30 years fixed vs. Interest only

[Puri Indah]

I have $340K left on my rental mortgage and I'm refinancing it now.

Got 2 options:

1). 30 years fixed at 3.70% or $1,565 monthly payment

OR

2). 10 years interest only at 3.65% or $1,030 monthly payment.

I have no W2, so refinancing after 10 years maybe a bit of a challenge.

What would you do?

[John Nachtigall]

This is just my personal opinion and certainly there are more experienced investors here, but I think that catastrophic failure (bankruptcy) occurs when you try to get too cute with financial engineering.   Simply put people take risk for little to no reward.  

The bank is willing to lend you a large sum of money at a fixed rate of 3.7% for 30 years.   It is entirely possible that in the next 30 years that is less than the cumulative rate of inflation.  It also "forces" equity appreciation through debt payment.   This is an amazing financial deal.   

The other interest only loan introduces risk of interest rates increasing, no equity paydown, and a 10 year cliff.  in exchange for these risks you get an extra $500 per month in cash.   But this is not a $500 gain, it is actually just the same $500 you would be paying down equity (since the interest rates are the same).    So the actual benefit is having $500 in cash vs earning $500 in equity.   You get the $500 either way.

In my opinion, truly wealthy people don't care about how much cash in is their pocket, they care about how much real wealth they have earned and retained.   Cash flow is important, but your actual net worth is measures by assets - liabilities.   

Now I am sure someone will point out you could take that $500 and invest rather than have it as "dead equity" in the building.   Certainly high level professionals like syndicators use this kind of strategy on a regular basis.   They supercharge their returns by maximizing leverage and placing as little value in equity as possible, very little factor of safety.   I would just point out that it is a strategy that works...until it does not.   I would point to the ruins of 2008...which everyone seems to have forgotten.   None of those bankrupt people thought they needed a factor of safety either.   

So my opinion, take the fixed rate loan, enjoy the lower cash flow and the appreciation of your asset, and know that you are leaving some gain on the table for a large reduction in risk.