking the money up into a house.

Yes, its software built on the same principal as the mortgage accelerator systems.

Yes, and I proved to the one person on these boards who was willing to post their mortgage accelerator spreadsheet (jasljohns) that their math was wrong enough that they pulled their spreadsheet off the website they referenced a couple of weeks after this thread http://boards.fool.com/hoa-mortgages-26454942.aspx?sort=whol...

So - show me the spreadsheet, not just the pretty graphs and sales presentation. And if the concept involves 'saving' the $1000 discretionary cash flow, then I'm calling BS if you aren't also showing what would happen if you applied the extra $825 - $850 per month to the FRM.

AJ

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120824 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 10:23 AM
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And here's a link to the spreadsheet with my math https://spreadsheets.google.com/spreadsheet/ccc?key=0AkZ4Sqj...

The assumptions and actual ARM and FRM and savings balances for each are shown. Here are the assumptions I used:

Assumptions
$200,000 initial loan

ARM Terms:
Initial Rate is 2.75% (AIM Loans 0 point rate for 5/1 ARM up to $417k as of 6 am CT 8/20/11)
Cap on initial adjustment is 5% (full lifetime cap) (AIM Loans 5/1 ARM terms)
Cap on subsequent adjustments is 2%
Initial P&I Payment is $816.49

FRM Terms
Rate is 4.125% (AIM Loans 0 point rate for 30 year fixed up to $417k as of 6 am CT 8/20/11)
P&I Payment is $969.30

Worst Case scenario: Rate on 5/1 ARM will bump to 7.75% rate after 60 payments, and stay there
Note: With a margin of 2.25% and a bump up to the nearest 1/8, this would imply a LIBOR rate of 5.375% or more - occurred during 9 different months in 2006/2007)
Rate on Savings is 7% (middle of road for Dave's 6% - 8% range)

Homeowner has $1816.49 per month to apply to mortgage/savings (Initial ARM P&I payment, plus $1000)

Under these circumstances, the homeowner would have enough in their savings to pay off the FRM in month 125, while it would take until month 136 (technically month 137, but I'll concede that the homeowner would probably have the extra $41.20).

So, under the worst case scenario of increasing to the max rate at the initial adjustment and staying there, the ARM would actually take 11 months longer to pay off using this morning's rates.

AJ

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120826 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 12:13 PM
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Hi AJ,
We can boil the math down far simpler & easier;

Let's start at an assumed 7.5 year payoff (plans may vary... but we'll go with this.)
THat's 90 months.
At a $200k balance, we'll need to average $2,222/month toward principal/MFA.

In the example the borrower already has $1,000 monthly discretionary cashflow to put towards the principal/MFA... leaving $1,222 to average over 90 months to hit the target.

All it takes to work is $1,222 or more of consumer debt coverage embedded in the budget, and/or consumption slack, which gets accelerated out of the way (redirecting that flow to the MFA principal) increasing the discretionary principal payments to what we need to cancel out the debt.

Again, its really not magic or rocket surgery. No sleight of hand... just simple cashflow management.

Cheers,
Dave Donhoff
Leverage Planner

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120828 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 2:01 PM
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"I would love to see more details on the zero-interest savings plan."

Here's an older recorded presentation on our cashflow system.

TRIQUEST Equity Accumulator
...
Again... not rocket surgery


OMG!
Dave, I was about to give you kudos for removing this con off your web site, where it was quite prominent the last time I visited it (sometime last year).

This isn't a "zero-interest savings plan". This is just another variation of the "money-merge" scam. You put every penny you have into the mortgage and then tap your HELOC for living expenses.

It's just smoke-and-mirrors razzle-dazzle -- cycling your income through a HELOC and giving you a crappy online software to bedazzle you.

Yes, the math works out -- because all you are doing is a complicated method of paying down the mortgage with all your spare cash. The tipoff is the term "discretionary cashflow". I guess in Dave's case they have you put it into a "separate Mortgage Freedom Account" instead of the mortgage, but that's just insignificant details.

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120830 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 5:30 PM
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We can boil the math down far simpler & easier;

But incorrect.

Let's start at an assumed 7.5 year payoff (plans may vary... but we'll go with this.)
THat's 90 months.
At a $200k balance, we'll need to average $2,222/month toward principal/MFA.


Well, based on my figures, it's closer to $2255. That's probably because I'm using 7% for the savings rate instead of 8%. But even then, you are still forgetting a significant issue: for the worst case scenario, the ARM payment increases by $520 in month 61 (and stays there). The bank is not going to let you keep making the initial payment amount - they are going to require that the amount that they receive increases by the $520 - so your savings contribution will decrease if you don't increase the amount from $2255.

If you are keeping your mortgage payment/savings contribution steady at $2255 per month, it will take you until month 99 to pay off the ARM, while doing the same mortgage payment/savings contribution for the 30 year FRM allows you to pay off the mortgage in month 97 - still 2 months earlier. Here's a spreadsheet that shows that scenario: https://spreadsheets.google.com/spreadsheet/ccc?key=0AkZ4Sqj...

If your goal is actually a 7.5 year payoff and you start out with a $2255 mortgage payment/savings contribution, then to adjust for the adjusted payment, you would need to add $520 a month to your mortgage payment/savings contribution amount, so you need $2255/month for the first 60 months, then you need $2775/month for months 61 - 90. If you apply that payment to the FRM, you do turn up $746 short of paying of the FRM in month 90, vs. having $11 more than you need to pay off the ARM in month 90. So the total advantage over 90 months: $757 Here's a link to a spreadsheet with that scenario: https://spreadsheets.google.com/spreadsheet/ccc?key=0AkZ4Sqj...

And just in case you're not tired of this exercise yet, one other scenario that one could come up with to adjust for the maximum payment increase in month 61 would be to have a constant mortgage payment/savings contribution, assuming that the mortgage payment will increase by the $520 max in month 61. That amount would be $2400 a month. Doing this will result in you having enough money to pay off the ARM in month 90 with $117 extra in the savings account, while you would be $640 short of paying off the FRM. So, net advantage to the ARM of $757. (sound familiar?) Here's the link to that spreadsheet https://spreadsheets.google.com/spreadsheet/ccc?key=0AkZ4Sqj...

Again, its really not magic or rocket surgery. No sleight of hand... just simple cashflow management.

No, it's not sleight of hand. But when one actually runs the numbers for the worst case scenario, it doesn't really show the huge advantage that you like to tout 'for even the worst case scenario'.

And I'm still waiting for information on where one can get 7% savings without surrender charges or tax implications, so that the check can actually be written to pay off the mortgage.

AJ

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120831 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 6:19 PM
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Yes, the math works out -- because all you are doing is a complicated method of paying down the mortgage with all your spare cash. The tipoff is the term "discretionary cashflow". I guess in Dave's case they have you put it into a "separate Mortgage Freedom Account" instead of the mortgage, but that's just insignificant details.

Actually, the math still doesn't work out all that well in the worst case scenario, unless you are really willing to put enough money into the savings account that you will have enough money to pay off the mortgage in 7.5 years or less. In the examples I ran based on Dave's numbers, the total savings over 90 months was $757 for a $200k mortgage. That's about $8.41 a month in savings.

If one really is willing to put away that much per month, they could get most of the same benefit by getting a 15 year FRM in the 3.375% range for no points, or pay down a couple of points to get a 3.0% rate. The 15 year FRM payment wouldn't be that much more than potential payment shock would increase the ARM payment to - at 3.375%, a the P&I would be $1417 for a 15 year FRM, at 3.0%, the P&I would be $1381. Compare that to the $1337 that the ARM could move to in the worst case scenario.

So, using an ARM that you have the possibility of keeping for more than 7.5 years vs. a 30 year FRM, or even a 15 year FRM, really is betting that the worst case scenario of interest rates increasing to max and staying there won't happen.

AJ

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120832 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 7:11 PM
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Hi Ray,

I guess in Dave's case they have you put it into a "separate Mortgage Freedom Account" instead of the mortgage, but that's just insignificant details.

That's hardly insignificant, but certainly not complicated.
===============
Hi AJ,

Well, based on my figures, it's closer to $2255.
7.5 years is 90 months... times $2,255 is $202,950, ignoring *any* credit interest. Why do you need the extra $3k?

But even then, you are still forgetting a significant issue: for the worst case scenario, the ARM payment increases by $520 in month 61 (and stays there).
Uhh... no. By the end of month 60, your remaining 5 yr ARM loan balance at the previous 2.75% amortized is $183,835.
Your MFA (ignoring any positive interest accumulation) at an average $2,222 is $133,320.

You *could* immediately stroke your $133,320 check against the loan prior to adjustment, and be left with only $50,515, at a new worst-case interest rate of 7.75%... creating a new payment of $381.55... which is a savings of $434.94 from the original pre-adjustment payment of $816.48.

If you did, that $434.94 payment reduction would add to the acceleration of the remaining $50,515 balance. Add the $434.94 to your $2,222, and you''ve eliminated the mortgage as a liability in just 19 more months. 1 year, 7 months beyond the initial 5 year fixed period, *WORST* case.

6 years, 7 months total.... Worst case... No positive credits on savings considered.
-------------

If we credit the MFA a minimum fixed 5% rate (off from your offer of 7%) we get an MFA of $151,899.15. Stroke *THAT* against the 60th month balance, and we are left with just $31,935.85. The new payments at 7.75% over 25 years would be $241.22... a savings of $575.26.

At that to the $2,222 cashflow available, making it $2,797.26, and you've reduced elimination to jsut 12 months... cancelling the liability on the balance sheet in 6 years even.

+++++++++++++++

But let's assume you do not stroke the check to collapse the hedged leverage spread;
The 61st beginning-of-month balance of $183,835, amortized over 25 years, at 7.75% presents a new monthly payment of $1,388.56.

NOW... although *THAT* is $572.08 more than the original $816.48, that is the worst it can ever get.

Your 60 month savings over the 30 FRM at 4.125% is $9,702.00. That alone, without any positive crediting on the savings, covers another 17 months of payments before the 5 yr ARM is even with the expense of the 30 FRM. That's 6.5 years.

