Which Mortgage Loan Is The Best For Your Business?By Paul Esajian on May 26, 2015
Do you know which mortgage loans are best for real estate investors?
While there may be fewer real estate financing options out there today, the choices can still be confusing. Picking the best loan program and features can make a big difference in actual returns, as well as being able to weather the unexpected. So how do the options stack up?
30 Year Fixed Rate Mortgages
The 30 year fixed rate mortgage is really the bread and butter of the mortgage industry. It provides stability, predictability, and safety for buy and hold real estate investors. With interest rates still at incredible lows, but predicted to rise, locking in low payments for 30 years can be a very smart move. It’s also worth pointing out that these long-term fixed mortgages are almost unique on the world stage. They are one of the big perks of investing in U.S. real estate.
15 Year Fixed Rate Mortgages
With interest rates low, and many real estate investors focused on being debt free sooner, 15 year fixed loans have been more popular. They slice the time to being free of a mortgage in half. They also normally come with lower interest rates. Together this means paying dramatically less in interest over the life of a loan. And to purchase an asset. There are 25, 20, and 10 year fixed rate mortgages too. But the most notable difference is between the 30 and 15 year fixed. The down side to these loans for investors is the higher monthly payment. You have to pay the loan off in half the usual time. That can take a huge bite out of cash flow. It also means that if rental properties go vacant there is an even bigger void to fill. While equity may be built up faster, investors must watch the cost of lost opportunity. For example; if you are plowing money down on a 4% rate mortgage, but are missing deals that could return 20% or more per year; you are losing out. The higher payments may also be detrimental to debt-to-income ratios and qualifying for additional funding. For investors planning to buy and hold properties for the long term a 30 year fixed rate loan can offer a lot more freedom. Remember you can always pay the loan down faster when times are good. When cash flow is leaner then at least you’ll have more flexibility.
Adjustable Rate Mortgages
Adjustable rate loan or ‘ARMs’ can provide real estate investors with even lower rates and payments in the short term. Lower rates are normally offered for the first 1, 5, or 7 years. This can be great if you plan to flip houses, or have an exit strategy with an expiration date sooner than your first adjustment. However, in a rising rate environment these loans can sabotage investors that don’t plan ahead. Yes, you may be able to refinance later. But how much is that going to cost? And what are rates going to be like then?
Interest Only Loans
Interest only loans seem to be making a bigger and bigger comeback. These ‘IO’ loans can offer even more flexibility for real estate investors. If you plan to hold the property for just a couple of years, and are confident in rising equity, then interest only might help maximize cash flow and total returns. Just be aware that when the interest only honeymoon is over, payments can go up significantly.
Loans with Pre-payment Penalties
Pre-payment penalties have stung plenty of real estate owners in the past. They have not only been expensive, but have blocked some from being able to sell. But they aren’t always bad. A modest pre-payment penalty on a property you plan to keep for the long haul may actually be a good thing. For example; do the math on getting a 1% interest rate cut for 30 years in exchange for opting to take a pre-payment penalty for the first three. Just be very meticulous about checking the terms of the penalty.
Commercial Mortgage Loans
Many lenders have transitioned to commercial real estate funding only. There are fewer rules, regulations, and liabilities. This gives them more flexibility in making common sense loans. It can also give real estate investors more flexibility in creative deal structuring. These lenders will often loan on residential property too, just as long as you don’t plan to live in it yourself.
Blanket mortgage loans have also risen in popularity since the crises of the early 2000s. These allow investors to leverage multiple properties with just one loan. There can be huge operational and cost advantages to this for borrowers. Just watch for individual releases. You don’t want a million dollar loan that locks up 10 $100,000 properties until the whole balance is paid off. Be thorough in reading the fine print.