Buy and Hold Amortization Years

[Account Closed]

Hi just posing a scenario out there for buy and hold investors. If you have a private investor willing to put up all the funds for a buy and hold, how long of a mortgage would you prefer? In our example you're buying a 100k house that rents for $900. You can get a 30 year mortgage and cash flow a couple hundred every month or you can get a 15 year and basically break even. Which would you prefer? I'm curious what long time investors would do because I may have a situation where I need to decide coming up. 

[Bill Gulley]

Not that simple.

What's your goal, cash flow or equity?

What's the expected hold time?

What's the condition of the property?

How long will the property be functional without significant improvements?

Initial rent is 900, what's the market like? Any forced appreciation possible?

What are the differences in the interest rates?

Same loan terms other than amortization?

What's your ability to cover the additional payment required during vacancies?

Generally, the longer amortization will win, until cash flow becomes less crucial for an investor.

Your personal financial position will play on the right choice, are you retiring in 18 years or 8 years, and too much equity can be difficult and expensive to take out of the walls later on.

I don't hold very long, at about 7 to 10 years the depreciation falls with less of an advantage, that means it goes up for sale. Having lots of equity means if I were to do some creative sale, I'll have to finance my equity. For some that's fine, others want their money.

Need to map out your goals, your intentions of holding a property and then finance accordingly. Good luck :)

[David Krulac]

Iif you are starting out and have little to no funds, I'd go with borrowing as much as you can for as long as you can.

If you are an intermediate investor has good cash flow generating, you may want to mix it up with some 30 yr amorts, and some 15 yr amorts.

If you are a seasoned investor, maybe not acquiring as many new properties, looking to ratchet down a little, then maybe go all 15s.  But since there is no age discrimination in mortgage lending even if you are 75 yrs old you can still get a 30 yr amort. 

[Account Closed]

@David Krulac @Bill Gulley Thanks for the responses. I guess the answer I expected was it just depends on investor preference which is what you guys are saying. I'm assuming interest rate is the same on both terms, property is move in ready, I've got cash to cover a vacancy. I was thinking I might prefer a 15 year regardless of if I plan on holding for 7 or 15 years. Reason being I would like to create as much equity as I can more so than collecting $200 a month cashflow. I'm also an agent so I could easily throw it on the MLS and cash out the equity whenever I'm ready as well. I'm not certain this is the right approach though having never done a true long term buy and hold.

[David Krulac]

@Account Closed 

Interest rates for 30 yrs are typically slightly higher than 15yr fixed rates.  So by getting a 30 yr rate, even though the interest rate is higher the payment is actually lower because it is spread out over a longer term.  If the cashflow is tighter, you might want to go 30yrs. 

[Account Closed]

Originally posted by @David Krulac:

@Account Closed 

Interest rates for 30 yrs are typically slightly higher than 15yr fixed rates.  So by getting a 30 yr rate, even though the interest rate is higher the payment is actually lower because it is spread out over a longer term.  If the cashflow is tighter, you might want to go 30yrs. 

 Ya I understand that when going through a traditional lending method. In my scenario its a private investor willing to do the same rate on either year period. 

[Ned Carey]

Keep in mind in most mortgages you can make pre-payments with no penalty. So you can always pay extra every month and pay a 30 year mortgage off in 15 years. If you have a 15 year mortgage and have cash flow problems you cannot simply send the bank less. 

I would go fro the longer mortgage and use the money saved as a cash reserve.

[Account Closed]

Originally posted by @Ned Carey:

Keep in mind in most mortgages you can make pre-payments with no penalty. So you can always pay extra every month and pay a 30 year mortgage off in 15 years. If you have a 15 year mortgage and have cash flow problems you cannot simply send the bank less. 

I would go fro the longer mortgage and use the money saved as a cash reserve.

 Great point! That's something I hadn't considered. It makes sense the reason most people get 15 year from the bank is for the lower interest rate. So if I'm getting the same rate I should just get the 30 and pay more if I choose to. 

[David Krulac]

@Account Closed 

While private lenders are willing to do 30 yr amorts, most will want a balloon and a payoff long before 30 years.  The best I ever personally got was a 15 yr private mortgage with no balloon.  We started negotiations at 3 yr term with a balloon.

