Hi all! I'm in process of closing on a 96k rental property and trying to decide btw 15 and 30 year mortgage. Below are numbers:
Purchase price: 96,000
Down payment: 20%
Interest rate: 3.125% on 15 yr, 3.85 on 30 yr
Monthly payment on 15: $845
Initial portion towards interest: $208
Monthly payment on 30: $670
Initial portion towards interest: $257
I know the conventional thought is to always opt for the 30 year. But with these numbers, does it make more sense to go for the 15 year? Only about $100 once interest payment is deducted. Thanks in advance!
I just went through a similar issue as you buying my first rental house. Just because I could afford it, I took the 15 year. Now I am trying to get a loan for a 4-plex, and the rental house doesn't show the most amazing cash flow. Now I am wishing that I got the 30 year and paid it back in 15 years. That would show greater monthly cash flow, that would help me qualify for future mortgages.
always take the 30 year, as you can pay earlier if you like, and you gain more cash flow.
you gain no benefit from taking a 15 year. paying a house of early removes one of the best aspects of real estate: leverage. Also, you gain equity from paying if off early but that's harder and more expensive to access than the additional cash flow you gave up by taking the 15.
interest rate reduction doesn't matter much as the tenant will be paying the interest.
I'm sure my friend @Joe Villeneuve would like to chime in....
...and, you don't reap the supposed benefit if the 15 year until the end of the mortgage. While paying the first 5-10 years, all you've done is paid more money in interest...it's the lender that gains.
Also, as @Alexander Felice says, "...more cash flow" and "...the tenant is paying the interest (as long as you have positive cash flow)".
Joe brings up a good point. To expand on it. If you took out a 30 year mortgage and paid $100 extra per month, you would NOT pay it off in 15 years. In other words, paying extra principal on a 30 year is not the same as taking a shorter term. This is because interest is front loaded on a loan. Keep in perspective that Alexander Felice is a banker according to his profile. No offense to bankers, but they are are going to be biased in their view point. Banks make all their money off interest and fees.
There is incredible power in being debt free and paying all cash. Don't get me wrong, financing is usually necessary to get into real estate and I have personally benefited from it. The ugly side of financing is all the people it has financially destroyed. You just need to be careful and never let anyone convince you that paying off debt is a bad idea - especially a banker!
This community is awesome, thanks for all the input!
To clarify, the CF difference is actually $175, as I was deducting the $50 additional in interest I'd be paying for the 30yr to round out to around $100. But as mentioned earlier, that additional interest amount is being paid by the tenant.
Question to investors in response to the value of extra CF - assuming you opt for the 30 year, if the CF is so valuable, do you actually pay off extra principle each month or are you pocketing that CF? (this also would assume you dont have any major repairs pending)
I'm getting the feeling that CF outweighs equity for most on here. As a new investor, I had this vision that ultimate goal would be to achieve tons of equity across your properties.
Generally speaking, I like high amortization periods over low ones. Better to keep your cash flow high in my judgement as liquidity can be the biggest problem real estate investors face. Indeed, even seasoned investors are often cash poor. But that's just my opinion, so take it for what it's worth.
Real estate is about leverage. Those who don't use it aren't necessarily playing the game wrong, but they definitely are not taking full advantage of the ability to grow their money. It's like the difference between gardening with the dirt in the ground or using Miracle Grow.
When you borrow money, you should pay it back as far into the future as possible. The dollars you borrow today that you pay back in 20 or 30 years will be worth much less then. Besides, a free and clear house will only return you around 6% on the equity. You'd almost be better off just lending out your money at 8-10% than owning a free and clear property.
Getting the 30 year mortgage will maximize your cash flow today which is the whole point of buying rentals. Plus you can deduct the interest you pay. If you have to get a mortgage, doesn't it make sense to get one with the lowest possible payment?
Personally, almost all my mortgages are interest only. I see no point in amortizing the principal balance down by $50-100/month. It takes decades to pay off a house and does nothing for me. I want the lowest possible payment today. The cash flow that I earn TODAY is the number one benefit I can use right NOW.
I definance properties by swapping equities, flipping houses and using those checks to definance large chunks of debt or by selling and 1031 exchanging into better properties.
If you must get that fast amortization, get the 30 year mortgage and pay it like it's a 15 year mortgage. Then, if you have a vacancy, need to spend some money on major repairs, or get into a cash crunch, you can go back to paying the lower payment on the 30 year mortgage until the situation changes.
maximize your cash flows and reinvest. Money is way too cheap right now not to maximize this, plus it gives you additional cushion just in case.
@Asma A. most people here say 30. I agree but the training behind it is more along @Aaron Mazzrillo's post.
Yes you could pay a lower interest with a 15yr than a 30yr mortgage. Yes you could always pay off the 30yr sooner if you wanted. But the point is, that extra $100/mo is basically only earning you 3.15% or 3.85% buy having a 15yr mortgage or paying the 30yr off early.
I've got better things to do with that $100 than earn 4%. I want to use it as a down payment on the next property where leveraged it can earn me 20% ROI or more.
