30-Year Mortgage Gives A Better Shot At Building Wealth

Blog Mortgages & Creative FinancingWhy a 30-Year (NOT 15-Year) Mortgage Gives You a Better Shot at Building Wealth

It’s a question that is frequently asked by homeowners and real estate investors around the nation:

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Should I go with a 30-year mortgage and have a lower monthly payment, or should I go with a 15-year mortgage and pay off the loan much faster?

And the answer, as is so often the case, is always: it depends.

However, if we rephrase the question, expressing a goal, we can certainly come up with an answer to help homeowners and investors understand which type of loan IS preferable.

So, for the purposes of this article, we will frame the questions like this:

If my goal is to give myself the greatest statistical probability of building more wealth over time, should I go with a 30-year mortgage and have a lower monthly payment, or should I go with a 15-year mortgage and pay off the loan much faster?

The short answer to this question is this:

Go with the 30-year mortgage, and especially so in this current market of low interest rates.

If you are a bit of a math nerd and want some statistical analysis behind why the 30-year mortgage is superior to the 15-year (or even shorter loan periods), read on.

cash-on-cash-return-real-estate

Why a 30-Year Mortgage is Better Than a 15-Year Mortgage

I created a spreadsheet to model out the logic behind why a 30-year mortgage is advantageous to a 15-year mortgage — which can be downloaded here. This spreadsheet, like any financial model, is based on some assumptions. Please bear in mind that this analysis is for a rental property, but the conclusions are similar for homeowners.

Here are some of the key assumptions that go into this model:

I assume that property prices and rents will increase with inflation at about 3.4% per year.
I assume that interest rates are about 3.5%.
I assume that expenses related to maintaining the property will be about 50% of the rent the property would collect.
I assume that rents are about 1/10th of the value of the property.
I assume that the stock market produces 11.5% annual returns.

Some or maybe all of these assumptions might be things that you disagree with. I recognize that there is no consensus for those assumptions and invite you to go ahead and download my model and play with them. It’s possible that some cases, changes to the assumptions in this model might result in situations that favor the 15-year loan, though I expect those cases to be the exception, not the rule. Note that I do not make assumptions for the following:

Differences in interest rates: This might favor the 15-year loan, as 15-year loans might have lower interest rates.
Tax implications: For homeowners and real estate investors, interest is tax deductible. This might favor 30-year loans further, as the mortgage interest is partially offset.

In this model we compare three scenarios:

Buying a property with 20% down on a 30-year loan
Buying a property with 20% down on a 15-year loan
Buying a property with 100% cash and no loan

Let’s compare some of the key metrics going on over 30 years in these two charts:

ROE OK, so let’s point out something right off the bat. Real estate, on average, performs worse than the stock market when bought completely with cash. It is only with leverage that average real estate returns begin to exceed the returns offered by stocks over a long period of time. You can see that in year one, both a 30-year and a 15-year loan produce high average returns for investors. This is because the property is at its most leveraged point during this timeframe.

Related: Are Extra Mortgage Payments Worth It? A Look at the Numbers

The reason for this is that leverage amplifies returns. If you buy a house for $100,000 in cash and it increases in value by $10,000, you’ve made 10% on your money. If you buy a house for $100,000 with a down payment of $20,000 (a loan of $80,000) and it increases in value by $10,000, you’ve made 50% on your initial $20,000 investment.

Over time, as you pay down the loan, and as the property appreciates in value with inflation, your leverage decreases. To continue our example, if in 10 years you’ve paid down 25% of your $80,000 loan (balance is now $60,000), and the property has increased in value to $120,000, you are now leveraged at 50%. As your leverage decreases, so does your return on equity.

So our first chart now makes sense â the return on equity is lower for less leveraged real estate, on average. You pay down the loan faster on a 15-year mortgage and therefore have less leverage each year than with the 30-year loan. Therefore, your return on equity is lower with a 15-year loan than a 30-year loan.

If you look closely at the graph, you’ll notice that the return on equity for the all-cash investor increases over time and that once you pay off the loan in year 15 for the 15-year loan investor, the returns also increase (that’s the bend in the red line in the graph).

The reason for this is that this model assumes that all excess cash flow is reinvested, in this case in the stock market. An investor with a 15-year loan will produce less cash flow than either the all-cash investor or the investor with the 30-year note for the first 15 years and therefore will not be able to reinvest that cash flow.

It is that reinvestment of cash flow that separates the 30-year note investor from the 15-year note investor. The investor with a loan term of 30 years will have lower payments, will generate more cash flow up front, and will be able to reinvest those cash flows sooner than the investor with a 15-year mortgage. Only for a brief snapshot in time — a handful of years after the 15-year mortgage is paid down — will one see higher cash flow in the case of a 15-year note.

This is why the investor with the 30-year note has both more net worth and more cash flow at the end of the period we look at in this study. The reinvested cash steadily compounds to build a portfolio that appreciates with the stock market and spits out regular dividends.

Over time, the effects of more leverage and greater cash flow compound to the extraordinary advantage of the investor with the 30-year loan:

Conclusion

Does this analysis necessarily mean that a 30-year loan is right for you? Like I mentioned at the beginning of this article, the answer to that question is “it depends.” There are many reasons why a 15-year loan might be better for you than a 30-year loan. Maybe you prefer to be debt-free as soon as possible. Maybe you don’t think you have the discipline to reinvest the cash flows as soon as you receive them.

How you view your life and your personal finances is completely up to you.

But if your goal is to choose the financing that will help you create as much wealth as possible over time, then a 30-year loan is likely to be a better bet for you than loans of shorter timeframes.

Just remember, even with a 30-year loan, you begin to deleverage to the point where you are no longer earning returns in significant excess to those historically produced by stocks, on average, about 7-10 years into the loan cycle.

It’s important to revisit your goals every few years — you might find that it’s time to refinance and buy more property, or you be content to coast on the cash flow you’ve created already, acknowledging the possibility of declining overall returns.

Looking to set yourself up for life as early as possible and enjoy time on your terms? Scott Trench’s new book Set for Life is now available! Whether you’d like to “retire” from wage-paying work, become less dependent on your demanding nine-to-five, or simply spend time doing what you love, Set for Life will give you a plan to get there. This isn’t about saving up a nest egg. It’s not about setting aside money for a “rainy day.” Set for Life is an actionable guide that helps readers build the accessible wealth they need to achieve early financial freedom.

[Editor’s Note: We are republishing this article to benefit newer reader to this blog.]

Investors: Do you agree with this assessment?

Feel free to disagree — just let me know your rationale!

By Scott Trench

Scott Trench is a perpetual student of personal finance, real estate investing, sales, business, and personal development. He is CEO of BiggerPockets.com, a real estate investor, and author of the ...
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122 Replies

Claude S. Investor from Savannah, Georgia

Replied over 3 years ago

Please explain the first of two charts further. If one pays 100% cash for the home, then net income (annual cash flow) should be higher than the other two right from the start. If one invests that NOI then your assets would grow, correct? Am I missing something?

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

Claude – cash flow IS higher for the all cash version right from the start. Perhaps what’s confusing you is that the use of leverage means that you are buying an asset that is 5X larger when you purchase using either a 15 or 30 year loan vs all cash ($100,000 buys $100,000 of house with all cash, but $500,000 if you buy with a 80% LTV). The all cash investor is producing more cash flow and reinvesting it right from the start, but his cash flow gains are dwarfed by the appreciation that is multiplying the net worth and cash flow for the leveraged investors. Think about it. If rent on your $100,000 property is $1,000 per month, and on the $500,000 property is $5,000 per month, then a 3% rent increase means $30 more in cash flow in the first case and $150 more in cash flow in the second case. This works even when expenses rise proportionately. Again, if expenses are $500 per month for the $100,000 property and rise 3% that’s $15 – the net increase is $30 – $15 or $15 in excess cash flow per month. In the leveraged case, that is multiplied. If expenses are $2,500 per month, and increase 3% that’s $75, and the owner will see $75 more in monthly cash flow each passing year. Thus, he will soon surpass the cash flow of the all cash investor on the smaller property due to the fact that he is playing with numbers on a far larger scale. It’s only in the first few years that the all cash investor sees the advantage in cash flow generation.

Peter S. Rental Property Investor from Denver, CO

Replied over 3 years ago

Hey Scott, Interesting analysis. I’m curious about something you said in the conclusion: “Just remember, even with a 30-year loan, you begin to deleverage to the point where you are no longer earning returns in significant excess to those historically produced by stocks, on average, about 7-10 years into the loan cycle.” Does this mean that it would make sense to refinance one’s 30 yr mortgage every 7-10 to stay more leveraged? Or to even do a cash-out refi at that point?

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

Hi Peter – I often refer to this dilemma as one that besets the “moderately wealthy investor” – Once you begin to deleverage, where your have more than 50% equity in properties, then your returns no longer significantly outpace that of historical stock market returns. At that point, my opinion is that yes, investors should consider releveraging or exiting real estate investments. Why own and manage real estate when the returns are lower and the work is harder on average than buying the S&P 500 index?