At *only* a positive growth of 5% on the MFA during the initial 60 months, strictly on the payments savings (and no additional discretionary contributions,) the MFA reaches a total of $55,270.23. At a $572.08 subsidy to payments, that extends the outperformance of the 5 yr ARM another 40 months...

or just 3 1/3 years beyond the initial 5 yr term...

8.3 years outperforming the best-available 30 FRM in the WORST CASE.

Longer & higher superior results in everything *LESS* than worst case.

=================

And I'm still waiting for information on where one can get 7% savings without surrender charges or tax implications, so that the check can actually be written to pay off the mortgage.

You're "still waiting" because you didn't ask! Besides, this is really a topic for another board... but I'm happy to explain here.

There are no penalties, credit forfeitures nor surrender charges to access your accumulated funds. MFA account loans are available on on open draw basis (same as a HELOC) on your account cash value at a contractually fixed rate of 5-6%, depending on the company. The account balance that the funds are drawn against continues to be credited for the full basis at your choice of 5% contractually fixed, or reset-indexed which averages 6-8.3% tax-free (7.42% in the worst of all 20 year rolling average periods since the S&P inception.)

Yes... that means that each dollar borrowed on the MFA account is actually not at *COST* but at a positively arbitraged *CREDIT* of anywhere from an effective 1% to 5% depending on your tax ramifications. But we didn't take *ANY* of that into account in the above examples.

Pulling an account loan to pay off a mortgage balance (or for literally any other reason) is a 24-72 hour turntime process, from phone request to cleared wire.

Cheers,
Dave Donhoff
Leverage Planner

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120833 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 7:17 PM
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If one really is willing to put away that much per month, they could get most of the same benefit by getting a 15 year FRM

Of course, then they would be illiquid, which is FAR riskier than the expenses of a straight 30 FRM at premium.

The keys are;
A) stay as liquid as possible. Liquidity kills risks.
B) reach the point of debt-cancellation, while simultaneously defending your liquidity, as quickly as possible.
C) Costs (in the way of unecessarily higehr rate premiums) are pre-loaded risks... they eliminate future safety by eliminating liquidity. Reduce them as much as possible.

Amortization is not your friend in this aspect.

Cheers,
Dave Donhoff
Leverage Planner

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120834 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 8:03 PM
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7.5 years is 90 months... times $2,255 is $202,950, ignoring *any* credit interest. Why do you need the extra $3k?

Because you're paying interest on the mortgage (even at only 2.75%, it adds up). Unless you are saying that in addition to your $816.49 payment, you are making a $2222 savings contribution? For a total of $3,038.49 out of pocket to savings and mortgage payment each month, for someone who nets $5k a month? That's more than 60% of the net devoted to the mortgage payment and the MFA.

But even then, you are still forgetting a significant issue: for the worst case scenario, the ARM payment increases by $520 in month 61 (and stays there).
Uhh... no. By the end of month 60, your remaining 5 yr ARM loan balance at the previous 2.75% amortized is $183,835.

Actually, the balance after making 5 years of $816.49 payments on a $200k loan at 2.75% is $176,797.49. The remaining 25 year payment at 7.75% is $1,336.87 - $520 more than than the initial $816.49 payment. (The amortization is in the spreadsheets - of course, if you would like to post your own spreadsheets.....)

Your MFA (ignoring any positive interest accumulation) at an average $2,222 is $133,320.

Not if you are also making the mortgage payments out of the $2222/month, or else you are devoting more than $3k a month to combined mortgage payments and the MFA.

You seem to be making mistake similar to the one that the jasljohns was making - counting your mortgage payment in 2 places - in your MFA account, and actually making your mortgage payment with it. He was counting the HELOC payment by counting it toward both the principal and the interest.

There are no penalties, credit forfeitures nor surrender charges to access your accumulated funds. MFA account loans are available on on open draw basis (same as a HELOC) on your account cash value at a contractually fixed rate of 5-6%, depending on the company. The account balance that the funds are drawn against continues to be credited for the full basis at your choice of 5% contractually fixed, or reset-indexed which averages 6-8.3% tax-free (7.42% in the worst of all 20 year rolling average periods since the S&P inception.)

OMG - It is the "MoneyMerge" account. Here we go again, 6 years later. And if it's the same "MoneyMerge" spreadsheet, it still has the same issue of crediting the same money to 2 different places.

You were the one who used to say it would only save you a pizza's worth of interest. You seem to have changed your mind.

AJ

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120835 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 8:35 PM
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Hi AJ,

To start off with, mea culpa in my immediate spreadsheeting... but my errors handicapped, not helped me.

The mortgage amortization in Excel shows that only $2,165 extra is needed on a 30 year loan, $200,000, at 2.75% (granted, ignoring the last 2 theoretical years of 7.75%.)

If we look at EOY60/BOY 61, the remaining principal is $176,991.79 (close enough to yours of $176,797.49.)

You seem to be making mistake similar to the one that the jasljohns was making - counting your mortgage payment in 2 places - in your MFA account, and actually making your mortgage payment with it.

Nope, I am not.

$2,165 (or $2,222, or $2,255) is the average discretionary cashflow *IN ADDITION* to the $816.48 mortgage. That's $2,981 out of $5,000 total take-home, leaving $2,019 consumable revenue... not at all unrealistic.

OMG - It is the "MoneyMerge" account.

Its the same in *PRINCIPAL* (but not that actual software program.) In my useage it is applied to liquidity accumulation and a positive credit spread. There is no dual crediting. It is simpler than you are making it... it is merely the old-fashioned debt-snowball-payoff strategy technified to an easier-to-execute mapped out daily sweep account budget.

You were the one who used to say it would only save you a pizza's worth of interest. You seem to have changed your mind.

Yes, and no. It is still functionally worthless (even dangerous) if used to actually send your good cash into illiquid real estate equity directly (unless you have some illiquidity economic death wish ;~) It also does not (as a snowball system) save much interest in & of itself.

*HOWEVER*, as a functional tool to accelerate debt cancellation by liquidity accumulation (an MFA,) it is quite powerful (at least for the majority of folks who do not have the inclination or spreadsheet skills to build it out and maintain it for themselves.)

As I just showed, it can cancel out a 30 year mortgage in well under 10 years... often just 6-7... assuming certain economic basics common for many (if not most) households (discretionary income to apply to the snowballing effects.) Further, itcan usually do this *WITHOUT* requiring most people to reduce their actual lifestyle quality... simply bringing the efficiency of the managed cashflows to bear does the trick.

Lastly, a positive credit spread is a welcomed plus to the overall strategy, but not all required for success.

Cheers,
Dave Donhoff
Leverage Planner

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Author: MetroChick Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120838 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 9:03 PM
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As I just showed, it can cancel out a 30 year mortgage in well under 10 years... often just 6-7... assuming certain economic basics common for many (if not most) households (discretionary income to apply to the snowballing effects.)

It's the "discretionary income to apply to the snowballing effects" that I think most people do poorly with. I think it's more likely people use an ARM to get into a house they can't afford with a FRM (therefore there is no extra discretionary income to apply to the mortgage) or have a way of increasing their lifestyle while they've got a temporary lower mortgage through an ARM and then eventually find themselves where the ARM's going to reset, and there's no wiggle room left in their household budget because they've upsized other expenses.

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120839 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 10:25 PM
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$2,165 (or $2,222, or $2,255) is the average discretionary cashflow *IN ADDITION* to the $816.48 mortgage. That's $2,981 out of $5,000 total take-home, leaving $2,019 consumable revenue... not at all unrealistic.

Well, it doesn't seem realistic to me for someone to devote 60% of their income to their housing expense, without even accounting for property taxes, insurance, maintenance or repairs. And that doesn't even account for those other little things like food, clothing, retirement contributions, college savings, auto expenses, etc.

But even if it is realistic, it's still a lot more than the $1,000 per month in discretionary income that you originally indicated would be sufficient to hedge against the worst case scenario of ARM interest rate risk.

I still contend that if "all" someone with a $200k mortgage can devote to their combined mortgage payment and MFA contribution is $1000 more than the ARM payment (and that would be a stretch for a LOT of people with a $200k mortgage), it's not enough to hedge against the worst-case scenario. That's the first spreadheet I posted a link to: https://docs.google.com/spreadsheet/ccc?key=0AkZ4SqjXR2didG9...

In the worst case scenario, with $1000 discretionary income over the initial ARM payment, there is enough money in the MFA to pay off the FRM 11 months sooner than the ARM, so in that case, the ARM will cost more than the FRM.

AJ

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Author: KKoleto Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120840 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 10:59 PM
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Hi All,

We just used the 5/1 ARM as a tool, nothing more. We've been retired 4 years and 9 years ago we re-financed both our primary residence and summer home with 5/1 ARMS and did not spend a lot of money doing so.

We did this knowing we would retire in 5 years and although we selected plans with fixed caps etc. we enjoyed lower rates on both mortgages for 5 years. We did not plan to support both home mortgages in retirement. So the plan was to sell the residence and move into the "summer" home, which we did.

I enjoyed reading the debate on the subject, but I offer this story as an example of a planning tool.

Regards,
Ken, Fool

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120842 of 126962
Subject: Re: FRM vs ARM debate Date: 8/20/2011 11:14 PM
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debt cancellation
...
cancel out a 30 year mortgage in well under 10 years... often just 6-7


That's the phrase that's the tipoff to this con. "cancellation"
You don't "cancel" a mortgage, you pay off a mortgage.
That BS about cancellation is just to throw smoke in the air so the mark can't see what is really going on.

*WITHOUT* requiring most people to reduce their actual lifestyle quality... simply bringing the efficiency of the managed cashflows to bear

More tipoffs. 1) This has them throwing the majority of their income to the mortgage (or the side-account that is mentally linked to the mortgage). This will have a definite effect on their lifestyle.
2) There is no way to "manage cashflow" to create money out of thin air.

