Why use adjustable rate commercial loans???

Question

So I am meeting with the commercial division of my local bank tomorrow. They have done my last three conventional loans, and with my primary residence I am at the limit for 20% down easy money.  My loan officer said they can do more conventional loans (these will be number's 5-10), but they will require 30% down moving forward. So I figured I should pursue the commercial/portfolio loan route for more favorable terms and now I'm second guessing it and here's my reasoning; I'm almost positive this bank (or any others for that matter) will have a max term 5 year balloon. That scares me. What if interest rates climb back up from historic low levels? And if/when they do how much is my 60k house worth? 50k, 40k? Who knows?  So why not lock in a 30 year conventional loan at 4.5% with forced equity of 30% even if it means I'll have to move a little slower.  Outside of real estate investments we are a strict Dave Ramsey no debt household so this decision seems counter intuitive to everything we've worked so hard to accomplish.  I'm wanting to invest in a rental portfolio that will allow me total financial freedom in 5-8 years, which I know will require an aggressive acquisition rate. Decisions decisions... What are your thoughts on leverage and adjustable rates? Thanks in advance for any input!

Scott Schultz · Answer

as an investor why would you finance over 30 years, unless you need the income now?  i do shorter amms because i want them paid off, and keep the cash flow, its one thing if you want 100+ properties, but 15- 20 paid for ones gives me an easy 6 figure income forever, and ever, and my kids lives and their kids lives if managed properly. pay alittle more now for the flexibility, and get them paid off, so what if you have to re-up in 3-5 years, interest rates wont be 10% then, and if they are inflation will drive your rents to cover it anyway, inflation is great in real estate, it means your property will be worth more,  but the purchase price was pre inflation. Dont be worried, just keep plugging away, and never do a 30 year.

Max T. · Answer

Lot of different but well reasoned/experienced perspectives on this thread. Great read!

There's no one right way to do it in REI. At the end of the day if you buy a good asset and manage it properly you're going to come out alright.

Joel Owens · Answer

Adjustable rate mortgage can be good when you know you are owning the property short term.

So for instance a value add property where you are increasing the value and know you will be selling off or doing a refinance. Optimal on those is to get an interest only loan so the payments are real low while you inject capital into the property itself. On those properties you don't really care about principal pay down as much.

What is important on these types of loans is no prepayment penalty. I have seen others use those loans thinking they will hold and then they get an offer in a couple years they can't refuse and want to sell. Now they have this big pre-pay penalty to deal with.

So if your strategy is to get investor loans for SFR houses then getting the up to ten properties locked in for 30 years makes sense.

The other poster getting a 10 year fixed rate loan at 4.6 with a 25 year amortization from a bank is very hard to find. Most are 3 to 5 years and some push to 7. 10 is out there but very tough to get.

Most asset classes cycle every 7 to 10 years so you want at least that amount of time with a loan so you can refi or sell at the optimal time and not because you used short term debt for a stabilized asset where the existing cash flow is the main return.

If you do go the commercial route you want to "stress test" the property you are getting a loan on.

So if you get a 7 year fixed loan with  a 25 year amortization at say 4.5% fixed what does that look like over time?

You can play around with a typical amort. pay down in that time period and then plug in a higher interest rate to see what you could do to stay at the same cash flow. For instance running the numbers you see in year 7 with pay down you could go from a 4.5% rate to 6.5% and stay at the same cash flow.

Additionally you can play with if you do not have a big pre-pay penalty putting so much down of the cash flow each year to accelerate pay down what that would make the balance in year 7.

That might make you go from 4.5% to 7.5% on the rate for refi and still maintain the same cash flow. Now 7 years later that dollar today is not worth the same then so it would be diminished returns with inflation. With a lower LTV then a bank might do interest only 7 years from now if the asset has appreciated and the loan paid down to 50% ltv.

With investing everything is fluid and you can model out certain situations so that you can move with the market but nobody can predict 100% accuracy on what will happen years from now.

Gabe G. · Answer

There are credit unions that will give you 10 conventional, true 30 year mortgages fixed.

You should max those out first.

No one would go to commercial adjustable in this environment, unless they are maxed out.

I am at that 10 point now and considering commericial, because that's my only option. But if I could get more 30 year fixes, I would continue doing that.

Michael L. · Answer

Since the downturn a group of single-family rental lenders has emerged to provide debt solutions for investors with 10 or more properties as well as alternative options for those capped out of DTI restrictions on conventional loans, who want to purchase or refinance sfr properties.

Portfolio loan basics: 5-yr term, 30 yr am, rates between 5.5-7.5%, non-recourse

Chris Mason · Answer

@Brian Smith - for 5+ financed properties, it should just be whatever the down payment requirement would have been, plus 5%. So 25% down for SFRs, 30% down 2-4 units.

Flavio Zanetti · Answer

@Ralph R. some other banks don't require a higher down payment for 4+ loans but they do require more leverage from your end if you don't want to. For example, I am shopping around for rates on a  3 family and banks have asked me to prove 6-12 months proof of expenses (even if it's in a 401K savings fund) if if I decided to do 25% down.

Good luck on your negotiations...

Flavio

Why use adjustable rate commercial loans???

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