I want to put as little down as possible and pay it back as slow as possible. Think of it this way. If you could pay it off today (pay cash and not get a mortgage) you are not growing your net worth. You're just trading cash for equity and essentially earning 4% (saving 4% by not paying interest on a mortgage). So what that you have equity and cash flow. That's not the best use of your money.
Asma, did you read my previous post? That $175 can buy you another property with zero cost to you and allow you to pay off your first property before the 15 year amortization payment, without having to add funds. If you take one step further and apply the same payment for your paid house at 165 months and start applying to your second home. You will have 2 properties paid for free and clear in 18 1/2 years.
I mentioned this because you said you wanted to buy more property.
@Asma A. as you can see, the opinions are varied. Ask me, and I would say take the 15. Why? I am almost debt free and the cash flow is HUGE. Do I get a lower return? Yes. Do I sleep very well at night with little debt and great income? Absolutely! What is right for you? There really is no right or wrong answer to your original question, only what is right or wrong for you. There are positives and negatives to both scenarios, so look at your current situation, your near future goals, and make a choice. As long as the property cash flows, you have money for reserves, etc either way sounds good. Are you making money on the purchase? I will not make a purchase unless I get it well under market value. The 1st rule is: you make your money when you buy. Everything else, including deciding on a mortgage term, is secondary. I believe that if all investors followed this one rule, all investors would make more money.
I vote 30 year all day long. I would take a 50 year if they offered it!
1. It's harder to qualify with 15 year loan.
2. You can reinvest that cash flow into more properties earning a higher rate than the money saved on 15 year interest.
3. Due to inflation money is worth more now than 15 years from now. I think using thay cash flow now is more advantageous.
4. There is not much advantage with the 15 year until you get into the later years of the loan. How many investors don't refinance or sell 10 ten or 15 years later?
@Asma A. What a lot of people are missing here is that the more equity you have in the rental the less money you have working for you. It's the same thing as having a bunch of money saved up and no definite goal. Why would you want one paid for rental worth $100,000 when you could for the same $100,000 have 5 -$100,000 rentals with 30 year notes. What's going to be worth more in 15 years the 5 partially paid for properties or the one paid for property?? 1 rental doesn't make you an investor. 5 is a start
30 year mortgage every-time.
In rental real estate there is no point to have a 15 year note. That would increase risk.
15 year note also diminishes two of the best things in real estate. Cash Flow and Tax Advantages. You actually want debt on every property, if it gets to low that is problem and hurts your return on equity.
Go with a 30. Thank me later. Cash is king. That is how you eat in bad times.
By paying the loan off faster, you would only be getting a 3% rate of return on the additional payments! You should be able to beat that by a factor of 10 by opting to invest that additional cash flow into more rental properties.
Im closing 4 refis in NW, DC this month (total $2.65 million over 4 mortgages). Have 4.25% 30 year IO for 10 years (in year 3). Going to 3.375% 15 year fixed. Cash flow good at 3.375, but not like cash cows at 4.25 IO. I struggled with 30 v 15. Everything that was said on here on 30 is absolutely correct imo, . . .
But I went 15 bc I 1) have a stable, high paying job, 2) All the cash from the properties ate a hole in my pocket, and 3) if u take 25% off my rental income from these properties as refinanced, they still have positive income so my LTD wont be screwed. 15 year will force discipline on me in how I manage these properties and provide further motivation to take this to the next level.
Get the 30. Any pre-payment penalty will be long gone by the 15 year mark. Then YOU can choose when to pay off the mortgage. In my experience 15 years is a LONG time. I guarantee... you will change your plan with this property.
Keep your options open.
Thanks all! I decided to go with the 30 yr at 3.875%. Looking forward to a little extra cash and focusing on acquiring good tenants. That's an entirely different topic!
Appreciate all the valuable feedback and best of luck to all.
Congrats! Asma
Remember your goal. You need to plan your work, then work your plan. The $175 extra cash flow needs to go to work for you. If you just spend it which is nice and fun, You will still have a big mortgage in 15 years and nothing to show for it but maybe some shiny things you purchased and no longer have value. To save up a 20% down payment will take you another 9 years.
Get creative try and buy the same thing you just did. Use the $175 cash flow to pay for the down payment loan. HELOC, personal loan, hard money, seller finance down. Lots of options.
Buy Right!
Thanks, @Jim Costa! I take it you prefer to save for the next property, rather than pay down principle.
If you don't mind me asking, do you have more than 4 properties? I saw on a couple other threads that getting financing tends to be much harder after the 4th. This is only my 2nd, but I'm wanting to plan ahead by adjusting my purchase prices if need be.
Yes. I own 10 properties 2 are free and clear. It is nice to collect the money and not have a mortgage. I also find myself not in a hurry to get things done as quick because they are paid off. Bad habit to get into. I'm thinking of refi now ( I have to do within 6 months) while rates are low and buying more units.
