Recent news that mortgage rates have dropped to around 2% has made headlines in some financial reports, bolstering claims that these near record low rates are creating an ideal market for investors to seek financing for income property. But those attractive bargain basement rates apply to the slippery ARM (Adjustable Rate Mortgage) rather than the stable, fixed rate mortgages recommended by Jason Hartman to maximize returns on rental property investments.
At first glance, ARMs appear to be a good option, offering financing at initially low payments. The ARM is a complicated type of loan that, on the surface, appears to offer a break for borrowers in a budget – but which proved to be a trap for many homeowners in the housing collapse of the past few years.
As its name indicates, the ARM is an adjustable rate mortgage, which means that after an introductory low rate such as the 2% currently being advertised, the interest rate on the loan begins to rise, adjusted according to an external benchmark such as certificates of deposit or Treasury bills. ARMs are issued for varying periods. But when held long enough, the rates may eventually exceed those of a fixed rate mortgage.
The initial low rates of the ARM attracted many potential homeowners before the housing meltdown of 2008-2011. These rates allowed buyers who would otherwise not have been able to finance a home to get mortgage payments they could afford. But when the initial constant low rate became adjustable, payments shot up, pushing many unwary homeowners with marginal finances into foreclosures.
Less glamorous but significantly less risky is the standard fixed rate mortgage. Even at today’s low rates, interest rates on a fixed rate mortgage are higher than an ARM of an equivalent term – around 3.5%. But these rates are locked in for the term of the mortgage – and a 30-year term offers the lowest payments.
Fixed rate mortgages are far less complicated than ARMs. Borrowers know what the payment will be every month, making it easier to budget. And for investors, this fixed payment is easier to cover by rental income since it is predictable. With refinancing, investors can continue to keep payments stable while making a return on the investment through rents.
As Jason Hartman points out, home equity is vulnerable, and paying off loans in order to own a house free and clear can place an investor at a disadvantage, such as in situations like the recent Hurricane Sandy, which damaged many homes in several states. Mortgage holders in those states became eligible for mortgage relief due to the crisis – a benefit not available to owners of paid-off properties.
Likewise, mortgage holders profit from economic variables such as inflation, which can reduce the value of mortgage debt over time, and also from leverage opportunities unavailable to those who heed traditional financing advice and invest their own money into properties in an attempt to own them free and clear.
In the world of income property investing, ARMed means dangerous. But a fixed rate mortgage for 30 years, as Jason Hartman recommends, can be an investor’s friend, locking in financing rates and keeping savings in the bank to maximize long term gains.
The Jason Hartman Team