Andrew Banker from Shreveport, Louisiana

Replied over 3 years ago

Great article. Enjoyed reading your thoughts. I did have a thought about the following question: “Why own and manage real estate when the returns are lower and the work is harder on average than buying the S&P 500 index?” One big advantage for me is estate planning. I plan to fully depreciate (max my tax advantages) and own properties that kick off an income stream at my retirement (as a diversification to what I put in traditional accounts), then pass those properties to my heirs at my death so they can take advantage of a stepped-up cost basis and start depreciating all over again. At retirement, most will be paring back their equity positions in favor of lower return for less volatility (bonds). For me, the return on the real estate, even paid off, will have a better ROI than the conservative portion of a traditional retirement portfolio. And, being that I’ve been taking good care of my properties over that time, I think the “risk” at that point ought to be pretty low.

Ann Miller from Moses Lake, Washington

Replied over 2 years ago

I like your point!

Joe J. Rental Property Investor from West Lafayette, IN

Replied over 3 years ago

One possible answer to the “why” would be “diversification”. Yes, it’s possible to own shares in a traded REIT, too (as I do now, one focused on commercial RE as my directly-held investment RE is SFR), but there’s something to be said for holding a portion of one’s assets in bricks-and-mortar, I think.

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

Thanks Brandon – congrats on all your success!

Claude S. Investor from Savannah, Georgia

Replied over 3 years ago

I understand the leverage. In your first chart however the line for cash flow for the cash purchase (blue line) should be higher than the other 2 from the start, correct?

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

Yes – it is higher – the problem is the scale of the graph. The amounts are relatively close together at first, and the differences compound over time. The blue line actually starts higher and above the 30-year and 15-year mortgages. It just quickly falls below the green one in a few short years.

Adina

Replied over 1 year ago

Hello Scott Great article. I have a HELOC with variable interest rate. Would it be smart to use that for a property down payment?

Katie

Replied over 3 years ago

Even without restating the question, you could easily answer that it is not an either-or choice. Go with the 30-year mortgage which gives you a lower REQUIRED payment, and pay it off on a 15-year (or faster if you choose) schedule. If there is some unforeseen problem, you can always go back to the lower REQUIRED payment for a while. A problem while paying a higher required payment could snowball, resulting in foreclosure or bankruptcy. Speaking of bankruptcy, one highly visible person suffered several bankruptcies due to over-leverage. To rephrase Peter’s question, Does this mean it would make sense to always be paying interest and never building equity?

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

Katie – the key is balance. I’d say at first, it makes sense to have lots of leverage and multiple income streams (namely, a job) to help you cover the financing costs. As your real estate portfolio matures, you will begin to deleverage and your returns wil fall, but your cash flow will increase. Keep a balance at that point. Releverage some, and make sure that you have lots of equity protecting your investment, AND lots of cash flow, but then leverage to the point where your returns are still very strong. Love the additional point on the 30 year mortgage.

Steve Vaughan Rental Property Investor from East Wenatchee, WA

Replied over 3 years ago

From the title I was so surprised you were the author, Scott! For new purchases in the 3’s, even I mostly concur with your assessment. Do need to note that 15-yr rates are better, sometimes significantly, percentage-wise than 30’s. When I refi’d some of my older 30-yr 6.5% loans to 15’s in 2012, the difference between a 15 and 30-yr was over 25%. 3.125% vs 3.9%ish. Historically both are great rates, but a big % difference. Check for arbitrage in these rate differences! Looking into it a little bit, I found that when the 15-yr pays off, the 30-yr balance would only be paid down about 25%. Still 75% to go! Proves that the word mortgage comes from the french word, muerte, which basically means ‘until death’. Just replace mortgage with ’til death’ and view the posts that pop up all the time. “I want to refi my ’til death. Should I get a 15 or a 30-yr?” “Is a cash out til death the best route to go here, or should I just save?” Fun stuff! I like the cash-flow discipline the 15-yr loans require. It is riskier having a larger required payment at first, but before you know it, the thing will be gone. Poof. Try it as your income base becomes more secure. In general, rents will rise enough to make the ‘missed cash-flow’ of a few hundred a month a meaningless rounding error. As the houses and apts are paid off, all you have to worry about is how best to spend or reinvest your money. I’ll admit finding a good or comparable ROI on your cash-flow is tough with these high RE prices, record high Dow and savings rates near 0, but it’s a good problem to have. It gives you patience and options and freedom from scrambling to find another deal. Thanks for another great article!

Sean Cole Investor from Cincinnati, OH

Replied over 3 years ago

Given that the focus of BP is real estate investing, it seems that an interesting and appropriate model to build would reinvest cashflows into additional real estate using more leverage. Your IRR would then be assuming a higher reinvestment rate that the stock market example now being used.

Sean Cole Investor from Cincinnati, OH

Replied over 3 years ago

I also think that you’re overly penalizing the all cash buyer by assuming that he/she also only has $12,500 to invest in real estate, given that you show their net worth to be $12,500 at Year 0. To be fair, it seems that they ought to be given the $50,000 starting point of the house that the leveraged investors bought. This has a very different result for net worth due to the exponentially larger cashflows being generated by the “free and clear” property. From an ROE perspective, there’s no doubt that leverage is better. To see this example, change cell C3 on the “Model” tab from referencing $Inputs.C5 to $Inputs.C10

M Knauss from Dallas, Texas

Replied over 3 years ago

Interesting catch Sean – but wouldn’t the value of house actually be $62,500 as the $50,000 only represents the leverage at a LTV of 80%. $50,000/80% = $62,500 Year 1 Property Value.

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

Thanks for the suggestions Cole! The math in this model is the same for a $12,000 house as a $50,000 house as a $500,000 house. At any point, no matter your cash position, you can buy a larger real estate property with leverage. Therefore, the person buying with all cash is always, always missing out on potential leverage. As for reinvesting with leveraged real estate. That’s a complicated model. I will (and am) building it! But, I’m not there yet. The compounding power is staggering when you replace paltry stock market returns with sustained 20-30% returns from leveraged real estate.

Brandon Rooks

Replied over 3 years ago

Cash is great if you are Risk Adverse. However, a $ 50,000 ALL Cash house is not a house that I would want to own in my Portfolio compared to (2) $125,000 houses with 20% /$ 25,000 down or even (3) $ 100,000 houses with a 15% / $45,000 down option. Sometimes investors get focused on a specific number such as Cap Rate, Cash Flow, Annual ROI or Equity & lose site of what is the Quality of the Investment. A $ 50,000 house, in almost every major market across the country, will be a home that is in an area of the city you should stay away from. Everyone has their own preference or comfort level …. However, staying true to your original topic, you definitely can build wealth faster & stronger with Leverage. Just ensure you are leveraging the right type of property that attracts a better tenant class, that is newer or new construction, that has an opportunity for true equity gains & that will have less Tenant Turn Issues, Vacancies, Maintenance, etc… For those that can not decide or do not believe what other experienced Investors have found to be true about Quality ( not just ROI ) then Buy (1) 50K house for Cash & (1) $125,000. house with 20% down / $ 25,000. Then track the results for 1, 3 & 5 years and see which comes out ahead.

Sean Cole Investor from Cincinnati, OH

Replied over 3 years ago

That wasn’t exactly what I was trying point out (it’s Sean, by the way). Your math, which is fine, shows that we’re better off getting a $50k house with a mortgage of 30 years if we only have $12,500 to invest. In other words, your cash buyer is only able to buy a $12,500 house in this example. What I was trying to say is that the cash buyer is overly penalized in this scenario because their rents should only be $125 if I understand your post correctly, instead of $500. This alone is a gigantic impact on the outcome. If that was the intention of the model, it’s certainly correct. There’s no perfect model for this kind of comparison, but I think that the difference in house value owned by the cash vs. financing investor is such a big impact on the outcome that I had to point it out.

David Joselson Investor from Boca Raton, Florida

Replied over 2 years ago

I definitely agree it would be useful to see the result of reinvesting the cash flows in more real estate. Also, I feel the 11.5 % returns from the stock market are way above the historical norms. The next few years they are expecting just a little more than break even with equities because they have gone up so much recently.

Gene Schwandtner

Replied over 3 years ago

You will never convince me of a 30 being better. I have always bought planning on a 15. I started in my early 20s. Once the first came paid, I put that money on the next. Next thing you know, you are still young and everything is paid for.I am adding one unit a year now, all cash. No stress

Katie

Replied over 3 years ago

You can still do that with a 30-year mortgage. You just pay it as if it were a 15-year mortgage, or even a 10-year mortgage.

Daniel D. Real Estate Investor from Fort Worth, Texas

Replied over 3 years ago

One question: in your bio it states that you are a life-long rugger.. Does this mean that you eschew tile & laminate? Can you elaborate?

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

I play and enjoy generally being around the sport of rugby 🙂

David T.

Replied over 3 years ago

I found that I couldn’t put a 30 yr on a home owned by an LLC. Am I missing something, or are your properties in your name personally?

