3 or 5 year Balloon in todays market?

Question

I'm wondering what investors are doing right now regarding interest rate terms. Example;  3 year is a bit less than 5 year. I'm wondering the risk/reward of locking in the lower rate for 3 years vs. 5 year if the difference is .175. The tempting thought is take the cheaper one and bank in 3 years rates have come down and i can refi. The other though I've had is, its small enough difference, I should go 5 and can always refi before the term if rates have dropped enough to justify. Wanted to bounce that off this crew. Thanks in advance for the thoughts!

Carlos Ptriawan · Answer

LOL.Huge difference between 3 / 5 year ARM and baloon.I would not worry too much about ARM because it's not baloon and you can always refi BUT.Considering appreciation rate is 4% (conservative), if 6% interest rate is until 2024, and LTV is moving 5-6% per-year, so it's always best to lock with the longer ARM, in this regard 5 years.For me I always purchase 10 years. Reason is simple. My LTV would be 40% in 10th year and home price at least would appreciate by 75%. So I may sell the house.

Eliott Elias · Answer

Balloons are for clowns. Avoid them.

Chris Aranda · Answer

*Messed that up, meant 3 & 5 year arms. Not ‘balloon’. Thanks for the call outs and the advice! @Dave Skow @Eliott Elias

Carlos Ptriawan · Answer

I got 10 year arm for 5 % and it's movable arm lol, check credit union .....

Caroline Gerardo · Answer

5 or ask for 7

Chris Aranda · Answer

@Eliott Elias - spot on. I messed that up. Meant 3 & 5 yr arms.

Henry Clark · Answer

We do commercial thus normal is 5 year balloon.  We are on 7 now after consolidating loans and refinancing.

All about risk management.  For us after 7 years, we don't care what the interest rate or economy looks like, our equity position will be about 70% and fine.  As you mentioned can always refinance if rates drop.

We do Self storage which is mainly composed of what is your occupancy and then what is your financing.  Very little maintenance or management costs.  If we can take Risk (interest rates changes) off the table we will "buy" down and lock in on that.

If your reading other posts, MFH syndications if shortterm or maturing are getting hammered, if they didn't build into their business model.  So case specific. Also, the spread in interest rates as you mentioned.  At .175 you go with the 5 years, no matter what scenario you're in.

What are your specific deals and debt/interest positions?

Dave Skow · Answer

@Chris Aranda- thanks   1) most home loans are not  " balloons "  ....if you are  talking about  3, 5 yr arms - these programs  will  allow the rate / paymnet  to be adjusted  after the  intial fixed rate period  and  most arms  adjsut  every yr    2)  for less than .25% - the  5 yr  option is  worth  the extra  2 yrs  ...you might also  consider looking at the  7 and 10 yr options  3) if you think you  will  refinance in 3 yrs or less -  you might  focus on using a rate option that has a  low loan fee  option so you dont waster monewy in fees you wont  get  use out of   4) good luck

Cory J Thornton · Answer

@Chris Aranda -

I do have a few thoughts. Take all of them at face value since we are all doing deal with very different goals, very different risk tolerances, and in different environments. That said, hopeful something will at least serve as brain storming fodder.

I love that way Thomas Sowell talks about these kinds of things, "everything has a trade off." The goal is to know the "trade off" of each decision, and be ready to live with/absorb the downside of whatever path we as investors choose. As decision makers, we are trying to assign a probability to a potential outcome and then place our bets accordingly. If I was making this decision I would want to get a good sense around the following factors ...

- What will happen with inflation in the next three years?

- What will happen with employment rates in the next three years?

- What are the courses of action the Fed will consider to adjust for the answers to the first two questions?

- What is the probability of an Executive Office roster change, and what could the potential effect be on monetary policy.

I see all of these things as being key in trying to predict what happens to rates. For me, I have a few guesses but I don't have what I think is a high probability answer to any of these questions. For me, the unknowns would cause me to seek a way to stabilize by locking in a known rate for a longer period of time.

It is also worth saying that if a deal is so tight that a .175 difference in the rate is meaningful, then that in and of itself may be cause for concern. If the deal is a cash cow where .175 isn't a factor, then that may also give you some safety in taking the lower rate, knowing you can easily absorb a higher rate on the back end if in three years rates are up and not down.

If you are dealing with a smaller local bank, then it may be worth asking them what their process is for changing a rate. Some small banks don't require a new loan closing and will shuffle paper, renew debt mid stream, and lock in a new rate for the cost of some administrative fees. Knowing how your bank would handle a request to reduce the rate, if rates go down, may help you make a decision.

Best of luck on your learning and investing journey. I think this is a great topic of discussion and I am looking forward to seeing what other thoughts this community has.

3 or 5 year Balloon in todays market?

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