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Avoid Adjustable Rate Mortgages on Income Property


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Although adjustable rate mortgages have their place, in most income property scenarios you would be wise to avoid these like the plague.  This is especially true if you have a long term investment strategy.  You see, unlike a 30-year fixed rate mortgage, the interest rate on an adjustable rate mortgage (ARM) will change depending on how the underlying index to which it is tied changes.  Most often, this change represents an increase in the rate you are paying.

An ARM will generally be expressed as a 1-year, 3-year, or 5-year ARM.  During the initial 1, 3 or 5 year period, the interest rate on the ARM will stay the same.  But after this timeframe, the interest rate will adjust itself based on the underlying index.  The problem with this is that your mortgage expense becomes unpredictable the farther out in time you go from the origination date.  In other words, if you plan to hold the property for 10 years, it is impossible to know what your adjusted rate will be 10 years from now.

Of course, there may be a few scenarios where you might want to consider an ARM to finance real estate.  One is obviously if you have a short term strategy.  If you get a 5-year ARM and you plan to sell in 3 years, then it might be worth considering.  Or you could plan to refinance before the initial fixed rate period expires.  However, just keep in mind that even in these scenarios, you’re going to be rolling the dice a little with an ARM.  You simply cannot predict the future, and hence you can’t say for sure what the market or mortgage rate indexes will look like years from now.

The bottom line is that an ARM introduces a little bit more unpredictability and uncertainty into your real estate business.  In my opinion, even a little extra unpredictability increases risk, and therefore is simply not worth it.  Instead, opt for a fixed rate investment property mortgage.



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