Look, all you need to do to show that this is bogus is to do some simplistic math. Not completely accurate, but close enough.
To pay off the mortgage you have to pay all the principal plus the interest.
As a back-of-envelope SWAG:
$200,000 principal over 10 years = $20,000/yr = $1667/mo.
Average prin bal is $100,000. At 2.75% that's $2750/yr = #230/mo.
Rough total: $1900/mo.
Mortgage calculator show $1908.22 /mo

To pay it off in 7 years is $28571/yr = #2381/mo principal.
Rough total: $2610/mo
Mortgage calculator show $2620.19 /mo

Now, are you saying that somebody with an income of $5000/mo is going to be able to devote half or more of their income to the mortgage payment? That's an annual income of only $60K. There's no way a typical family that is making $60K can send half of it to the mortgage. Not unless they are living in Dad's basement and eating from dumpsters.

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120845 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 12:25 AM
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Hi MetroChick,

It's the "discretionary income to apply to the snowballing effects" that I think most people do poorly with.

If you are referring to the "average" or less types, I don't think anyone will disagree. I've just detailed a strategy that *MY* clients have used, with (so far) zero failure at all.

===================
AJ,

Well, it doesn't seem realistic to me for someone to devote 60% of their income to their housing expense, without even accounting for property taxes, insurance, maintenance or repairs. And that doesn't even account for those other little things like food, clothing, retirement contributions, college savings, auto expenses, etc.

If the $200k example is 80CLTV, then we are talking about a $250k home. 1.5% is a generous factor for taxes & insurance, thus $312.50/month. 1% is reasonable for basic maintenance & repairs, that's $208.33. That's $520.83 from the $2,019 consumable budget, leaving about $1,500 for food, clothing etc. That's about $50 a day. Not extravagant, but quite workable for a single person or a young couple in a $250k home area of the country.

People in higher cost areas, and/or with larger families, or more expensive lifestyles as a choice, or without discretionary cashflow or obvious inefficiencies in their budgets may or may not cancel out their mortgage as quickly... but almost everyone can do so much faster than the 30 year period, and stay liquid along the way.

I'm certainly not saying this is a "one size fits all" strategy... but it fits a *LOT* of people, and for those who are able to exploit it, they can get much cheaper, safer & quicker solvency (ability to pay the entire mortgage balance in a check, at their whim,) than any other strategy.

===================
Hi Ken,

I enjoyed reading the debate on the subject, but I offer this story as an example of a planning tool.

Sounds like its worked well for you... congrats on retirement!

===================
Ray,

You don't "cancel" a mortgage, you pay off a mortgage.
That BS about cancellation is just to throw smoke in the air so the mark can't see what is really going on.


When your available liquid assets are equal to, or greater than, your mortgage... that event can be named something. Its not paying off the mortgage (until the mortgage is actually being paid off,) yet it is still significant in that you are 100% solvent. I call it cancelling the mortgage... what do you like to call it?

More tipoffs. 1) This has them throwing the majority of their income to the mortgage (or the side-account that is mentally linked to the mortgage). This will have a definite effect on their lifestyle.

No... one of the initial steps in the planning process is to clearly define and budget current lifestyle expenses, as a standard and minimum. Everybody sets their own levels. If a $60k earner, owner of a $250k home with a $200k mortgage... is comfortable consuming at a rate of $50 a day, they can be 100% solvent in 6-8 years, if that's what they want.

2) There is no way to "manage cashflow" to create money out of thin air.

Nor is that anybody's claim.

Again... really not complex... just buttoning down the specifics and managing for results. People really do this... and they are really succeeding. I've had people with a lot more discretionary income (as a ratio of the expenses) who have already eliminated all amortized and high-rate consumer debt, and cancelled out all mortgage debt, achieving "100% solvency." I have dozens more on the path, at varying stages of acceleration.

Some are on path for complete elimination/cancellation in 5-10, to as long as 15 years.

*ALL* of them can stroke a check to collapse the leverage spread in place for each of them, and continue in the traditional fashion; illiquid & cash-starved. They get addicted to the safety of the MFA account though... its far safer than the illiquid alternatives, and once "Momma gets it" its the only way they'll ever go.

Cheers,
Dave Donhoff
Leverage Planner

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Author: spinning Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120846 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 12:52 AM
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I have found this very confusing but here is my understanding so far. It sounds like you (Dave) are saying that if you can find a bunch of extra money to save, then you can save enough to equal the amount of the mortgage. Then there is nitpicking over exactly where to put this bunch of extra money and how to get more interest on this money, and the type of mortgage. But the big deal seems to be finding a bunch of extra money every month. That is what allows you to pay off your mortgage in a decade.

At first I thought you were saying this extra money was the difference in payment between the ARM and fixed, but now it seems that you agree this is way too small to let you pay off a mortgage in a decade.

Have I got it or am I still confused?

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120847 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 2:43 AM
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spinning: "I have found this very confusing but here is my understanding so far. It sounds like you (Dave) are saying that if you can find a bunch of extra money to save, then you can save enough to equal the amount of the mortgage. Then there is nitpicking over exactly where to put this bunch of extra money and how to get more interest on this money, and the type of mortgage. But the big deal seems to be finding a bunch of extra money every month. That is what allows you to pay off your mortgage in a decade.

At first I thought you were saying this extra money was the difference in payment between the ARM and fixed, but now it seems that you agree this is way too small to let you pay off a mortgage in a decade.

Have I got it or am I still confused?"


You got it.

"Lastly, anyone who finances with a Debt To Income ratio of 35% or less has sufficient positive income cashflows [i.e. save something like 40% of income after paying mortgage and other living expesnes] that I can build a plan to accumulate enough of a side account (what we call a Mortgage Freedom Account) to completely cancel out (on paper) the mortgage balance by the 9th year (somewhat coincidentally.) Of course, we do *NOT* typically actually have them stroke a check to cancel the mortgage leverage... for a variety of strong financial reasons... but they have the CAPACITY to do so, which gives them the freedom & security to make other safe-but-assertive financial moves."

The more I read, the more hokey the plan gets.

Regards, JAFO

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120848 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 8:33 AM
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If the $200k example is 80CLTV, then we are talking about a $250k home.

Okay.

1.5% is a generous factor for taxes & insurance, thus $312.50/month.

It's not nearly generous enough in Texas (or a lot of other places). Property taxes alone in Texas generally run 2%, with insurance at least another 1/2% - more likely 3/4% - and that's with a $2500 (1%) deductible. Even 2.5% bumps the $312.50 up to $520.83; the 2.75% would be $572.92

Having owned homes in 6 different states across the country, I can tell you that in only one of those states would I feel comfortable with a 1.5% estimate for property taxes and insurance. And since that state is now in big financial trouble, my guess is that 1.5% won't be a good estimate for long.

1% is reasonable for basic maintenance & repairs, that's $208.33.

In Texas (land of lots of roof replacements - see high insurance cost) I would probably up that, but even if I don't, we're up to $729.16 - $781.25.

That's $520.83 from the $2,019 consumable budget, leaving about $1,500 for food, clothing etc. That's about $50 a day. Not extravagant, but quite workable for a single person or a young couple in a $250k home area of the country.

Well, I have that you're down to $1290, at best, which is actually $43 a day. And with utilities (electricity, water & nat gas - not including phone/TV/internet) on my $200k home in Texas (land of lots of $200k - $250k homes) running an average of $400 a month, you're down to less than $900 a month for food, clothing, replacement car(s), college savings and retirement funding. Assuming 1 Roth at $5,000 and no 401(k), that's $416.67 a month. So, now you're down to about $450 a month for food, clothing, phone/TV/internet, college savings, HOA fees and everything else. And, that was only funding 1 Roth, not 2 (for a couple), or any 401(k).

Sorry - don't buy that it's 'doable' for *most* young couples or young singles.

People in higher cost areas, and/or with larger families, or more expensive lifestyles as a choice, or without discretionary cashflow or obvious inefficiencies in their budgets may or may not cancel out their mortgage as quickly... but almost everyone can do so much faster than the 30 year period, and stay liquid along the way.

But once again, an MFA can be done with either an ARM or an FRM.....And for the majority of people who are not able to free up enough cash flow for an MFA to pay off the mortgage within 7 years, the worst case scenario has the cumulative 5/1 ARM P&I payments exceeding the cumulative FRM P&I payments in month 85 - 7 years and 1 month. So the ARM savings only pays for 2 years and 1 month of 'protection' (and that's if the homeowners actually put the money aside).

For people who absolutely going to be out of their house within 7 years - no big deal. Go for the 5/1 ARM.

For those who are planning on staying in the house for at least 7 more years (knowing that frictional costs of buying and selling usually make a stay of less than 4 - 5 years a likely net loss) a 5/1 ARM is gambling that you can get out of the loan at a lower price than your reset will go to, in the worst case scenario. If one is comfortable with the payment that the loan will reset to, it may be reasonable gamble. But for those who don't have the income to withstand a $520 a month payment increase - it could mean having to sell the house when they don't want to.

AJ

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120849 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 10:15 AM
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But the big deal seems to be finding a bunch of extra money every month. That is what allows you to pay off your mortgage in a decade.

Yes, this is the key. Either that, or being absolutely sure you can get out of the loan before you have run through the savings.

At first I thought you were saying this extra money was the difference in payment between the ARM and fixed, but now it seems that you agree this is way too small to let you pay off a mortgage in a decade.

Yes, in the example given of a $200k mortgage with a 2.75% ARM vs. a 4.125% FRM, making the only the required payments, the difference in payments savings only provides about 2 years of protection against the worst case payment increase. So after 7 years, if you are still in the same ARM, you would have been better off with a FRM.

You should run the numbers for your situation - with different spreads/rates/balances/interest rate increases, the length of time will vary. And you also need to make sure that you can handle the potential of a significant payment increase - in the example, the payment increased from $816 to $1336 - an increase of 63% - in the worst case scenario.

