What's the best mortgage length you all do?

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Albert Bui · Answer

Sounds like he has done well for himself but one comment I would add is that break even cash flows can be a bit risky if his only other source of income is his work in the event he has an emergency. This would be true especially if he has a higher income or job since state disability or work provided disability only pays a fraction of a income earners pay.

10-15 year fixed loans again can provide "break even," cash flows because most of the payment is principal with a smaller fraction of it being interest.

Only the interest is a write off as a taxable expense not the amortization of his principal so its possible to be cash flow break even like you mentioned from a month to month perspective, but since his interest is lower he may very well have "taxable income," and tax liability to pay for that will have to come from his other income sources or job.

So all in all I think its good to have a good balance between appreciation/pay down type of property/cash flow sources so that it aligns with a persons goals on their cash flow and balance sheet statements.

Some people work too hard to focus on the balance sheet only or spend too much time on cash flow statement. The specific balance for each person may vary and there are tons of blogs debating the topic of appreciation or cash flow.

Prudent financial planning would include both, risk management, protection, and tax planning as well.

Account Closed · Answer

Dylan,

When you say he has a breakeven cash flow, do you mean the rents just cover the mortgage.  Or do you mean that the rents cover the mortgages and all repair & maintenance expenses?  I would guess that with 10/15 yr mortgages, the rents are only covering the mortgages, which means he's pumping in additional equity into his real estate business to fund maintenance, repairs and vacancy expenses since he doesn't have sufficient cash flow to cover these additional cost in addition to making the mortgage payments.

There is nothing wrong with this strategy as long as you have additional free cash from your regular income to cover these additional costs that may not occur every single month, but do occur nonetheless.

Taking the 15 yr mortgage can reduce your cost of capital, thus increase your net income, but it comes at the expense of free cash flow.  I would suggest using a combination of 30 and 15 yr mortgages if you have multiple properties.  Creating the scenarios where you have sufficient cash flow to cover mortgages and repair and maintenance expenses while trying to achieve the lowest overall cost of borrowings.

Case in point: I have a 15 yr mortgage on a rental property that has negative cash flow of $50 a month not including any repair, maintenance and vacancies.  However, each month the tenant make the $1K p/mo rental payment $600 goes toward principle or $7,200 in equity a year (which increases every year as the interest portion decreases each and every year).  Let's say I have to come out of pocket $1,500 a year for repairs, which is high by the way, and an additional $600 to cover the mortgage payments not covered by the monthly rent.  I'm basically trading $2,100 of out of pocket expenses for $7,200 in equity just by reducing the principle balance and does not include any appreciation.  That's not a bad return.  In fact, I've almost tripled my money.  If I had taken the same $2,100 and invested it in a diversified stock mutual fund, I can almost gurantee you I would not have tripled my money in one year.

It's tough to do this with multiple properties, since it would become very expensive to come out of pocket for R&M on several properties.  However, if you have other holdings that generate lots of good FCF, then using a mix of 15 and 30 yr mortages is a good balance.

One other point that is important to take into consideration is the ability to obtain additional financing in the future to grow your holdings.  Lenders generally will only give you credit for 75% of the rents, so if you have a $1,000 mortage and you collect $1,000 dollars in rent.  The lender will only count $750, which means $250 is being counted against your debt-to-income ratio.

Unless you have a super high paying job or extremely low living expenses, it will be difficult to continue taking that kind of hit if you're still trying to acquire more property using financing.

These are all factors you have to consider.  Again, finding the right balance to achieve your objectives will be key.

Mike H. · Answer

One thing I would add. Since he has a full time job (i.e. teacher), there is only one way he could be writing off all his paper losses for his regular income. Unless you're classified as a "real estate professional", you are limited to a 25k loss writeoff.

And in order to be classified as such, he would have to prove that:

1) He spends at least 750 hrs on his real estate activities (possible, but....)

2) He spends more time on his real estate activities than he does at his regular job.

To me, that second one would be the tricky one. If he's spending 40 hrs a week as a teacher, he would have to prove he is spending over 40 hrs a week on real estate. Seems a little unlikely.

That said, they say that this real estate professional designation is a huge red flag to the IRS - especially if you also have another full time job.

What's the best mortgage length you all do?

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