An adjustable-rate mortgage (ARM) is a type of home loan where the interest rate can change periodically, usually in response to changes in the market. ARMs are a popular choice for real estate investors because they often come with lower initial interest rates than fixed-rate mortgages, which can make them more affordable in the short term. However, there are also risks associated with ARMs that investors should be aware of before deciding whether to use one for their real estate investments.
Pros of Adjustable-Rate Mortgages:
Lower initial interest rates: As mentioned, one of the main advantages of an ARM is that it often comes with a lower initial interest rate than a fixed-rate mortgage. This can make it more affordable for investors to borrow money to purchase a property, especially if they expect to sell or refinance within a few years.
Flexibility: ARMs can also be a good option for investors who are unsure about how long they will hold onto a property. Because the interest rate on an ARM can change, investors have the flexibility to either keep the loan if rates go down or refinance if rates go up.
Potential for savings: If market interest rates go down after an investor takes out an ARM, they may be able to save money on their mortgage payments. This can be especially beneficial for investors who plan to hold onto a property for a long time.
Cons of Adjustable-Rate Mortgages:
Risk of rising interest rates: The biggest risk associated with an ARM is the possibility of rising interest rates. If rates go up after an investor takes out an ARM, their mortgage payments could become unaffordable. This can be especially risky for investors who plan to hold onto a property for a long time.
Limited predictability: Because the interest rate on an ARM can change, it can be difficult for investors to predict exactly how much their mortgage payments will be from one year to the next. This can make it challenging for investors to budget and plan for the long term.
Potential for payment shock: Another risk of an ARM is the possibility of a "payment shock," where the interest rate adjusts to a much higher level than the investor was expecting. This can result in a significant increase in the investor's mortgage payments, which could be difficult to afford.
Overall, adjustable-rate mortgages can be a good option for real estate investors who are looking for a more affordable way to finance a property in the short term and who are comfortable with the risks associated with an ARM. However, it's important for investors to carefully consider whether an ARM is the right choice for their specific investment goals and financial situation.