I have an investment property I am currently pursuing. Its a four unit with monthly rental at 2,700 per month. Appraised at 235k my offer is 190k with seller contributing closing cost. Interest only looks appealing for first few years. However, I feel it looks to good to be true. Am I missing something on is interest only loan a good option? or should I try a 3/5 year arm? Thank you in advance for your advise.

James :slight_smile:

Depends upon your deal and your investment plan. Will the property cash flow with an amortizing loan? How long will you hold the property as an investment? How quickly will the property appreciate, or are property values declining.

There are situations where an interest only loan makes sense, but for most long term investments an amortizing loan gives you a lower total loan cost over your holding period. As your holding period increases, so does the cost of financing that interest only loan.

For example, consider a $100K amortizing loan at 6% over 30 years. At the end of 30 years, you will have paid $215,838.19 to retire this loan. The same $100K loan at 6% as an interest only loan for 30 years will cost you $316,000 to retire the loan.

There is not good cash flow on the property on a amortized loan. This is why I was looking at an 3/5 ARM or maybe interest only for a few years. I may keep the property 5-7 years. Maybe longer

I like the FLEX plan it has 4 pymt types min, intrest, 15 or 30 yr this way I can choose the option I want when I want. I can max cash flow with int only or pay prin. at 15 yr rate. But most of the time I pay int. only. I also recommend this to all my clients if.

What terms are you being quoted on your amortizing loan? With a loan amount of $190K and a 30-year fixed rate loan at 6%, your debt service is only about $1140 per month.

Against a rental income of $2700, this leaves you $1560 monthly to cover all your operating expenses and have some left over for cash flow.

If the operating expenses are so high that you can’t cash flow with an amortizing loan, then the property is priced too high, the rents are too low, and/or the operating expenses are too costly. Essentially, you are paying $50K for a unit that you will rent for $675 per month. At first glance, these numbers should cash flow even with an amortizing loan. Are you sure about your operating expense numbers?

An interest only loan might help you cash flow, but you are really only deferring your principal payments and paying a little more interest each month for the priviledge. Your total cost of financing the property will be higher with the interest only loan than with an amortizing loan.

What happens when a major repair expense comes up? How many months of your cash flow will be consumed by a roof replacement?

Rather than trying to make a bad deal marginal by tinkering with your financing, you might want to reconsider the investment criteria that makes you think this is a good deal in the first place.

Remember that an interest only loan does not reduce your loan balance. I hope you are not depending upon future appreciation to bail you out. Appreciation over a short term is never guaranteed. Your market may see a 20% drop in housing prices in the next five years. When this happens, could your loan to value get upside down? If so, you have to bring your own money to the settlement table to pay off the loan balance because there is no equity in the property.

Personally, under these circumstances, I would pass on this property and look for something more profitable.