More equity or less money down on my first purchase ?

47 Replies

I am buying my first property for rental income . It is 4-plex . I have couple finance options. The first one Is putting %10.5 down 4.62 interest rate no seller concession . So I am paying 37K out of my pocket with %10.5 equity . The second one is %5 down %5 intest rate with 3 percent seller concession total 21K down but only having 3% equity . With the second option my cash and cash return higher but my cash flow is $210 lower per month . And I feel I am wasting money for having only %3 equity. Which route should I take , any input would be helpful .

What exactly are the CF/month with the two options?

Do you have a minimum ROI and monthly cashflow that you look for? If so, you'll want the financing strategy that allows you to meet those requirements for you. If not, I would suggest defining those requirements so you can use them when analyzing properties and financing strategies.

For example, you likely don't want a property that cashflows $20/month, but has a 400% ROI. You also probably wouldn't be excited about a property that cashflows $500/month, but has a 1.2% ROI. The key is picking the strategy that meets your minimum cashflow requirement (say $200/month per door) and your minimum ROI requirement (say 12%).

Both roi and cash flow meets my target on both case . When I put 16 K more down payment it brings me $50 extra per door total of $200 . What I mean by is that 16k differences I pay up front generates 200$ a month . Which is %15 . When you have 17 K on savings account it only gives you %1 a month. Or use that money towards purchasing my second house ? Tough decision 

Easy decision. Your cash is buying cash flow, the property is not generating cash flow on it's own. It will take 6.6 years @ $200/month to break even on your own cash. That is not wise investing. To test if a property is a good investment run your numbers with 100% financing. That will tell you want the property will generate in positive cash flow. If you need to put in cash then the property itself has negative cash flow and is a poor investment. This excludes areas like CA whidch is primarily faith investors.

Ideally you want the minimum amount of your own cash sitting dead in a property that will produce a descent amount of positive cash flow on it's own merits. You never want to buy cash flow unless all you care about is bragging rights with other investors. Investors that buy with cash or pay down mortgages are deluding them selves into believing they have a property that produces high positive cash flow. They don't. There is a distinct difference between investing in real estate that produces cash flow and using their own cash to buy that cash flow. If all a investor wants is cash flow there is no reason to run the numbers, every property will do that by paying cash.

Buy with minimum down and save your cash for the next one if you are still growing. If you have all the properties you want pull all your equity and invest in a income fund. Diversify, you should easily earn 10% on it long term.

I'd suggest that you only invest in deals that give you the ability to pull all of your cash back out in six months or less. That way you don't have a dilemma. Good luck! 

Originally posted by @Mehmet Eksik :

Both roi and cash flow meets my target on both case . When I put 16 K more down payment it brings me $50 extra per door total of $200 . What I mean by is that 16k differences I pay up front generates 200$ a month . Which is %15 . When you have 17 K on savings account it only gives you %1 a month. Or use that money towards purchasing my second house ? Tough decision 

 Stop using "%" to validate a decision.  $16k doesn't generate $200 a month...it "buys" it.  All you are doing is taking $16k out of your bank, and getting it back monthly, $200 at a time.  That means before you make any profit on this decision, you have to recover the $16k...which at ONLY $200/month, will take you 80 months to recover.  That makes no sense. See what @Thomas S said above

...also, I would forget using ROI on cash flow investments. All it does is mask a bad deal.

@Mehmet Eksik how much risk are you comfortable with? What is your debt coverage ratio; cash flow relative to the loan payment. The higher that ratio the less risk. The lower the ratio the better your cash on cash return. (That assumes the interest rate on the loan is lower than the return without a loan) I would not feel comfortable with only 3% equity but that is because I want to buy well below current market values. I want to have equity built in due to a great purchase price.

That extra 16K cash putting down not only generates extra $200 monthly income also will give me extra %7.5 on equity . The purchase price is not below market. And i will have to spend more on renovation

Originally posted by @Mehmet Eksik :

That extra 16K cash putting down not only generates extra $200 monthly income also will give me extra %7.5 on equity . The purchase price is not below market. And i will have to spend more on renovation

 No it doesn't.  All you are doing is transferring $16,000 from your control, to a dead space.  That $16,000 is equal to $16,000 in your bank or in your property.  When it is in your bank you control it.  When it is in your property you don't...and it is dead.  All you are doing is moving money from one place (your bank) to another (in one of the floor boards of the property)...it's the same $16,000.

It's not your job to gain equity.  It's the job of the tenant, to buy it for you, and the market to appreciate it for you.  It's your job to just stay out of the way and manage it.

Originally posted by @Mehmet Eksik :

That extra 16K cash putting down not only generates extra $200 monthly income also will give me extra %7.5 on equity . The purchase price is not below market. And i will have to spend more on renovation

 ...and it isn't "generating" anything.  You are "spending" $16,000 up front, to get it back at $200 for the next 80 months...at which time if all goes well, you will then start to make a profit.  If you let the tenant buy your equity for you, then you are making a profit now.  Follow the money...ALL of it.

if i run my numbers like with %100 cash financing (including capital expenditures and all that )  i am still getting %4 positive cash flow. Plus %2 yearly appreciating. I do think this is a good deal but just not sure if putting more money down serves me better financially.  My primary goal is to create enough passive income to retire early and travel the world.   

