Adjustable Rate Mortgage Shock
Adjustable Rate Mortgages (ARMs) can often seem like a tempting option when interest rates appear to be declining. As someone who has built and manages a sizable rental portfolio, I’ve had my fair share of experiences with ARMs. In this post, I'm sharing insights from my personal journey to help you better understand the potential risks and rewards of opting for variable rate debt.
Understanding the Current Market Climate
Hey, I'm Cameron from Emerson Property Management. With interest rates fluctuating between 6% and 8% at the time of this recording in 2024, many might consider ARMs a viable option. But before jumping in, it’s crucial to contemplate how these rates can transform over time.
My Personal ARM Experience
Back in 2017, I decided to try a variable rate mortgage on one of my properties. Initially, the interest rate was an attractive 3.25%. However, post the initial five-year lock-in period, the rate hiked annually, currently standing at 7.625%. This rate hike has transformed my principal and interest payment from $473.51 to $720.49, marking a whopping 52% increase.
The Pitfalls of Variable Rate Debt
This substantial increase is a prime example of why I'm cautious about variable rate debt. My personal strategy involves maintaining a majority of my portfolio on fixed-rate loans, which remain unaffected amidst surging rates, helping me absorb the increased costs of this variable loan. But for those whose portfolios heavily rely on variable rates, a monthly payment hike of this magnitude can be devastating.
Assessing Your Risk Tolerance
When contemplating ARMs, it's imperative to conduct a thorough risk assessment:
Rate Caps: Understand the maximum rate cap for your loan. In my case, the highest possible rate is 8.25%.
Stress Tests: Conduct a sleep test: Can you rest easy knowing your mortgage may escalate by over 60-70%? What’s your exit strategy if the rates peak?
Moreover, consider how these fluctuations might affect larger investments. Imagine managing a commercial property where a monthly payment of $100,000 surges to $152,000. It's crucial to ensure there's adequate cushioning in your portfolio to handle such upticks.
Broader Implications on Your Financial Health
It’s important to remember that mortgage payments aren’t just about principal and interest. Increasing property taxes and insurance premiums are other factors that can affect total carrying costs. My own taxes once increased by over 20% in a year – without even delving into insurance.
Final Thoughts
In conclusion, while ARMs might appear tempting due to initially lower rates, it's essential to weigh these potential savings against possible future increases. Building a diversified portfolio with a mix of fixed and variable debt, coupled with a robust risk management strategy, can safeguard against financial surprises.
I hope you found this insight helpful. If you’re interested in understanding how taxes and insurance impact overall payments or want a deeper dive into commercial ARMs, let me know in the comments.