Unless you have loads of cash tucked away, chances are you will need a rental property loan when you want to buy an income generating rental property. Naturally you will want to make sure you get the cheapest loan possible so that you won't end up paying more than you have to over the life of the mortgage loan.
There are two major ways to save money on a rental property loan. It includes getting the lowest possible interest rate and paying less total interest over the life of the loan.
There are three basic types of mortgage loans with their own advantages and disadvantages depending on your short and long term plans for your rental property. We are talking about fixed rate, adjustable rate and convertible loans here.
1. What Exactly are Fixed Rate Loans?
A fixed rate rental property loan is perhaps the most straight-forward loan available to landlords. This loan is so-named because the interest rate does not change over the lifetime of the loan. Unlike adjustable rate and convertible loans, your payment will not change according to the fluctuations in the market.
A fixed rate loan is generally the best choice if the mortgage rates are relatively low when you buy, such as during a recession or slow housing market. It's also a good choice if you plan to keep your property long term and want predictable mortgage payments.
2. How do Adjustable Rate Loans Work?
Fixed rate loans tend to start off with rates much higher than adjustable rate mortgages (ARMs) and convertible loans. In contrast, adjustable rates start low, then adjust upward at regular intervals and may eventually surpass fixed interest rates.
Why choose an ARM? If you can't afford current fixed rates but don't want to pass on that excellent rental property ARMs can help you get in. You will also want to have an exit strategy though, whether this means refinancing to a fixed rate later on or selling your property after a few years.
3. Finally What are Convertible Loans?
A third option that you can go for is a convertible loan with an adjustable rate for the initial time period of usually 3 to 7 years. After this time, you will have the option of converting your loan to a fixed rate.
It's also important to remember that the longer the term of your loan, the more you will pay in interest over time. A shorter loan term will mean a larger mortgage payment every month but this will reduce the total cost of your rental property loan at the same time. So it's a good idea to choose the shortest loan duration that you are able to afford.
Which Rental Property Loan is Right For You?
If you plan to keep the property long term, a fixed rate mortgage is usually best. If you plan to keep the property for just a couple of years, an ARM is a good choice, but it carries risks if you can't get out of the loan after the initial lock-in term. Finally, the convertible loan is a nice middle ground that will let you switch to a fixed rate later on.