You are missing the point.  The more money out of pocket, the more the property costs you....that you have to recover before you start making a profit.

Stop using "%".  They are hiding the real evaluation/analysis numbers ($$$$).

...and that 2% yearly appreciating you mentioned, happens the same if you put 100% down or 0% down.  That 2% appreciation is based on the value of the property...not how much equity you have in it at any given time.

I have 2 math questions for you based on the following given information:

A - Property value = $100k
B - Down Payment = 20% = $20k
C - Cash flow = $4k/year
D - Mortgage PMT = $430/month; $5,160/year
E - Total payments made (P&I) = $154,800; $174,800 including DP 

Q1:  How much does the above property "cost you"?
Q2:  When do you start making a profit?

Bonus Question:  If you changed the above scenario to the following:

A - No Change
B - Down Pmt = 25% = $25k
C - Cash Flow = $3640/year
D - Mtg. Pmt. = $400/month; $4800/yr
E - Total Payments made (P&I) = $144,000; $169,000 including DP

...answer Q1 & Q2 again.

Updated about 2 months ago

Please see revisions in post below

how come cash flow is less in second option? you are putting more down..My fear is that i am getting only %3 equity if i decide to sell house in short term i will lose money as the purchase price is not below the market . and I am putting %5 down in second loan type( %2 difference goes to PMI up front instead of monthly charge)

If i dont put more money down , what am i gonna do with extra 16K .. sitting in the bank unless i found a deal produce more then %15 return. Plus that creates  more equity in if i sell it unless the market crashes ..

Originally posted by @Mehmet Eksik :

how come cash flow is less in second option? you are putting more down..My fear is that i am getting only %3 equity if i decide to sell house in short term i will lose money as the purchase price is not below the market . and I am putting %5 down in second loan type( %2 difference goes to PMI up front instead of monthly charge)

 Answer the questions please

Originally posted by @Mehmet Eksik :

If i dont put more money down , what am i gonna do with extra 16K .. sitting in the bank unless i found a deal produce more then %15 return. Plus that creates  more equity in if i sell it unless the market crashes ..

I don't think all of us that have tried to explain this to you can do a better job of it. I think the problem is you really don't understand how money works...and you are so in love with % numbers, you are missing the fact that you are not gaining anything...just moving equal value from one place to another. In the end, this will cost you a lot more than you think you are saving. You're not following the money in $$$$ because you are getting lost in %. You're thinking like you're investing in the stock market. REI is nothing like the stock market in any way.

Like I said above...please answer all the questions I presented.  The answers to your questions are found in the answers to mine. 

Updated about 2 months ago

The questions are revised and can be found below

Originally posted by @Mehmet Eksik :

how come cash flow is less in second option? you are putting more down..My fear is that i am getting only %3 equity if i decide to sell house in short term i will lose money as the purchase price is not below the market . and I am putting %5 down in second loan type( %2 difference goes to PMI up front instead of monthly charge)

 ...and why are you in such a hurry to "spend" your $16k?  The fact that you ask, "what to do with it" if you don't spend it on equity should tell you something right there.

I'm revising my numbers from above:

I have 2 math questions for you based on the following given information:

A - Property value = $100k
B - Down Payment = 20% = $20k
C - Cash flow = $4k/year
D - Mortgage PMT = $430/month; $5,160/year
E - Total payments made (P&I) = $154,800; $174,800 including DP

Q1: How much does the above property "cost you"?
Q2: When do you start making a profit?

Bonus Question: If you changed the above scenario to the following:

A - No Change
B - Down Pmt = 25% = $25k
C - Cash Flow = $5160/year
D - Mtg. Pmt. = $400/month; $4800/yr
E - Total Payments made (P&I) = $144,000; $169,000 including DP

...answer Q1 & Q2 again.

@Mehmet Eksik I was going to say the same as @Thomas S. . It's best to put the lowest amount possible in this case so that you can buy another property rather than waiting 6.6 years to get your additional down payment back. Eventually you'll pay the property off and have much more cash flow. If the market goes up, you can raise rents eventually and increase your cash flow, as well as try to cut some expenses. When we buy properties, we try to put as little down as possible so that we can use the rest of our money for either a rehab or for another property. 

Joe, thanks for the advise i am here discussing with you guys because i am new at this. I am more numerical person as i am an engineer as you can tell. I love numbers. I think what you guys saying is that in the beginning it is better to have less equity and have more investment. Is it less riskier that way ? To answer to your question"when do you start making profit" it will always depend on appreciation is not it . It looks like you can start making profits earlier on the Q1. But if you decide to sell Q2 you will pull more money as you have more equity

@Mehmet Eksi Please just answer the 2 sets of 2 questions. The answers are simple. I'm not asking for explanations... just want the simple answers. Hint: all the answers are numbers
@Joe Villeneuve if you’re so good at math then why are you asking such a basic question of how much you should put down for the property.

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