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

Personally, my properties are owned by me personally. I plan to transition them into LLCs in a few years, but as I “house-hacked” to get started, it seemed kind of pointless to put them into an LLC that could be easily pierced – who is going to say that there’s a separation of personal and business when I lived in the same building as my tenants? Much of the time, folks personally guarantee real estate loans on properties that are small multifamily or residential. While you’ll hear a big debate here, you’ll meet few investors that don’t personally guarantee the LOANS on smaller investment real estate properties. The property may be owned by LLCs, but the majority of investors that I’ve come across tend to personally guarantee the debt.

Brandon Rooks

Replied over 3 years ago

Utilizing Leverage through a Conventional Fannie Mae / Freddie Mac Mortgage is great for up to 10 mortgages & definitely the way to get the BEST Rates for the properties. They even recently expanded so that you can utilize the 20% down on up to 6 mortgages for Single Family Homes & 25% down on those same six mortgages on Multi-Family. The down payment requirement only jumps by 5% once you are at Mortgages 7 – 10. Of course if you plan to 1031 any of those properties in the near future (1 – 5 years) then it makes sense to just leave them in your personal name. If you did deed them into a Trust ( my preference ) or an LLC …. then you would have to deed them back out into your personal name again before selling, so you could take advantage of the 1031 Exchange. Once you have amassed the Portfolio you want to hold for long term (10+ years) then deeding into a Trust & then having your LLC Manage the Trust, is a great way to add layers of protection.

Adam Elboim Real Estate Investor from Cherry Hill, New Jersey

Replied over 3 years ago

Scott, I’d love to see your analysis if the real estate investor relevers after 15 years. My wife and I take advantage of the lower interest rates associated with a 15-year mortgage, then when the loan is paid off, we relever at 70% LTV (which property has appreciated 75% with average 4% annual returns). This is the true power of the 15-year mortgage – it gives you the ability to extract equity/leverage earlier and at a higher valuation than in a 30-year loan.

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

I don’t think I’ll make that one specifically, as the investor can relever at any point. I think the point at which one should relever is when returns dip below about 15% or so. That’s about 5-7 years into a 30-year loan. That way, you are sustaining much higher returns over the life of your investment, not just relevering once the loan is completely paid off.

Brandon Phillips from Cranberry Twp, Pennsylvania

Replied over 3 years ago

But with a 30 year loan you would have better cash flow each month. You can take that extra cash flow and buy another property or invest it in something much quicker than with a 15 year mortgage.

Melissa

Replied over 3 years ago

I would like to hire the person who has invested in stocks and bonds over the past 20 years and made an 11.5% average return net of fees… I’d suggest 6% as your benchmark.

Brandon Phillips from Cranberry Twp, Pennsylvania

Replied over 3 years ago

I like that he used such a high bench mark. That means he won’t settle for a low ROI property. Why put so much effort into real estate when you can just sit on your but at home and make a good ROI in a low cost index fund? I see a lot of people buying property that might make 10% ROI and I won’t touch anything less than 20%.

Jas Russ Investor from Plano, Texas

Replied over 3 years ago

Agreed 100%. 11.5% sounds like a number Dave Ramsey. Even 6% can be questionable.

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

Yeah I hired that person! I buy VOO – an S&P 500 Index fund. My return might be 0.05% trailing behind it due to their exceptionally low fees. But that’s ok: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html If you don’t think that’s the right benchmark – well, that’s why I left the assumption for you to make in the spreadsheet. Feel free to change it.

Brandon Phillips from Cranberry Twp, Pennsylvania

Replied over 3 years ago

I’ve been trying to convince friends, family and strangers for years that 30 year mortgages are a way better option for your own home, for rentals or investment properties. I find that those in 15 year or less mortgages are extremely afraid of debt for any reason. It doesn’t matter that logic and math dictates that a 30 year mortgage is better. Some people see the 3.25% for a 15-year vs 3.6% for a 30-year and think that they are saving money by going with the 15-year. I’ve tried to explain opportunity cost and all that, but it is usually met with a, “but what happens if you lose your job, the bank is going to take my house.” I usually respond that I have way more money in the bank and I’ll be fine for a decade, but the idea of having more than about $1000 is nonsense to most Americans. However, I expect that 95% of serious real estate investors have done their own math and are using mortgages over cash to leverage their money and are using longer mortgages vs shorter to take advantage of opportunity cost.

Brandon Phillips from Cranberry Twp, Pennsylvania

Replied over 3 years ago

Mike Dymski Investor from Greenville, SC

Replied over 3 years ago

IMO, REI is too much work to not earn more leveraged returns and the commercial lenders feel it is too much risk to have shorter amortization periods by requiring a certain level of DSC.

Chris

Replied over 3 years ago

Cash flow is king, debt of any kind eats into cash flow. Borrow money at the longest possible terms and pay it back as quickly as possible. Typically the investors that sing the leverage song only do so until a downturn and they run into trouble. Real estate finance isn’t magic. Frankly if a property can’t pay for itself in 10 maybe 15 years it’s a poor deal anyway.

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

If cash flow is king, then the 30 year mortgage seems more effective – you produce more cash flow up front, and throughout the process, right? You only have more cash flow for a very short window with a 15 year loan..

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 3 years ago

while a lot of philosophies work great on paper, and function flawlessly if all is well, BUT, what happen when we see a market correction, it will happen in a 30 year period, but we dont know when, I have seen many investors follow this formula, and end up losing everything in 2008 when they couldn’t refi, tenants gost slim, or their commercial notes came due, (not everyone is using fannie loans, some of us have too many or dont qualify) when you finance $80K on a $100K purchase, and a correction hits, after tenants are in a while it may be worth $60-70K I saw this a a lot in 2008, one gets foreclosed on and the house of cards fall. I have not experienced this, but i saw a ton of people collapse that way. even 10 years into a 30 year you have barely touched the principal. To each their own, but its not for me, 10 years or less, Prefer paid off. Cashflow is the metric of success NOT Net worth!!!

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

So here’s my problem with your logic here. You seem to be arguing that cash flow is the metric of success. How on earth does that support a 15 year loan? The payments are higher on a 15 year loan! If you believe that it’s best to have as much cash flow as possible, and fear losing the property so badly, you’ll get a 30 year loan, and pay it off as quickly as possible with accelerated, extra principal payments, right? That way, you can pay it off early AND have the option to pay less to scrape by if a downturn comes and you can’t rent the place.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 3 years ago

a 10 year is my choice, if you finance, because the success is not now, its later when you want to not work, so you have full cash flow in 10 years and you saved a ton of interest, its about cashflow in retirement, NOT today, delayed gratification my friend.

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

I get your point – you want all paid off property. I still don’t understand – why not get a 30-year loan and choose to pay it off sooner? The option to do so can’t hurt can it? You can pay a 30 year loan off in 10, just put as much as you can towards paying it off!

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 3 years ago

The reason to not do a 30 is kinda the same reason Dave Ramsey’s Debt Snowball works, it has to do with discipline, 95% of people would start out paying on a 10 amm, but would not continue as life happens, yes the math works, but in reality almost no one would follow through, if you do a 10or 15 year amm and you get in a bind, you will have enough equity to refi, and forcing yourself to go through the process will make you think if you really need the money, or you can live without for a bit. it has everything to do with psychology vs math. Yes from a purely mathematical standpoint the 30 makes sense,

Brandon Rooks

Replied over 3 years ago

It has been entertaining watching all the comments in regards to the 15 / 30 yr Mortgage Debate. It is like watching a Political Debate between Democrats vs Republicans and both sides think only their way is the right way. It all goes back to your Original Headline for this Post ” Why a 30 yr builds wealth faster than a 15 yr Mortgage” The difference in rate is usually minimal, however the P&I payment is significantly different. You will have an Opportunity at Higher Cash Flow with the 30 yr Mortgage and therefore have more Liquidity in your Reserve account to handle many pop up issues. That net cash flow is greatly reduced with a 15 yr Mortgage and you may find yourself having to do a Cash Out Refinance for major repairs or longer than expected vacancies or pull out of your pocket. Here is an example of a side by side comparison of an actual property that I am selling right now. Here are the fixed numbers that I am using. Sales Price $103,900. Down Payment at 20% / $20,780. Taxes, Insurance & Property Management = $314. Monthly Rent = $ 1,050. I will also use a conservative 4% Appreciation. Now the only thing that changes is the P&I. P&I will be $421.16 at 4.5 % on a 30 yr & $614.83 at 4.0% on a 15 yr. This means Net Monthly Cash Flow is $ 314.84 on the 30 yr & $121.17 on a 15 yr. So let’s look at this scenario. You can earn $56,671 of cash flow in 15 yrs on a 30 yr Loan & this is a 18.2% Annual Cash ROI (key factor here) You can earn $21,810 of cash flow in 15 yrs on a 15 yr Loan & this is a 7.0% Annual Cash ROI (key factor here) Let’s consider if you sell the property choose to apply all cash flow towards the property to accelerate and pay off the loan faster. Your would pay off the 15 yr loan in 11.83 years ( collected cash flow was $46,287 during this period ) Your would pay off the 30 yr loan in 12.26 years ( collected cash flow was $17,206 during this period ) The difference in this scenario is that you earned $29,081 more in Cash Flow in virtually the same amount of time. Once they are paid off, they both generate the same amount of cash flow. So YES …. the 30 yr wins out on building wealth faster & the Key Factor is your Annual Cash on Cash Return. There is nothing wrong with a 15 yr, it just reduces the amount of leverage you can take advantage of in building your wealth faster !

