This will work only if your friend plans to stay in that condo until prices go back up to today’s levels, i.e. 12 years. If they’re a young couple, perhaps a baby will come along in 3 years, and they’ll want to sell and get a house with a yard. They’ll be upside down on the mortgage. They’ll sell for $200K, and owe the bank $400K. Then they’ll get the $350K house w/ yard, and get the mortgage on that. Now they owe $550K in mortgages.
Even if they stay for 12 years, there is still the interest rate risk. I look at it this way: I am 100% certain that housing will crash, and I’m 80% certain that it will crash by 50% over the next 4 – 6 years. However, I have no idea what the Fed will do with interest rates in 2010, and neither do they.
If housing falls by 50%, interest rates must increase by 50% from today’s levels to break even on the payments, so they must go from 6% to 9% as you said.
If they go higher, your friend wins. As long as they can afford the payments when they are fully adjusted, your friends might be okay with that strategy.
Anyone financing with an ARM has a high likelihood of edning up on foreclosure.com.
Each month they delay their desire for homeownership (delayed gratification, as I teach my kids constantly when they want something), the cost of the condo will go down by $5 – $25K. By fall, that condo might be only $325K, and we know interest rates are not going over 5% by fall.
In closing, they must meet 3 criteria to win this game. If they have a fixed rate mortgage they can afford for at least 12 years (or an ARM where they can make the full payment after it adjusts) and they are guaranteed secure jobs/living situations so they can ride out the bubble, and interest rates go up over 9%, they win.
Best of luck to your friends, and congrats on a well-thought out strategy. It’s a gamble, but it might work for them. I’d advise them to wait. (NOT INVESTMENT ADVICE)
