I use an adjustable rate mortgage (ARM) for a number of reasons on my rental properties and my personal property. I can get more than four loans on a property with ARMs, the rates are lower and at one point I used to pay off my mortgages quickly. Many people feel that an ARM is very risky because the rate can increase over time. It is true that many ARMs are risky and they are not the best option for many buyers. For some home owners an ARM can be a very good loan that saves money, lets you buy more properties, and is not very risky.
What is an Adjustable Rate Mortgage (ARM)?
Adjustable rate mortgages or ARMs have gotten a bad name the last few years, because many people used them to buy houses they could not afford before the housing crisis. An ARM is a loan that starts with a low interest rate, but the interest rate can increase after a set period of time. A 5/30 year ARM is a 30 year loan with an initial rate that is fixed for the first five years, but can increase on the sixth year. There is a cap for how much the interest rate can increase after the adjustment period, and a minimum it can decrease. An ARM can adjust up or down depending on what interest rates do. On my loans the rate might start at 4.5 percent, but could raise up to 8 percent. The rate cannot increase more than 1 percent in any given year.
Adjustable rate mortgages have lower interest rates than fixed mortgages
I like 5 year ARMs because they have a low interest rate guaranteed for 5 years. ARMs can have rates that are 1 percent less than a 30 year fixed rate loan. That 1 percent difference in interest rate can save hundreds of dollars a month. If you heard horror stories about ARMs in the past, there were some people who used them carelessly. You used to be able to get ARMs with very low rates that would jump to very high rates after only one year or 6 months. Many times buyers could not qualify for a home with the normal 30 year fixed rate loan, but they could qualify for the lower payment the ARM offered. I would not suggest using an ARM because you cannot qualify for a 30 year fixed rate mortgage.
An adjustable rate mortgage may be your only choice to finance multiple properties
Another reason I use an adjustable rate mortgage is they are one of the few options available from my local lender. I use a portfolio lender who lends their own money on loans; they do not sell their loans to other companies or investors like most banks do. My portfolio lender offers a 5 year and 7 year ARM as well as a 15 year fixed loan. The 5/30 year ARM has the lowest payment, lowest interest rate and works perfect for my cash flow strategy. The reason I use a portfolio lender is many lenders will not loan to investors when they have more than four mortgages. My portfolio lender will lend on as many loans as I can qualify for, but I must use their limited loan options. Portfolio lenders can also be a great option for getting a loan on a home that needs repairs. Here is a great article on other ways to get financing when you have more than four mortgages in your name.
Are ARMs riskier than a fixed rate loan?
ARMs have gotten a bad name the last decade due to the high number of loans that were foreclosed on during the housing crisis. The reason so many people lost their homes with an ARM was they qualified on the low initial interest rate. When the rate on the adjustable rate mortgage went up after five, three or even one year, the home owner could no longer afford the payment. If you are thinking of getting an adjustable rate mortgage, make sure you can afford the payment increases even if you think you will have the loan paid off by then. Do not depend on being able to refinance to get yourself out of the loan. Buy properties below market value, and this will allow you to sell the home as well.
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An adjustable rate mortgage may be cheaper than a fixed rate loan
The interest rate on an ARM is lower in the beginning of the loan than a fixed rate loan. The ARM may be cheaper than a fixed rate loan even if you do not pay off the ARM right away and the rate increases. During the five years that the ARM is at its low rate, you are saving money every month over the fixed rate loan. Even if you don’t pay off that ARM and the rate adjusts, it would still take years for the total cost of the ARM to catch up to the fixed rate loan. If you reinvest the money you are saving from the ARM and make a higher return on that investment than the interest rate on the loans that will make you even more money. It usually takes 8 years and an ARM adjusting to its maximum amount, before the fixed rate loan saves you money.
An Adjustable rate mortgage is a great loan, especially when you have few other options. Be smart when deciding to use an ARM and it can be a great tool for any investor. The biggest mistake you can make is not being prepared for a payment increase if you are not able to pay off the loan or refinance. If you are prepared to hold the loan, you should be just fine.