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Fixed Rate or ARM For Rental Property Mortgages.
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Real Estate Agent
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Remember that fixed rate mortgages are more steady for the long term. If you are buying a property as a long term investment there is nothing better than locking in that low rate for an extended period of time. ARMs may be good if you are planning on holding the property for a short period, like when you are flipping the property. From my experience ARMs typically adjust annually or semiannually so you get a fixed rate (often lower than 15 or 30 fixed) for that period of time. If you buy a property and sell it 5 months later you just got cheaper money. The key is to look at the fees and terms of both loans for every deal you do, sometimes one will be better than the other.
Allen Fletcher
Nicholas Misch The answer depends on how long you intend to hold the property. I have a friend who uses ARMs because his closing costs are $500 (low priced props) and he knows he won't own them in six or so years.
If you are planning on long term holds here, where do you think that rates are headed in the next five to ten years. Definitely up, so the gamble on rates cannot go your way.
I had one ARM in the past, and it went my way when it adjusted, but only because the market collapsed. My cash flow went up, but the value dropped 20%. And when I thought that rates would start to climb again I would have to pay 3k or whatnot to refi into a new fixed rate. Not exactly a slam dunk.
In general, for the average investor, a longer term fixed rate that is in line with your intended holding period would be most appropriate.
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If values crash and you're stuck with a property that's worth less than what you paid, forcing you to hold for longer than you had planned, you'll be glad for that fixed rate loan.
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I think it would be acceptable to use an ARM for a rental property as long as they have a decent term (5-7 years). If I was buying smaller properties (1-4 units) I would try and get fixed rates. With interest so low right now, I would lock in as much as possible while the rates are this low. If the lower interest rate on the ARM allows you to buy more property, I would go that route. On a side note, once you buy property larger than 4 units or have 4 loans underwritten by Fannie/Freddie you will have to get commercial/portfolio loans. These loans typically have a balloon payment after 5 or 7 years. My point being, you will eventually be using loans similar to an ARM eventually.
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The ARM product was developed by bankers to induce folks to get a low introductory rate that they could get approved for based on their income and debt levels because of the lower payment terms. This way, they could generate revenue through service fees and then they were also hedged against interest rate fluctuations. When interest rates go from 4% to 5%, the bank with the most long term 4% fixed mortgages in their portfolio loses.
That being said, in the current interest rate environment, I would lock in as much fixed debt as you can and avoid ARM's completely. ARM's can make sense if you're a flipper where there is already a very short holding period and a significant holding risk because you're betting on the market being there when you sell. For rentals, even 5-7 years, I would still opt for a fixed mortgage. Your monthly cash flow could disappear quickly if rates go up at all.
So I have done both.
One my first property it was FHA and a 5/1 ARM. The lower interest rate, helped me out because I was just getting started. (I did pay that pesky PMI but that was my own fault.) After the 5 years, my interest rate could only go up (or down) a maximum of 1% per year. It was also capped that my interest rate would never be higher than 5% of my original interest rate for the life of the loan. I could live with the rate even at the worst scenario so I took it.
On the house I recently purchased, I looked into an ARM but it didn't seem worth it. The rate was .75% less than the 30 year fixed but there was not a cap to the movement after 5 years. I was able to lock in at 3.5% (since I am living in the home) and feel that it was the best for me at this time. Of course if I end up selling before 5 years, then maybe I would have wished that I did the ARM. Right now, I am a BRRR investors who is looking to build up a rental portfolio.
Best of luck to you.