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 3 years ago

Sorry, you dont seem to understand, an all cash position produces the most cash flow, and an opportunity for leverage if needed to be a cash buyer on future projects. I do a combo of flips and rentals, my flip profits buy more rentals free and clear, so say I have a typical property in my portfolio, that im all in all cash at $35K it produces $800/mo after taxes, insurance and management it leaves me with $650/mo it pays for another property every 4.5 years, and i never had a payment to make, but when i fip and make $50K i can buy another $35K property and have money for taxes, now we have more paid off. my point is the 30 year loan works for people with no money, i get it, but i see it as a risky endeavor, but I am a Dave Ramsey Disciple, if you cant pay cash for it, you cant afford it. and he keeps his LLC’s broken up in $5 million dollar piles, yes it takes longer to get going, but once its going its way better in the long run. 30 years is a heck of along time, I have no intention of working that long. and if you have payments, your working regardless of the tenants paying for it or not.

Dylan Robideaux from Baton Rouge, Louisiana

Replied over 3 years ago

How would you adjust this tool if you bought a house with $0 down?

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

Put a zero in the “starting equity” box, put a zero in the “leverage ratio” box, and put the amount of your loan in the white “loan amount” box. The tool wasn’t built with that in mind, and your ROE will appear to be zero. It’s really infinite in the first year. Also, you will never produce any returns with the all cash real estate portion, as you can’t buy real estate for cash if you don’t have any starting equity/cash 🙂

Account Closed from Winnipeg, Manitoba

Replied over 3 years ago

These are great discussions I’m seeing here in the comments. There are 2 camps: going with the 15-year or 30-year mortgage. Like Scott said, it depends on our goal. With my current situation, it makes sense to have a 15-year mortgage. I have a mortgages and will be paying them off 8 years from now. Then after that, that is when a big jump of cash starts flowing once mortgages are paid off. Then the extra cash will be used to purchase other properties. This way makes more sense to me. Not so much for the 30-year mortgage. The only thing I see for the 30-year mortgage is just cash flow over time.

Sean Cole Investor from Cincinnati, OH

Replied over 3 years ago

I’m a “cash if you can” guy. There can be no argument that cashflow from a debt-free property is higher than one carrying debt. If you’re investing the net cash into the stock market at 11.6% or whatever, owning property with no debt (and thus no mortgage payment) is the best route to achieve the goal posited in the original post.

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

I will disagree. Cash flow from a debt-free property is ONLY higher than one carrying debt in the first 5-10% of any average 30 year period. The remaining 90-95% of the years that one holds a property with a 30-year mortgage in a case such as the one I posited in this study, the cash flow is higher for the property carrying debt than the property bought with all cash. Do you want to maximize cash flow today? Or end up with 2, 3, or 10X as much in future years? This article discusses the latter. We ARE NOT talking about immediate cash flow. We are talking about what gives the reader the “greatest statistical probability of building the most wealth over time.” The 30-year note produces more wealth AND more ultimate cash flow, assuming one reinvests their gains across the vast majority of typical investment properties. If that isn’t your goal, and you seek immediate cash flow, then this analysis won’t help with your different goal very much.

Brandon Rooks

Replied over 3 years ago

If you would like the Proformas I used in my last scenario, let me know what email address I can send them to. I have them broke down for the scenario I gave a few minutes ago.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 3 years ago

I agree with the math, what i have a problem with is reality, and just based on the intent of the article, i dont disagree, But i am concerned with all the 80+% users on BP that have done zero to 2 deals that see this stuff and bury themselves in mountains of mortgages, and end up as slaves to the lender and properties. as i have stated earlier, i have seen your Philosophy put into action by others and fail, not saying its not functional, i have also watched a much more conservative approach taken and those folks make it through lean times, yes they may not have as big net worth, but they do have better cash flow, if I finance on a 10 year, and you on a 30, I will get greater cashflow for 20 more years than you, and the difference in total interest paid is so significant that it makes up for the early years cash flow reduction. All i can say Scott Trench, is How many do you have on your plan? i would like to see a follow up at 10,15, and 30 years to see how that worked out for you. Best of luck, Im done with this thread.

Brandon Rooks

Replied over 3 years ago

Those that lost their A** or properties went into Adjustable Rate Mortgages, 5% or No Money Down and did not have sufficient cash flow to sustain their properties and ride out the storm when the Mortgage and Real Estate Market Collapsed. If you buy the property RIGHT, it does not matter if the property loses value during a bubble. Property Values will come back with time and get right back on track. Just be smart when you leverage, insure you have cash reserves & you let the Cash Flow build up your funds & you do not decide to buy More Expensive Cars, Bigger Houses, Toys & Go out to Fancy Restaurants all the time. Yes, be SMART about leveraging in the right way and use some discipline to build a Real Estate Portfolio that will take care of you when it comes time to retire.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 3 years ago

Brandon Rooks, Thanks for that, but I get commercial money at 4.5% no pints 15 year amm and require 20% down, I would never buy a 1-4 family for $100K Way too much money in my book, all in at sub $40K after rehab, with $700-$850 rent is my target, I do have to re up every 3 years, but it doesnt cost me anything until the second reup for a BPO, they dont require an appraisal just a BPO. I have 2 LOC as well at 75% LTV @ 4.5% no cost to maintain. My job is to pay the bank as little interest as possible to insure my success! Just my Plan, its not for everyone.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 3 years ago

Brandon Rooks I agree with your comments about discipline, that’s Key! Scott Trench, Who can get 30 year fixed Loans anyway, doesnt everyone on BP have their 10 FNMA loans maxed out? once you become successful the rules of the game changes, on commercial side the number is limitless, but any decent bank wont amm more than 20 years, some go 25, but either way with a 3-5 year balloon, the equity has to be there at the end of the term or its called due, in the 30 year world you can only 10X once, then the rules change.

Sean Cole Investor from Cincinnati, OH

Replied over 3 years ago

Hold up! You’re saying that if I buy a $50,000 house for cash and you buy a $50,000 house with a mortgage, you have higher cash flow than me in a couple of years? Even with a mortgage payment? I’m sorry, but that’s just not possible.

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

NO! I’m not saying that Sean! I’m saying that if you invest $50K you have two choices! ONE – buy all cash. TWO – buy a $250K property using your $50K downpayment and a $200K mortgage. If you buy the $250K property and compare the results a few years later, you have higher cash flow AFTER A FEW YEARS than the guy who took his $50K and bought an all cash property. That is indisputable math – in a market appreciating with inflation at least.

Brandon Rooks

Replied over 3 years ago

Funny how the conversation when a whole lot of other directions from the original topic. I also must have started to come off “Salesy” …. my last reply was “Under Moderation” Guess my input on this topic is now under being watched by the BP Police …. LOL Just offering up my rules for real estate and experiences over the past 16 years in the business.

Sean Cole Investor from Cincinnati, OH

Replied over 3 years ago

Sean Cole Investor from Cincinnati, OH

Replied over 3 years ago

Timothy

Replied over 3 years ago

8 years, nice man.

Brendon Woirhaye Rental Property Investor from Whittier, CA

Replied over 3 years ago

I’ve done a similar analysis for my own properties, which led me down the path of 30yr for the 4 and under units. Although my property income can certainly pay for higher 15 year payments and it seems appealing to have them paid off sooner, I am able to have sufficient cashflow *now* which accumulates to the point that I can purchase another property every year. It is wonderful to have different options – 30 year, 15 year, 20 or 10 year, or cash – to help us meet our goals.

Replied over 3 years ago

Thanks for the shout out Brandon. Just to clarify on the specialty (portfolio) loans Minimum loan size $75K, max LTV 75%. We have a few different products, for investment purchases in this forum, one basically has more paperwork with lower rates, the other, less paperwork with a touch higher rates.

Brandon Rooks

Replied over 3 years ago

Scott Schultz there are definitely many ways to win in Real Estate & for the Person with the Experience & Time to buy, rehab, manage, grow & restructure their Portfolios, there are multiple ways to win. There is no doubt about that. I personally & rarely ever purchase a property under the 100K price, but that is because I want properties that are less than 20 years old or are brand new construction & are 3 Bed, 2 Bath, 2 Car Garage & a minimum of at least 1,200 sq. ft. That is just the space I am most comfortable in and it allows me to more comfortably purchase in multiple cities and states across the country. There is definitely ways to make and build a strong portfolio of properties in the space you are in and glad to see you are doing well. Your principles & strategies are obviously paying off for you. Kudos and all the Best in your future acquisitions.