Short term balloons themselves are a hazardous.  That balloon payment can creep up very fast.  Be careful.  I also prefer fixed rate mortgages over adjustable mortgages.

[Bill Gulley]

Take a 30 Amortization, lower required payment, then you can make additional payments to fit any pay off period you like. Stay away from short balloons, if there are any. To refi you should shoot for at least 25% equity to meet balloon requirements. Cash is better than equity, save it. You'll be in a position to pay down if you need to and you can invest savings or use it at a better rate than the interest in the walls creates.

If you have private financing, be prepaired so sell if you have a higher LTV, people die, things happen with people that don't with banks and others end up holding that paper or managing it and issues can arise. Borrowers have risks with loans as well as lenders. :)

[Ndy Onyido]

@Bill Gulley 

Thanks for the leading questions...

Does cashing out after 7-10 years something you recommend due to depreciation effect?

Don't mean to distract from the mail trail but I thought the reverse was  the case. 

Some thoughts?

Thanks.

[Bill Gulley]

@Ndy Onyido 

The holding period from a tax standpoint will be unique to each property and to each owner. That spread was to single family dwellings.

Other expenses and amounts to capitalize from improvements are anticipated as well to be assessed with respect to rental income and increased equity.

Example and considerations:

If I buy a house that has a 7 year roof,  in 8 years it has reached the end of it's economic and physical life, a repair may cost $7000. Question becomes is the 7K worth it, are rents increased (usually not), will equity increase, not really, capitalized that amount will be depreciated which may not significantly off set income.

Don't want this to sound like a justification to be a slumlord, allowing deferred maintenance decreases equity, rates or appreciation and income and can change the quality of tenants you may draw upon. There has to be a balance.

The visual impact of that roof can be an issue, but that isn't something that pops up overnight, you can observe the condition over time and estimate replacement.  

If I were to sell that property, the cost of the roof is considered in pricing it. It's possible to give a 4K allowance for the roof and it may sell. If that is the case I may have lost a few months of appreciation acquired, it's not a cash expense to me. Homes in my area generally appreciate at about 3+% annually without rehabbing. A buyer will have a higher amount for depreciation to take in the early years of holding that property.

I usually have very little for maintenance in the first 5 to 7 years, it goes to the quality of the property purchased. I don't allow deferred maintenance, especially that can be obvious.

It's a lot like buying a car with 30K miles on it, drive it for 42K and sell it before it hits 75K where their may be a more significant drop in value.     

This approach is to cash flow and equity where it is at its greatest point, the growth business phase. After growth you have maturity and then you may have a decline in a business cycle. For me, time was more valuable than being a landlord, the attention to management increases through the maturity phase and may well increase as physical and functional depreciation sets in. That doesn't mean that holding a property and paying it off isn't profitable, it certainly can be, but long term holding just wasn't for me. :) 

[Ben Leybovich]

You shouldn't be buying $100,000 house that only rents for $900/month - you will lose money...

[Account Closed]

Originally posted by @Ben Leybovich:

You shouldn't be buying $100,000 house that only rents for $900/month - you will lose money...

Out in here Vegas that is a really good return for a SFR. An average home in a good area out here sells for 200k and rents for 1200...

[Ben Leybovich]

If you are underwriting to IRR and driving that IRR with appreciation, then perhaps. But, cash flow wise you won't make it on those spreads, @Account Closed ...

[Account Closed]

@Ben Leybovich I understand the spreads aren't as good as say investing 100k in a multi family but those just don't exist out here in Vegas. You're looking at least spending 200k to get a decent one. So in this situation I'm getting a house for 100k thats worth 130-135k and is ready to rent or be flipped. My thinking is maybe sit on it for a few years and hopefully have some cash flow and appreciation. I would already have created a bit of equity getting a good deal on it. But this is only if I don't have to put any money down with a private investor. If I have to put money down then I'm just gonna flip it.

[Ndy Onyido]

@Ben Leybovich 

Thanks for your usual frank talk, if $900 on $100k will lose money, what about $1050 on $86k house in KC?

[Ndy Onyido]

@Bill Gulley 

This is a whole lesson for me :). Thanks a bunch...very intuitive and helpful

[Ben Leybovich]

@Ndy Onyido $80,000 for $1,200 approaches making sense :)