Fixed vs Variable rate Mortgages

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Fixed vs Variable rate Mortgages

Saleh Saif
United Arab Emirates · Member since 2019 · 2 posts · 0 votes

Dear BiggerPockets community. Hope everyone is having a great journey in real estate so far.

I have been looking for an answer for this question for a long time now, so I thought: "There is no better place to find the best answer regarding real estate other than BiggerPockets, and I'd love to share the discussion with the community, so here we go.

Background:

I am a rookie real estate investor and I live out side the USA, so financing rules, regulations, and options are way different.

Financing rules and regulations:

I live in the UAE (United Arab Emirates). The government's regulations dictate that: "The minimum down payment for your first property under your name is 15%, the second property 35%, and the third or more 50%. This regulation has been in effect after the 2008 crisis, which hit the country (specially Dubai) very hard.

Financing Options:

After shopping around for financing, I was able to find two options:

  • 1. Fixed Rate Mortgage.
  • 2. Variable Rate Mortgage.

Fixed Rate Mortgage: A type of mortgage with a fixed interest rate on the whole tenure of the loan.

Variable Rate Mortgage: A type of mortgage with a changing interest rate, depending on the country's central bank interest rate.

Problem:

Of course, as every savvy investor will tell you: "Never take a variable rate interest mortgage", because in this case, you are killing one of the real estate wealth generators, Loan Pay down, which only works if the loan had a fixed interest rate.

Here is the issue I'm facing. The longest fixed rate mortgage I was able to find had a 7 years tenure, where the variable rate mortgage can take up to 25 years tenure. This makes the variable rate more attractive, since you will be cash flowing with easy monthly payments, but having a variable interest rate.

So here is the main question: 

Would you rather take a 25 years variable rate mortgage, or a 7 years fixed rate mortgage (assuming 3.25% interest rate, and 15% down payment for both options)?

Special thanks to the BiggerPockets community:

I wanted to take this opportunity to thank this amazing community for teaching me all about real estate from across the world, and opening freedom doors and excitement in my life. Thank you so much for changing my life to the better.

Cheers!

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Justin R.Pro Member
Rental Property Investor · San Anselmo · Member since 2015 · 659 posts · 600 votes
4y

I dont see the value in a 25 year maturity if the interest rate is variable and not capped. Is there a ceiling to your variable option?

Assuming the aforementioned 3.25 rate, the fixed 7 year sounds more stable.

Other things to look into are the loan costs, prepayment penalties, and ease of lending. 

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  • Justin R.Pro Member
    Rental Property Investor · San Anselmo · Member since 2015 · 659 posts · 600 votes
    4y

    I dont see the value in a 25 year maturity if the interest rate is variable and not capped. Is there a ceiling to your variable option?

    Assuming the aforementioned 3.25 rate, the fixed 7 year sounds more stable.

    Other things to look into are the loan costs, prepayment penalties, and ease of lending. 

    1Reply
  • Saleh Saif
    OP
    United Arab Emirates · Member since 2019 · 2 posts · 0 votes
    4y

    Thank you for the reply Justin.

    Here is a comparison for both options.

    Ease of financing:

    1. Both financing options have similar levels of difficulty to finance.

    Fees:

    • Variable interest, No fees.
    • Fixed interest, 0.5% of property purchase price upfront.

    Early settlement Fees:

    • Variable interest, 1% of remaining principal amount.
    • Fixed interest, No early settlement fee.

    Risks:

    • Variable interest, minimum cap 3.25% but no ceiling (which sounds very risky after reading your reply).
    • Fixed interest, big installments amount, thus negative cashflow in the beginning.

    Opportunities:

    • Variable interest, small installments amount.
    • Fixed interest, property free and clear after loan matures and cheaper interest rates.

    There were more options for a fixed rate loan tenures:

    1. 3 years tenure with 2.49% interest rate.
    2. 5 years tenure with 2.75% interest rate.
    3. 7 years tenure with 3.25% interest rate (mentioned above).

    The only obvious issue with the 3 and 5 years tenure is the bigger installments each month, but after the payment matures, the property is mine free and clear on a shorter time frame and cheaper interest rates.

    0Reply
  • Dave Skow
    Lender · Seattle, WA · Member since 2014 · 2k+ posts · 899 votes
    4y

    definitely a fixed rate  mortgage

    1Reply
  • Jason Merchey
    Investor · Hendersonville, NC · Member since 2013 · 755 posts · 281 votes
    3y

    Saleh,

    I guess we lost ya! Two posts and then you flew the coop, as we say in the U.S. :)

    Anyway, I know that one of the issues facing Praxis Capital now is that they favor variable rate mortgages on their massive loans (when they invest via syndications in apartment complexes). When rates were at 3.5% or whatever it seems good and responsible. Now, facing 6% loans, it can be a NOI killer. Those rate caps do some good for a while, but then when they expire the cost skyrockets.

    At least, this is my understanding.

    So bottom line is: in my opinion, you'd do better with fixed. If fixed loans are going for 5-8% in this inflationary environment, well it makes investing tougher. Another reason why investing with leverage can be fraught with difficulty. I personally favor being relatively debt-free, but I get that big syndications don't like to just invest with the money they raise, because there is no leverage (making it possible to offer investors those 10%-20% IRRs). I think leverage/loans takes REI from a game of hitting singles and doubles to trying to hit a home run, to use a metaphor.

    1Reply
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