With regard to real estate investment, one of the most important decisions an investor must make is how to finance their investment. Common options are variable, ARMs and fixed mortgage rates, each with their own set of pros and cons. In this blog post, we'll break down the differences between them and help you decide which is the best option for your investment.
Fixed rate mortgages offer a sense of stability and predictability for investors. With a fixed rate mortgage, the interest rate remains constant throughout the life of the loan, which allows borrowers to budget and plan for the future with confidence. This can be especially beneficial in a volatile economic environment, as it allows borrowers to insulate themselves from sudden interest rate hikes.
Fixed rate prepayment penalties: A fee charged by the lender if the borrower pays off their loan before the end of the term. This fee is intended to compensate the lender for the loss of interest income that would have been earned if the loan had been paid off over the full term. The amount of the fee can vary, but it is typically a percentage of the loan balance or a set dollar amount. It's important to note that not all fixed rate mortgages have prepayment penalties. Some lenders may offer "no-cost" or "low-cost" mortgages with no prepayment penalty. Additionally, some lenders may have a clause that allows for a certain amount of prepayment each year without penalty, this is usually between 20-25% of the original loan amount.
Fixed rate mortgages can be a good option for investors who value stability and are willing to accept the trade-off of potentially higher interest rates in exchange for the peace of mind that comes with a fixed rate loan. Ultimately, the decision to choose a fixed rate mortgage will depend on an investor's individual financial goals and risk tolerance.
A variable mortgage rate is a type of mortgage where the interest rate can fluctuate based on market conditions. This can be beneficial for multifamily real estate investors as it may offer lower rates than fixed mortgages in low interest rate environments, or lower economic volatility, potentially leading to lower monthly mortgage payments. However, the downside is that when interest rates rise, so do the mortgage payments, which can be a significant financial burden for investors.
Additionally, variable mortgage rates can make budgeting and forecasting difficult for investors. Ultimately, the decision to choose a variable mortgage rate should be based on an investor's risk tolerance and financial stability as with the fixed rate mortgage.
Another option is adjustable rate mortgages (ARMs). ARMs are often a popular choice for investors. These types of mortgages offer a lower initial rate, which can be attractive for those looking to free up more capital for investing. However, it's important to be aware of the potential drawbacks of ARMs.
One major downside to ARMs is that the rate can quickly increase over time. This means that investors could end up paying more in the long run, even if they initially benefited from the lower initial rate. To mitigate this risk, some investors opt for rate caps, which limit the amount that the rate can increase. Unfortunately, rate caps have become quite expensive in recent years, making them less appealing as a risk management tool.
Key differences between ARMs and Variable rates:
The ARM has an interest rate that can change periodically, typically every year. The rate is based on an index, such as the Treasury index, and is usually set at a fixed rate for a certain period of time before adjusting.
A variable loan is a type of loan that has an interest rate that can change at any time, based on market conditions. This type of loan is typically offered by banks and other financial institutions, and the interest rate is usually based on the Prime rate.
Ultimately, the best mortgage option for a real estate investor will depend on their individual financial goals, risk tolerance, and the specific details of the investment property. Careful consideration and research is key to finding the mortgage option that is right for you.