Katie

Replied over 3 years ago

In my market, the median price for houses that meet your criteria is $1.2 million. The minimum for a “contractor’s special” is about $400K.

Brandon Rooks

Replied over 3 years ago

Katie, that is just one reason I am VERY Happy to have a Network of Builders & Suppliers across the country in Memphis, Charlotte, Columbia, Kansas City, Oklahoma City, Columbus, Indianapolis, Birmingham, Atlanta & NW Arkansas ( Fayetteville, Bentonville, Rogers ) as well as Reliable Property Management in each area so that I can consistently acquire & help my clients acquire properties that yield a minimum of a 15 % Annual Cash ROI. All Turnkey & Rented at closing, so they are performing from day 1. You do not always have to stick with your backyard, it is a great big country out there. One way I like to look at it is this : ” Would Warren Buffet be the man he is today, if he ONLY invested in companies in Omaha, Ne. ?- His Hometown”

Katie

Replied over 3 years ago

You do not have to stick with your own backyard, this is true. One of my goals is to improve the rental situation (in my own little way) in my own backyard. Right now, local investors do not even think about cash flow. they buy only for appreciation. Even though the rent is really high here (Just this past week, I looked at a crummy one-bedroom unit is a 5-unit place that was renting for $2250), investors pay too much to acquire the property, so they have no reserve for repairs. They make the units barely legally habitable and rent them out. In the case of the property I saw last week, three investor-partners purchased the property three years ago for $900K. At that time, it had already been red-tagged by the city. The investors figured that since the illegal modifications had been really well done, they could simply get an “as-built permit,” (probably this advice came from their buyer’s agent)and they would be good to go. Instead, the city is requiring them to restore it to its original configuration as a duplex at an estimated cost of at least $200,000. Instead they put it back on the rental market as is. The city is about to seek a judgement against them, so they have put the property on the market for $1.8 million. I am not sure they can get even the $900K they originally paid. My problem with turnkeys is the end buyer seems to buying all the risk. What is your client’s recourse if the rehab turns out to be shoddy, or the tenant turns out to be really bad, or the property fails to return 15%? Would it not be to your advantage to maximize your profit? How do you leave 15% for your client?

Brandon Rooks

Replied over 3 years ago

Katie, I definitely understand markets similar to what you are in and all the pitfalls that can happen. It is the one reason we avoid those markets. I would NEVER buy based on appreciation… might as well go to Vegas and put that money in the slot machines. Yes, you may win or lose, just depends on when you choose to walk away from the Slot Machine. Also, in many of those types of markets, the state is more Tenant Friendly than Landlord Friendly and I have seen the Owners that it takes 6 to 12 months to get a bad, non paying tenant out of their home. So here are some of our most basic rules of buying Turn-Key props in other states : 1) Buy in Landlord friendly states. Where you can successfully evict anywhere from 15 to 45 days 2) Have Local Property Management in place that has a successful 10 year track record and manages at least 100 properties & has a satisfied clientele. ( We have a vetting process for this ) 3) Working with Local Renovation Teams. Again, all part of a vetting process. Ensure they have a successful track record, 10 + years in the business, have completed over 100 Renovations & still have a repeat buying clientele. ** We demand that our Suppliers bring us properties that fit OUR CRITERIA and we price out that property right from the start. They then complete the purchase, the renovations, then we have a 3rd party Home Inspection, then go back to the Team to repair ALL items found on the Home Inspection Report & then we have it reinspected by our Home Inspector to ensure all repairs were completed. Then before we allow ourselves or our clients to close … Our Renovation Team has to cover the cost of tenant placement through our Local & Licensed Property Management Company & pay for a 1 yr Home Warranty before we close or let our Clients close on the Property. 4) New Construction – We have a great network of Builders that build us brand new units with very nice finishes and of course these all come with a 1 yr Builder Warranty as well as some longer warranties from the manufacturers for Windows, Roof & Mechanicals. Plus we make the Builder purchase an extended 2 yr Warranty through our Preferred Home Warranty Company all as added protection. 5) All properties have to appraise & of course pass the criteria from our National Lenders to go all the way through the process to closing. 6) We look at all properties based on a 3 to 5 year Exit Strategy. Meaning, if our client wanted or needed to unload the property in the next 3 to 5 years, could we help them sell their property and reasonably expect to come out ahead after paying 6% Real Estate Commission Fees. 7) We also tend to stick with properties that are less than 20 years old. There are some varying circumstances or compensating factors that we can look at on a case to case basis. 8) We also go to emerging markets and when the numbers drop below our 15% minimum annual Cash on Cash Return… we leave the market. There are always things that can happen with even the best property or what appears to be a great tenant. That’s investing and the risk you take. However, we work hard to minimize or mitigate the things that can go wrong, so that our properties will perform for long after we acquire them or help our clients acquire them. This may is why 70% of our clients come back to buy with us year after year for the past 11 years. We have a great network and a successful track record and that is why I was able to help our clients acquire 953 properties last year across the country. I consider all of my clients ….. clients for life and I am there to help them grow, manage and restructure their portfolio in the years to come. I hope this helps clarify what we do. You can find me on Linked In if you have more questions and want to communicate offline. I am just stating what works for us and it may be a good model for others. Real Estate is not a One Size Fits All & there are so many ways to make money and time, experience and patience … many can have success in Real Estate Investing.

Katie

Replied over 3 years ago

Wow. Thank you for your prompt, lengthy and detailed response. I agree that buying based on appreciation is foolish, however, since everyone else here is doing just that it makes it difficult to compete. Just down the street, there is a duplex that would cash flow at $750K. I offered $700K to get the ball rolling. Somebody else bought it for $950K. No new tenants moved in this week, and given the work going on, it looks like it might be a flip. My market is interesting. The vacancy rate is 0.5%, so rental inventory is pretty much nonexistent. Tenants rent crummy places because the good places never come available. Even if a tenant is leaving, it will most lucky never reach the rental market because the landlord will accept a referred tenant. So if you are lucky enough to know someone in a good place with plans to leave, you have a chance. Tenants in these crummy places do not complain to the city or the landlord because it is just too risky. Even though the landlord can not send a 30-day notice in retaliation (they must wait at least six months), after six months they are likely to send a 30-day notice. Given the low inventory, it might be impossible to find another place within 30 days. There has been very little new construction for decades, so most houses are at least 50 years. Those “newer” houses rarely come on the market, so what you see are houses that are 80-120 years old. It is quite a strange market. What has been happening with all the cheap money is that people are taking out home equity loans and restoring the facades of these old Victorians and Craftmans, so the neighborhoods are starting to look better.

Sean Cole Investor from Cincinnati, OH

Replied over 3 years ago

I need someone else to show me how you can buy a $50,000 with a mortgage and have higher cashflow than the $50,000 house I bought without one.

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

No one is suggesting anything close to what you are insinuating with this comment. It is obviously absurd to think that a property with a mortgage on it produces more cash flow than if that EXACT SAME PROPERTY were owned free and clear. We are making a different point – If you have $50K you have a choice. That choice is to buy one $50K property with all cash, or a real estate portfolio worth $250K. Now that portfolio can be 5 $50K homes identical to the all cash one, or one $250K property producing 5X the cash flow, but either way it is financed with a $50K down payment and a $200K mortgage. In that scenario if the $50K house produces $500 per month in cash flow and the $250K portfolio produces $2500 per month in cash flow, the all cash investor should produce MORE cash flow in the first year, and maybe the next few. But, the guy using the mortgage will RAPIDLY SURPASS the all cash investor in a market that appreciates with inflation. This is because of more math – if $500 in rent goes up 10%, you now get $50 more per month. If $2500 in rent goes up 10% you get $250 more per month. Your financing costs stay the same, so you get to pocket the difference. Again, no one would ever argue the case you are suggesting with this comment. Is this point clear? It’s fine to argue, “Oh that will never happen in reality” and that’s fine to disagree with – this is demonstrating what happens, on average, across most of America, over time. Obviously, the leveraged investors would be well-advised to keep ample cash reserves and to be conservative and proactive with his management to avoid losses that might force him to lose the property – but the same could be said for the all-cash guy to a slightly lesser extent.