AJ

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120851 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 12:10 PM
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Hi Spinning,

It sounds like you (Dave) are saying that if you can find a bunch of extra money to save, then you can save enough to equal the amount of the mortgage.
<SNIP>
Have I got it or am I still confused?

Close, but not clear. Its not "extra" money that's being used, its the money already existing in the cashflows that is not being efficiently applied to the results.

We're not assuming any *extra* or *external* income.

===============
AJ,

So someone with these example numbers in Texas needs more discretionary cashflow... OK. The example is merely that, an example. The underlying principles work in texas just fine.

an MFA can be done with either an ARM or an FRM

Of course! These are 2 different isses, neither requires the other.


the worst case scenario has the cumulative 5/1 ARM P&I payments exceeding....
a 5/1 ARM is gambling...
in the worst case scenario...

'Worst case scenario' is always a good thing to be aware of.... but probability scenarios are far more important to make weighted decisions from.

Taking a 30 FRM is no less gambling; Its a gamble that loses if the higher probability events of less than meltdown markets occur. There are usually different levels of insurance coverage available at varying costs... wise folks choose carefully, both with an eye to coverage *AND* costs.

If someone actually believed the probabilities of a worst-case scenario were high, meaning rates would adjust "limit up" and stay there, then they'd have to have low enough lifestyle expenses and/or high enough discretionary income to cancel out their mortgage in their 7-9 years of outperforming a 30 FRM.

The MAJORITY of people (who are paying attention, anyway) do not believe that a systemic meltdown with limit-up rate adjustments is actually imminent. There is uncertainty prevalent about when... at what rate of breakdown... and how far the eventual rate market climb will result.

So that means if "worst case" gives a 7-9 year window, and virtually nobody seriously puts a "worst-case" as the most likely scenario, the *EFFECTIVE* case to plan for is probably something like 10-15 years-ish.

I'll *ABSOLUTELY* say that people who don't want to think about it and don't want to manage cashflows ought to go ahead & pay up on the premiums of a 30 FRM (or even a shorter amortization, as long as they keep minimum safety reserves & sufficient insurance coverage.) If you can't be bothered, or simply aren't capable or inclined to manage your finances yourself, then paying a premium elsewhere is the 2nd best option (far better than winging it blindly.)


Again, the basic principles always apply, and we've burned a long thread rehashing obvious knowns;

A) 5 yr ARM mortgages cost 35-45% less than 30 FRM each year for 5 years,
B) With most ARM caps, those savings can supplement later adjusted payments and outperform the premiums otherwise charged for the 30 FRM for anywhere from 7-9 years (depending on the caps,) in the worst case environment,
C) The worst-case environment in this case, and in our current position of cyclical market history, is
still possible, but an extremely low probability likelihood,

D) Snowballing to eliminate high cost debt and gather reserves is the fastest way to accumulate liquid capital without counting on increasing income,
E) Using a system to do so is usually more effective than winging it,

The keys to optimum home leverage management are;
F) stay as liquid as possible. Liquidity kills risks.
G) reach the point of debt-cancellation, while simultaneously defending your liquidity, as quickly as possible.
H) Costs (in the way of unecessarily higehr rate premiums) are pre-loaded risks... they eliminate future safety by eliminating liquidity. Reduce them as much as possible.
J) Amortization is not your friend in this aspect.

Cheers,
Dave Donhoff
Leverage Planner

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120855 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 1:50 PM
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So someone with these example numbers in Texas needs more discretionary cashflow... OK. The example is merely that, an example.

And a lot of other places, too - not just Texas. Texas was also just an example, and as I said, of the 5 other states I've owned in across the country, I think your estimates are low for 4 of them. And I haven't owned in 'high cost' areas (like CA, MA, NJ, NY or VA) that you excluded.

The underlying principles work in texas just fine.

The underlying principles always work - it's just a questions of how much discretinary income that you have to have compared to your mortgage costs in order to fully hedge against the worst case scenario. Sorry, but devoting 60%+ of one's income to the mortgage and MFA contributions is unrealistic for MOST people.

A) 5 yr ARM mortgages cost 35-45% less than 30 FRM each year for 5 years,

Only if considering just the cost of the interest paid. From a cashflow perspective, the ARM is actually closer to 15% - 20% less costly than the FRM. When you are focusing on the cashflow in order to fund the MFA, it seems 'salesman-like' to focus on the interest only savings, especially when you say:

B) With most ARM caps, those savings can supplement later adjusted payments and outperform the premiums otherwise charged for the 30 FRM for anywhere from 7-9 years (depending on the caps,) in the worst case environment,

since the only savings that can help supplement the later adjusted payments are the cashflow savings.

C) The worst-case environment in this case, and in our current position of cyclical market history, is
still possible, but an extremely low probability likelihood,


Really? As already pointed out, resetting to the max of a 7.75% for an initial 2.75% ARM and a 2.25% margin would only require the LIBOR 12 month rate to be above 5.375%. LIBOR history only goes back to Sept, 1989 (missing out on the really high rates in the 70s/80s), http://www.wsjprimerate.us/libor/libor_rates_history.htm but even during that time, LIBOR was above 5.375% for 106 out of the 220 months between September 1989 and December 2007 - so nearly half of the time from the LIBOR's inception until the credit crisis manipulations began in 2008, the LIBOR was at or above the rate that would cause a current ARM to reset at the max.

That doesn't seem 'extremely low' to me, especially considering that it didn't capture the 'high rate' times.

AJ

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Author: spinning Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120856 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 2:02 PM
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Close, but not clear. Its not "extra" money that's being used, its the money already existing in the cashflows that is not being efficiently applied to the results.

I don't understand what you mean by "efficiently applied". Can you give some examples? I would like to understand if I am already efficiently using my cashflows or not.

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120857 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 2:22 PM
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AJ,

The LIBOR is not some bizarro beast detached from the rest of the global economies. As a liquid index it has come to be fairly closely correlated with the rest of the interest indicies, and they *ALL* live in the same universe of global historical cycles.

We still have a long way to go for the interest markets to fully digest the artificially forced highs of the late '70's and early 80's.

=====================
Hi Spinning,

I don't understand what you mean by "efficiently applied". Can you give some examples? I would like to understand if I am already efficiently using my cashflows or not.

If I had never spoken with you personally, and only observed your online conversations, I would already assume you manage your cashflows quite well. My direct interaction confirms that.

Proper cashflow management considers tax effects, interest rates, crediting rates, amortization burdens, daily interest versus monthly (when applicable,) and gets the absolute best result per dollar available, each day.

Taking a 15 FRM at 3.5% tax-deductible, while carrying a 2%/month-amortized non-deductible revolving balance at 8%, is a no-brainer example of bad management.

There are almost unlimited examples of inefficient management. Efficiency is just cashflow sails very well trimmed to get the absolute best results.

Dave Donhoff
Leverage Planner

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120858 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 2:39 PM
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The LIBOR is not some bizarro beast detached from the rest of the global economies. As a liquid index it has come to be fairly closely correlated with the rest of the interest indicies, and they *ALL* live in the same universe of global historical cycles.

I never said it was a bizarro beast. What I pointed out was that during the 'non-manipulated'/'normal' months from Sep 89 - Dec 07 (and even that's debatable - there are lots of arguments that the rates were kept too low for too long in the early/mid 2000s), for 106 out of the 220 months (48%), LIBOR was at a rate that would max out an ARM originated under current terms.

Assuming we return to 'normal' times in the next 5 years, 48% of the 'non-manipulated' months still does not feel like an 'extremely low probability' to me.

Having been given these statistics, are you still maintaining that the possibility of maxing out a 5 year ARM at the first reset is 'extremely low'?

AJ

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Author: Globetraveler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120859 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 4:15 PM
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Close, but not clear. Its not "extra" money that's being used, its the money already existing in the cashflows that is not being efficiently applied to the results.

Huh? This is where this all seems like smoke and mirrors. When someone asks if your method is using extra money that one would may have, you deny it and say it's not but rather using existing cash flows. Excuse me, what kind of non-sense answer is that? You and I both know we are talking about extra money that could be used to pay down a mortgage.

In layman's terms, most people don't have "already existing cash flows", they have income and debts, and the difference between the two would be extra money that can be used for something. Care to explain the difference between existing cash flows and extra money?

The question on my mind, and I suspect on everyone else's is how an ARM is so much better than having a 30 FRM when both are talking about a payoff in 7.5 years. The risk I see the ARM is with the rates going up and the amount of "savings" could be easily canceled on a significant rate hike that doesn't happen on a FRM.

I understand the advantages of having a MFA, where you are putting significant income into savings, thus creating liquid assets. However AJs spreadsheets and the ones I have tried don't match your numbers when comparing ARMs and FRMs.

I seem to be pretty naive at this stuff, I can't seem to make the math work on what you are trying to say. Anyone can do a chart and post numbers and figures, however the truth comes out when one can see spreadsheets and the actual math formulas used to make something work.

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Author: joelcorley Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120860 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 4:36 PM
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spinning,

Dwdonhoff wrote, Close, but not clear. Its not "extra" money that's being used, its the money already existing in the cashflows that is not being efficiently applied to the results.

To which you asked, I don't understand what you mean by "efficiently applied". Can you give some examples? I would like to understand if I am already efficiently using my cashflows or not.

Seems clear enough to me. It's money you pull out of your ***...

Honestly, it seems pretty insulting to tell Fools that you're all too stupid to figure this out - which is what all Dave's hand-waving seems to say. The fact of the matter is Donhoff's math just doesn't work and neither does his story.

In the same post he claims that it's not extra money, but that's exactly what he's agreeing with aj485 that it is further down. (I know that's what aj485 is assuming it is and he seems to be agreeing with her.) It simply can't be a more efficient use of existing cash-flows. You don't have to be an accounting major to figure out that you can't shave 22.5 years off of a 30 year mortgage by simply managing your payments (even if you bundle your entire paycheck into the equation) more efficiently. At most doing so might shave a year or two - it's certainly not going to save you thousands/month. Managing cash-flows more efficiently is exactly what the Money Merge Account was all about. I think we've already put that idea in its proper place.

