Financing Options: Comparing FRM vs ARM on Buy & Hold House Hack

[Sebastian Robles]

Hello! I am looking to buy my first investment property using an FHA 203k loan. My goal is to maximize cash flow to pay off current loan balances and increase my savings rate. I'm looking at two different lending options.

Regardless of which option I choose, my plan is to refinance by Year 5 of owning the property to: a) get rid of PMI if appreciation is good and LTV < 80%, and b) cash-out equity to purchase a second house hacking property.

Assumptions:

• All in cost: $506,500 (purchase price + rehab costs + closing costs)
• FHA 203k already accounts for ARV, no natural appreciation, value is flat with LTV at Year 5 between 88-90%
• 30 year Fixed Rate Mortgage 6.5% APR and 3.5% down, P&I of $3,091
• 5/1 Adjustable Rate Mortgage 6.0% APR and 3.5% down, P&I of $2,932

That's an additional ~$150 in monthly cash flow during the first 60 months of owning the property prior to refinancing if I go with the ARM route.

Rationale: I'm looking to get a property that cash flows at least $250-$300 monthly. Adding the $150 from ARM is a significant bump. The goal with the additional cash flow is to aggressively pay off my remaining car and student loan balances within 1-1.5 years. Doing so would unlock an additional $500+ monthly.

Refinance at Year 5:

• About 3% ($15k) refi costs baked into the new loan --> ARM savings offset some of this cost, vs having to pay it all on FRM
  
• Baseline Scenario: 6.25% APR and ~$2,850 P&I --------> +$82 monthly cash flow
• Conservative Scenario: 7.25% APR and ~$3,220 P&I --> -$138 monthly cash flow

After 5 years, there is some buffer for APR to increase and it'd still add to my monthly cash flow. Even if APR goes to 7%, by no longer having a car and student loan payment, the $138 extra cost after refi is better than paying $500 on current loan balances.

The decision comes down to having a "safer" loan option with thinner cash flow vs higher cash flow and the risk of rising rates. The high rates are still a risk with a FRM though, so if rates are high after 5 years, I'd be stuck with the PMI from the FHA.

Please let me know what you think and if there's other things I'm not considering.

[Matthew Crivelli]

Take the 30Y fixed mortgage and cut out $150 in expenses from somewhere else in your file. No one has a crystal ball when it comes to rates, an ARM is a risk. You're cash flowing a small out considering the value of the home. I would be taking any cashflow you do get and save it for when unexpected circumstances arise. (vacancy, surprise repairs, insurance deductible if you make a claim, etc.) When margins are this slim, you need emergency cash reserves. I'm not sure what your ARV is projected to be but this may be a better flip than a rental.

Also - 203K loan for an investment property? I though this was for owner occupied projects?