Arm loans have become an increasingly popular financing option for real estate investors looking to purchase investment properties. By utilizing an adjustable-rate mortgage (ARM), investors can secure lower initial interest rates and payments compared to traditional fixed-rate loans. This enables greater purchasing power and cash flow flexibility during the early years of ownership. However, ARMs also carry interest rate risk and may require refinancing. Understanding the pros, cons, and key considerations around utilizing an ARM for an investment property purchase is critical. This article will provide an overview of how ARM loans can facilitate investment property acquisitions, along with key factors investors must weigh when opting for adjustable-rate financing.
arms provide access to lower rates and payments than fixed mortgages initially
One of the primary appeals of ARM loans for real estate investors is the ability to obtain a lower initial interest rate than with a fixed-rate mortgage. Often the rate differential can be 0.5% – 2% lower for a 5/1, 7/1 or 10/1 ARM compared to a comparable 30-year fixed loan. This reduced rate translates into lower monthly payments, enhancing cash flow during the early years of ownership. With rental income offsetting a lower mortgage payment, investors may achieve higher positive monthly cash flow than with a fixed loan. The increased affordability and cash flow an ARM provides can be key to making a rental property purchase feasible.
arms offer greater purchasing power for investors due to lower rates
In addition to lower payments, the reduced interest rates ARMs offer also equate to greater purchasing power for investment property buyers. By opting for an adjustable-rate versus fixed, an investor may be able to afford a more expensive property while maintaining a similar monthly payment as they would have with a fixed-rate loan for a lower priced asset. This increased purchasing capacity can allow an investor to acquire a more appealing property in a more desirable neighborhood. However, investors must ensure the property’s rental income will sufficiently cover payments once the ARM resets to higher rates.
arms enable investors to capitalize on short-term ownership strategies
For real estate investors who intend to own investment property for only a few years, ARM loans can facilitate this short-term holding strategy. By taking advantage of low initial rates and payments, investors can enhance property cash flow during their ownership period. And if they sell prior to the ARM resetting to higher rates, they will have benefitted from lower financing costs while owning the asset. This can boost overall return on the investment. However, ARMs are generally less suitable for long-term buy-and-hold investors, as eventual refinancing will likely be needed as rates rise over time.
arms carry inherent interest rate risk as rates reset higher
While their flexibility can be appealing, ARM loans also carry inherent interest rate risk. As ARM rates begin resetting to higher levels in accordance with broader market rates, an investor’s financing costs will rise. This may diminish cash flow over time or even create cash flow challenges. Depending on how high market rates climb, an investor may struggle to make payments or have insufficient rental income as rates adjust upward. Careful consideration of rate caps and worst-case payment scenarios is essential.
refinancing may eventually be required as arm rates rise over time
Since ARM rates will progressively move higher over the life of the loan as they reset on schedule, an investor must be prepared to refinance the mortgage once rates reach untenably high levels. This introduces future refinancing risk, as there is no guarantee rates will be favorable for refinancing when the time comes. Investors must factor this refinancing probability into their decision to utilize an ARM. Developing a clear exit strategy for the property before rates become unaffordable is prudent.
ARM loans can provide real estate investors with an attractive financing option for investment properties due to low initial rates and flexible payment options. However, the interest rate risk inherent with ARMs must be properly evaluated. Having an exit strategy and ability to refinance is key. Carefully weighing the pros and cons relative to a fixed-rate mortgage is important when determining suitability.