Posted on: 19th Oct, 2007 06:54 am
A lot of sites and other resources I\'ve come across claim that Interest Only or Option ARMs are the best choices for investment properties. Offline sources and LO\'s say that these can be dangerous loan types. Any thoughts on using these types of mortgages for investment property? Or on the best type of investment (rental, flip, etc.)?
Not necesarrily, you need to define your financial need e.g. how long you will hold these properties?, what is the purpose of them , are you building a real esatte portafolio or just merely want to do a flip. Once you define you R.E. Stragegy then go an pick the best loan program thert match your needs
They are usually not a good thing. It is up to you whether or not they benefit you. Let me try to clarify. Interest only and option arms pay lenders and brokers the most money per deal. So when that is put into perspective you can start to see why they are pushed so heavily. I have heard some strange reasoning behind their benefits. Let me break it down unless you can make more money through another investment, it is never a good deal to pay interest only or worse even less than the interest which is called negative ammortization.
So I do not recommend them. I will not sell a product to someone unless they need it. No matter how much the banks are willing to pay me in bonuses.
Now let me conclude with this. There is a situation this could benefit an investor. Say you plan on flipping a house in less than 6 months. As long as it sells you are OK, but what if it doesn't? You are in a deeper hole than when you started if you have been paying only interest or less.
The funny thing about interest only is do the math. Usually the savings from the normal payment are trivial because of the way interest ammortizes over 30 years. Add in that you get charged a higher rate for the interest only option and your payment is almost the same as it would have been anyhow.
If anyone wants to see some math on this let me know.
So I do not recommend them. I will not sell a product to someone unless they need it. No matter how much the banks are willing to pay me in bonuses.
Now let me conclude with this. There is a situation this could benefit an investor. Say you plan on flipping a house in less than 6 months. As long as it sells you are OK, but what if it doesn't? You are in a deeper hole than when you started if you have been paying only interest or less.
The funny thing about interest only is do the math. Usually the savings from the normal payment are trivial because of the way interest ammortizes over 30 years. Add in that you get charged a higher rate for the interest only option and your payment is almost the same as it would have been anyhow.
If anyone wants to see some math on this let me know.
"Usually the savings from the normal payment are trivial because of the way interest ammortizes over 30 years. Add in that you get charged a higher rate for the interest only option and your payment is almost the same as it would have been anyhow. "
Hey Eric, but how is this possible. you mean the normal payment without interest only and with interest only are the same? could you explain with the maths?
Hey Eric, but how is this possible. you mean the normal payment without interest only and with interest only are the same? could you explain with the maths?
"Hey Eric, but how is this possible. you mean the normal payment without interest only and with interest only are the same? could you explain with the maths?"
No problem here is the math.
Loan amount $100,000
30 year fixed ammortization @ 6%
Payment = $599.55 Total to pay off in 30 years
30 year fixed interest only @ 6.5% (you get a higher rate for interest only options)
Payment = $500 interest only payment (and after your interest only period the payment will recast to a much higher amount / and you have paid off NO principle. (at recast time many things can happen, often the note is due in full (means you'll have to refi or sell) Or the loan recasts and is paid off during the remaining of the 30 years at a much higher payment.
So you see the payment for doing interest only is only $99 less than the 30 year fixed in this example.
I am being more than fair with the interest difference because it could be as much as 1% difference in the rate. A lot of the interest only loans that I have priced end up being less than $100 difference in payments.
No problem here is the math.
Loan amount $100,000
30 year fixed ammortization @ 6%
Payment = $599.55 Total to pay off in 30 years
30 year fixed interest only @ 6.5% (you get a higher rate for interest only options)
Payment = $500 interest only payment (and after your interest only period the payment will recast to a much higher amount / and you have paid off NO principle. (at recast time many things can happen, often the note is due in full (means you'll have to refi or sell) Or the loan recasts and is paid off during the remaining of the 30 years at a much higher payment.
So you see the payment for doing interest only is only $99 less than the 30 year fixed in this example.
I am being more than fair with the interest difference because it could be as much as 1% difference in the rate. A lot of the interest only loans that I have priced end up being less than $100 difference in payments.