To shave 22.5 years off that mortgage, you MUST prepay the principal. (Or put the money into some savings plan for a future payoff.) To do that you MUST have additional income/savings that you can DEDICATE to the mortgage pay-off. Simply manipulating your current cash-flows can't magically make that happen. But I think you already know that - you're just trying to pin Donhoff down on it.

I skeptical that you can get Donhoff to do that because he's trying to sell a financial product / service. To admit that would be to admit that none of his clients will benefit. And I suspect you won't be able to get him to say that...

- Joel

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120861 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 7:00 PM
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AJ,

The initial 10 years (or so) of the LIBOR were not years it was highly integrated into the global system. In the last 5-10 years it has become deeply integrated, both in the bank's represented in the index, and in the use of it as a buying & cross-hedging platform.

The LIBOR can be projected to behave in correlation with all the rest of the major rate indicies, including debt data going back several hundred years.

None of them will be rallying very much, very soon.

==========
Globetraveler, & JoelCorely,

The least you could do before flapping your arms & crapping everywhere is to actually read the details of the thread.

The math & the principles all work fine, and none of the prior thread participants are in disagreement about that.

Some people are arguing that 'the average person' can't behave with enough discipline to make a snowball system work. I do not disagree.

Some people are arguing that it takes more net discretionary cashflow, as a percentage of income, to get equivalent results in Texas. I do not disagree.

Some have a fearful opinion of the rate markets are going to suddenly react completely out of long-term historical character. I have a different opinion. The fearful opinions have been prevalent since I arrived... they've been wrong since I've arrived. My market opinions and projections have been published here at TMF for about a decade now, and have been overwhelmingly accurate (knock on wood & toss a pinch of salt, in gratitude to recFIRE GardenBunny!)

Your total income is your total income. If you are sending unecessary dollars toward higher costs, or higher amortizations, than necessary, those dollars are *AVAILABLE* cashflows that are not *extra* money in any way at all.


Globaltraveler,
The question on my mind, and I suspect on everyone else's is how an ARM is so much better than having a 30 FRM when both are talking about a payoff in 7.5 years.

The 5 yr ARM is 35-45% cheaper than the 30 FRM, each year, every year, for the initial 5 years. Every dollar saved outside of your equity can grow at or above its offsetting mortgage costs, and at the 5 year mark should the mortgage rate leap above 5-6% (i.e. 7.75%) the funds accumulated outside the home equity could be transferred into equity at 5-6%, creating a lower cap on the funds than the mortgage caps.

The likelihood of this is low, but the safety factors are high.

The risk I see the ARM is with the rates going up and the amount of "savings" could be easily canceled on a significant rate hike that doesn't happen on a FRM.

This comment about ARMs vs FRMs show you have no clue about what we've covered in this thread. In the catastrophic worst-case scenario (which is *EXTREMELY* unlikely... but still,) the ARM maximum adjusted total payments will remain LESS than the 30 FRM for at least another 2-4 years.

That's *WORST* case. Any market movements occuring within the higher probability spectrum puts the outperformance of the 5 yr money at longer (even much longer) than 9 years.


LOOK... this is *REALLY* not so incredibly complicated!!!
MOST in this thread are probably *ALREADY* doing this...
(You're just not thinking about it as such.)

If you accumulate enough liquid capital that you *could* pay off your mortgage, then you've achieved what I help my clients achieve!

There are cleaner & faster paths to achieve this than others. It's rarely achieved by random intuition. We've covered the mutually agreed principles more than once in this thread... it is really *NOT* rocket surgery.

Cheers,
Dave Donhoff
Leverage Planner

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120862 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 8:57 PM
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"But the big deal seems to be finding a bunch of extra money every month. That is what allows you to pay off your mortgage in a decade."

Yes, this is the key. Either that, or being absolutely sure you can get out of the loan before you have run through the savings.


But this is just silly.

What you are actually saying is "If you can save/invest a bunch of money every month, in a few (7-10) years your portfolio value will be than you owe on your mortgage".

Well, DUH!!

There is absolutely NO linkage between your investment portfolio and your mortgage. None. The only linkage is mental--playing games on yourself by mentally earmarking the portfolio to pay off the mortgage when the balances become equal.

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120863 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 9:03 PM
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And I would submit that anybody who has the discipline, dedication, and financial (investing) acumen to grow their investment portfolio from $0 to near $200K in 7-10 years has no need to play this kind of mental game on themself.

The people who benefit from these mental games are people who need the advice of Dave Ramsey. And those are people who don't have any extra money to put away, not the discipline.

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120865 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 10:23 PM
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Your total income is your total income. If you are sending unecessary dollars toward higher costs, or higher amortizations, than necessary, those dollars are *AVAILABLE* cashflows that are not *extra* money in any way at all.

Give it up, Dave. One of the worst places to try to defend the money-merge concept (no matter what you call it) is to regulars on a TMF board.
All of business about "cancel mortgage" and "discretionary income" and "managing cash flows" are just signals that somebody is trying to pull something over on us.

=================================
This thread is intermixing two completely independent things.
1) FRM vs. ARM
and
2) paying off a mortage in 1/3 (or less) of the scheduled time.

FRM vs. ARM is simply a question of taking on the interest-rate risk of an ARM vs. the increased cost of a FRM.
You think the risk is negligible, I don't. Moreover, I think that it's better to take no risk w/r/t your house, but to isolate the risk to your investment portfolio. If you get hit by the risk in your investments, it means you have to keep working. If you get hit by the risk in your house, it means you have to vacate your home.

Saying that the average duration of a mortgage is 7 years (and therefore inside of the worst-case risk scenario) is true but meaningless. The general statistics don't matter when you are an individual. What matters is how long YOU are going to be in the mortgage. When YOU are the one whose rate has hit limit up and are now having to pay 2.3 times your initial rate.

------------

I think that the whole business of "take a lower payment and apply the difference to principal" is silly, and is the same kind of fallacy as the thinking that says making extra principle payments is the same thing as earning 4% (or whatever your rate is) on your money. The fallacy is called "anchoring". The implicit assumption is that the "correct" payment is X (the higher payment of the FRM) and that the difference between X and Y (the lower payment of the ARM) somehow "belongs" to the mortgage (either directly or indirectly via a MFA).

Well, people don't really *act* this way, even though many people *talk* this way. My initial rate on this house was 7.25% and I've refi'ed it down to 4.0%, with several steps on the way down.
At 200K, the 7.25% P&I was $1,364. At 4.0% the P&I is $955.
NOBODY says, "That's an extra $409 that I can apply to the mortgage."
What everybody actually says is, "I have reduced my required monthly payment by $409."

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120866 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 10:41 PM
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The initial 10 years (or so) of the LIBOR were not years it was highly integrated into the global system. In the last 5-10 years it has become deeply integrated, both in the bank's represented in the index, and in the use of it as a buying & cross-hedging platform.

What do you consider 'the global system'? Because when I look at the 12 month LIBOR rates vs. a few indices (US Prime, 10 year CMT, and the US Fed Funds rate, the variances the first 10 years don't look much different than they do for the last 5 years. The rates all follow the same basic pattern. LIBOR generally shows more variation than the other rates, but the magnitude of the variation is within similar ranges for each index whether you're looking at older data or more recent data.

But, since the data I presented doesn't support your theory, I guess you're free to ignore it. Ignoring it doesn't make it go away, though.

Some have a fearful opinion of the rate markets are going to suddenly react completely out of long-term historical character. I have a different opinion.

So your opinion is that for at least the next 7 years, rates won't return to where they were in 2006/2007? Because for the 5/1 ARM used as an example in this thread, rates would have to stay low for at least 7 years in order to have the 9 year advantage over the FRM that you keep talking about.

AJ

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Author: BoredPerson One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120867 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 11:36 PM
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The least you could do before flapping your arms & crapping everywhere is to actually read the details of the thread.

Hehe ... the slick salesman loses his temper. He a little upset he can't fool the Fools as easily as he does his clients.

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120868 of 126962
Subject: Re: FRM vs ARM debate Date: 8/21/2011 11:48 PM
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Ray,

All of business about "cancel mortgage" and "discretionary income" and "managing cash flows" are just signals that somebody is trying to pull something over on us.

You're just being obstinate... having sufficient liquidity to pay off the mortgage is what you *ALREADY* do, so its a bit disingenuous to try to pawn it away as "trying to pull something over on us."

FRM vs. ARM is simply a question of taking on the interest-rate risk of an ARM vs. the increased cost of a FRM.
You think the risk is negligible, I don't.


Right, and I'm not throwing mud at *YOU* for having an opinion different from mine. I'm simply saying that from my perspective you are still overpaying going forward, and from past opinions of the market, and your overpaying, have proven true (whether by skill or luck.. Bill Gates still maintains he is successfull by luck, so there you go.)

We're still talking market opinions though, and its not lost on me that the only opinions that matter are the opinions we act on... and further, comparing results against each other is completely pointless.

I've probably paid *FAR* less in leverage market insurance than you (and most folks) have... but although I've lost nothing on the asset-side of my liquid portfolio, my avg annual returns are non-home-run boring in the 5-6% range (so far.) My real estate portfolio is cashflow-amazing, but has also truncated a good 15-20% from the market value highs, but those are all over my acquisition basis & are "buy unti I die" timeframes so I'm unconcerned in that aspect. You may have done much better than me on the asset-side (in fact, I hope you have!)

Moreover, I think that it's better to take no risk w/r/t your house, but to isolate the risk to your investment portfolio.

I completely agree. As you build liquidity you build the capacity to manage all of your risks, and are able (in essence) to self-insure instead of paying a premium to a mortgage bank for low probability high impact risks. Self-insuring, when one has the capacity, puts their home at no risk just as equally as externally insuring.

Homeowners with no reserves and no substantial cashflow potentials are trapped in paying up for a bank to cover their low probability risks, because they can't cover the slight chance of a higher expense.

That's the whole point of building sufficient liquidity to cancel out your mortgage liablity (you still haven't suggested your alternatively preferred term for this action... so scoffing it away is again disingenuous.)


