ARM vs FRM

[Eric Jacobson]

Can someone please describe to me the thought process they go through when deciding on whether to finance a property through fixed or adjustable rate mortgages? More specifically, I'm talking about residential single-family investments. Now my understanding is that ARMs typically offer lower rates to the borrower because much of the interest rate risk is transferred from the lender to the borrower. This spread between the ARM and FRM rate also will depend on variables such as the index, the margin, adjustment frequency, and any interest rate or payment caps. It seems to me like if I'm going to have a short holding period (1-3 years) that I would want to take advantage of the ARM, especially if there is a good teaser rate, because the interest rate risk will not be high enough for this short time to justify me paying more for the FRM and a stable payment. Now, I don't have any investing experience (yet) but I'm looking to start soon after graduating so I was hoping for any real-life insights on this topic. Especially now where rates are so low and the fed looks to stop its program of buying mortgage backed securities in March, the fear of rising interest rates has hit us all. I was wondering how this might also affect the decision of ARM vs FRM. Thanks!

[Account Closed]

Hi Eric...
One thing I know from doing real estate financing for a longtime is that no one product fits everyone. Their is no "perfect mortgage" if their was we would only have one product.

Everyone's situation, goals, issues etc are different.

In this market a very tight margin exists between fixed and arm's. So, in general most folks these days have opted for the fixed rates - especially in this fear driven market.

A few reasons a person may choose an adjustable over a fixed rate:

1) They are tight on ratio's and the only way to qualify is to get that extra little bit of a lower rate.

2) I have a lender who will finance and allow a closing under a Corporation Name (Fannie, Freddie, FHA - Most banks portfolios wont allow this) - they dont offer fixed rates.

3) The amount of the loan. Surely on a 30k mortgage the difference in rate makes such a minimal effect on payment - but for those with large loan amounts they can surely save an awful lot of money by having a lower rate even if it is only slightly lower - not to mention that the loan amount ammoritizes much faster - the client saves a ton on the monthly payment - with good caps - the borrower has very little risk and has the initial on going savings and faster ammorization to bank on. Then yes, it makes sense. I have done the numbers on some clients and yes it pays for them to do a ARM - again these are large loan amounts.

Do a Ben Franklin - put the plus's and minus's on paper look at the numbers and find out what is right by you.

Other thought look into buying down the fixed rate - if the property will appraise maybe you can negotiate seller concessions and use those funds to buy down whatever mortgage you choose.

Carter