Are you torn between choosing a 30-year fixed rate mortgage loan and an adjustable rate mortgage (ARM)? I’d argue that the 30-year fixed mortgage loan isn’t the best choice and could end up costing you more. For most homeowners, a 7/1 ARM or 10/1 ARM is a smarter choice, as it could save you a significant amount on mortgage interest expense.
I’ve taken out various types of mortgages since 2003, and I’ve found that an adjustable rate mortgage is generally cheaper and saves more money in the long run. We’ve been in a period of declining interest rates since the 1980s, so paying more for a 30-year fixed mortgage loan isn’t necessary.
Banks are big fans of 30-year fixed mortgage loans. Why? Because they earn more from larger, longer-term loans as they can charge a higher mortgage interest rate. Banks often play on the fear of the unknown, selling borrowers the peace of mind that comes with knowing your mortgage rate won’t increase over a 30-year period. But there’s something else banks don’t want borrowers to know.
Interest rates have been decreasing since the late 1980s. This is due to the Federal Reserve becoming more efficient at managing economic cycles and the US becoming the global standard for sovereign assets through the purchase of US treasury bonds.
By understanding what the latest 10-year treasury means, you can save a lot of money, potentially make a lot of money, and stop worrying about the future. Borrowing long-term is not the best use of funds. Those who push you towards 30-year fixed loans are either not economics majors or bond traders, or they have a vested interest in you borrowing for as long as possible so they can make as much money off you as possible. The higher the rate, the easier it is for them to earn a wider spread, which means more profits.
Here’s why I think a 30-year fixed mortgage loan is a waste of money and why I recommend most homeowners get a 7/1 or 10/1 adjustable-rate mortgage instead:
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Upward sloping yield curve: Due to the time value of money and inflation, the longer you borrow, the higher your interest rate. If you borrow at a 30-year fixed rate, you are borrowing at the most expensive part of the yield curve.
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Average homeownership duration is much shorter than 30 years: The average duration one lives in and owns a home is about 12 years. So why would you borrow a 30-year fixed rate mortgage for? It’s more logical to match your mortgage fixed rate with your expected duration of stay.
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Adjustable rate loans have an interest rate cap: Contrary to what the media and mortgage officers might have you believe, your mortgage rate won’t skyrocket and become unaffordable once the adjustable rate loan period is over.
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If rates rocket higher, you will be OK because your house is likely appreciating: The 10-year yield is a reflection of inflation expectations. If the 10-year yield and mortgage rates are rising, that means inflation expectations for higher growth are also rising.
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Interest rates have been coming down for 40 years: Rates have gone down for 40 years in a row. Yes, there will be occasional inflation spikes mainly due to supply shocks, but the long-term trend is down-to-flat.
Insurance salesmen and mortgage officers are very skilled at evoking fear. They’ll paint worst-case scenarios of super inflation and crushing payments so you can pay more money now than you should. A 30-year fixed provides a great peace of mind that your payments will never go up. But at what price is this worth?
An adjustable rate mortgage is the best type of mortgage to get for most people. Why pay more mortgage expense than you have to?
Please note there is a BIG difference between a negative amortization loan and an adjustable rate mortgage. A Neg Am loan causes your principal to grow larger every month because it is by definition, negatively amortizing. People who have normal ARMs have not been getting in trouble. When their ARM floats, their rates are LOWER than when they first locked!
If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest and oldest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments. You can invest beyond just where you live for the best returns possible.
Another private real estate platform to consider is CrowdStreet. Crowdstreet is a marketplace that mainly sources individual commercial real estate deals from various sponsors around the country. This way, you have more customization to build your own select private real estate portfolio.
Make sure you diversify your portfolio and do your due diligence on all the sponsors. Look up their track record, their management, and whether they have had any blowups before. Although CrowdStreet screens the deals, you have to do your screening as well.
Both platforms are sponsors of Financial Samurai and Financial Samurai is a six-figure investor in Fundrise funds. Our views about real estate are aligned and Fundrise is my favorite platform.
Financial Samurai was founded in 2009 and is one of the most trusted personal finance sites in the world with over 1 million pageviews a month. Sam has taken out both a 30-year fixed and an ARM over his 22 years investing in real estate.