Brandon Rooks

Replied over 3 years ago

Katie, We have New Construction properties in 8 different cities around the country right now that hit all of our requirements and minimum returns. I like to take LUCK out of the equation and make the deals happen for me and my clients. You can find me on Linked In if you would like to know more. I helped my clients acquire over 950 properties last year all with an average price of 100 to 175K each. They are out there … you just have to know where to look. 🙂

Brandon Rooks

Replied over 3 years ago

Sean, The key behind this is not to compare a $50,000 Cash Purchase to a $ 50,000 Financed Purchase. The article is about leveraging for higher returns & a 30 yr vs. 15 yr. Let\’s take the $50,000 that you are discussing. Let\’s say you spent the same $ 50,000 to buy a house for ALL cash. You would have $615 a month cash flow based on the following: $ 800 Monthly Rent $ 65 Monthly Taxes $ 65 Monthly Insurance $ 55 Monthly PM Fees. However if bought that same $ 50,000 house using leverage & 20% / $10,000 down, you could purchase 5 of those same $50,000 houses. The Monthly Cash Flow for each house is now $ 405.34 per month based on the exact same numbers above. 5 Houses x $ 405.34 = $ 2,026.70 per month. Now the REAL Question is what is the Quality of a $ 50,000 house. I personally would never own another $50,000 house in my Portfolio. My experience with Tenants, Repairs, Maintenance, Vacancies, Evictions, Legal Fees, Trashed Homes, etc in the Low Rent / Low purchase price homes was that my great cash flow was quickly relinquished in, owning low end or subsidized housing. Although you can still have issues with tenants that are paying $ 1,000 or even $ 1,500 a month in rent …. all of the items I mentioned above were GREATLY diminished when I went into the higher Asset & Tenant Class. Therefore buying a $ 100,000 house with $ 400 a month net cash flow & using 20 % down financing …. I can purchase 2 of those homes and still have money left over out of the 50K and average $ 800 a month in net cash flow. Plus, my 100K homes can reasonably expect to have much better equity gains & being a 3 Bed, 2 Bath, 2 Car Garage home with an average of 1,500 sq. ft. or more …. makes it a much easier home to sell on the retail market to someone that wants to OWN their own home. This is just based on my experience and I do know many successful investors that manage and maintain their own properties in their areas in that lower price point. It just does not work for my personal portfolio. I like to be hands off and just INVEST and let my Property Management Companies take care of all the Tenant, Maintenance Calls, collect the rent, place new tenants & send me my checks every month. Best of luck to you in all your future acquisitions.

Sean Cole Investor from Cincinnati, OH

Replied over 3 years ago

That’s exactly the point I’ve been trying to make since this article was posted! The spreadsheet assumes the cash investor is only buying a $12,500 house instead of the $50,000 house the leveraged people are buying. Thanks for proving the point I’ve been trying to make.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 3 years ago

I think the concept of the article relates to the concept of Velocity of money, meaning if you have $100K to spend, you could buy 2 $50K houses, or you could put 20% down on 5 properties affording more potential down the road, but I would argue, that if i purchased 2 $50K houses, all cash, with forced equity, i could leverage that equity to buy even more properties, however, at some point this is a house of cards, especially early on , like the last 30 days, where i had a Water supply lateral Rupture, and a storm take out a tree, and all my profit for the month was wiped out. people get strapped that way, I can absorb it, but many would struggle.

AJ Ridge

Replied over 3 years ago

Another thing to consider about deciding 15 or 30 is this: Apply the same amortization schedule to the 30, that you would have to the 15. This not only lets you pay the loan off at about 15.6 years, save on all that interest, and you’re also not locked into that higher payment, if you don’t pay the higher payment one month because you need money elsewhere, make it up later. Also, and this gets major underplay in the marketplace, Underwriting. Credit score, assets, and DTI (debt to income) are the three most heavily weighted criteria when qualifying someone for a loan. The payment for a 15 year is going to affect someone’s DTI not only for the subject property in question, but also for future purchases. With rates as low as they are today, unless you have a ton of disposable cash and could care less about rates and ROI, and just looking for something to spend your money on, 30 year fixed is the way to go.

Tim Porsche Investor from Denver, Pennsylvania

Replied over 3 years ago

Good discussion going on here, but I’m seeing a lot of people who seem to be confusing Cashflow with Return on Investment. A lot of comments go to the tune of, “but cashflow is so much greater when a property is all paid off”. This is absolutely true, but while cashflow is greater your ROI is MUCH lower (and to be fair so is your risk) than if you are leveraged. Consider the following properties: 1. $100,000 property owned free and clear producing $9,600 net profit per year 2. $100,000 property owned with 20% down and producing $4,000 net profit per year Property number one has greater cashflow, but the ROI on it is way lower than on property number two. 1. $9,600\$100,000 = 9.6% ROI 2. $4,000\$20,000=20% ROI This is only taking into account cashflow as an ROI metric for property number 2. Add in principal paydown and appreciation and your ROI is even higher still. And remember, when you get say 4% appreciation on a leveraged house your ROI hasn’t gone up 4% but 20% in this example! You’ve added $4,000 in appreciation but you only have $20,000 invested, so that is a 20% ROI bump. If you’re leveraged, that 4% appreciation only adds a 4% ROI bump for you.

Sean Cole Investor from Cincinnati, OH

Replied over 3 years ago

Your point is valid, however my family can’t spend ROI and we sure as heck can spend cashflow.

Tim Porsche Investor from Denver, Pennsylvania

Replied over 3 years ago

You absolutely can spend ROI if it is in the form of more cashflow and not appreciation. Think of it this way, if you have $100,000 to invest you can… A. Invest all $100,000 into one property that you pay cash for. You make $500\month from this after all bills are paid, which is $6,000 per year so your ROI is 6%. B. Invest $20,000 of the $100,000 in five different properties, that each cash flow at $225\month after all bills are paid. Your monthly cashflow (that you can spend 🙂 ) is now $1,125 because you are leveraged, and your ROI is 13.5% instead of 6%. Take into account the principal on all five houses that is being paid down, and any appreciation, and it becomes even better for you. If you’re looking to minimize risk, which is completely legitimate and everyone has different risk tolerances, buying cash might be the way to go. But just from a numbers standpoint, looking at the math, using leverage gives you far better ROI and cashflow all things considered.

Jesse Hargrove Investor from Charlestown, New Hampshire

Replied over 3 years ago

I don’t understand the interest is tax deductible theory. I hear it all the time. Like paying interest is a good thing. If you pay 10,000.00 in interest you can deduct it. But if you are in the 25% bracket for example. That will knock off 2500.00 off your income. If you paid no interest you would pay 2500.00 in tax. That would leave you with 7500.00 in your pocket at the end of the year. I understand if you can not pay cash you will need a loan. But for me paying interest is not a good thing. Could some one explain to me if I am missing something.

Steve Vaughan Rental Property Investor from East Wenatchee, WA

Replied over 3 years ago

You’re exactly right, Jesse. The ”tax benefits” of paying more interest is a fool’s strategy. Send me $10,000 and I’ll return $2,500 (or $3,300) any day of the week! If you want a tax deduction, give to a charity instead of a bank.

Deanna Opgenort Rental Property Investor from San Diego, CA

Replied about 2 years ago

Touting the deductiblity of interest is just pointing out that paying $100 of interest is not the same as $100 out of your pocket (it’s only $75 out of your pocket). The real tax appeal of real estate is depreciation I’m actually surprised that wasn’t addressed in this article – in the earlier examples the owner of the $50k home would only get to depreciate on about $40k (the structure), paying income tax on all but $1,145 per year while the person with 5 leveraged homes would get to depreciate on $200k worth of structures, (a $7,272 annual deduction) making the income virtually tax free for the first few years.

Chris Smith from Clearwater, Florida

Replied over 3 years ago

I lost interest in this article as soon as I saw your expected stock market returns of 11.5%….seriously…? You completely compromised all the calculations by using that as your comparative value. That seems pretty biased and unrealistic if you ask me.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 3 years ago

Im with ya @Chris Smith, the average investor doesn’t earn 6% the numbers are completely unrealistic!!!

Scott Trench President of BiggerPockets from Denver, CO

Replied over 3 years ago

Choose whatever number you want – I acknowledge that those returns are an assumption that others might disagree with. I do, however, cite my source for those returns and link directly to the raw data where that number is derived from in my model. Perhaps you could use some data or refer a source in this reply instead of just saying that numbers are “biased and unrealistic” – I’d be interested to see a source that suggests a significantly different arithmetic average for stock market returns invested in S&P 500.

Brandon Rooks

Replied over 3 years ago

Excellent way to handle those last responses in regards to Stock Market Returns. The numbers are really inconsequential anyway. All Stock Brokers and Financial Advisors are famous for promoting between 8 – 12% returns in the Market, but choose segments in history that can prove that and rarely show you the past 12 months. Real Estate has outperformed the Stock Market throughout History and tracking the stats of all investments. If a Stock Broker told you the TRUTH about Returns & what happens when another economic Tornado happens on the other side of the world can do to the Value of your Portfolio, then you would see a lot fewer people investing in the Stock Market. I personally will take a HARD ASSET any day over a Piece of Paper or Online Account Value Report. When Brexit happened, people lost money, panicked and pulled out, same thing happens everytime we hear some new Global or National Hiccup happen. Greece Defaulting, 2008, Black Monday, etc….. If you BUY your RE Asset Correctly , with Proper Leverage and sufficient Cash Flow, you could ride out any storm.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 3 years ago

According to Forbes the 20 average is 2.5% and 30 year is 1.9% http://www.forbes.com/sites/advisor/2014/04/24/why-the-average-investors-investment-return-is-so-low/#5a728e3663a4 and here is another referencing the S&P actual returns of sub 4% http://www.foxbusiness.com/features/2013/08/12/average-return-wall-streets-dirty-little-secret.html I know Dave Ramsey regularly talks about 11-12% returns in S&P funds, and the 30 year average return of the S&P 500 is around 11% but that doesn’t take into account the fees associated with your account, and unreturned losses over time, and that almost no one keeps a fund for 30 years, heck not to many funds are even around that long. and a real estate investor should not hold a property for 30 years either, they should at some point upgrade (1031 exchange) into bigger better properties so they can continue depreciating.

