Mortgages & Creative Financing

5 Reasons to Choose a 30-Year Mortgage Over a 15-Year

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Mortgage loan agreement application with house shaped keyring

As a first-time home buyer before the last market downturn, I loved the idea of a 15-year mortgage. Being debt-free was my goal before I had even heard the term “financial freedom.”

I thought of a shorter mortgage term as the financially responsible thing to do (as long as I could afford the monthly payments). I even set aside a property with a 15-year mortgage for each of my kids, which would be used to pay for their college educations when the time comes.

But over the last few years, as I have gained a much better understanding of real estate financing and leveraging, I have gained a new perspective. I have learned that low-risk leveraging is my friend and that 30-year mortgages are better than 15-year mortgages for a long-term buy and hold investor trying to scale her portfolio—especially in this market cycle.

Assuming that you are reading this post because you are interested in making a decision about an investment property (as opposed to a primary residence), let’s get into four key definitions that we will need clarity before moving forward.

Real Estate Financing: Key Definitions

What Is Amortization?

Amortization is reduction of debt over specific time period. When it comes to fixed rate real estate mortgages, a mortgage payment will include the interest payment and the principal payment (which brings the amount of the loan down).

Usually, the initial years of the loan will have higher interest payments and lower principal payment. During the later years of the loan, the opposite applies.

What Is PITI (Principal, Interest, Taxes and Insurance)?

Most times, mortgages come with an escrow account set up by the lender, which will allow the lender to pay your property taxes and insurance premiums on your behalf. The addition of these components make up the acronym PITI (principal, interest, taxes, and insurance).

What Is Net Operating Income?

Net operating income (NOI) is guided by a simple formula:

NOI = Revenue From a Property (i.e., Rental Income) – Operating Expenses

Examples of operating expenses are vacancy reserve, management fees, utilities, rental licenses, etc.

What Is Cash Flow After Financing?

Cash flow after financing will take into account the financing expenses. In this case, because we are considering two financing options, it is important to consider cash flow after financing as opposed to before.

Cash Flow After Financing = NOI – CapEx Reserves – Financing Costs

With that in mind, now let’s discuss the key advantages of longer-term mortgages.

Related: How to Accelerate Your Mortgage Payoff

What Are the Key Advantages of a 30-Year Mortgage?

Here’s why I love 30-year mortgages—particularly in terms of scaling a portfolio. Read on to determine whether this is the right approach for growing your portfolio, too.

1. Higher Cash Flow

For an investor building a passive income portfolio, the longer the loan period, the higher the cash flow. This is of course because your monthly mortgage payment will be considerably lower for a 30-year mortgage, as your loan is amortized over a longer period compared to a 15-year mortgage.

Note that most financing options for properties owned in LLCs do not offer fixed longer-term amortization. Usually rates reset at five or seven years with some cap on the rates for the life of the loan.

However, the above turns out to be the best strategy regardless of whether the loan is conventional or commercial, because if in the future interest rates go up, the higher cash flow for a loan amortized over 30 years will have more room to absorb the increase in the expenses and costs than the one for 15.

2. Avoiding the Debt to Income Ratio Plateau

Whether it is mortgages that are conventional or commercial for properties owned in LLCs, as an investor who primarily invests in smaller multifamilies or single family properties, one can hit what I like to call the “debt to income plateau.”

Debt to Income = Debt Payments / Gross Income

Lower cash flow doesn’t just impact an investor’s monthly passive income, it also impacts an investor’s debt to income ratio (DTI). Even when properties are held in LLCs, the DTI ratio becomes a factor in purchasing smaller multifamilies (under five units) and single family homes when approaching most banks for mortgages.

If you are stuck in this plateau, your options are:

  1. Going with a bank that offers low doc (short for “documentation”) loans; however, such banks are limited and have higher interest rates and fees.
  2. Investing in larger multifamilies where your personal debt to income ratio doesn’t matter.
  3. Selling assets which are affecting your debt to income adversely.

business colleagues meeting in boardroom going over paperwork

3. Dodging the Dreaded DSCR Distraction

Whether investing in single family homes with a conventional mortgage or a large multifamily with a commercial mortgage, debt service coverage ratio (DSCR) is something none of us can avoid.

DSCR = NOI / Total Debt Service

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DSCR is considered by banks when approving a loan to compare level of cash flow to debt obligations. The result gives an unbiased indication to the lender of whether the borrower will be able to pay the loan back with interest. The majority of lenders I have worked with require a DSCR of at least 1.2.

The bank may choose to reduce the amount of the loan if the DSCR does not fit their criteria. Alternatively, they may amortize it for a longer period. With this in mind, a 30-year mortgage has a higher chance of getting approved than a 15-year mortgage.

