A Jumbo loan (any loan amount exceeding $625,500) is common in our high-cost area. Jumbo loans are considered more risky to lenders, so their interest rates are higher and guideline requirements stricter. You have choices in Jumbo loan programs – your decision can be based on your financial risk comfort level and your goals for the house (how long you intend to own it).
Generally, you have multiple Adjustable Rate Arm (ARM) loans to choose between (3/1, 5/1, 7/1 and 10/1 ARMS) and Fixed Rate Mortgage programs (15 and 30 Year Fixed). Many of my Jumbo loan clients typically choose the 7/1 or the 30 Year Fixed, but what I would like to highlight in this blog post is the difference in spread between electing for a 30 Year Fixed interest rate and a 10/1 ARM, since the 10/1 is the most conservative of the ARMs.
A 10/1 is an interest rate that is fixed for the first 10 years of the loan, and then adjustable the remaining 20 years. After the 10th year, the rate is subject to adjustment annually (that’s what the “1” is for in the program name). The adjusted rate will be based on a fixed margin (usually 2.5%) plus an Index (usually the 1-year LIBOR). The Index is what we have no idea about in the future. The payment will be based on that calculation, and then amortized over the remaining life of the loan.
Assuming a $1MM loan amount, 25% down payment and FICO score greater than 760, current interest rates (as of time of writing) are:
- 30 Year Fixed: 4.875% with no points (APR 4.91%). Monthly mortgage payment = $5292.08
- 10/1 ARM: 4.0% with no points and a Lender Credit of -.25% to be applied towards closing costs (APR 4.012%). Monthly mortgage payment = $5292.08. Monthly mortgage payment = $4774.15
Over the ten-year period, if you select the 10/1 ARM, you can look at the savings both from a monthly payment perspective as well as principal reduction.
Combined savings is as follows:
- Difference in payments: $62,151.60
- Difference in reduction: $22,647.42
Total savings in ten years = $84,799
At this point, in ten years’ time, you can take this total savings and further reduce your principal, or invest it. It will take discipline, but using this ARM as a financial investment tool can benefit you significantly. However, if you have risk concerns about an ARM OR confidence that you will own this home and keep the loan for greater than ten years, sometimes that peace of mind in selecting a conservative 30 Year Fixed loan surpasses financial savings.
