Which Way To Go?
I've talked with mortgage brokers, loan officers, real estate agents, financial planners, and friends and relatives. Everyone has a different opinion about the best type of loan to get. If you have any thoughts on this, I'd really appreciate hearing them.
I'm buying a 4-unit property for $320,000, putting 20% down and planning to occupy one of the units. The cash flow from 3 units will cover PITI. This will be the second rental property that I will own.
This is a long-term proposition- I'm planning on holding it for decades. I don't really need additional cash flow from this property right now, and I have savings in reserve in case of emergency.
Given this basic information, should I go fixed or adjustable? Some people say you're crazy to go 30 year fixed, while others say lock in the low rate now since rates will certainly rise in the next couple of years.
While I'm fairly risk-averse, I don't want to go fixed if a 5/1 or 7/1 ARM would make more financial sense.
Also, I would be willing to pay points for a lower rate. I don't have other investments, so it's not like I'm making a better return on this money elsewhere, and some people say I should pay as many points as possible. Is this a good idea?
Thanks for any help on this.
Tracy
Based on you stating that you don't need the cashflow, have reserves, plan on living there forever and don't invest in anything else, I would go w/ a fixed rate.
Assuming you are buying in Oakland, it is a rent control city, going w/ a fix will help you better control the situation. Whereas, if you go w/ an ARM, when the fixed period is up, your interest and pymts might rise to where you might not be able to increase rents to keep up. Also if you choose to refi when your fixed term is up for your ARM, you will have to pay closing costs, which might eat up all the savings you had by going w/ an ARM over a fixed rate in the first place. Another thing, most people who are able to save money but don't need to, by going w/ the ARM, end up spending that savings on things they don't need or just putting it in a savings accnt where interest doesn't keep up w/ inflation, so either way they are losing money.
As far as paying points to get lower interest, I would do it. The points you pay are tax deductible, so you eventually get the money back and get a lower rate.
This is just my opinion.
Hi Tracy,
I think this is one you may have to answer for yourself, as a lot has to do with risk tolerance – but you really could argue it both ways.
As I'm sure you know, with the current interest rates and the deal you’re talking, you’re looking at roughly $500/mo difference between a fixed and an ARM.
I try to consider as many factors as possible on both scenarios, (potential rate increase per yr. on the ARM, lifetime cap, tax benefits, appreciation, rent increases, etc.) to get a better idea of how many years down the road the crossover point might be between the two. And then how many more years the breakeven point would be.
Personally, I like the ARMs right now. I think they’re a great cash-flow tool, and I might look at that $500/mo as another property I could afford. But that’s just me.
Good luck! It’s sounds like you’ve found a nice property and either way should serve you well.
Thank you for the comments. It really helps to hear how experienced investors look at a situation.
jmBROKEr, I am in Oakland, and rent control is a concern. The peace of mind a fixed loan provides outweighs the initial savings of an ARM, so I'm leaning that way.
Some people tell me that refinancing is so easy now, though, and often can be done quite inexpensively, that I'd be a fool to pay the higher fixed rate. Others say that the current lending climate will not last forever, and that lenders may not be offering such low-cost refinancing as they are now, so the closing costs that you mentioned are indeed a factor.
mcole, the $500 difference is why I'm so conflicted. Of course, the adjusted vs. fixed comparisons show that the fixed loan is better over the long haul. A lot seems to depend on the assumptions on where rates are headed, and the cost of refinancing when (if) they start moving up.
Thanks again,
Tracy
TracyH
The difference btw a 5/1 or 7/1 ARM vs 30 year fixed is about 1-1.5% in interest rate. Based on you poss loan amount, you're looking to only save around $200/mo going w/ an ARM, not $500 as mcole thinks. $200/mo is still a good amount of savings, but it is not $500/mo, just wanted you to make an informed decision.
Also rates are at a 30year low now, almost 40 year low. Which means most likely they will be higher in the future.
I think an important question to ask yourself (regardless if you are living in the property or if is strickly investment) is "how long do you expect to keep the property". If the answer is "long term" and/or >5 to 7 years" then I highly recommend you take advantage of the low fixed interest rates. If the rates go lower -- then refinance. I also agree with some of the comments in regards to paying points. I often pay points on my investment properties but my purchase prices are so low that the points are nominal and it lowers the payments significantly. But you really need to compute all the various scenarios to ensure you have covered every angle.
Good Luck!
You're right on the money, jmBROKEr. I was at Wash. Mutual and Citibank last week, and I was looking at 5.25% fixed with 1 point vs. 4 % 5/1.
Lavonc, I am thinking long term on this and that low fixed rate is awfully tempting. It's interesting how it depends who you talk with, though- one highly referred mortgage broker really tried to persuade me to go with an adjustable.
Thanks to you both for the input. And I think I will pay points and lower the rate.
Much appreciated,
Tracy
Hi Tracy,
I guess need to clarify my previous post, as I was challenged on my numbers. I should have said, "as much as" $500 per month. Sorry about that. But there ARE pay option ARMs out there that go pretty low.
There’s a program now that is a Stated Income NOO, 5/1 year adjustable at 1.65%, 0-1 point, with an 80% LTV. I haven’t used it and don’t know the particulars, so I can’t vouch for this one yet.
But I am closing on a property right now doing a NOO 5/1 at 2.95%, with an 80% LTV. Could it go negative? Yes. However, if I want to keep my payments down, I could go interest only. I also put a 1.95% on my own home, and I’m not even close to a negative position with it. But that’s a different scenario, and I can go fixed whenever I want.
My point before was simply that the right ARM can have a big impact on cash-flow. And based on the fixed rates I've seen, that could potentially be "as much as" $500 per month.
Hi mcole,
Thank you for the additional information. I think the mortgage broker I mentioned above was referring to the same kind of loans that you are, where the monthly savings were substantial. Because I'm not that familiar with these loans, I didn't really understand what he was talking about during our phone conversation, but he invited me to stop by his office to discuss the options. He absolutely felt that an ARM was better than a fixed right now- in his opinion, it wasn't even close.
One thing I'm still not sure about: How important is the interest rate forecast? Of course, no one knows for sure when or how much they're going to move, but how big a factor is this? The ARM proponents I've talked with say that when rates start rising, I simply refinance and get into something else. Before that, I've saved a significant amount by paying the lower rate. I suppose, then, that the cost of refinancing must be taken into account.
So confusing- and yet very interesting to me. I really appreciate all the help here.
Tracy
I think...this is a no brainer...when yo uhave historically low interest rates, and your time horizon is long term, why wouldn't you lock those rates in?!
Hey Bravewave,
I'm thinking along those same lines. The counter argument I've heard is that 1) no one knows what the rates are going to do 2) the savings on a 5/1 over a fixed would be significant in the early going 3) if rates did rise, you could use those savings to cover the cost of refinancing 4) even though people may believe they are going to hold long-term, circumstances change and many people end up selling earlier than expected.
While these points seem valid, I'm still leaning toward a fixed with 1.5 points.
Thanks for the reply,
Tracy
Tracy,
I would. Get it done and know you're locked in. From the standpoint of risk management, you've now dialed in your risk parameters. That's a big plus.
David