Related: What’s Better for Investors — a 15-Year or 30-Year Mortgage?

4. Hedging the Market Cycle

With more and more data pointing toward an impending market downturn, it is important to keep a higher buffer between rental income and expenses. The expected issues an investor faces during a downturn are:

  1. A tenant who normally pays rent on time loses his or her job during a market downturn and is unable to pay rent.
  2. Vacancy rates go up.
  3. Rents decrease.

In each of the above scenarios, a lower monthly payment is a much better option for owners in terms of covering a mortgage with limited cash reserves.

5. Tax Deductible Interest

Mortgage interest payment tax deductions are higher for a 30-year mortgage due to the higher interest paid. I don’t think of this as a major advantage, but it is definitely something to consider when doing an analysis.

Considering the 15-Year Mortgage Option

I do understand the lure of a 15-year mortgage—it is a good way of ensuring that a larger amount of money is put toward the equity of a property. Interest rates for 15-year mortgages are usually (and sometimes significantly) lower than 30-year mortgages, allowing an investor to contribute more toward the principal rather than interest payments. Plus, the loan can be paid off in half the time!

However, if your goal is to pay off your mortgage early, one option is to get a 30-year mortgage and pay more than the required amount each month, which would go directly toward your principal. This approach gives you the flexibility to pay off your mortgage early, without committing to a 15-year amortization period.

For all of the aforementioned reasons, a 30-year mortgage is a great way to scale as a buy and hold investor.

Are there other pros/cons of longer-term mortgages that I’ve failed to mention here? 

Add them in the comment section below. 

 

Palak Shah is the owner and founder of Open Spaces Capital, a real estate development company and Open Spaces Women Portfolio Plan, a coaching program to empower women with knowledge to build wealth and financial independence using the BRRRR strategy for real estate investing. She graduated with a masters in Mechanical Engineering from the University of Illinois and has worked as an engineer in various industries and capacities. After the birth of her two kids and realizing that she needed to create a life with financial independence that allowed more time for her family, she decided to make the move to entrepreneurship. Though Palak has invested in real estate for many years, in her first three years investing full-time, she purchased, renovated, rented, and refinanced properties creating a portfolio worth $3.5 million. She was honored by Billy Penn in the “Who’s Next Real Estate and Housing” series highlighting Philadelphia’s most dynamic real estate, housing, and development professionals under the age of 40. She was also featured in the .Real Estate InvestHER’s recent podcast episode.

