Is ARM worth it for 1st property?

Question

Good day BP family,

So I have my first investment property on the hook. With the interest rates on the rise, my lenders initial quotes changed drastically. Now it's 20% down 1.365 pts at 7.625 rate.

This led me to seek out other options.  I recieved a 25% down with 0 pts, 7% rate 5/1 ARM.

In both cases my plan is to refinance IF rates ever drop.

Now the 25% DP is a bit out of reach for me but if it worth paying it up front then I would definitely consider it. I know it will lower my mortgage which will increase cashflow but not sure how I feel about ARM loans.

Is it worth getting an ARM? or should I stick with a fixed rate?

Thanks in advance!

Chris Mason · Answer

FYI going from 20% down to 25% down on a rental property is an automatic 1.25 discount points less (source). So your comparison is a bit apples to oranges, almost all of the reduction in points is b/c you're evaluating a FRM at 20% down v ARM at 25% down. Going to 30% down is another 0.5 discount point reduction, which would put you out of "discount point land" entirely, and into "lender credit for your closing costs" land (what we typically call "negative discount points).

So now it's basically ARM at 7% (0 points) v FRM at 7.625% (0 points), and my answer there is that 0.625% off the rate isn't enough that I'd take an ARM.

Shame on that LO for not telling you that. For about a year now, I've been refusing to quote rental prop mortgages with less than 25% down until AFTER I share what 25% down would look like.

Josh Young · Answer

I feel like I need to elaborate on the math here, lets assume a 5 year hold period since that's how long the ARM stays at 7%, so with the ARM you'd be putting 3.635% (extra DP minus points) more into the deal up front, but you'd save 3.125% (0.625 x 5) over the course of 5 years, so it's pretty close as far as cash outlay, but the difference is that 5% of the deal is going into equity with the ARM and that same 5% is going into interest/points with the Fixed rate mortgage.  So that means interest rates would have to increase a lot after 5 years to make the fixed rate the better choice, and if rates decrease your rate will adjust down without any refinance closing costs, but I can't stress enough the importance of having reserves to give you time to pivot if something unexpected happens, extra reserves is the key to being a successful real estate investor no matter which loan you choose in this situation.

Josh Young · Answer

That’s a great question, if rates decrease and you cash out refi into a fixed rate loan in 3-4 years then 25% down is a better deal, but only if you have the reserves and the risk capacity to cover if rates increase in the next 5 years. What if rates increase, values go down, and rents stay the same? That’s unlikely, but possible, just make sure you understand the risks.

Is ARM worth it for 1st property?

Most Popular Reply