Katie

Replied over 3 years ago

Actually depending on the assumptions and parameters of the study, historic market returns range from about 6% to 12% annualized. However, the actual number does not mean much when other studies, year in and year out, show that individual investors get only a fraction of the market return, usually 1-3%, again depending on study methodology. One major assumption of historic market returns is that you bought “the index” 100 years (or however many years the study is using) and held on until now,and are still holding on. Nobody did or does that. Then consider the typical retail stock investor habit of buying high and selling low, instead of the other way around. No wonder individual returns are so bad.

David Ingle from Chandler, Arizona

Replied 12 months ago

I realize this is a bit late but, No true at all. 11.5% is a good number. Long term stocks portfolio’s can return well over 12% over a 10yr and longer period, increase your income by an average of 10% per year, can reduce volatility when compared to the S&P( 2008 Sp down 37.5% we were down 16%) and continuously reduce risk of loss of investment the longer you hold. This is why you should have a financial advisor helping you and stop thinking you can manage portfolios on your own.

Katie Rogers from Santa Barbara, California

Replied 12 months ago

Sure, a long-term stock portfolio CAN return well over 12% over a 10 year or longer period, but it may also fail to do so. Depends on which 10-year period you choose to look at. From 2003-2013, the annualized return of the SP500 was less than 7%. Estate planners usually base their projections on assuming 8% annual return. Some financial advisers caution that because so many companies have dragged future returns into the present through various accounting means, going forward average annual returns might be significantly less than 8%. Some financial advisers suggest erring on the side of caution by assuming a 4% annual return. I have a certain financial instrument that I have owned for many decades. Its actual return has been far less than the projections made at the time I purchased it. Distributions today were forecast to cover 100% living expenses, but they actually only cover about 1/4 of living expenses.

Dan Currotto Real Estate Investor from Clearwater, Florida

Replied over 3 years ago

I would take the longer amortization and apply principal payments of my choosing. It will give you more flexibility in the long run.

Jerry W. Investor from Thermopolis, Wyoming

Replied about 3 years ago

I normally disagree with Scott on his posts, and my strategy is different than his, but he has some very valid points here. He is essentially talking about the internal rate of return of the money you invest. A guy named Frank Gallinelli wrote a book about What Every Real Estate Investor Needs To Know About Cash Flow that is amazing, but it is not a quick read but is incredibly good. Scott is talking about the RATE of return, not gross return. The guy who only puts down 20% could buy 5 identical properties compared to the guy who paid all cash. So for the same amount invested he gets appreciation on 5 properties, not one. I agree that the 30 year loan gives you a higher rate of return if you can reinvest the excess cash flow. In my situation if I let the cash flow add up in a savings account until I have enough to buy another property it takes years and I would prefer to pay down my 5% interest payments sooner then tap the equity with a second mortgage when the equity is high enough. The idea is if you can borrow money at 3% or 5% but can invest it and get 15% as a rate of return, then you need to keep pulling out equity and buying more properties. The real problem is that when you get big enough to be commercial you no longer get 30 year loans, and now that I am old enough to get senior discounts at restaurants I have decided I would rather pay mortgages off and have less hassle than to continue to grow my portfolio. I also have to deal with a local recession that makes less leverage more appealing. Good article Scott. Keep doing posts that make people think.

Scott Schultz Rental Property Investor from West Bend, WI

Replied about 3 years ago

Here is another thing, that applies to the younger investor, Security, if you put 20% down on a 30 year amm, you gain almost zero equity in the first 10 years, unless appreciation is huge (a gamble at best) my philosophy is never borrow more than 60% LTV, and do it on a 10 or 15 year, mine are commercial, so I have to re up my notes every 3-5 years, now if the market tanks again, and we lose 20% in value (pretty huge dip here in WI) im still protected with 20% value remaining to get my re-fi done. Understanding that Scott T is talking about secondary market 30 year fixed, but a lot can happen in 30 years, if numbers were the only factor, he is right, But security, DTI and having a net worth as you grow is important too, besides, once you max your 10 secondary market loans now they look at you differently, and scrutinize your plan, Bankers are blown away when an investor has 10 ot 15’s with big equity and still make a profit, it makes it easier to see you know how to make money.

Hans Thurau Investor from Tustin, CA

Replied about 3 years ago

Great perspective! Reading through all the comments, including the points and counterpoints were very insightful. Regarding lending sources for rentals (as well as flips), I’ve seen a couple ads come up on Bigger Pockets. One was for Lending One, the other for Center Street Lending. I checked out both; Lending One seems legit on the rental and flip. They do offer 30 year loans. Center Street didn’t seem to offer 30 year loans as far as I can see. Anyone have experience with any of these loan houses or have other sources that are specific to rental / flip investors? I currently have 7 rental units and looking to get back in the game. Thank you!

Larry T

Replied almost 3 years ago

Hi Scott, I appreciate your research and writing. It is my understanding that practically all 30 year mortgages can be paid down on a monthly basis as if they were 15 year mortgages, as long as the larger monthly payment does not exceed the prepay limit of the loan. If this is the case, the flexibility in monthly payment amounts that the 30 year term gives is a big advantage over the 15 year term for the investor. Also, if the larger monthly payment is made, the investor is lowering the effective interest rate on the 30 year loan and making it closer to the rate he or she would have gotten from the bank if the loan were originated as a 15 year term. What are your thoughts on this? Reply Report comment

Larry T

Replied almost 3 years ago

Na Boyd

Replied over 1 year ago

Doing a 15 yr vs 30 puts you 15 years ahead on the amortization schedule. Because the interest rate is higher and because the interest rate is off of such a large number (the value of the home) Even if you make the 15 year higher payment on a 30 you will still be years behind schedule on building equity when compared to a 15 year loan. So from that standpoint it better to do a 15 year. I’m not saying a 15 year is better because we haven’t taken into account leverage and buying/ investing the extra payments needed for a 15 year. Only that making 15 year payment amounts on a 30 year mortgage doesn’t get you close to paying off the mortgage in 15 years.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 1 year ago

Im with you @NA BOYD in the end it comes down to goals and aspirations, and where you are in you investing, For me I prefer a shorter pay down, and then getting lines of credit to be a cash buyer on future deals. the other thing is 15 vs 30 is pretty much limited to secondary market loans, (generally 10 per person) so this thread is suited for the armature investor, or at best beginners. More seasoned investors cant get that financing.

Larry T

Replied almost 3 years ago

Ubelio Fernandez Real Estate Agent from Las Vegas, Nevada

Replied over 2 years ago

I understand that buying a house with a loan it is a good strategy to build wealth over time, it is a smart move for people who dreams to be an investor when they don’t have the money source to fulfill their dream and a very good approach to gain ownership of a home. But for sure it is a bad assumption that matter of offering a “Better” recipe considering a very particular model with five key assumptions that “some or maybe all of these assumptions might be things you disagree with” Only to go to the point read this from the article “The reason for this is that leverage amplifies returns. If you buy a house for $100,000 in cash and it increases in value by $10,000, you’ve made 10% on your money. If you buy a house for $100,000 with a down payment of $20,000 (a loan of $80,000) and it increases in value by $10,000, you’ve made 50% on your initial $20,000 investment” That’s remember me someone who says something like this, “numbers is one of the most important things, but they are like bikinis, they show a lot of things but not the most important thing” the gay who make 50% on his initial investment still have the property encumbered by a mortgage, vacancies and bad debt will be an stressful problem, he has a little access to the equity of his property and a long road ahead. On the other hand, the gay who only make 10% on his money, has a home free and clear with a lot of exit strategies, like renting, rent to own with owner financing, selling with owner financing, access to the equity of the property and repeat three of four times the wining model of the investor who make 50%, only to mention a few. Yes, I prefer $110K of wealth, 10% of my cash investment and a lot of further investment possibilities strategies than $30K that represents 50% of my cash investment and less possibilities. Sometimes 10% is more convenient than 50% even when math shows us a different answer.

Joe Arlt Real Estate Agent from Vienna, Virginia

Replied over 2 years ago

This academic analysis has been interesting, something we would have studied during my MBA 30 or so years ago. But after 20 years in the business and hundreds of deals, I can report that here is how REAL investors think: 1. No need to do the 20% down and get a mortgage from a bank thing. There are plenty of people that will let you take over the payments on their existing mortgages, always with no qualifying and often with little or no money required. 2. The required financial analysis can be done on the back of an envelope. 3.25% vs. 3.9%? Really? I hung up my Excel spreadsheets when I left Wharton. Real investors spend their time finding deals and lining up financing. The rest is a rounding difference. We borrow from private lenders at 6-10% and use the funds to pay cash for junkers we can steal, or on down payments and closing costs on take over payments deals, or we lend it to other investors at 15% and 5 points and maybe a piece of the equity, on low LTV rehab deals. You don’t need an HP 12C to figure out that these returns work. 3. REAL investors don’t put their money into passive investments they can’t control. Why buy a stock or index fund at full retail (and it is by definition always priced at full retail) when they can buy real estate, in a market they’ve been working for years, at 30% off?

