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For a certain property my lender will only give an ARM (10 year fixed, 1 year adjustable afterwards), which is based off the U.S. Treasury rate. However I would really prefer a fixed rate mortgage.

Is there any way to hedge or short sell or buy some futures contract etc., such that I would lock in the current rate of the ARM (3%) for the whole 30 year duration of the loan? That is, if after 10 years the rate goes up, I will offset the increased mortgage payments with profits from the hedge. And if the rate goes down, I would offset the losses from the hedge with the reduced mortgage payments.

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    That's called "30 years fixed rate loan". – littleadv Jun 3 '16 at 4:00
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    Pay it off in <= 10 years. Even if you go 11, the principle will be small enough not to matter much. – Pete B. Jun 3 '16 at 11:54
  • Hypothetically interest rate swaps do what you want, but I doubt they are available/affordable to a personal investor. – d_dd Jun 4 '16 at 4:41
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Not really. What you want is essentially an option to take a 20 year 3% loan ten years from now for the balance of your loan. In theory such an instrument might exist, but in reality it doesn't, because if it did, whoever would sell it to you would also be willing to give you a 30 year fixed mortgage in the first place. Ten years is a long time -- be sure there's no prepayment penalty and you have a decade to shop around for a replacement fixed rate loan.

  • Well almost an option, since an option you can choose not to exercise (if the rates go down). I want something that I will be forced to exercise. – user9809 Jun 3 '16 at 7:25
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Spreadsheets are your friend.

You don't offer the dollar amount, so I'll offer $100,000 and you can scale it up to your numbers.

$100,000 at 3% requires a payment of $421.60.

Instead, pay $477.42, the payment that 4% would require. Now, 10 years hence, you owe $68,220, with 20 years left. Even at 6%, your payment will be $488.75, just a bit higher than you've been paying. Usually there's a cap, 5%, so if things really go to heck, your payment will max at $570.62 after fully adjusting. This is less than a 20% increase from the original payment you were making, and, while I refrain from prognosticating, it's fair to say, the same macroeconomic events that would put your rate up so high will all have inflation follow. The mortgage will feel no higher than the price of everything else that went up in your life.

10 years is a long time, there are many variations on this idea to implement. Another is to simply increase payments by the same percent as your annual raise. You'll continue to lower the balance and get ahead of any forced rise in payments. In general, this plan should finish the mortgage in 17-20 years depending on the level of raises and what rates actually do.

To answer your question - there's no simple way to buy such a hedge.

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One option, similar to what JoeTaxpayer suggests, would be to take some amount above your minimum payment and invest it in an investment - or investments - that are likely to do better in a higher interest rate environment. There are Interest Rate Hedge ETFs; there are ways to invest in the bond market (a "bond ladder" where you reinvest every so often a portion of your bond holdings in the new higher interest rate bonds); or investing in companies that will prosper in a higher interest rate environment, including banks, FOREX trading firms, etc.

Which is better (prepaying your mortgage, or investing) largely depends on whether you can get a higher return than 3%, and what your risk profile is. If you're normally risk-averse I would prepay the mortgage, but if you are less risk averse you could certainly invest the excess and hope to get a better return (then using the proceeds from that to pay off a chunk of the house when the returns become negative relative to the interest).

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    +1 - I considered this proposal, but opted for brevity. – JTP - Apologise to Monica Jun 3 '16 at 18:12
  • Ironic, perhaps, that you with the longer name are typically inclined to brevity while I with the shorter version am not :) – Joe Jun 3 '16 at 18:22
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Try another lender. Or accept that a variable rate loan is a trade-off, giving you a lower rate now for more risk later. Or both.

Realistically, rates are fairly obscenely low right now. I would strongly suggest locking in the best fixed-rate you can get and calling it good.

  • I would, but this is a type of property (a co-op with a majority of units owned by one person - the sponsor) that lenders will only lend ARM for. – user9809 Jun 3 '16 at 7:23
  • I take it you aren't in the US, then. If that's really the situation -- if you have tried several other banks rather than taking someone's word for it -- I have nothing to offer. – keshlam Jun 3 '16 at 9:09

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