    Christopher Johnson Contractor from Delray Beach, FL
    Replied 2 months ago
    Nice article. What you say makes sense. A couple key notes: age of investor matters for long term goals. Also, I have heard this time and time again about people putting more money towards a loan to pay off early. It is great in concept and difficult practically speaking, especially with investment properties that should be set on "auto pilot" as much as possible. Great article and it was helpful.
    Palak Shah Developer from Philadelphia, PA
    Replied 2 months ago
    Thanks for your input Christopher Johnson!
    John Cummins
    Replied 2 months ago
    Excellent points, Leverage is king, in fact after having thirty five years and a number of long term, short term and cash deals of my own to analyze, I venture that a great argument may be made for interest only loans. Just my humble opinion.
    Palak Shah Developer from Philadelphia, PA
    Replied 2 months ago
    Thanks John Cummins, you bring up a great point. The cash flow is definitely going to be better with an interest only loan.
    Alaina Donofrio from Denver, CO
    Replied 2 months ago
    Good article! I will say I think some of this depends on what your goals are. For instance, I want to be retired (I WILL be retired) in 15 years, hence I'm refinancing both my primary and my investment properties to 15 year loans. I already pay the extra towards my primary residence, so for me it's getting a slightly lower rate, and also keeping me on track as I can't retire until my residence is paid off (whether my primary residence is this one or one I 'downsize' to...and I use quotes because my place is pretty dang small! Let's say relocate to a lower COL area). I'm refinancing my rental because I have a pretty high rate in relation to today's rates, I'll be 1.5% lower, and the payment on a 15 is only $100/mo higher than the payment I have now. I have enough free cash flow from the property to absorb this, and again this will keep me on track for my retirement. I'm also not actively looking to buy in the near future, but I do have enough reserves in various other accounts that I can put a good chunk down and still have enough to weather over a year of vacancies (banks like that) so if the market does take a downturn I can grab something. So I think for the vast majority of people reading this blog your advice is spot on. I feel that my goals are better served getting the properties paid off more quickly. Is it the most logical choice? Maybe not, but there's also the emotional aspect of it and what people are comfortable with.
    Michael P. Lindekugel Real Estate Broker from Seattle, WA
    Replied 2 months ago
    Alaina, paying off early or acquiring real property assets for all cash can have an detrimental opportunity cost. let's say your after tax cost of borrowing is 3%. that means your promissory note stated interest rate is higher. when you account for the interest tax deduction, then your effective after tax interest rate or cost of borrowing is 3%. let's say you can invest in some assets such as stocks, mutual fund, etc. for an after tax yield of 7%. if you pay cash for the real property, then you are losing the ability to invest that cash at 7%. that is your opportunity cost. if you acquire the real property with debt financing of an after tax cost of 3%, then you can invest the remaining cash after the down payment at 7% after tax. your net after tax yield is 4%. Most Americans are terrible at saving. homes become de facto savings accounts. in times with high interest rates in which the cost of borrowing exceeds the alternative investment yield, then the investor should pay down the debt as fast as possible instead of investing the different in alternative assets. your home is not really an asset in the investment sense despite what some uneducated real estate brokers may tell you. it is a decision to own you shelter not rent it. absent increasing the size or making it more opulent your home does not appreciate. there was no value added to the home. it is one year older and the same home as a year a go. the price went up because of asset inflation in the housing market. potential buyers losing purchasing power in the housing market. That is not appreciation. That is inflation. Income producing property is different. If apartment building increases NOI 10% from the previous year through rent increases, then value has been added. Investor may be willing to pay more. That is appreciation. If the same apartment building has the same NOI as last year and investors are wiling to pay more, then that is price inflation. Income producing assets can experience appreciation and inflation. When investors pay more and corporate earnings are not increasing, then we have stock market asset inflation. Too much inflation leads to corrections or bubbles in any asset class. For your home, maintaining debt is a low cost interest deductible way to invest cash in alternative investments that yield more than the cost borrowing. I would not pay off debt on income producing assets for the same reason. Don’t leverage debt more than 80% LTV. More than that is a fool’s game for a recession.
    Glenn F. Rental Property Investor from Virginia Beach, VA
    Replied 2 months ago
    Great write-up. However, inflation doesn't cause corrections and bubbles, an imbalance of too much demand with too little supply causes that. Inflation is just a devaluation of the dollar where it is worth less. On inflation, it is your friend if you are on the borrower side. Even for your own personal home. Every year you are paying back the loan with cheaper and cheaper dollars thanks to the government. The fed will adjust policy to make sure that they target 2-3% inflation every year. This means you are buying your home or investment property cheaper every year or think of it as a coupon for 2-3% off your payment. This is why I always advise people to own their home vs rent. 10-15 years from now when everyone is paying market rents, an owner would be paying 1/2 that. That's real money in your pocket.
    John Chapman Investor from Pullman, Washington
    Replied 2 months ago
    There is also an opportunity cost to a 15 year mortgage. I use the cash flow from my properties to save up for the down payment on the next property/opportunity. Since the cash flow is reduced in a 15 year mortgage, I can lose one or more opportunities in the future.
    Palak Shah Developer from Philadelphia, PA
    Replied 2 months ago
    Great point John Chapman - this is one of the many advantages of choosing a loan that allows for a higher cash flow.
    Cody L. Rental Property Investor from San Diego, Ca
    Replied 2 months ago
    In other news, 4% interest is better than 6% The fact that 30 year is better than 15 year should be obvious to anyone (no offense if it wasn't)