Saying that the average duration of a mortgage is 7 years (and therefore inside of the worst-case risk scenario) is true but meaningless.

Actually, to the wise risk manager (even as an individual) it is quite meaningFUL! If you have accumulated the means to absorb the 1 in 20 chance that you'll remain in your loan beyond your 7th year, you have earned the privilege of safely paying less for your "insurance." Its tantamount to a "good driver discount" for car insurance. If you've played it safe & disciplined, there's *zero* reason to pay the cash premium that those without reserves must pay.

As for the rest of your "anchoring" paragraph, I no idea WTH you are talking about... sorry.

===============
AJ,

So your opinion is that for at least the next 7 years, rates won't return to where they were in 2006/2007?

I'll actually go further, I do not believe the rate markets will reach their 2006/2007 highs for at least 10 years from here (2021.)

That's just my opinion, and I can support it... but I am not going to try to convince you. There are plenty who see my reasoning, and have the capacity to self-insure to exploit the benefits.

You can disagree. We all get the results we each play for.

Cheers,
Dave Donhoff
Leverage Planner

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Author: joelcorley Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120869 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 1:19 AM
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dwdonhoff,

You wrote, The least you could do before flapping your arms & crapping everywhere is to actually read the details of the thread.

I did read the thread before flapping my arms, etc., etc.

Also, The math & the principles all work fine, and none of the prior thread participants are in disagreement about that.

No. In fact you've avoided presenting any of your math at all, so it's not possible to challenge it directly. But it seems pretty clear from earlier in the thread (the one I read anyway) that you were originally double-counting the principal payments - the same as the people pushing that Money Merge Account software. When called on it you not only didn't admit it was a problem - you said that it was actually in your favor! (Without explaining why or how.)

And in fact I know aj485 doesn't agree with you and would love to poke holes in your math. She's just too polite to say it.

And, Some people are arguing that 'the average person' can't behave with enough discipline to make a snowball system work. I do not disagree.

You are mistaken. Its not a matter of averages. No one here honestly believes that any person - not just an average person - making $5K/month can dedicate more than 60% of their paycheck toward this or any other mortgage payoff scheme.

Those Fools that could or might have paid off their mortgages in 7.5 years or less have done so by changing the underlying assumptions. Either they have more income, existing savings reserves or bought a less expensive house. Given the parameters you originally put forth, a 7.5 year pay-off seems completely unfeasible.

Also, Some people are arguing that it takes more net discretionary cashflow, as a percentage of income, to get equivalent results in Texas. I do not disagree.

No. aj485 (not "some people") pointed out that Texas as well as a number of other states have much higher home-related expenses than you are projecting. She was saying that if dedicating 60% puts most people "on the edge", they'd be falling off the edge in most states she's lived in because she thinks you're underestimating expenses.

And no, aj485 did not waive her hands and say "net discretionary cash-flow, as a percentage of income." She cited numbers - estimates of very real expenses.

And, Some have a fearful opinion of the rate markets are going to suddenly react completely out of long-term historical character. ...

There are uses for ARMs. And I don't disagree that taking out an ARM might be the optimal move in some cases. I also think that the lower rates go, the less *LIKELY* it is that an ARM is the right move.

Beyond that I don't think that if you are able to pay off your mortgage in 7.5 years that the difference in ARM vs. FRM rates really makes that much difference. Now if you're going to pay it off in 5 years, clearly the 5/1 ARM is superior ... but again I don't think the interest savings is that big a factor. If you're talking about a much longer time horizon, to me the limited interest rate risk of an FRM becomes increasingly attractive given today's super low rates.

Finally, If you are sending unecessary dollars toward higher costs, or higher amortizations, than necessary, those dollars are *AVAILABLE* cashflows that are not *extra* money in any way at all.

The unnecessary dollars you're speaking of (ARM vs. FRM) aren't going to make a huge difference. aj485's spreadsheets already show that fact.

I'm not saying it's not worth doing the ARM vs. FRM analysis when you're financing the house; but ultimately to pay off a mortgage in such a short time frame you simply need to throw more of your income at it. For most people that means make a more money ... or buying a house who's mortgage is a relatively smaller fraction of their paycheck. It's not about optimizing cash-flows.

So far all I see from you in this thread are hand-waving, contradictions and boastful claims. But if you can't back it up with hard numbers, what you're saying is just wind...

- Joel

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120870 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 10:48 AM
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I'll actually go further, I do not believe the rate markets will reach their 2006/2007 highs for at least 10 years from here (2021.)

Okay, so you believe that we are going back to the 50s/60s from an interest rate perspective, since that's that last time that the rates haven't reached where they were in 2006/2007 for more than 10 years. If you believe that, I can understand why you think that an ARM issued today maxing out is a 'low probability event'.

However, you continue to state that opinion as though it's a fact, and refuse to support the opinion with anything other than "it's what I believe". If you are unwilling to support your opinions with data, then you stop stating your opinions as facts, and instead state that in your opinion, it's a low probababilty event.

That's just my opinion,

Okay, you finally admitted it, but it took how many posts?

and I can support it... but I am not going to try to convince you.

Why not? That's what I keep asking you for - data or analysis to support your opinion that that it's a low probababilty event that an ARM will max out.

I have presented data that shows that it's a reasonable possibility, and you refuse to refute that data with any data or analysis. If you continue to do this, then I am even more convinced that your opinions are based on nothing but smoke and mirrors, and you are just trying to sell the 5/1 ARM so that you have a continuing business when people need to refinance.

AJ

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Author: Globetraveler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120871 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 11:09 AM
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The least you could do before flapping your arms & crapping everywhere is to actually read the details of the thread.

Dave,

Thanks for the quick insult, I appreciate it. It makes me think SO much more highly of you when I stated that I don't understand what you are doing.

Here is the deal, I DON'T understand how you are coming to your figures. I looked at AJ's spreadsheets and they make sense, If rates stay low, sure at ARM is a better deal and I understand that you believe that they will.

You say that YOUR plan will shield anyone from a possible ARM rate hike and produce some numbers, however as I said, I am pretty naive at this stuff, so I just don't get how you arrive at those. How exactly does your MFA offset the possible interest rate hike? Are you saying that just because I've paid down my mortgage a good deal after 5 years, that this has shielded me from the rate climb?

Maybe the confusion is I just don't understand your marketing terminology. I used the example of "extra income" or what I like to call, left over money. You like the term "existing cash flow" When I speak of a MFA or mortgage freedom account. It's a saving account that I use to build up savings with my "left over money" and when it reaches a certain amount, I make a lump some payment toward the loan. I seems your MFA is some sort of loan product, which may be the crux of my not understanding things. How can taking out a second loan be a good thing when compared to saving the money outright?

The biggest hurdle I probably face is that I don't see a house as a straight out investment. When you talk of liquidity in the home, I don't see it that way. If is place where I live. It is only liquid if I sell it, otherwise it is just a home and hardly a liquid asset. If that's how you are explaining the offsets in AMR -vs- FRM, then this is where I have a fundamental difference in opinion. I can't realize those gains if I an ARM resets and I still desire to remain in the home.

You accuse me of flapping my arms and dumping on this thread. I apologize if that is what you thought my intentions were. I just don't understand the math or exactly your terminology at times.

PS: Telling me it this isn't rocked science isn't helping.

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Author: xtn Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120872 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 1:27 PM
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According to the financial statements of FannieMae, over 97% of *ALL* 30 year notes are turned over (paid off due to refinance or sale) by their 7th year

I think this is a factoid. That is, it is literally true, but implies something that isn't generally true at all.

I would like to point out that it doesn't imply anything at all. It's a statement clearly dealing with only one bit of data. Any other idea somebody may get from it comes from inferring something that isn't touched on at all.

The only area of concern that the statement doesn't provide info for is the time range of their sample. I guess it's safe to assume it's at least seven years, but otherwise we don't know. It might be an average since MannieMaes inception for all we know, which would include good economies and bad; rising rates and falling. It might not. We aren't told and the statement doesn't make any implication whatsoever.

xtn

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Author: xtn Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120873 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 1:33 PM
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Oh I forgot to mention...

...I'm siding with Dave.

It's about probable real spending over the long term for me. Taking an ARM right now means I would probably spend less - overall - for the next ten years and that means I would have spend less total money to live from birth to death. At least on housing. Leaving it to spend on something else or not to spend at all as I see fit. Less money spend equals more money still in the pocket.

xtn

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Author: MetroChick Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120874 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 2:02 PM
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According to the financial statements of FannieMae, over 97% of *ALL* 30 year notes are turned over (paid off due to refinance or sale) by their 7th year

If one bought in 2005 at the height of the market with an ARM, then it re-set in 2010, but the person couldn't afford it and the house was short-saled or foreclosed, would that scenario be counted in the "Fannie Mae 97% stat"?

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120875 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 2:21 PM
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All of business about "cancel mortgage" and "discretionary income" and "managing cash flows" are just signals that somebody is trying to pull something over on us.

You're just being obstinate... so its a bit disingenuous to try to pawn it away as "trying to pull something over on us."


Not being obstinate at all. Terminology is important. When somebody invents new words and phrases for a concept instead of using the standard, normal, well-understood, everyday words, you have to ask why. Why don't they just use the standard terminology? The most common reason is that they are trying to blur what they are talking about.

The people who commonly use the terms "mortgage cancellation" and "discretionary income" are pushing the money-merge" concept. Google them. What the heck does "mortgage cancellation" mean, if not "pay off the mortgage"? Everybody knows what "pay off the mortgage" means -- and it's a simple concept.

Using a term like that raises a red flag. It's a warning sign that somebody is probably trying to blow smoke up your leg.

having sufficient liquidity to pay off the mortgage is what you *ALREADY* do
Right. But I don't call it "mortgage cancellation". Nor do I call it "car loan cancellation". (I have not only a mortgage but also 2 car loans.)
What I call it is "having a positive liquid net worth". That's what everybody calls it. That's what they call it on a loan application. Net assets minus net liabilities.

