Hi Folks, I'm fairly new to RE investing and wanted some input on using interest only mortgages/loans. I currently have 3 properties under contract. Two of the properties I plan to sell within 1-3 years. The third is a duplex unit that will cash flow nicely so I will likely hold that property longer. I'm contemplating doing interest only mortgages on the other two properties to maximize cash flow and stock pile some capital for my next purchase. Are there any downsides to this strategy that I may not be aware of?

Thanks!

If the local market corrects or you need to dump quick you will be overleveraged with no principal pay down.

How much extra cash flow are you getting with the interest only loans per month per property?? Does the loan mature in just a few years?? I know you are planning on 1 to 3 years but situations change and what if you want to hold them. Now years later you have refi costs and most likely higher debt service with a higher interest rate.

Don't talk yourself into a deal with special financing.

A few glaring down sides. The 1st if rates go up and its not likely they can do that immediately but they will in a bit and when they do who knows how fast they will go up.
Go back To Ron Reagon years and study what happened there. Prime rate interest went from about 11% in 1979 to 21.5% in 1981.
They did this to slash inflation and it did work its an example what can happen if things begin to get crazy in the economy.
Right now interest is too low because at zero.. savers are getting killed and the bond market is about to explode and the stock market has been going crazy because of inflation. Inflation is a dangerous thing if it takes off.
Long story short is if you get a 3 year interest only what happens if you cant get out in 3 years and you wake up to see rates at 9% would it matter?
Also my other fear of interest only is if you dont stock pile cash for a refinance instead of new acquisition if rates rise you may not qualify for a refinance.
Im not all negative on the matter at 3% its pretty juicy if you can get it. Maybe a more prudent plan would to just pile up cash then refinance showing banker your fat cash balance at end of 3 years instead. I would make it easier to qualify getting into long term if you wind up stuck in these 3 properties longer then 3 years. Its like preparing a 2nd exit strategy if things go wrong.
3 years in Real Estate is a really short time line. Its better to look at real estate in a 5 to 10 year time period. If your just fix and flip maybe no problem. Just my take on the matter.
By the way, I and my buddies have over the years have called these exploding mortgages.

Great insight guys thanks!

Most lenders won't let you have an ARM adjustment in the same year as your interest only to fully amortized adjustment. For instance, if you get a 5/1 ARM IO the first 120 months is interest only no matter what the market rate adjusts to after the initial fixed 5 year period.

My advice to my clients is that you should only do IO with more than 25% equity and in an appreciating market. You should also have a short term goal to refinance or sell the property. If you are cashflowing enough with an I/O over a fully amortized loan, then take that money and earn higher interest than what you are paying.