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Mortgages & Creative Financing

Do Adjustable Mortgage Rates (ARMs) Make Sense?

Leon Yang
Expertise: Mortgages & Creative Financing, Personal Development, Real Estate News & Commentary, Real Estate Investing Basics
46 Articles Written
Interest Rates

Today I pulled up a Purchase Rates Assumption from Chase Mortgage just out of curiosity to see what the rates are like today.

So this is what I find:

30-yr fixed: 3.875%

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15-yr fixed: 3.125%

7/1 LIBOR ARM: 2.875%

Agency 5/1 LIBOR ARM: 2.500%

Okay, I usually don’t deal with mortgages and I don’t have the best idea of what exactly entails a 7/1 LIBOR ARM or an Agency 5/1 LIBOR ARM. But I do notice there’s a big discrepancy on the interest rates between a 30-yr fixed and an Agency 5/1 LIBOR ARM. Over the course of interest payments, it can potentially make a huge difference.

Related: Check out Today’s Rates in the BiggerPockets Mortgage Center

But Which is Better?

First, I’d like to say between 30-yr fixed and 15-yr fixed, I am a big fan of the 30-yr fixed, especially in today’s environment. I like 30-yr fixed rates because right now real estate debt will not get any cheaper. I will elaborate on this concept in a future post why 30-yr fixed is better than 15-yr fixed.

So now let’s compare 30-yr fixed to 7/1 LIBOR ARM and 5/1 LIBOR ARM.

So ARM, or adjusted mortgage rates, goes like this. The first part of the number shows you how many years the current interest rate is fixed for. With aspect to LIBOR, the future adjusted rates would be a certain percentage over what the LIBOR rates are. LIBOR is the London Interbank Offered Rate. It is a rate that banks in London use to lend to each other. Unfortunately, as we’ve learned in recent news, it often gets fixed by banks amongst themselves.

Since we don’t know what the market is going to be like in five to seven years, can we be certain that interest rates won’t rise dramatically?

It is hard to say. Typically there are caps to ARMs that limit how high the rates would go. However, you certainly don’t want to see your rate go from 2.5% in one year and 7% the next. The changes in interest rate can dramatically change your monthly payments.

But what if your investment plan is to own the piece of real estate for only three years? Now would that make sense?

Yes. It is still, however, a speculative bet. The market constantly changes so you never know whether it will be a good time to sell before your LIBOR changes.

On the other hand, you can protect yourself by refinancing again. The rates may be lower depending on the market environment, but it is safe to say that it won’t be as low as 2.5%.

Are you ready to take that risk? Or would you rather pay 1.375% extra for the peace of mind that your interest rate will never, ever change?

Photo: Chris Butterworth

By Leon Yang

Leon Yang is an active real estate investor in Las Vegas. He is a buy and hold guy who also likes to flip from time to time. His main passion is to traveling to the less traveled places and inspiring others to become financially independent through real estate.

    Mark Ferguson
    Replied over 6 years ago
    I finance all of my properties with ARMs for a few reasons. 1. I have 7 rentals and my portfolio lender only offers arms and 15 year fixed. 2. I pay off my houses using snowball effect and don’t plan on having any of the loans reach the adjustment time frame. 3. I have more cash flow with an arm which I use to pay down mortgages faster. One thing people rarely consider with an arm is all the money they save before it adjusts. Even if you have an arm that adjusts on the 6th year a couple percent you are still way ahead of the game staying in that arm for a year or two because if the lower rate the first five years. With the 1.37% higher rate it takes a couple years after the ARM adjusts to for the fixed rate to be cheaper.
    Dave Van Horn
    Replied over 6 years ago
    I agree with Mark, some of the best $$ I’ve made in RE was utilizing ARM’s and reinvesting the extra Cash Flow.
    Shaun
    Replied over 6 years ago
    30 year fixed rate and ARMs both have their place depending on your strategy. If you plan on making just your min payment and keep the placed levered the duration you want lock in that rate as long as you can. If like Mark you are paying it off as quick as you can then go for the ARM so as much of your payment is going towards principal as possible those first 5-7 years. If you have not paid it off by then there is usually a yearly cap on an increase (typically like 2%) and a lifetime cap. So it isn’t like your rate will go from 2.5% to 10% overnight. Like Mark said you can get enough advantage those first several years to more than offset a couple high rate years after. One last thing about an ARM is once the fixed period is up the loan re amortizes at each adjustment. So if you been paying down the balance your payments could go down a lot even with a rate hike. Not that is a big deal if you are aggressively paying it down, but it gives you some financial flexibility a fixed rate doesn’t. Finally if getting a fixed rate I see no situation where I’d get a 15yr if 30 is an option. The tiny rate gain isn’t worth locking in a far higher payment. If you want to pay it off faster just pay it off faster. The amount saved paying a 15yr vs paying a 30yr in 15 isn’t that much so keep the option of a lower payment if you have a tough month here or there.
    Shaun
    Replied over 6 years ago
    30 year fixed rate and ARMs both have their place depending on your strategy. If you plan on making just your min payment and keep the placed levered the duration you want lock in that rate as long as you can. If like Mark you are paying it off as quick as you can then go for the ARM so as much of your payment is going towards principal as possible those first 5-7 years. If you have not paid it off by then there is usually a yearly cap on an increase (typically like 2%) and a lifetime cap. So it isn’t like your rate will go from 2.5% to 10% overnight. Like Mark said you can get enough advantage those first several years to more than offset a couple high rate years after. One last thing about an ARM is once the fixed period is up the loan re amortizes at each adjustment. So if you been paying down the balance your payments could go down a lot even with a rate hike. Not that is a big deal if you are aggressively paying it down, but it gives you some financial flexibility a fixed rate doesn’t. Finally if getting a fixed rate I see no situation where I’d get a 15yr if 30 is an option. The tiny rate gain isn’t worth locking in a far higher payment. If you want to pay it off faster just pay it off faster. The amount saved paying a 15yr vs paying a 30yr in 15 isn’t that much so keep the option of a lower payment if you have a tough month here or there.
    Shaun
    Replied over 6 years ago
    30 year fixed rate and ARMs both have their place depending on your strategy. If you plan on making just your min payment and keep the placed levered the duration you want lock in that rate as long as you can. If like Mark you are paying it off as quick as you can then go for the ARM so as much of your payment is going towards principal as possible those first 5-7 years. If you have not paid it off by then there is usually a yearly cap on an increase (typically like 2%) and a lifetime cap. So it isn’t like your rate will go from 2.5% to 10% overnight. Like Mark said you can get enough advantage those first several years to more than offset a couple high rate years after. One last thing about an ARM is once the fixed period is up the loan re amortizes at each adjustment. So if you been paying down the balance your payments could go down a lot even with a rate hike. Not that is a big deal if you are aggressively paying it down, but it gives you some financial flexibility a fixed rate doesn’t. Finally if getting a fixed rate I see no situation where I’d get a 15yr if 30 is an option. The tiny rate gain isn’t worth locking in a far higher payment. If you want to pay it off faster just pay it off faster. The amount saved paying a 15yr vs paying a 30yr in 15 isn’t that much so keep the option of a lower payment if you have a tough month here or there. Reply Report comment
    Michelle
    Replied over 6 years ago
    I thought about going with a 5/1 ARM at the time I bought my SFR. I didn’t know at the time how fast I wanted to pay the mortgage off and was a little worried that if I didn’t pay it off in 5 years that the interest rates would be much higher than the 4.25% I ended up with on a 30-year. Knowing what I know now, if/when I do it again I’d probably go with an ARM for the extra cash flow.

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