Elon Musk Took This Mortgage Risk. Should You?

You probably shouldn't follow the billionaire's lead.

Elon Musk is a well-known entrepreneur. The billionaire is best known for his role as Tesla's CEO as well as for founding SpaceX.

Despite the fact that Musk has plenty of money, he took out several very large mortgages. Specifically, he borrowed a whopping $61 million to pay for five properties located in California.

When Musk took out his mortgages, he made a decision about the type of loans to take out. The choice he made is one that carries substantial financial risks. While Musk has since sold all of his homes, we can learn from his prior purchases.

Musk took a big chance with his mortgage loans

When Musk borrowed money for his homes, he chose a specific kind of mortgage called a hybrid-adjustable loan. The mortgage was a 30-year loan, which means he had three decades to pay it off. But unlike a 30-year fixed-rate mortgage, the loans didn’t provide a guarantee of stable monthly payments.

Instead, Musk's loans had an initial starting rate of 3.5% for the first several years. After the initial introductory period, this 3.5% rate is not guaranteed. The rate can adjust based on a financial index that it is tied to. As a result, if the financial index showed that rates were rising, Musk's interest rate and monthly payment would both go up.

Adjustable-rate mortgages aren't just available to wealthy entrepreneurs like Musk. Anyone can take out this type of loan when they borrow to buy a home, if they choose to do so. But, opting for an adjustable-rate mortgage may not be the best idea for the average person.

Here's why an ARM may not be an ideal choice for the typical home buyer

Musk was able to take a chance on a hybrid-adjustable mortgage since he's a billionaire. With his amount of wealth, he could easily afford to take the chance that his rate would go up and his payments and total borrowing costs would increase if and when that occurred.

Since it wouldn't have been a financial catastrophe for Musk to see his monthly payments increase, he was able to opt for an ARM that offered a lower starting rate, even if that meant there was a chance he ended up paying more over time.

Musk was also unlikely to find himself in a financial position where he wouldn't be able to refinance his loan if he needed to, especially given his personal wealth and his long-established borrowing relationship with major banks, including Morgan Stanley.

The typical borrower, however, may not be so well equipped to bear the risks associated with adjustable-rate loans. For the average person, if rates rise -- and there's a good chance they will -- seeing a big increase to their monthly mortgage payments could cause serious financial hardship. And the typical borrower could easily find themselves in a position where refinancing when they need to is difficult or impossible, as they could see a decline in income or property values.

Ultimately, while a hybrid-adjustable mortgage may have been a fine financial decision for Musk, those who don't have his billions should likely opt for a 30-year fixed-rate loan that provides a guaranteed payment for the life of the mortgage. This offers certainty that payments won't change so borrowers can make sure buying their home will be affordable over time.