I got a good question from a friend, and thought I'll share my perspective. Long post warning :) But, it worth reading! Also, feel free to comment and let me know what your thoughts or other perspective!
Cash or cashflow? How high of a debt burden would you feel comfortable with?
Case-study: My rental property has a monthly Net Operating Income of 2,100 USD.
Lima One offered different loan scenarios ranging from 65% to 75% LTV.
A 65% loan cashes out $120K with PITIA being 1,700$/m
A 75% loan cashes out $150K with PITIA being 2,030$/m
What would you do with an extra $30K and is it worth the risk (to you) of giving up 300$/m in cashflow? and possibly having to use your own money to pay the mortgage, if the tenant defaults?
This is a very good question! The best way that I can answer it correctly is to know what the end goal is. So, I am going to make a few assumptions:
1. The NOI calculated after removing all expenses to include: vacancy consideration, maintenance, capital expenditures, management fee (I always include management fee, because my long term goal is not to manage it myself- either outsource or pay someone to do it within my company).
2. The goal is to replace W2 income with rental/passive income in the near future (within 5 yr)-- not immediate (1-2 yr) or long term (within 10 yr).
3. Both payment options are feasible to manage if vacancy occurs/tenant defaults.
First, I think you should probably shop around to see what other rates/terms you can get from different banks- the monthly payments seems really high. Typically, for mortgages between 120K-150K you should expect $900-$1100 PITI payments on a 30 yr fixed rate. If traditional loan is not an option, some banks/lenders will do a 5 yr balloon loan with 15-20 yr amortization (let me know if you want me to deep dive into this concept).
Ok, so let's go! (Zohan TM)
So what can you do with 30K? Assuming the interest rate is 5%, then this is technically cheap or cheaper money. If the goal is to replace your income from rentals, then this can be a down payment/repair money on your next rental. You will have to justify the loss of the $300 cashflow by buying more cash flow- pretty much if the 30K will be used to buy additional cash flow, then the average cash flow should increase. The main benefit of buying additional unit/s is that your average risk for vacancy goes down, and the future net worth will increase by appreciation.
The downside of this will be more noticeable in the short/medium term- if the tenant defaults while the other unit/s is not ready, and you have to pay the difference. Also, this can negatively affect your ability/chances to finance/refi other projects in the near future because your debt-to-income ratio might be too high (although this can be solved with more rental income, so this is also a short/medium term problem).
Another idea is if you have credit card debt or any other debt that is more expensive, then this can be a way to save on interest payments.
So, what are my personal opinions and what did I actually choose when faced with similar scenarios:
My goal is to replace my income within 2-3 yr (immediate to short term), and while doing so, I am going to continue working to pay bills/sustain a lifestyle. Personally, I prefer positive cash flow and to reduce my risk exposure. If the 30k is going to increase my average cash flow, and I am able to afford it when the worst comes to worst (both units are empty), then I will consider it. But, because my risk tolerance is low, I will require that the average increase in cash flow be very significant - this is just me, I tend to view the world a bit more conservative than others.
When we refinanced our properties, we only refinanced the money we put in the property- complete BRRRR (sometimes we left some money in the deal). This helps us to keep positive cash flow on every property and reduce our risk exposure.
Another caveat, the way we grow, and this might explain why we only refi what we need, is by partnering with others and using creative solutions to fund our projects. Let me know your guys thoughts on this, there is no right a wrong answer- as long as your goal aligns with it!