I'll disagree with Eric to a point but he is right about one thing wich is the main thing is you need to know what you are doing. In some cases it is possible to get interest only loan at almost the same rate as the fully ammortised payment. And interest only loans dont pay as much as 30 yr fixed ones. And it is possible to make the interest only loans and option arms work to your advantage. But you need stellar credit, positive cashflow and the ability to make fully ammortised payments if nessesary.
This works in a layered investment scenario or in a bull market when houses go up in value fast and is not suitable for everyone.
Both option arms and interest only programs enjoy a smaller payment allowing an investor to buy more property for his money or allowing a better cashflow. Unfortinutelythese programs give only limmited time with these lower payments and the property needs to be turned around and payed off /resold in 3-5 years.
Here is example of how this would typically work.
Say you have $2000/mon you can spend on a property you want to buy. A conventional 30 yr fixed loan at 6.25% would allow you to buy a 325k property, a interest only at 6.625% would allow to buy a 370k property, and a 2% minnimum option arm payment would allow for a 523k property. Now this means an investor can buy more/larger propertiesand rent them out for more $$ and in a bull market he gets more return when he sells them. For example if he can sell the properties 4-5 yrs down the road at 20% profit then on a conventional loan he would make 65k, on int only 75k, and on option arm $104k. This is very simplistic way of looking at it and there is alot of things to concider but its sort of howit works. The problem is an average consumer will not be able to deal with this.
When this does help an average consumer is when their income varies greatly from month to month such as with self employed people or seasonal workers. This way they can pay lower payments when things are tough and extra towards principle when things are good.
The biggest mistake people make with these kinds of loans is assuming the payment that is asked for is all they need to pay. This will get you nowhere fast.
This works in a layered investment scenario or in a bull market when houses go up in value fast and is not suitable for everyone.
Both option arms and interest only programs enjoy a smaller payment allowing an investor to buy more property for his money or allowing a better cashflow. Unfortinutelythese programs give only limmited time with these lower payments and the property needs to be turned around and payed off /resold in 3-5 years.
Here is example of how this would typically work.
Say you have $2000/mon you can spend on a property you want to buy. A conventional 30 yr fixed loan at 6.25% would allow you to buy a 325k property, a interest only at 6.625% would allow to buy a 370k property, and a 2% minnimum option arm payment would allow for a 523k property. Now this means an investor can buy more/larger propertiesand rent them out for more $$ and in a bull market he gets more return when he sells them. For example if he can sell the properties 4-5 yrs down the road at 20% profit then on a conventional loan he would make 65k, on int only 75k, and on option arm $104k. This is very simplistic way of looking at it and there is alot of things to concider but its sort of howit works. The problem is an average consumer will not be able to deal with this.
When this does help an average consumer is when their income varies greatly from month to month such as with self employed people or seasonal workers. This way they can pay lower payments when things are tough and extra towards principle when things are good.
The biggest mistake people make with these kinds of loans is assuming the payment that is asked for is all they need to pay. This will get you nowhere fast.
Here is another example where this interest only loan would work well. Say you are 10 yrs from retirement and your household income $5000/mon making your 30yr fixed 6.25% mortgage of 250,000 at $1540/mon very affordable so you can put $500 extra towards principle every month. Only at this pace you will still have more then 6 yrs payments left when you hit retirement or if you pay just the $1540 then well over 10 years. Payments will not change they will still be $1540/mon but if your pension is $1000/mon and your SSI is 800/mon and you get $700 from your 401k you only making $2500/mon wich can force you to strugle with payments/retire later/refinance the home/or use your 401k to pay it off.
Now if you go with interest only option on a 30 yr fixed it has a 10 yr interest only option and any extra is going straight towards your ballance. So even with higher rate of 6.625 on a 250k mortgage and same payments of 1540+500/mon you are paying $1380/mon in interest and the rest goes towards your principle so at the end of year one your balance is 242k, year 2-233.5k, year 3 - 224.5k, year 4 - 215k, year 5 - 205k, year 6 - 195k, year 7 - 183k, year 8 - 171k, year 9 - 158k, year 10 - 144k. At this point your 144k remaining balance will reamortise itself over remaining 20 years on the loan making your payment $1084/mon wich is $500 lower then the first scenario. It is true that this will cause you to pay your loan longer and hence pay more interest on it but it will be a comfortable enough payment where you dont have to strugle.
