Mortgage Interest Rates Are Rising. Will They Crush Your Rental Portfolio?

Mortgage Interest Rates Are Rising. Will They Crush Your Rental Portfolio?

3 min read
Sterling White

Sterling White is a multifamily investor, specializing in value-add apartments in Indianapolis and other Midwestern markets. With just under a decade of experience in the real estate industry, Sterling was involved with the management of over $10MM in capital, which is deployed across a $18.9MM real estate portfolio made up of multifamily apartments. Through the company he founded, Sonder Investment Group, he owns just under 400 units.

Experience
Sterling is a seasoned real estate investor, philanthropist, speaker, host, mentor, and former world record attemptee, who was born and raised in Indianapolis. He is the author of the renowned book From Zero to 400 Units and the host of a phenomenal podcast, which hit the No. 1 spot on The Real Estate Experience Podcast‘s list of best shows in the investing category.

Living and breathing real estate since 2009, Sterling currently owns multiple businesses related to real estate, including Sterling White Enterprises, Sonder Investment Group, and other investment partnerships. Throughout the span of a decade, he has contributed to helping others become successful in the real estate industry. In addition, he has been directly involved with both buying and selling over 100 single family homes.

Sterling’s primary specialities include sales, marketing, crowdfunding, buy and hold investing, investment properties, and many more.

He was featured on the BiggerPockets Podcast episode #308 and has been contributing content to BiggerPockets since 2014, with over 200 posts on topics ranging from single family investing and apartment investing to mindset and scaling a business online. He has been featured on multiple other podcasts, too.

When he isn’t immersed in the real world, Sterling likes reading motivational books, including Maverick Mindset by Doug Hall, As a Man Thinketh by James Allen, and Sell or Be Sold by Grant Cardone.

As a thrill-seeker with an evident fear of heights, he somehow managed to jump off of a 65-foot cliff into deep water without flinching. (Okay, maybe a little bit…) Sterling is also an avid kale-eating traveller, but nothing is more important to him than family. His unusual habit is bird-watching, which he discovered he truly enjoyed during an Ornithology class from his college days.

Education
Sterling attended the University of Indianapolis.

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Mortgage rates are going up. Some real estate investors might find that soon puts them in a very difficult financial position. How bad could it get? What do you do?

Interest rates can make a huge difference in the profitability of rental properties. According to BankRate.com, average mortgage rates rose half a percentage point from September to December 2016. That might not sound like much, but even small changes can be very expensive, and rates could rocket far higher than most imagine. Most analysts expect the Federal Reserve to keep pushing rates up for now, even if it is only to give them room to address a future recession. Of course, those who were in the business in the early 2000s know that rising rates were actually one of the big factors which forced the foreclosure crisis.

Related: 4 Popular Mortgage Programs for First-Time Home Buyers

How High Will Rates Rise?

How high could mortgage rates go? As of early December, average 30-year mortgage rates were around 4%. That’s still crazy low. If you look at the data from the Federal Reserve Bank of St. Louis, we are still experiencing the lowest rates since 1971. That’s as far back as they are tracked. The average over the last 40 years has been around 7.5%.

So, let’s just say you have a $300,000 loan on a rental property at 3.5% (because you took it out a couple years ago). Your principal and interest payment would be $1,347.13 per month. Let’s say that with all other expenses totaled, you net about $200 each month in positive cash flow.

credit-report-loan

Now, if you need to refinance and rates are back up to that average of 7.5%, you’d end up with a payment of $2,097.64 each month. You’d be paying $750,51 cents more every month. You’d not only lose your positive cash flow; you’d have to find $550.51 from somewhere else each month just to break even. That’s hoping your tenant is paying on time and your property taxes or other costs haven’t risen as well. How many properties with $500 in negative cash flow each month can you afford to hold on to? If you made $5,000 per month from a day job, you would need all that and more just to keep afloat. This is exactly how the 2008 crisis happened. You can play around with this free mortgage calculator to see how the numbers would change for you based on different interest rates. I would definitely recommend checking out how much more you’ll actually pay for the property based on a higher interest to see those numbers too.

Related: Recently Self-Employed? What You Should Know Before Applying for a New Mortgage

Finance Your Investments Right

The publicly traded REITs that utilize large amounts of leverage, as well as those investors buying on low cap rates with interest only in their terms, oftentimes take a big hit when rates go up. This is why buying and financing right are crucial steps. Another big con in the last few years has been companies promoting investments with 5 or 10-year balloon mortgages. What happens if you have a balloon mortgage, ARM, or flexible line of credit on a property you actually plan to hold for 30 years or more — especially in an environment where rates can virtually only go up? Let’s just say you better have a lot of equity to ensure you can sell.

cash-flow-rental

What can you do instead? Real estate is still a fabulous investment. That’s why the banks make these types of loans. But you could buy cheaper properties, pay cash or partner up, and not use debt. Or you could borrow less, maintain more equity, and take long-term fixed rates.

What if you already made the mistake? Refinance and lock in low long term loan rates now if you can make the numbers make sense. Or cash out and readjust your portfolio with new assets.

What are you doing to protect your investments against rising rates?

Let me know with a comment!