why would anyone take 30 year fixed...

3 Replies

... over 5/1 ARM for investment property

Right now the 5/1 ARM seems to be 1% below 30 year fixed (lets say 3% and 4% for argument sake)

For the first 5 years I am saving a large amount of cash. After 5 years 2 scenarios

a) Rates are higher because the economy is on fire => I can get higher rents to offset the burden. Note my break-even point is 5% so rates have to be higher than 5% for me to loose money with ARM over 30 year fixed. Simplisticly speaking my rate has to be 5% for the next 5 years for it to be a wash (I saved 1% for 5 years with ARM and lost 1% with ARM over next 5 years). Is this right?

b) Rates are lower or same so I am anyway better of in the adjustment period.

The arm rates can go up to 8-10%. At that time refinancing would make it so you would have to go to 6-7% mortgage. The rents may not pay either. You might not be able to sell the property to offload it. In reality arm is for someone who will sell in 5 years or has the cash to self insure themselves.

@Roy Mitle

As a Canadian venturing into U.S.A. markets, I have often asked the same question.  Here we do not have mortgage terms longer than 7-10 years and most folks use a 5-year term, so the concept of ones mortgage rolling-over every few years is par for the course ... you simply renew/refinance, or pay out, as your mortgage comes due.

On those 5-year terms, you have a choice of either a fixed-rate mortgage (on a 25 - 30 year amortization) or a variable rate mortgage (which floats with the prime rate).  Presently a fixed mortgage is running around 3.0% which the variable rate is about half a point lower at 2.5%.

While I have not found ARM products in the U.S.A. to be quite as flexible as variable rate mortgages at home, the principal is the same. You analysis is also correct, once you are 20 - 50% into a 5-year variable/ARM mortgage, interest rates will need to rise substantially to wash away the interest payment you have saved. By the time you are 60-80% in, rates would need to better than double for you not to come out ahead.

Conversely, the arguments for a long-term fixed mortgage (30-year in the U.S.A.) are peace of mind and better cash-flow (which is not always the case).  Where interest rates have predominately one direction to move (up), locking into a longer term fixed-rate mortgage is less risky than it would have been 5-8 years ago.

BTW:  Good choice of name.

@Roy 

@Roy Mitle

If you have been investing or involved in real estate before and after the melt down that the economy suffered, then you know banks can change.  I use to think the 3-5 yr locked in terms were the way to go, but now it makes me nervous.  I had a piece of land that I bought with 10% down years ago.  Five years later I had to refinance due to a balloon payment.  Then lot is not worth anywhere neear what it was before, and now the bank does 70% Ltv.  That is why I choose not do take that option anymore.