Key Points:

• ARMs are becoming attractive again with expected rate declines, offering lower initial payments.
• Ideal for early homebuyers, but plan for possible rate increases after the initial period.
• Consider future income and potential refinancing; we’ll revisit in January after possible Fed cuts.
• Most Americans largest investment is their homes, but even a small investment in The Next Nvidia could grow to be worth substantially more.

Lee and Doug discuss the potential benefits of adjustable rate mortgages in the current and future interest rate environment, especially as interest rates are expected to decline over the next few years. They reflect on how ARMs got a bad reputation during the financial crisis due to poorly structured loans that caused many borrowers to default when their rates reset to much higher levels. However, they suggest that in today’s context, with interest rates likely to decrease, ARMs could be a smart choice for new homebuyers or those early in their home-buying journey. They emphasize the importance of planning for the future when rates reset and ensuring that one’s income will increase sufficiently to cover higher payments if necessary. They plan to revisit this topic after a couple of Fed rate cuts to assess the market and provide insights on whether ARMs are a good option at that time.

Transcript:

Face it, we know that rates will be going lower.

We know that.

And so whether you do it now or you do it a year from now, it’s going to make sense.

Adjusted rate mortgages got such a bad name during the financial crisis.

It’s like, I mean, reminding people of the story.

You had people, mostly subprime borrowers, who came in, they got a  teaser loan for the first quarter, sometimes three years.

So let’s say the teaser was at 2%.

All of a sudden, they wake up one day and the next month it resets at eight and a half.

All of a sudden, these people who, you know, could afford their mortgage, maybe it was $600.

Suddenly their mortgage payment is like $1,600.

Huge numbers of people, hundreds of thousands of people get hit with this over a period of about 18 months.

And there were some other causes for the financial crisis, but this is certainly near the top of the list.

Default rates went through the roof.

And, you know, you rarely see banks leading with adjustable rate mortgages because they don’t want to look like they’re fools.

You know, it’s not necessarily a good way to win friends and influences people.

But we’re now getting to the point where we’re seeing interest rates drop.

What do you think about this?

Well, I think right now it’s a really good idea.

And you’re right. The 07, 06, 08, I mean, we were this close to the abyss.

We were that close.

And you got to remember, at the last moment, Merrill Lynch had to go in and buy Bank of America or they would have gone out of business.

I mean, it was really bad.

I was working at a major Wall Street bank at that time.

And the one I had worked at prior to that was Lehman Brothers and they went to zero.

And yeah, it was really, really bad.

And it wasn’t just those teaser mortgages, but it was they weren’t vetting anybody.

Anybody could buy a home.

You know, the mortgage brokers were just they were just ignoring everything that’s so closely monitored now, which is good.

I mean, sometimes it takes the brink of disaster to get the regulators or the regulations back in the spot they should be.

But now after two years of interest rate increases and a year of waiting where interest rates were held at the current level and Fed funds is five and a quarter to five and a half, you know, so it’s a blended rate of about 5.30.

Now, I mean, the futures market’s pricing in for sure a 25 basis point decline in September and some are putting more in the rest of this year.

Some are even saying there’s a 50 basis point drop coming.

But the one thing we do know for sure is for the next two or three years, rates are going to be going down.

Yeah, so let’s look at this from the standpoint of somebody who’s about to buy a house.

If you’re real, real, real lucky, you might find, what, a 6-7 on a 30-year fix?

Six and three-quarter, yeah.

It’s come in a little bit, though.

A little bit.

So if we go shopping now for an adjustable rate mortgage, we can probably do pretty good for the first five years in terms of the interest rate.

Oh yeah.

And if we’re going to look at this through your eyes, which I think is a good idea, you’re gambling that interest rates five years out are going to be pretty good.

They’re not going to be insane.

So maybe the thing adjusts up to, at that point, seven or eight.

You’ve still had the advantage of three to five years of a much, much lower payment.

Yeah, exactly.

And that’s the key.

And, you know, who knows? They’ll probably lower rates all through 25.

Maybe all through 26.

Now, they’re not going to push them back to zero.

But, you know, they could take them back to a more normal sort of three for Fed funds, three and a quarter.

And that’s, you know, that’s a full two percentage points lower than they are now.

And, you know, that would be a significant savings for especially if you’re a younger person trying to buy your first home or trying to do your first step-up home.

Maybe it’s a good route for them to take as well.

I like the route for people who are early in the home-buying cycle of their lives.

Yeah.

I think particularly if you know your income is going to be pretty good the years it resets, you know, what I would do is I’d say, okay, look, this is going to cost me a thousand dollars a month during the first five years.

What can I live with after that?

In other words, if I were planning my own finances and somebody said, well, it’s going to go to $1,750, you’ve got to be pretty certain that your income is going to rise at a nice clip over the next five, six, seven years.

So if you ask me to do this on a first, second home, that’s how I would look at it when I plan my finances, not how nice is it to have now.

Obviously is great, but also let’s guess as somebody who’s buying this home, what can I chew when the reset happens?

Because what I don’t want to do is find out, wow, this was a great deal and then take a real beating once the thing resets.

Yeah, right. That’s not a solid point.

And so in what would be a kind of reasonable scenario, let’s say, and most, most arms are 15 years.

You can get them shorter.

There’s 15-year arms and there’s seven-year arms.

But one would think, let’s say they do lower rates for the next two years.

They’re probably not going to immediately move them back higher because we know the damage that’s been done to the economy already because of high rates.

The good thing, let’s say that your rate declined for two or three years and then remained the same for, say, three to four years.

Okay, so you’re out six or seven years.

Well, if you think rates are going to start to move back higher, you can go in and refi that arm to a 30-year fixed.

Right.

You are so clever.

Well, look, here’s what we’re going to do.

Let’s see what the next two cuts are.

Let’s look up what we can get an arm for when that happens.

So maybe it’ll be in jail.

I’ll find that out.

I’ll check it out.

I’ll check banks and I’ll check mortgage companies.

And I think what we’ll do for people that day is we’ll say, okay, two Fed cuts.

We looked it up online.

This is where you can get it.

The way I would look at it if I were buying a house with an arm is, and then we tell people, this is how we’d look at it.

We’re not going to tell people to take it or not, but looking at it through the lens of somebody in our cases who was very old and owned a number of homes.

Here’s what we think of the thing.

So let’s come back.

Let’s come back to it, say January.

Okay.

Sounds good.

Let’s look at it then.

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