Lender- 40 year loans

[LaTonya Clark]

Just got an accepted offer on a quad. Seller won’t budge on price and it will be tight for cash flow. Is it smart to take out a 40 year loan to get some cash flow? 

[Mitch M.]

Quote from @LaTonya Clark:

Yeah. I’m very skeptical of getting a40 year loan. When is it a smart situation to get one? I thought my situation would be one. 

Honestly, I’ve been around long enough to see 50-year loans, interest-only mortgages, and 40-year mortgages with balloon payments after 15 or 30 years. I’ve also dealt with loans where payments didn’t even cover all of the the interest owed each month—those deferred interest.

 With a 40-year mortgage, however, most of your payments go toward the interest, and almost nothing goes toward the principal balance. AND... A lot of them contain Balloon Payment Provisions. That is essentially a waste of money. You're better off opting for an interest-only mortgage, saving on payments, and then refinancing it into something more conventional when interest rates drop—or, if possible, making a plan to pay down the principal.

Interest-only loans, which typically last for the first 5 to 10 years of the loan term, offer two key benefits. First, they allow you to make lower payments during lean times, such as during remodeling, vacancies, or when you need to qualify for a loan before completing a renovation. But there's something else that many people don't realize: these loans  "constant recast" during the interest-only period.

For example, if I make an extra $400 payment one month, my interest-only payment will decrease the following month. You also have the ability to re-amortize the loan to suit your timeline.

Let’s say I have a $500,000 interest-only mortgage on a property. I make my regular interest-only payments for the first 7 or 8 months, and my interest-only period lasts 5 years. But if I decide to pay an extra $2,000 per month, in addition to my (dropping month after month) minimum interest-only payment, when the loan is recast to principal and interest, the new payment will be based on the remaining balance ($396,000) spread over 25 years. This results in a significantly lower payment after the reset. 

I've used this strategy on multiple properties, and it's worked well for me. Over time, I've accumulated more cash reserves and don't need as much flexibility, but I'm actually in the middle of a refinance right now using an interest-only mortgage—because the pricing with the lender and the corresponding ARM is more favorable than a comparable principal-and-interest loan.

The key with these alternative or "exotic" mortgage types is that you need to be financially savvy and have a solid plan. If you don’t, you could find yourself in financial trouble.