I'm not very knowledgeable about FI products/mortgages and was hoping someone with more experience could verify my thinking here. What I want to do is compare a current day fixed versus ARM mortgage. For a fair comparison I want to keep <b> fixed payments on <u>both </u> loans the same </B> and see which one is paid off quicker, essentially finding the one that you end up paying less interest on. For the fixed rate, it is simple, just do the calculations and sum up the total interest paid each month...done. But for ARM, I have made the following assumptions: - Most ARM rates are prime rate plus some "margin" - Prime rate is very correlated to libor - Using eurodollar futures the expected future (expectations hypothesis) of libor rates can be extracted - Using these predicted expected rates figure out the interest paid each month for the ARM I'm expecting both fixed and ARM total interest paid to be close to each other, but that's what I want to investigate. Any flaws in my thinking/assumptions here? I'm doing this basically for myself and then I'll probably post up the results on my blog.

yeah...you forget to factor in time. Alot of things can happen in 5 to 7 years. If hyperinflation takes hold, that arm could go to 20%. You have an unknown variable in your equation. When dealing with hundres of thousands of dollars, you really need to know that something is not going to change over the course of time. If you were lucky and the ARM was cheaper, was it really worth taking the risk to saving a few thousand dollars over 30 years where as if ARMs interest goes through the roof, you could end up paying 100k more over 30 years or so (if you dont forclose.) I think not. Fixed is always the safest bet.

Sure but how long does one plan to stay there, time as you mentioned. Does one have kids going to school, could a person be downsizing in 7 years due to age, etc. These are questions which need to be considered.

You are a product of the banking industry and screaming exactly what they want you too. First they ask how much can you afford each month and then they sell you a fixed rate for 30 years. However when you look at the amoritazation tables you discover you are paying off the interest for the first 15 years and principal in the last 15 years. Most banks are borrowing money at .25% AND THEN THEY SELL YOU A LOAN FOR 5% OR MORE FOR A FIXED. The best deal on the market is the month variable rate based on libor. You interest payment will be half of the fixed rate and you can use the difference to pay off the principal. The beautiful part of the loan is that the monthly payment is calculated each month on the principal balance so if you are paying off the principal your monthly payment could actually go down. Variables also have caps and make sense if you plan to sell your current home in 5-7 years, if the property is an investment property earning rents, or if you have the cash or investments in kind to pay off the loan in case rates go crazy. But remember, the spread between variables and fixed rates are close to 3%. That in itself gives you plenty of time to redirect payments towards principal versus interest. Bottom line, with fixed rates you pay interest now principal later versus with variables, you pay prinipal now interest later. Variables tend to attract a much more savvy investor type than fixed rates do.

Uhm not quite.....ARMs have a lifetime cap of 5%. So if you get a 5/1 ARM at around 4.5% the most it can ever get up to is 9.5% regardless of the index. I believe pay option arms are the only ARM mortgages that don't have a 5% over initial interest rate and those are difficult to find nowadays anyway. Have 2 ARM mortgages on 2 properties and could not be happier, so basically not all arms are created equally.

dude you don't know what you're talking about. 3/1, 5/1, and 7/1 ARMs have a lifetime cap on the interest rate plus annual caps. mine is 9% lifetime with annual caps of 2%. personally i WANT interest rates to go sky high, so i'd earn 15% on a CD while paying 9% on my mortgage. right now my ARM is only 3%. i've saved thousands in interest with this ARM over a 30 year fixed.

Our ARM cannot go up more than it goes down+ capped at max 1%/ yearly. Good customers get a rate of around 2,5% (This is in europe)

Too many individual circumstances to argue this affectively. Arguments for fixed versus variable depend on how long you plan to stay in your house. Is he propert a rental property or a residence. Are you disciplined enough to pay down principal with the interest rate savings. Does the variable morgge have a provision to set a fixed rate at time when the benchmark begins to rise. Does the mortgage holder want to actively manage their interest rate and pay attention to current rates etc. The fact is that variable rates are lower and thus saves money. The risk of course is that rates can rise and without proper analysis of proper what if scenarious a variable may or may not make sense. Enough said right?