-------------
BTW, I don't have any problem with the terminology of "Mortgage Freedom Account". That's simply a shorthand way of telling people that *if* they want to pay off their mortgage early, to put the money into a side account instead of making extra principal payments.
To my mind, it's a better way of doing something that shouldn't be done in the first place(paying off your mortage ASAP).

------
...instead of paying a premium to a mortgage bank for low probability high impact risks.
A.K.A. picking up pennies in front of a steamroller.

It's the risk thing. As far as I can see, you are acknowledging that the risk is there but are handwaving it away. If the ARM rate hits the cap, that's $833/mo more interest. On 200K, the monthly payment (3.75% ARM) jumps from $926 to about $1550.
And it does not matter that the average mortgage duration is 7 years. What is the repair plan?
* Refinance? Okay, but the then current rates are 8.75%, so refi'ing doesn't help.
* Sell? Okay, and move to where? Buy another house? Okay, but the rates are 8.75%. Move into a refrigerator box? Friend wife may not be thrilled.
* Define it away? Declare that rates will not go up? I think that you are saying "I predicted rates would not go up, and indeed they haven't gone up, so my predictions are right, and you'll be safe with an ARM." To me, that's like saying, "I drove past a biker bar and flipped them the bird, and nothing happened, so I can always flip the bird to a biker bar and be safe." One of these days you'll get stomped into dirt--and be very surprised.

* Tap the savings/investment account that you've been putting the difference between FRM & ARM payment in? On 200K, 3.75% ARM and 4.25% FRM, that's $57/mo. SWAG, 7 years @ $57/mo = $4788. If you can grow $57/mo at 8% for 7 years, the total is $6420. That will last about 8 months ($6420 / $833)

I think that you are completely understating the risk. The plain fact is that the math doesn't work. The only thing that would work is adding a whole bunch of other money into your side account. But that isn't comparing apples to apples. It's comparing apples to apples-plus-a-dumptruck-of-money.

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120876 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 3:12 PM
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It's about probable real spending over the long term for me. Taking an ARM right now means I would probably spend less - overall - for the next ten years and that means I would have spend less total money to live from birth to death. At least on housing.

Knowing you, xtn, you probably have the ability (and the plan) to pay the mortgage completely off within 10 years. (From the leverage planning standpoint, this is a no-no because you are putting liquid assets into an illiquid asset.) So, for you, yes, an ARM is probably going to be cheaper over the entire term that you hold the mortgage.

For those who don't actually pay down significant prinicipal and/or pay off the loan in 10 years, whether they will save money with an ARM depends on what the interest rates are going to be in 5 years, and what kind of caps there are on the loan they take.

If interest rates are going to stay low (1 year LIBOR less than 4%) for 10 years, then yes, they will probably save money.

If the rates don't stay that low, but there are caps that limit each adjustment, including the first adjustment, to a maximum, then they might save money, but they might not. It depends on the specifics of their situation, the rates and the caps.

If the rates don't stay low, and there isn't a cap on the first adjustment, they will probably end up spending more money by using an ARM than they would have with the FRM.

AJ

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Author: xtn Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120877 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 3:47 PM
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Knowing you, xtn, you probably have the ability (and the plan) to pay the mortgage completely off within 10 years. (From the leverage planning standpoint, this is a no-no because you are putting liquid assets into an illiquid asset.) So, for you, yes, an ARM is probably going to be cheaper over the entire term that you hold the mortgage.

Yes.


If the rates don't stay low, and there isn't a cap on the first adjustment, they will probably end up spending more money by using an ARM than they would have with the FRM.

Like you said, it depends on the particulars. I think anyone who has some discipline and doesn't get into too much unexpected trouble is has at least a 51% chance to save money. It helps to combine some intent with the decision to buy a house 1X one's income instead of 3X. Goes a long, long way towards helping the intent become reality.

I don't think Dave ever said or even implied that it's guaranteed. I think he bases his recommendation on the arguable position that it should work for more people than otherwise. Can somebody get burned? Sure. Doesn't mean Dave's position is invalid.

I sometimes find myself wishing that people would realize making such decisions - as best as one can without actually knowing the future, of course - helps contribute to the fact that I have the ability to pay the mortgage off completely within ten years. So it isn't just a situation of: I have the ability so I can make the plan work. It's a situation of: I strive to make such plans work and because of this I increase my "ability." Instead of saying, "If I had more money I could take this risk and make it work," people might be better served by saying, "If I take this risk and make it work I will have more money."

xtn

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120879 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 4:10 PM
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It's about probable real spending over the long term for me. Taking an ARM right now means I would probably spend less - overall - for the next ten years

It's that word "probably" that's the problem.

The thing I've learned about making decisions is to always ask yourself, "But what if I am wrong?"

The way to assess your risk is to ask yourself, "Where will I stand if things go pear-shaped? Will I be okay? Will I get stomped into the ground?"

You buy insurance so that a low-probability high-loss event won't crush you. To me, an extra $57/mo to guarantee a low mortgage rate for 30 years seems pretty cheap. I look at entire housing expense: $983 P&I, $350 T&I = $1333. Add in another $250-$350 for utilites (water/sewer, electricity, gas) brings it up to about $1600. (Yeah, yeah, I know you have to pay utiiities & tax regardless of the mortgage.) Compared to $1600, a difference of $57 isn't a big deal.

Not to drag politics into the discussion, but I can't see rates staying low for too much longer.

The reason US rates are so low now is the crappy economy. We have elections next year and again 4 years after that. There's a good chance that the administration & congress will change parties next year, and a 100% chance that we'll have a new President in either one year or in 5 years.

Now, if power shifts hands in next year, it is quite likely that the new administration/congress will change policies to try to get the economy going. One thing they will NOT do is continue the same policies. Ditto for the election in 5 years. Heck, even the *same* party will change policies to try to fix the economy.

So, in 5 years it's pretty much guaranteed that the Federal policies will change and the economy will go up.
When that happens, the reason that rates are low will disappear, so rates WILL go up.

The reason world rates are low is the Euro problem, PIIGS, etc. Chances are quite good that this will be resolved one way or another in 5 years. If it is resolved successfully, then European rates will go up.

In either case, IMHO there's a very high probability that rates will go up dramatically in the next 5-10 years.

When they are at rock bottom like they are now, there's nowhere to go but up.

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120880 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 4:30 PM
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It helps to combine some intent with the decision to buy a house 1X one's income instead of 3X. Goes a long, long way towards helping the intent become reality.

Yeah, but that wasn't the case with the person that Dave was talking about - $50k income; $200k mortgage; $250k house. Even if you move it to $100k income, paying off a $200k mortgage in 10 years is going to probably going to require some significant lifestyle sacrifices and/or changes.

That's where I get concerned about people who are getting ARMs to "save money" but who don't really have the capacity to handle the maximum payment shock if it occurs. As lots of people found out in the bubble, you can't always refinace or sell your way out of a rate reset and the alternatives if you can't make the increased payments (modification, short sale, deed in lieu or foreclosure) are generally pretty painful.

So without a plan to actually pay the mortgage off within a shortened timeframe, or the ability to easily handle the maximum payment, should it occur, people who are getting ARMs are playing with fire, IMO. Only those who can handle the maximum payments, even if those maximum payments are a 'low probabability event' should consider getting an ARM.

AJ

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120881 of 126962
Subject: Re: FRM vs ARM debate Date: 8/22/2011 8:29 PM
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Hi Joel,

In fact you've avoided presenting any of your math at all, so it's not possible to challenge it directly.
See the little "Whole Thread" link at the upper left of your screen? Click it. I've presented all the math my strategy uses.

If that's not enough, here's the Excel amortization sheet I used;
http://dl.dropbox.com/u/8644020/Loan%20Calculator%20w-Extra%...

it seems pretty clear from earlier in the thread (the one I read anyway) that you were originally double-counting the principal payments - the same as the people pushing that Money Merge Account software. When called on it you not only didn't admit it was a problem - you said that it was actually in your favor! (Without explaining why or how.)
You're completely confused, and I urge you to read the thread a bit more carefully.
A) I re-stated there was no double counting, and showed how & why that was true.
B) The mistake I copped to was, in fact, a handicap to my argument, and the correct number was to my benefit. I will explain;

I originally took $200k, and divided it by 7.5 years (90 months) to arrive at a monthly principal paydown of $2,222. Somehow AJ got the figure of $2,255. After plugging it into the amortization schedule, the actual number is $2,165. That's *LOWER* than both of our estimates. The reason the actual number is less than the full amount divided by the total months is that the additional principal payments are above the internal amortization burden.

I still have no idea how AJ got $2,255... but her 60 month remaining principal was close enough to mine (given that differing amortization calculators can be a smidgen apart) to be acceptable.

FURTHER, my initially stated 60 month remaining principal was *far* too high, because I mistakenly looked at the 60th row, not the 60th year on the spreadsheet. This, too, artificially handicapped my initial numbers and improved my position once corrected.

You are mistaken. Its not a matter of averages. No one here honestly believes that any person - not just an average person - making $5K/month can dedicate more than 60% of their paycheck toward this or any other mortgage payoff scheme.
No, I am correct. I know many people doing exactly as I have explained. Allocating 60% of your take-home pay to accumulation is not outlandish when 40% is sufficient for your lifestyle budget, and for many that is fact.

Beyond that I don't think that if you are able to pay off your mortgage in 7.5 years that the difference in ARM vs. FRM rates really makes that much difference.
If you are in the position of "positive liquid net worth" by 7.5 years (or 8, 9, 10... whatever your reasonable expectation of rate likelihoods,) why would you voluntarily pay an unecessary 35-45% premium on interest terms that offer no protection you don't already have?