For advanced investors and those wanting to buy more than 4 units here is my take on mortgages:
I have always been on top of mortgages and underwriting guidelines which unfortunately gives me more knowledge than most mortgage brokers. It is hard to find a good mortgage broker that knows what he/she is doing. This isn't to bash on the profession but most are geared for your basic owner occupy purchase black and white loan. When you get into the investors arena competent brokers that are willing to do the work are hard to find but they are worth their weight in gold when you find one. Specially starting out. The guidelines have changed drastically over the last 10 years. I am not an expert but this is what I have figured out from hours of research and asking questions from my mortgage brokers. Most of this information can be found on a google search for Fannie Mae investor guidelines, cash out, or 5-10 units.
Their are 2 main ways a bank can do a loan. They can prepare a loan for a portfolio loan (more on this later) or they can prepare a loan that meets Fannie Mae guidelines. Most banks when the loan is complete and they have collected all their fees they sell the loan on the secondary market. This was the problem with the real estate bubble, bad loans were sold but that is another subject.
Most banks use Fannie Mae guide lines because once they sell the loan they get more cash in to do another loan and charge more fees. Thy are "flippers". They find the property (borrower), Do all the repairs (underwrite the loan) and sell on the secondary market. Step and repeat.
Fannie Mae guidelines changed as of 2009
1-4 mortgages
Fannie Mae guidelines are the same for the most part on 1-4 properties of 1-4 units. This is where most investors will fall and where most banks are comfortable lending. Once you have an investment property you now have to provide leases and the loan becomes a little more difficult. You have vacancy factors, capex, management fees, FMR, FMV, appraisals, front end ratios, back end ratios. Many times you will need letters to be written to explain things. Many brokers don't want to do the work. You will see a separation here from brokers looking for the automated acceptance to the professionals that step up and do what it takes. An investor in this category is similar to buying their first rental. Same hoops. You can get a first, put together a heloc for repairs and to buy more property. You can refinance and take cash out for new purchase.
5-10 mortgages
Now it gets a lot more interesting. Many banks don't even want to tread in these waters. The Fannie Mae guidelines become a lot more stricter. The LTV goes to 25% for SFR and 30% for 1-4 unit. So you will need a larger down payment. They want 6 months of PITI payments in reserve liquid funds for all your properties. All of the paper work above but now for 5-10 properties. If you have 4 plexes now you are talking about getting 20-35 leases and documenting everything. This loan now becomes a lot of work requiring many hours to put together. A good broker will be willing to do it. Once you hit 5 properties you can no longer get cash out (delayed financing exception). This also means for your existing properties. It may take you several years to get to this position. You may have seconds on some of your properties. you may have bought a property 15 years ago for 100K you have a mortgage for 80K. 5 Years later you get a 50k Home equity line of credit (HELOC). To continue buying property and to fix things up, another 5 years go buy and you are now ready to buy your 5th house (mortgage). You think when this is done I would like to combine the first and 2nd of my old investment property and get a new first and take advantage of the low interest rates. Maybe you even paid the first down to 60K. So you are looking at a new first of only 110K on a property worth 175K. Because you will be in the 5-10 mortgages and refinance for a second is considered cash out you will not qualify or be able to pull cash out. For those cash buyers. Fannie Mae changed the rules in 2009 because of the number of foreclosures that were taking place and to try and encourage investors to buy inventory from the auctions. If you fall into the 5-10 category and are fortunate enough to buy a property all cash at close. Fannie Mae will let you take advantage of "delayed" financing. In a nutshell they will let you refinance and pull out 65% LTV.
Over 10 mortgages not available for Fannie Mae guidelines seek alternative funding or find a bank that does portfolio lending.
A lot of smaller banks under 10 branches or credit unions are focused on their clients and offer what is called portfolio loans. All this means is that they are not planning to sell on the secondary market so they don't have to meet Fannie Mae guidelines. When the loan is done they plan on keeping the loan as part of their portfolio and will continue to collect the payments. This is great for you because it is back to old school banking. Lets loan to the people of character and look at the over all package. Don't get me wrong the numbers still have to make since but they make up their own guidelines. They can play with the ratios. The downside to this is sometimes they don't want to tie up their money. You may have a hard time getting a 30 year fixed rate mortgage. Most of these loans are looked at as a commercial loan. You may get a 30 year amortization but maybe a 10 year balloon. Because these are portfolio loans, they make up the rules. I would encourage once you are comfortable with real estate investing and you want to continue to invest you start looking for banks that offer portfolio loans and start to build a relationship with them.
For those that took the time to read this, you now more than most brokers and most bankers.
Next time you walk into your bank ask your banker can I ask you a question.
"Do you guys do real estate portfolio loans?" If you don't get that deer in the headlight look he/she will quickly guide you to the manager or to someone that does "loans" because that is all they understood. Once you get to a "mortgage specialist", you can ask if they do portfolio loans or if everything they do has to meet Fannie Mae guidelines. They will probably say they use Fannie Mae guidelines. Your next question is " if I own 5 properties can I refinance to take cash out as long as my LTV is under 70%" If they say yes, move on because they don't know the rules. If they are humble and say I'm not sure let me check into it, then they might be willing to do the work to get it to go through. If they say not if you own 5-10 properties. Fannie Mae won't allow cash out refinance. They know their stuff and that is the broker you want to work with. Good luck in your future portfolio building.
Buy Right!