Can you get an ARM for an investment property?

Financing an investment property can be an opportunity to build wealth through equity and appreciation, but it also means learning about different lending options than those available for a primary residence. An adjustable-rate mortgage (ARM) can be a good choice for investors who want to own a property for a shorter period of time or who are looking for a lower interest rate.

We’ll break down how ARMs for investment properties work, how their rates can differ from those used to buy a primary residence, and help you decide whether an ARM is the right investment property loan for you.

ARM loan basics

An ARM is a home loan that has an interest rate that can change over time. Usually, the rate is fixed for the first few years, usually 3 to 10, then changes regularly after that.

ARMs are quoted using two numbers, such as a 5/1 ARM or 7/1. These numbers refer to the period that the introductory rate lasts and how frequently the rate changes once the intro period ends. A 5/1 ARM has a rate that is fixed for the first five years, then adjusts once per year after that.

An ARM with a shorter introductory period may be a good fit for real estate investors who are looking for a loan for flipping a property. Longer rate locks can be useful if you want to rent the home out and don’t mind if the rate fluctuates down the line.

At each adjustment, the mortgage rate will change based on the calculation laid out in the mortgage documents. Usually, the rate is calculated using a benchmark rate, such as the ten-year bond rate, plus a margin, such as 2%. So, if the ten-year bond rate is 5% and the margin is 2%, the new rate would be 7%.

Many ARMs come with rate caps and floors that limit how high or low the rate can be. They may also limit the amount the rate can change at one time, which can protect homeowners from large fluctuations in rates. Often, the cap on how much rates can change per adjustment is 1% or 2%.

Non-owner-occupied loan rates

In general, lenders tend to charge higher interest rates on loans that are used for investment properties rather than primary residences. Lenders view investment properties are riskier because borrowers are not as incentivized to avoid default as they would be if the home they were living in were at risk of foreclosure. Investors may also struggle to find renters, meaning they aren’t getting the income they were going to rely on to pay the mortgage.

According to Experian, you can expect to see rates anywhere from 0.25% to 0.875% higher for investment property loans than mortgages for primary residences. That can mean a monthly payment that is anywhere from $15.38 to $54.72 higher per $100,000 you borrow. For a $500,000 loan that means paying between $76.90 and $273.60 more per month. That adds up over the life of a 30-year mortgage.

This is true for ARMs as well. You can benefit from the lower rate charged on ARMs, at least during their introductory period, but may not see the same savings you would get if you were using the loan to buy your primary home.

Pros and cons of ARMS for investors

If you’re thinking about using an ARM to buy an investment property, consider both the pros and cons.

Pros

Some benefits of using an ARM to buy an investment property include:

• Low interest during the fixed period. During the first few years of the loan, you’ll pay less interest than you would on a fixed-rate loan, saving you money.
• Reliable payment during the fixed period. Because the rate is fixed for the first few years, you don’t have to worry about your payment being unpredictable at first.
• Refinance your loan after some time. Once you’ve had the investment property for a while and have built equity, you may be able to refinance with better terms rather than letting the loan’s rate start to adjust.
• Boost your buying power. The lower monthly payment thanks to the ARM’s lower interest rate may boost your buying power, letting you buy a more expensive investment home.

Cons

ARMs aren’t perfect for every investor, so keep these drawbacks in mind.

• Payment may balloon during the adjustable period. Once the introductory period ends, your loan’s rate, and therefore monthly payment, could increase, making the property unaffordable.
• Investors can’t get the lowest possible rates. You won’t be able to get the best rate available on your ARM because you plan to use it for an investment property rather than a primary residence.
• Difficulty planning for the future. Investors often project their returns years or decades into the future so they can plan future investments or financial moves. Given that the interest rate of your loan could change every year, it makes long-term planning difficult.

The bottom line: ARMs are available to investors

If you’re a real estate investor, an adjustable-rate mortgage may be appealing due to its lower introductory interest rate. ARMs are a good fit for some types of investment, particularly house flipping, where you aim to sell the home before the loan rate begins to adjust, but they can also work for other types of real estate investment.

Before committing to an ARM, make sure you understand how adjustable-rate loans work and take a moment to ensure you can afford the payments if rates rise. If you’re ready to apply for a loan, you can start an application with Rocket Mortgage today.