Why I chose 10/1 ARM instead of a 30 year fixed mortgage and you should too if you live in a very high cost of living area.

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In September 2019, interest rates hit the lowest level since 2016, yet I chose to by a home in San Francisco on a 10/1 ARM jumbo loan. Why would it make sense to chose ARM instead of a 30 year fixed at such low interest rates? Let me explain:

Interest rates were 24% lower

Thanks to a relationship discount, I was able to get mortgage rate of 2.375% on a 10/1 ARM vs 3.125% on a 30 year fixed at Wells Fargo. My very modest 2000 sqft 4 bedroom home (2 kids + office) in San Francisco costs over $2m, so this translates to over $1000 per months in interest savings. Looking at it another way, if I stay in this home for exactly 10 years, I would save $120k, and if I invested this money into one of my favorite crowdfunding platforms, EquityMultiple at 8% preferred return or higher, that's over $200k I'm throwing away to interest!

Suppose I do stay in the home for over 10 years and interest rates rise to 6%, and suppose I end up staying for 18 years which allows my children to grow up and move out to college. I would have paid off 28% of the loan in 10 years, if I paid 6% for another 8 years, it would only be around $250k worse than paying the fixed 3.125% interest, but by then, the $200k I saved would have also continued to compound to nearly $400k!

At 6% or higher mortgage interest, it starts to make sense to put money into the mortgage to get the guaranteed 6%+ rate of return, so as someone who lives below their means and have other investments, I would consider allocating more money into the mortgage to pay it off sooner.

Home owners stay for an average of 8 to 13 years

If you live in a high cost of living area and planning to retire early, chances are you'll want to move somewhere that priorities lifestyle over commute, and there's a good chance those two places are not the same. My home is large enough so that I could stay longer than 10 years if life got in the way, but if I retire early as planned or even with a few years of delay, I won't want to live here much longer than 10 years.

We might be in a low interest rate environment for a long time

Japan has had negative interest rates for a long time. Sure our interest rate is historically low for the United States, but look at other developed countries like Japan. They've had low interest rates (<2% since the 90s).

To the surprise of the fed, these low interest rates have not caused inflation to rise and I'm willing to bet with Europe, Japan and other parts of the developed world having such low interest rates without increase in inflation, interest rates won't be significantly higher in the U.S. for a long time without structual changes in how these economies function.

Less interest is deductable under Trump's 2018 tax plan

If you live in a very high cost of living(VHCOL) area like San Francisco, a significant portion of your mortgage interest will not be tax deductable. Especially after the 2018 Trump tax plan which reduced the Federal mortgage interest deduction limit from $1m to $750k. Our friends in lower cost of living areas not only enjoy cheaper housing, but also lower effective interest rates due to tax deductions! Those of us living in VHCOL have to pay the full mortgage with after tax dollars, which is 40-50% more expensive for those of us paying the 10%+ California income tax!

Many countries don't even offer fixed rate mortgages

You might think fixed rate mortgages are common, but they are not outside the US! Most mortgages are variable rate in Austrlaia for example. That's not an excuse to go variable rate of course, fixed rate has its advantages to the lender, but the bank is taking a risk on lending you a fixed rate mortgage, and the risk premium comes in the form of a higher interest rate.


Each of the reasons for ARM vs fixed rate mortgage alone isn't enough for turning down such a low fixed rate mortgage but given our financial goals and having been financially responsible enough to mitigate higher interest rates down the road with higher mortgage payments, the ARM is certainly worth it for us.

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