Kurt

Replied over 2 years ago

I am not sure where you are finding these 30% off deals where you take over payments. In my market, there is nothing that isn’t 30% over what it was 3 years ago.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 2 years ago

If you are not finding 30% off deals, you are not looking in the right places, or you need to look at a different market, until there is a market shift

Kurt

Replied over 2 years ago

I rarely see anyone on this site advising people to wait until the market weakens. Here it’s all about doing as many deals as possible as quickly as possible, which is just not my strategy. Reality is it takes a long time to get the resources to buy a place and it takes a long time for the market to provide a decent deal. I am talking about on the order of 5-10 years. It’s a waiting game. But waiting patiently does pay off.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 2 years ago

Keep in mind, the 80/20 rule, same applies here, but I gt the feeling its more like the 95/5 rule on BP, like 95% of the people on here have never purchased a house, or only a personal residence, and everything they are spewing is “theory” they read in a book. Once an investor has been through market cycles then they have some credibility. the market right now in much of the country is not conducive to buying rentals at a discount, and like stocks, I dont buy at the top of the market, look at what the masses are doing, and go the otherway, most successful investors go against the grain. and I am on to run into the burning building when everyone is running out.

Kurt

Replied over 2 years ago

Ironic that there is all this hype at the worst possible time. I suspect this site will be long dormant the next time it’s a good time to buy.

Raj G. Real Estate Investor from Chantilly, Virginia

Replied over 2 years ago

Hi Scott, Does your analysis include PMI (private mortgage insurance) if the we have less than 20% down (trying to understand whether a 30 yr vs 15 yr is better for a primary residence). Thanks.

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 2 years ago

No, I dont borrow secondary market, money, and if you cant figure out 20% down cash or equity you shouldn’t bey buying investment property in my opinion, it would put you in a really bad spot even at only 20% down when we go into the next market correction. Personally I want options to get out of a property if I have to. I borrow commercial loans, and typically dont finance till after the rehab is done, at that point I expect to be able to borrow 60% LTV, and get my entire initial investment back, and more at times. if you have to use a 30 year to make the numbers work, you either need to find better deals, or look at a different market to invest in.

Bob Kehoe Flipper from Point Pleasant Beach, New Jersey

Replied over 2 years ago

Stock market return of 11.5%! Even with the monster rally from 2009 the S&P historical return is still only about 8.5% (dividends included).

Bob Kehoe Flipper from Point Pleasant Beach, New Jersey

Replied over 2 years ago

*9.5% not 8.5

Scott Schultz Rental Property Investor from West Bend, WI

Replied over 2 years ago

yea, those are the raw numbers, but I would like to see actual returns of that, very few people actually see those numbers in the stock market, especially in common vehicles, once you account for fees, and fear, the average market return for most stock investors is extremely low, only a couple %. If you could get those returns today consistently everyone could retire comfortably

Bob Schmitt from Seattle, Washington

Replied over 2 years ago

I think your spreadsheet has an error on the net cash flow for the 15 yr loan. Row 88 should have a formula that sums the cash flow (row 34) and the dividends (row 41).

Scott Trench President of BiggerPockets from Denver, CO

Replied over 2 years ago

Bob – Thanks for pointing this out. Yes, good catch. Adding in the negative cash flow from the missed opportunities to invest in the stock market and generate dividend further compounds the case for a 30 year loan vs a 15 year mortgage.

Dan Curley

Replied over 2 years ago

I was reviewing spreadsheet. Don’t understand why value of property for all cash deal is 12,500 and for 15 and 30 year it’s 62,500.

Ali Hashemi Investor from Southern Indiana, IN

Replied about 2 years ago

Makes sense. Great article. Very important to factor in exit strategy. If you plan to hold to term the graphs tell it all. If you plan to exit before full term the graphs are very helpful in indicating when it makes sense to exit. For example I bought my first property and factored my term based on knowing my plan was to hold for 3-5 years but definitely less than 7. If I held longer than 7 years I would’ve had to travel back in time to kick my former-self’s butt for electing the wrong note.

Darrell D. Rental Property Investor from Springfield, OH

Replied about 2 years ago

I think it’s important to note that the cashflow from a 30 year loan is saved and considered as net worth. Most people don’t save 100% of the cashflow. I use my cashflow as income… I live off of it. If you’re like me the 15 year loan offers a much faster opportunity to perform a 1031 exchange. Once the exchange happens, the cashflow will explode! For example, take the equity from one house, worth $200k and buy a million dollar property. Now you’ll be cash flowing thousands per month and your net worth will be a million after 30 years (instead of $500k) when considering property value alone.

Deanna Opgenort Rental Property Investor from San Diego, CA

Replied about 2 years ago

If you are living off the income it’s part investment, part annuity. As far as the appreciation numbers with the 1031 exchange returns, won’t that sort of depend on how good an investment the million dollar property is and which 30 years? A $1m class B middle-class multi-family is likely to behave very differently than a new $1m mansion in Texas.

Shaun Reilly Landlord and Rehabber from Newton, Massachusetts

Replied over 1 year ago

I think what usually misses the mark in all these 15 vs. 30 year type articles is that different investors have different goals and priorities. NOBODY thinks you will acquire more properties faster and with higher ROI, ROE, IRR ect… when buying with all cash or large down payments with traditional loans with shorter amortization periods. People doing that are looking at risk and maximizing cashflow in the short term (all cash) or mid term (payoff debt ASAP). So 15 year loans make no sense for the people that are willing to take a higher level of risk and are driven to maximize their percentage returns by all the various measures as quickly as possible. This question is only for the investor that is looking to acquire a small to medium portfolio (I’m calling medium several dozen residential units in 1-4 family buildings, as this also doesn’t apply at all once you go commercial). Now all that being said I would ALWAYS take the 30 year loan. Why? Because it is less risky than a 15 year loan. A smaller payment means you can weather a storm easier than if you are required to make a larger payment. Now after THAT being said there is no reason not to work to jettison the debt as quickly as possibly if you would like. Now there IS the inherent benefit of getting a lower rate on a 15 year loan. (As and aside I find it interesting that Scott makes a LOT of assumptions in his analysis but doesn’t take into account the difference in interest rate. This isn’t an assumption it is a fact. The actual rate you put in can be an assumption [though the current rates are simple to get] but the fact there will be a difference isn’t unlike an appreciation rate or returns on the stock market etc.) As other people have said in different comments you can just make the 15 year payment and pay the loan off faster. It won’t be 15 years but it won’t be much longer. As of today if you use the current rates (about 4.5% on a 30 and about 4.0% on a 15) you would payoff the 30 year loan with the 15 year payments in just under 15 years and 9 months. So why advocate for the longer term when you will end up paying about $13K more on a $200K loan? Well mostly because you can think of that as the premium paid on a 30 insurance policy for an economic emergency. If you have a 15 year fixed you HAVE to make the higher payment with the 30 you can always make just the regular payment (in that $200K case can lower the payment by about $465 a month). So if you have a prolonged vacancy or maybe lose you JOB or something else you can temporarily cut back to hoard current cash until things turn around.

Cory Binsfield Financial Advisor from Duluth, MN

Replied over 1 year ago

Awesome spreadsheet Scott! I’m a huge fan of locking in a historic low rate on a 30 year mortgage and buying ten decent cash flowing rentals as soon as you can. The extra cash flow allows you to weather storms like the last housing crash or save for the next down payment. Like others have pointed out, you can decide to pay off your loan sooner by simply kicking in extra principal payments once you decide to delever the portfolio. I’d like to point out that there is a big difference between average annual returns and compounded returns. It looks like you arrived at the 11.5% return by averaging the data set? The true return is based upon the growth of $100.00 from 1928-present. Due to volatility of the stock market, the compounded return is lower. The compounded return is 9.8%. Here is the calculator https://dqydj.com/sp-500-return-calculator/ If you ever want to geek out on returns, this is my favorite site for all things financial including S&P 500 and Dow calculators. Sadly, the vast majority of investors will never get this return unless they buy the S&P 500 index fund and never get scared out of it. Most investors buy active funds or individual stocks. Even with the lower return, the 30 year investor wins. Worse, why tie up equity in a 15 year mortgage when it can be reinvested at a higher rate?

Nelson Diaz

Replied over 1 year ago

I think a 30 years mortgage is best. Over all, using the technique in this video that let you reduce your mortgage less than 15 years and reduce drastically your interest payment. You can skip the pitch and go directly at minute 24. Copy and paste

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