Its always a tradeoff. So you have to think ahead.
Now if you go with interest only option on a 30 yr fixed it has a 10 yr interest only option and any extra is going straight towards your ballance. So even with higher rate of 6.625 on a 250k mortgage and same payments of 1540+500/mon you are paying $1380/mon in interest and the rest goes towards your principle so at the end of year one your balance is 242k, year 2-233.5k, year 3 - 224.5k, year 4 - 215k, year 5 - 205k, year 6 - 195k, year 7 - 183k, year 8 - 171k, year 9 - 158k, year 10 - 144k. At this point your 144k remaining balance will reamortise itself over remaining 20 years on the loan making your payment $1084/mon wich is $500 lower then the first scenario. It is true that this will cause you to pay your loan longer and hence pay more interest on it but it will be a comfortable enough payment where you dont have to strugle.
Its always a tradeoff. So you have to think ahead.
Great info guys! this forum rocks!!
I have a question to you all, what's is so different about teaser rates in hybrid and option ARm? Do theyw ork out differently for both the options? Thanks in advance
I have a question to you all, what's is so different about teaser rates in hybrid and option ARm? Do theyw ork out differently for both the options? Thanks in advance
Hello Jennifer,
The teaser rate is usually just that a tease. If the rate is 1% then that is what you pay while the teaser rate is active. After the loan ammortizes regularly for the rest of the 30 years. What happens is this if you have a 1% teaser rate that is not the actual loan rate. The loan might have an actual rate of 7.5%. Now for the time that you pay the 1% payment the difference of the 6.5% gets added to your loan amount. This is called negative ammortization. Your loan amount goes up. You owe more money at the end of the teaser period which you have to now pay back at a higher payment than you would have if you just did a normal loan from the beginning.
Let me know if that makes any sense to you.
The teaser rate is usually just that a tease. If the rate is 1% then that is what you pay while the teaser rate is active. After the loan ammortizes regularly for the rest of the 30 years. What happens is this if you have a 1% teaser rate that is not the actual loan rate. The loan might have an actual rate of 7.5%. Now for the time that you pay the 1% payment the difference of the 6.5% gets added to your loan amount. This is called negative ammortization. Your loan amount goes up. You owe more money at the end of the teaser period which you have to now pay back at a higher payment than you would have if you just did a normal loan from the beginning.
Let me know if that makes any sense to you.
I understand your point but say in hybrid ARM, let's take 5/1 year ARM (i hope i am on the right track), the rate remains fixed for 5 years. So, isn't it odd that the 1% rate would remain so for 5 years?Am i missing something in between? i thought it would be differnt in option and hybrid types, just a bit confused i guess?
I don't think you are missing anything. It would be odd to last that long. Normally the teaser rate lasts between 1 month - 1 year, at which time the loan recasts.
A hybrid arm is one that has a fixed rate for a set period. It can be 2/3/5/7/10 years. In comparison to a standard ARM which adjusts every year.
An option ARM is one where you get an option of what you want to pay every month. You can usually pick a minimum payment, an interest only payment, or a fully ammortized payment. Hence the "option".
The confusion comes because lenders are actually allowed to tell you that your rate and payment are based on the 1%. It is the borrowers responsibility to read the fine print. If you have read any of my previous posts you will see that I think this is a form of mortgage fraud, although legally it isn't (it is my personal opinion). Don't get me wrong there are times it could be used but only if the borrower fully understands what is going on.
A hybrid arm is one that has a fixed rate for a set period. It can be 2/3/5/7/10 years. In comparison to a standard ARM which adjusts every year.
An option ARM is one where you get an option of what you want to pay every month. You can usually pick a minimum payment, an interest only payment, or a fully ammortized payment. Hence the "option".
The confusion comes because lenders are actually allowed to tell you that your rate and payment are based on the 1%. It is the borrowers responsibility to read the fine print. If you have read any of my previous posts you will see that I think this is a form of mortgage fraud, although legally it isn't (it is my personal opinion). Don't get me wrong there are times it could be used but only if the borrower fully understands what is going on.