Real estate investing often involves using financing to maximize returns. One of the big decisions investors face is choosing between a fixed rate and adjustable rate mortgage. Each has its pros and cons and the right one for you depends on your investment strategy, risk tolerance and market conditions. Here’s the breakdown.
Fixed Rate
A fixed rate mortgage has an interest rate that doesn’t change for the life of the loan. This means your monthly principal and interest payments will never change, making it easier to plan for the future.
Pros
- Predictability: The fixed interest rate means consistent monthly payments, financial certainty and easy long term budgeting.
- Protection from Rising Interest Rates: If interest rates go up, your mortgage rate doesn’t, potentially saving you money over time.
- Simple to Understand: Fixed rate mortgages are straightforward, no complicated terms or adjustments to worry about.
Cons
- Higher Initial Interest Rate: Fixed rate mortgages often have higher interest rates than ARMs which means higher initial payments.
- Opportunity Cost: If interest rates go down, you won’t benefit unless you refinance which can cost you more and more fees.
- Less Flexibility: For investors who plan to sell or refinance in the short term, a fixed rate mortgage may not be the best financial choice due to the higher initial rates.
For
- Long Term Investors: Those who plan to hold the property for a long time and want payment stability.
- Risk Averse: Investors who prioritize financial certainty over potential savings from interest rate fluctuations.
Adjustable Rate Mortgages (ARMs)
An ARM has an interest rate that can change periodically based on market conditions. ARMs usually have a lower initial rate fixed for a set period and then adjusts at set intervals.
Pros
- Lower Initial Interest Rate: ARMs have lower rates than fixed rate mortgages, lower initial payments.
- Potential Savings: If rates go down, your mortgage rate and payments may go down without refinancing.
- Short Term Ownership: For investors who plan to sell the property before the rate adjusts, they can benefit from lower initial payments.
Cons
- Payment Uncertainty: Future rate increases can mean higher monthly payments and impact cash flow and profits.
- Complex Terms: ARMs have caps, margins and adjustment indices, more complicated to understand.
- Payment Shock: Big rate increases can mean big payments and financial stress.
For
- Short Term Investors: Those who plan to hold the property for a few years and sell before the rate adjusts.
- Market Savvy: Investors who watch interest rates and are comfortable with rate fluctuations.
Investor Considerations
When deciding between a fixed rate and an ARM consider:
Investment Horizon
- Long Term Hold: Fixed rate is stable long term.
- Short Term Hold: ARM can save you money if you sell before the rate adjusts.
Interest Rate Outlook
- Rising Rate Environment: Fixed rate protects against increases.
- Falling Rate Environment: ARM can adjust down, lower payments.
Cash Flow Management
- Stable Cash Flow: Fixed rate means consistent payments.
- Flexible Cash Flow: ARM starts lower but can fluctuate.
Risk Tolerance
- Low Risk: Fixed rate minimizes uncertainty.
- Higher Risk: ARMs can save you money but comes with volatility.
Market Conditions
- Economic Indicators: Consider inflation, Federal Reserve policies, economic forecasts that can impact interest rates.
Summary
Choosing between a fixed rate and an ARM is a big decision that can affect your real estate investment. Fixed rate is stable and predictable for long term investors or low risk tolerance. ARMs is lower initial payments and potential savings in certain market conditions for short term investors or those comfortable with some risk.
Check your goals, financial situation and market conditions and then decide. Talk to a financial advisor or mortgage broker to help.
