I’m having trouble understanding the best mortgage for my wife and I. We are expecting our first child in July. Any help would be appreciated. A bit about us:
We both work full time in tech and together make around $400,000 before taxes. Our monthly take-home pay is around $19,000. We live in a one-bedroom apartment in San Francisco, paying $4,200 a month. We have no debt or other major expenses besides basics like cell phone, internet, and car insurance. We’ve paid off all large purchases, including our car, and both have credit scores over 800. Our savings exceed $1 million.
We plan on putting $1.2M to $1.3M down after liquidating some assets, leaving us with about $100,000 in disposable cash for furnishings, baby items, etc. We plan on taking out a loan for around $700k-$800k, with a target home price of $2M.
Here’s where I’m stuck. Everyone I’ve spoken with has given us different advice about the type of mortgage to choose. We’d like to keep our monthly payment under $5,500, including property taxes. This would be about 29% of our monthly salary. Also, this will be a starter home, not our forever house, so we expect to stay for around 5-10 years before moving to a bigger place for the kids. Property taxes in San Francisco and the Bay Area are really high, about $20-25k a year.
We’ve been told by Wells Fargo to look at a 30-year fixed mortgage, but our financial advisor suggested a 7/1 interest-only ARM or a 10/1 interest-only ARM. I’m feeling overwhelmed and would love some help figuring out which is the best option. Any advice is appreciated. Feel free to ask any additional questions!
You won’t be able to have a $5-$5.5k monthly PITI payment on a $2M home. SF property tax is 1.17%, which would be around $2k/month on a $2M home. A 7/1 or 10/1 ARM can help lower the interest, not sure why Wells Fargo recommended a 30-year fixed. You could also buy down points to lower the interest rate, depending on how long you plan to stay in the home.
@Quincy
I see you have three different options for a 30-year fixed mortgage. Buying points means you’re prepaying interest on the mortgage, which lowers your APR. Essentially, you’re paying more upfront for a lower rate over the life of the loan. There’s a breakeven point where the lower APR saves you more money, but if you sell or refinance before that point, you’ll lose money. As for ARMs, they generally have a lower APR because the loan term is shorter, and the assumption is that interest rates will drop or remain stable when the ARM expires, so you could refinance to a lower rate.
Uma said:
You should go with the ARM only if its initial APR is lower than the APR of the 30-year fixed mortgage.
Yeah, Wells Fargo isn’t the best option. You should look for a financial advisor who is a fiduciary. The previous comment is spot on. An ARM can save you anywhere from 0.75% to 1.25%. I’d recommend a 10/1 ARM for more stability, though a 7/1 ARM might have a slightly lower rate. Choose one with a cap of 1% per year and a cap of 4% or 5%. You’ll likely refinance or sell before the loan term ends anyway, unless rates go up significantly, in which case, you’ll just ride those small increases to the cap or current rate.
@Harlan
Thanks for the advice. Is there a difference between a 10/6-Month ARM Jumbo Interest Only and a 10/6-Month ARM Jumbo? Which one would you recommend?
The 10/6-Month ARM Jumbo has a 6.5% interest rate and 6.77% APR.
The 7/6-Month ARM Jumbo has a 6.25% interest rate and 6.731% APR.
The 10/6-Month ARM Jumbo Interest Only has a 6.625% interest rate and 6.859% APR.
The 7/6-Month ARM Jumbo Interest Only has a 6.375% interest rate and 6.81% APR.
The interest-only ARMs might not save you enough, considering you won’t be paying down any principal. If you stay in the house for 10 years without paying any principal, you might regret it. We had a 7/1 ARM that included principal and interest, and after 8 years, we were surprised with a huge drop in payment. Keep shopping around and check with credit unions. You’re great borrowers and might get better deals elsewhere.
Basically, it depends on how much risk you’re comfortable with. Your ARM could go up or down. I’ve been lucky a few times with ARMs, but who knows what the future holds? A fixed loan gives you peace of mind, and if rates drop, you can refinance, though it will cost you.
Did you ask your financial advisor why they recommend interest-only? The thing with interest-only loans is that you’ll pay a higher rate and more interest upfront. The amortized mortgage would have you paying down about $70K in principal over 7 years. If you don’t mind paying more interest upfront for the smaller monthly payments, it might be worth considering. But make sure you fully understand the reasoning behind it.
Realistically, you can probably afford more than $5,500/month. With your high income, the usual percentage rules don’t apply as strictly. Even with daycare at $3k, you’d still have $12k leftover. If you want to lower your monthly payments, consider looking at townhouses in the $1.5M range or a cheaper house farther out and commute. Alternatively, look for a 2-3 bedroom rental in a more affordable area and commute.
You’ve done a lot of things right already, like saving and managing your credit. A 30-year fixed mortgage is a solid choice, unless the difference between that and an ARM is significant (like 0.5% or more). These days, the difference isn’t usually huge. A fixed mortgage will give you stability, which might be important with a baby on the way. Let me know if I can help further. Thanks, Matt!
There’s no one-size-fits-all answer; it depends on your risk tolerance. With your income, you likely have an investment strategy, so an interest-only loan lets you invest the extra cash elsewhere. Right now, rates are high, so a 30-year fixed is very front-loaded with interest. ARMs tend to offer better rates, and I’d choose a 7/1 ARM if the rate is 0.375% lower than a 30-year fixed. But if you want more certainty, a 30-year fixed will lock in your payment. If you plan to stay long-term, a 30-year fixed might be your best bet. Otherwise, an I/O ARM gives you more flexibility.