should i pay more down payment lower interest rate

Question

Hello,

That will be my first post and my first investment as well

I made an offer for a condo at chicago suburbs and finally it was accepted. it's a condo 2beds 2 baths for $195K. Now i am trying to apply for a loan and i have to pick between paying 25% down with 3.3% interest vs 20% down with 4% interest.

should i save the cash to use it to buy a new property in the future even and pay higher interest rate or use it to lower the interest rate?

Thank you

Joe Splitrock · Answer

You can't put 3% or 5% down on an investment property. Although he didn't specifically say it was an investment property, that is a fair assumption given the interest rates.

So the question is 20% down versus 25%. I do think interest rate and interest savings make a difference. Even if the tenant is servicing the debt, you still get to keep what is left over. If the debt service is higher, that means less monthly in your pocket. In this example:

3.3% with 25% down borrowing $146,250 and payment of $640.51

4% with 20% down is borrowing $156,000 and payment of $744.77

The difference is $9750 additional out of pocket for $104.26 monthly cash flow or $1251.12 annual. That is 12% annual return on the $9750 with 93 month pay back on initial investment.

I am a fan of running the numbers, then making a decision. "Badge of honor" would be an emotional decision, but so is making a decision without running the numbers. I think 12% is a pretty good guaranteed return on capital, so you have to to think hard about where you will get a better return.

All that being said, if I had an option of 3% or 5% down, I would never put 20-25% into a deal. Interest rate in that situation becomes less of an issue, because of the massive difference in capital. There is also the likely option to refinance in the future to reduce interest rate, so that needs to be considered. You could take a higher rate today and do a cash out refinance in the future, leaving 25% equity in the deal.

Part of this is risk tolerance, but most of it is future plans for your money.

Bud Gaffney · Answer

@George B. Keep your cash. Have your tenant rents pay the interest 😃

Bill B. · Answer

Less than $10k additional downpayment lowers your payment $104/mo or $1251/year, saves you almost $30k in interest over 30 years. So you're earning a guaranteed 10% on your money. I doubt that extra $10k will slow down your investment progress unless funds are truly tight. In which case I might suggest waiting a year anyway after first purchase to make sure your numbers are right and the property is performing.

Unless you plan on selling in the next 5 years (In which case I might suggest you not buy anyway.) You'll fee a lot better 5-10 years from now when you look at that interest rate and the fact you've gotten your $10k back and the next 20 years is gravy.

Steve Vaughan · Answer

.6% is my threshold to lay out more capital up front or in a higher PI pmt (like going with s 15yr vs 30yr) so I'd put down the extra $10k.

But some really can't afford to put up the extra 10k if they don't absolutely have to.  It depends on how much that means in your  world and if It will keep you from your goals.

John Warren · Answer

@George B. I don't disagree with the others here on this post necessarily, but I personally would rather put down 3% or 5% and do a low down payment conventional loan. Then you would be keeping 20-25k in your pocket to do another deal. If the condo is something you are going to live in for a long time then I guess having a lower interest rate makes sense for your primary, but if this is an investment then your money will be much better utilized by doing another deal. The potential "savings" over the course of a loan is irrelevant if you can keep your money moving and buy more units. The reason for this is that the dollar is worth significantly more today than it will be in 10, 20 or 30 years.

The other thing to think about is that when a tenant is paying you rent they are actually servicing the debt for you. So many newer investors get hung up on the interest rate like it is a badge of honor to have the lowest rate. I would rather focus on growing my capital and also on the return on capital. Those are the things that will help you grow your wealth long term.

Michael K. · Answer

@George B. I think @John Warren makes a valid point. The difference between 20% and 25% is not so large that it's really going to change your trajectory very much either way you go. Deciding between 3-5% and 25%, however, will make a big difference. Think about your ability to make money and store it. If you have a super high-paying job and are able to stash away tons of money every month then that's one thing, but if it takes you a long time to save up 10K then I would consider the low down payment option. This will also leave you with more money for repairs and upgrades, which will allow you to refi and recapture as well as raise the rent.

George Bechir · Answer

Thank you so much guy, i appreciated your help. I went ahead and decided to pay 20% with more interest rate and save the extra cash to buy another property.

Thanks for all the helps

Josue Vargas · Answer

That is a good question.  You didn't specify the loan term.  Is it a long term (keep forever) or short term?  I'm assuming is a long term 20 to 30-yr loan.

Basically the lower interest rate makes more sense.  You will have more capital to invest, therefore you will have other sources for greater ROI.

In other words you will make more $ elsewhere than tying the extra cash for the same loan, if that makes sense.

Danielle Jackson · Answer

All great advice! But what are your long term goals? More doors?

Don't forget you are borrowing at record low rates, especially relative to a 5.4% rate of inflation (and growing!).

Also, when you are running your #'s, don't forget to look at growth rates re: rental income. Average rental growth in the last 12 months was 11.5% on a national average. In some markets, it was closer to 22-25%. That is certainly something to factor in when considering keeping a little reserve versus putting it down. At a 12% rental growth rate within 1 year, would that cover difference in payment? How does cash flow look in both situations? What is the timeline for which that 10k be doubled or tripled and potentially be another down payment for a 2nd property? Is it worth having to potentially tap into the equity for this property and have to pay interest on your own cash at that point? Time value of money is a very real thing.

I know a lot to think about, but the picture we currently have isn't quite complete. Whatever you decide. CONGRATULATIONS on your first property. A lot to be excited about.

Nick Barlow · Answer

@George B. Keep cash for reserves and “rainy days”.

I desire a much higher reserve amount post-pandemic than I did when I was starting out pre-pandemic.

Good luck on your first investment!

should i pay more down payment lower interest rate

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