Sabrina and I are buying a new house next month. We went to me with our lender today and decided on a 5 year ARM interest only loan. This goes against what I have heard is a good idea, but I am pretty sure in this scenerio it is a smart thing to do. I thought I would post my reasoning here for anyone who may be interested. If you have reasons why this is a bad idea please feel free to post them below.
So here is our situation. We are going to be putting 20% down and paying closing costs in cash. We can afford the higher payment of a traditional 30 year fixed rate loan, but we cannot afford the monthly payment of a 15 year loan. what I consider to be the most important part of the equation is that the neighborhood we are moving into has been experiencing high property value growth (~ 20%/yr). Also, we are planning to move within a few years. The combination of putting 20% down and the high growth rate are what I consider to be my risk mitigation factors.
Risk? What risk?
If the market value of this property declines in the next few years we could loose money if we need to sell the house for any reason. Since we will not be paying any principal we will owe the same amount when we go to sell the house. If the value of the property declines we could end up upside down in the loan, except that we are putting 20% down.
Essentially we are only paying rent on this house. However, our gamble (business plan) is that the value of the property will continue to grow at a somewhat similar rate for another year or two. This house will be a liability for a few years, but it does have the opportunity to yield a pretty great return. As long as the house appreciates at a rate that is higher than our interest rate (which is below 6%), than when we sell the house in a few years we will have lived there for free and will still make money. To me this means I can count this purchase as an investment instead of as a liability. We will have some equity thanks to our down payment and the growth rate.
This idea of using an interest only ARM at a time of shockingly low interest rates goes against the better judgement of my father. My father has an MBA and a really good understanding of how money works. I think that I am properly mitigating my risk and maintaining an acceptable amount of risk for my age, but that will only be known when we sell the house. I do have two rules of thumb that I think validate my position.
(1) You make money when you buy, not when you sell. We are buying in a high growth for a price that is very favorable based on comparable properties in the neighborhood.
(2) A penny saved is a penny earned. If I went with a more traditional mortgage I would have both a higher interest rate as well as more of my cash flow tied up in the investment as opposed to using the same amount of money for home improvements and other investments which can produce a higher yield than paying principal in advance.
Any thoughts?
One Comment
[...] I just read a post by Chris Welch titled Misconception: Renting is for Suckers. My take on it is that when buying a house you are not making an investment as much as you are committing to a liability. They talk about PITI costs (Principle, Interest, Taxes and Insurance). This of course reminds me of my current situation which I wrote about in Why I Chose an ARM Mortgage. Here is some of what I said then: Essentially we are only paying rent on this house. However, our gamble (business plan) is that the value of the property will continue to grow at a somewhat similar rate for another year or two. This house will be a liability for a few years, but it does have the opportunity to yield a pretty great return. As long as the house appreciates at a rate that is higher than our interest rate (which is below 6%), than when we sell the house in a few years we will have lived there for free and will still make money. To me this means I can count this purchase as an investment instead of as a liability. We will have some equity thanks to our down payment and the growth rate. [...]