===================
Hi AJ,

Okay, so you believe that we are going back to the 50s/60s from an interest rate perspective, since that's that last time that the rates haven't reached where they were in 2006/2007 for more than 10 years.
Actually, I think rates are going to remain "bottomed-out" as they did from around 1870 through 1960;
http://screencast.com/t/KUBkY438fJF

That's what I keep asking you for - data or analysis to support your opinion that that it's a low probababilty event that an ARM will max out.
The historical market data tells almost everything needed to see where interest rates tend to dwell, without artificial enforcement. The only question then becomes; what is the likelihood of any global government (not even just the U.S.) having the firepower *AND* political appetite to openly force interest rates higher than the normal markets... while there are still people alive old enough to remember the pain from the last time it was done?

I don't think its too hard to look at the CURRENT political preference to artificially DEPRESS interest rates, to see that its *extremely* unlikely that that leopard will change its spots in our lifetime.

===================
Globaltraveler,

Thanks for the quick insult, I appreciate it.
No... you are right, you didn't deserve that. I am sorry.

Here is the deal, I DON'T understand how you are coming to your figures.
Did you read the principles behind my strategy first & foremost? Is there any confusion there?

Tell me which specific figures you aren't understanding, and I'll be happy to explain further, or point where it was already clarified. It really truly isn't complicated.

You say that YOUR plan will shield anyone from a possible ARM rate hike
We've talked about at least 2 (perhaps 3?) different strategies/plans I suggest. Sometimes they go well in combination, sometimes not. Every family's perfect fit is different.

How exactly does your MFA offset the possible interest rate hike?
Think of the MFA strategy as an account, or a "bucket" (like you would think of your 401(k) or IRA, or similar.) It can have anything in it, from cash to mutuals, to stocks, to safer instruments.. whatever you want.

If you know that the absolute worst case rate hike is strictly limited to $X amount, and you know that the likelihood of that degree of increase has a 'Y' probability (lets say 1 in 100, just to pull out an objective number,) then you have a basis for solid judgment. If you have the ability to cover (from your accumulated MFA) the potential increase that 1 in 100 times, you can take advantage of reaping the rewards 99 out of 100 times. If you have no reserves and stand to collapse entirely, you have no choice but to pay the premium for more expensive insurance coverage on even that very last 1% of risk.

You like the term "existing cash flow" When I speak of a MFA or mortgage freedom account.
Two separate things.

Cashflows; If you make $5k/month take-home and pay out $4,000, and the way you have your budget structured can be adjusted so that you pay out only $2,000, you may or may not have actually changed any expenses or costs, but you have increased the actual cash flows. Make sense?

MFA: you actually got it correct on your 2nd try;
It's a saving account that I use to build up savings with my "left over money" and when it reaches a certain amount, I make a lump some payment toward the loan.
Right... except you *MAY* make a lump sum payment... or, you may choose to earn more money with it than you are paying on your mortgage... or, you may choose to pay less in other insurance premiums because you can afford to self-insure, gaining more in savings than your mortgage interest costs.


I seems your MFA is some sort of loan product, which may be the crux of my not understanding things.
Nope, just a cash management strategy.

The biggest hurdle I probably face is that I don't see a house as a straight out investment
I agree! I don't see a home as an "investment" at all either, nor am I treating it as such. In fact, I am structuring to keep the home safer at lower costs of safety than the unplanned, unstructured alternatives.

===================
Hi xtn,

...I'm siding with Dave.
I realize that's certainly not always the case... but thank you!

===================
Hi MetroChick,

If one bought in 2005 at the height of the market with an ARM, then it re-set in 2010, but the person couldn't afford it and the house was short-saled or foreclosed, would that scenario be counted in the "Fannie Mae 97% stat"?
You do realize that anyone who bought in 2005 with a 5 yr ARM would have their payments DROP at their first reset, right?

To answer your actual question, all payoffs are included in the FNMA financials.

===================
Hi Ray,

What I call it is "having a positive liquid net worth".
OK... but frankly, that's still rather ambiguous when someone needs to get clarity around how it specifically addresses their personal home.

I'll try to remember to refer to it that way here for you.

That's what they call it on a loan application.
It may very likely exist on various private or commercial loan applications, or personal financial statement forms.... but its not on the standard residential mortgage application (form FNMA 1003.) The distinction of "liquid" net worth doesn't exist there; https://www.efanniemae.com/sf/formsdocs/forms/pdf/sellingtra...

As far as I can see, you are acknowledging that the risk is there but are handwaving it away
No, I am not. I am recognizing the potential maximum cost of the risk *AND* factoring the *PROBABILITY* of it occuring. As earlier stated with broad example, if you have the probability of losing $1 one time in 100, and winning 50 cents 99 times out of a hundred, the question becomes "do you have the reserves to you afford the 1% cost to gain the 99% rewards?"

GRANTED... we aren't talking 50 cents and $1, nor 1/100 odds... but I'm sure you (and hopefully others) get the idea. If you have the ability to absorb the low probability hit, you are not putting your home at risk.

===================
ALL,

Somehow 2 separate strategies have been forceably comingled beyond my explanation in the 2nd post of this thread.

The Mortgage Freedom Account accumulation accceleration strategy *CAN* work for *EVERYBODY.* For some it will work faster than others, but *everyone* using it will acquire "a positive liquid net worth" (aka "mortgage cancellation") faster than otherwise.

The 5 yr ARM versus 30 FRM strategy is very much relative to the capacity of the user to cover the low probability risks of a capped high rate adjustment. It also very much requires a comfort level with the dirty/naked numbers apart and separate from emotional feelings. This definitely works, but its not for everyone.

Cheers,
Dave Donhoff
Leverage Planner

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120882 of 126962
Subject: Re: FRM vs ARM debate Date: 8/23/2011 12:56 AM
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I originally took $200k, and divided it by 7.5 years (90 months) to arrive at a monthly principal paydown of $2,222. Somehow AJ got the figure of $2,255. After plugging it into the amortization schedule, the actual number is $2,165. That's *LOWER* than both of our estimates. The reason the actual number is less than the full amount divided by the total months is that the additional principal payments are above the internal amortization burden.

I still have no idea how AJ got $2,255... but her 60 month remaining principal was close enough to mine (given that differing amortization calculators can be a smidgen apart) to be acceptable.


The $2255 was calculated when I still did not understand that you were calculating the savings separately from, and in addition to, the mortgage payment. It is the total amount of mortgage payments plus MFA savings contributions required to pay off the mortgage in month 90 if the interest rate were to remain at 2.75% for the entire 90 months, and the assumed rate on the MFA savings was 7%.

However, when a max increase is applied to the ARM in month 61 and the combined payment/MFA amount remains constant, the payoff time increases to 99 months. This compares to a 97 month payoff for the FRM using the same $2255 combined payment/MFA contribution and 7% MFA savings rate.

Actually, I think rates are going to remain "bottomed-out" as they did from around 1870 through 1960;

So are you explaining your reasoning to your clients who you are recommending 5/1 ARMs to, explaining the potential consequences of the 'low probability event' occurring, and qualifying your 5/1 ARM customers at the maximum potential payment?

Personally, I think that only the data after Bretton Woods (1944) is likely to be applicable to today's world - excluding most of your data.

I don't think its too hard to look at the CURRENT political preference to artificially DEPRESS interest rates, to see that its *extremely* unlikely that that leopard will change its spots in our lifetime.

Except for the fact that, as rayvt pointed out, we are likely to have a different administration in 18 months, and constitutionally required to have a different administration (although not necessarily a different party) in 5 1/2 years. Add that into the easiest way for the government to pay off the debt that has been accumulated is to inflate their way out of the debt, and I think that there is equally valid reasoning for higher rates, rather than continuing low rates.

The 5 yr ARM versus 30 FRM strategy is very much relative to the capacity of the user to cover the low probability risks of a capped high rate adjustment. It also very much requires a comfort level with the dirty/naked numbers apart and separate from emotional feelings. This definitely works, but its not for everyone.

IMO, customers being given the choice of 5/1 ARM vs. an FRM should be given both interest rate viewpoints, and allowed to make their own choice, PROVIDED that they actually qualify at the maximum payment amount that the 5/1 ARM could increase to. If someone does not qualify at the maximum potential payment for an ARM, I don't believe they should be offered the ARM.

AJ

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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120883 of 126962
Subject: Re: FRM vs ARM debate Date: 8/23/2011 1:16 AM
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Hi AJ,

So are you explaining your reasoning to your clients who you are recommending 5/1 ARMs to, explaining the potential consequences of the 'low probability event' occurring, and qualifying your 5/1 ARM customers at the maximum potential payment?

Of course! I'm a fiduciary when acting as an independent mortgage broker, I fully explain & document the variables as best I can, always. The choice of strategy is always up to the client, and I don't make a dime more either way. I want my clients to get the best long-term results possible. That's how & why I beat my competition.

Except for the fact that, as rayvt pointed out, we are likely to have a different administration in 18 months

Yeah... well, we had a "conservative" administration prior to our current Chief, and how'd that work out for economic responsibility?

I don't see anything changing unless "the people" reject both sides of the "big government" spectrum, and unless the Ron Paul afficionados pull a rabbit out of their hat, it ain't gonna happen this next round. If we get another 4 years of the established momentum, the current system could very possibly tip beyond the point of return into bloat-until-death.

If that happens, mortgages really won't matter. Homeownership becomes a matter of personal defense.

Cheers,
Dave Donhoff
Leverage Planner

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Author: xtn Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120884 of 126962
Subject: Re: FRM vs ARM debate Date: 8/23/2011 9:29 AM
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It's about probable real spending over the long term for me. Taking an ARM right now means I would probably spend less - overall - for the next ten years

It's that word "probably" that's the problem.

The thing I've learned about making decisions is to always ask yourself, "But what if I am wrong?"


Sure. But do you always decide to take the safe route even if the probability of being wrong is low? Even if you are wrong in this case it would be a long time* - as Dave reasonably points out - until the ARM might be considered a "high loss event."

xtn

*Assuming reasonably available contract terms regarding adjustments and caps.

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Author: xtn Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 120885 of 126962
Subject: Re: FRM vs ARM debate Date: 8/23/2011 9:30 AM
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So, in 5 years it's pretty much guaranteed that the Federal policies will change and the economy will go up.

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