    Robert Clark from Los Angeles, CA
    Replied 2 months ago
    Unless you're referring to interest earned :) While I agree with you, we have to recognize everyone has different perspectives & desires.
    Mike White
    Replied 2 months ago
    Loved the article, i could not agree more
    Palak Shah Developer from Philadelphia, PA
    Replied 2 months ago
    Thank you Mike White!
    Daniel Ventura
    Replied 2 months ago
    100% agree with this. As a lender I always show my clients how to pay a 30 year like a 15 but without the above mentioned issues!
    Palak Shah Developer from Philadelphia, PA
    Replied 2 months ago
    Thanks Daniel Ventura.
    Patrick Harold Rental Property Investor from New Orleans, LA
    Replied 2 months ago
    If you were considering refinancing your 30 yr mortgage into a 15 yr mortgage with the reasoning being build more equity while living there and then rent it out when I move. More equity would allow me to take out a larger heloc to buy more properties.
    Susan Maneck Investor from Jackson, Mississippi
    Replied 2 months ago
    For me it all depends on the interest rate. If the interest rate is lower on a 15 yr. loan, I'll go that route. If it is the same then I go 30 years
    Tushar Prasad
    Replied 2 months ago
    So no need to pay attention to the inverted yield curve?
    Colin March Rental Property Investor from Portland, ME
    Replied 2 months ago
    Good article. I can't believe this is really a debate at all. Very succinctly: --Longer amortization creates a smaller monthly payment and that creates more cash flow which create more flexibility and optionality (if you don't understand the value of optionality, please learn this because it's one of the main benefits of real estate investing) --Interest rates are currently flat so taking on longer term debt and longer amortization vs shorter comes at no extra cost --Max leverage creates max ROE. This is math so don't bring your emotions to this debate. --If you can invest at a better return than your interest rate (eg, 4%), take you cash and reinvest. Don't pay down more debt than you need to. Re-lever when you can by reinvesting in more real estate.
    Palak Shah Developer from Philadelphia, PA
    Replied 2 months ago
    Thanks Colin March, totally agree! The best part of Real Estate Investing is that it can be leveraged unlike stocks so why not take advantage!
    Eric Allgeier Rental Property Investor
    Replied 2 months ago
    Great article. Very in depth and all good points. I only have one counter point: I’ve been going with fixed 15 year loans for smaller properties because the difference in cash flow is often not that great. For example- If I purchase a $70k house, a 15 year mortgage will cost me about $1500 per year more in my payment but it will save me $35k in interest over the life of the loan. That’s money that goes right in my pocket; not to mention that when the home is paid off I’m keeping all the rent (minus tax and insurance of course). Multiply that across many homes and your making hundreds or thousands of dollars more than you would have. Having said that; I would definitely go with a 30 year on more expensive purchases usually over 150k or so. Thats when the cash flow factor starts to really kick in. Thank!!
    James Edens
    Replied 2 months ago
    I had trouble finding a 30 year mortgage for a rental I bought last September. Both my local bank and local credit union insisted that 15 years was all that was available for a non-owner occupied house. Any advice for me? I am suddenly very interested in a refinance for a lower rate and the possibility of more cash flow. Suggestions???? Thanks.
    Palak Shah Developer from Philadelphia, PA
    Replied 2 months ago
    Hi James Edens - I would call multiple more banks. There are many great loan programs for residential rentals and it is worth spending the time researching this. I would recommending also looking into low doc loans. Though these banks have higher interest rates, the cash flow doesn't get impacted because of longer amortization plus they are investor friendly.
    Greg Jeanfreau from New Orleans, Louisiana
    Replied 2 months ago
    We put our first few on 15 year mortgages because we could still cash flow a little bit, but with rising prices and interest rates, the numbers are just too tight. So now we are rolling with 30 year refi's on new BRRRRs. It's nice to have the cash flow, but I miss the paydown factor. Something that most people don't mention with paying down faster is that if you get some of these rentals paid down low enough, you can open a line of credit on them to use for additional "cash" to close on more deals and get better prices because there is no financing contingency. We'll see how this all works when the proverbial **** hits the fan again...
    Palak Shah Developer from Philadelphia, PA
    Replied 2 months ago
    Thanks Greg Jeanfreau, another great way to scale. This would take longer but it is good for peace of mind.
    Andrew Syrios Residential Real Estate Investor from Kansas City, Missouri
    Replied 2 months ago
    If you can get a 30-year mortgage, I definitely recommend it. Out here in the midwest, pretty much the only thing you'll get offered is a 20-year mortgage.
    Vadim Liakh
    Replied 2 months ago
    Hello all, IMHO it is all about Fear vs Greed. No fear and too much greed, over leverage and you may not survive next economy downturn. Too much fear and you miss many good opportunities and have nothing... I find that for me it works best when I have 60-70% LTV loans once property is stabilized. For my 5-7 unit properties, I do 20-25 years amortization and 5-7 year balloons, min 25% down, rates are 5.5-5.75%. Too bad that fixed 30 year is not available for over 4 units.
    Arnab Sinha
    Replied about 2 months ago
    Great article Palak!! So what's next for you? Are you moving on to larger (>5) multi family investments (commercial)? Depending on your answer, maybe we could chat further. :)
    Jeffrey Bower
    Replied about 2 months ago
    Great article and sage advice.
    Don Taylor from Raleigh, NC
    Replied about 2 months ago
    This helped alot, thanks guys and gals
    Margaret DelColle Real Estate Agent from Philadelphia, Pennsylvania
    Replied about 1 month ago
    Thank you for all these responses! We are reviewing our portfolio looking if we should refi any of them. After talking to a few lenders it seems our mix of 15 and 30 year mortgages is good. We are semi-retiring soon and because of our ages feel we need to keep a continuing growing cash flow just in case we need it down the road. These posts have been very helpful to us. Posters mostly are not talking about what the age bracket is and how their opinions may be different because of where they are in life.