Is 20% down the single best option with investment?

15 Replies

My husband and I keep arguing about one point and we are putting this out for bigger pocket users to decide on.

He says that when looking at a property as a potential investment the only way to go about it is to put 20% down or less, get a loan and create positive cash flow.  He won't budge on this.

I say, this is useful for evaluating a property and it's a tool to decide whether to purchase or not but it's not the one and only way to look at financing.  We are relatively new in property investment btw.  We currently have two rental properties and have enough funds to put 50% down on a third.  One is payed already and the second we just bought with 20% down.  I want to find a 'good deal'.  I agree 100% with him that we use tools to evaluate options.  However, for me it makes sense on this third rental to put 50% down and realize the income to pay off the properties faster.  Instead, he wants to buy two additional properties.  We both have full time jobs, I'm in my late 30s and he's in his late 40s and not planning on quitting our jobs for at least 10 years.  We're managing the properties on our own.  Also, the market currently is fluctuating and I don't think it's smart to maximize our debt at the moment in case values drop dramatically or there's a lag in finding renters.  Although we are in the northern bay area and there's high demand for housing. Your thoughts? Hopefully my husband and I finally put this to rest. 

Originally posted by @Account Closed :

Also, the market currently is fluctuating and I don't think it's smart to maximize our debt at the moment in case values drop dramatically or there's a lag in finding renters.  Although we are in the northern bay area and there's high demand for housing. Your thoughts? Hopefully my husband and I finally put this to rest. 

If you put 50% down on the property as you suggest, if the value drops dramatically, then poof, there goes the cash you used to purchase.   You guys are really just discussing leverage and your risk comfort levels.

@Account Closed  

There is no perfect investment strategy that is the right answer for everyone. You have to evaluate your goals, risk tolerance, and opportunity cost of a higher down payment.

That being said, money is incredibly cheap right now. You can lock in a mortgage for 30 years at 5% and 75%-80% LTV. Think about this. Rent will almost certainly go up over 30 years. The house will appreciate. Inflation will surely continue. All of this is happening while your mortgage is locked in at 5%, for 30 years!

Would you loan someone a couple hundred thousand dollars at 5% amortized over 30 years? I sure wouldnt. My money is worth more than that. 

20% down allows borrowers with most optimum interest rate.  However, if you operate on break even basis then you should put down more. 

You can take a HELOC from that rental all paid as additional down payment to meet his must "<=20%" criteria. So 30, 40, 50% down still meets his requirements. You also need to assess if both are out of work whether you can sustain your current life style. This serves as stress test to include what happens if % of your tenants are unable to pay rent.

It's a personal decision  There is no right or wrong.

MANY people on BP like to put as little down as possible and refinance out any equity as fast as they can and use this money to buy another property.  They do not have a goal of every actually paying off any property.  Kind of like a pyramid scheme with no end, always financing out the equity to buy more.

I can not do that, I am financially conservative.  I always have had an plush emergency fund, since I was a teen.  I was raised with the 'be debt free' as much as practical value system and always keep extra funds for whatever emergency that comes up (renters that burn the place down, or just play the no rent/eviction game, or car accidents, or medical situations, whatever).

I buy rentals for cash, fix then up and hope to rent most of them forever.  But I can afford to invest this way, and feel 'safer', no worries, this way.  If I take 6 months or 9 months to fix up a house before renting, I am still financially ok.  The property in the area I invest in went up 16% last year, can not beat that now a days, so property sitting is doing ok, even if it is not rented yet.  This way when there is an unexpected issue I am not worried, but still living a good life.

If I was depending on that rent to pay the mortgage, I would be worried, cut out vacations, etc to get the house finished and rented ASAP.  I would be stressed.  Someone else may not be.  Its all personal choice in how we invest, what risks we can live with.

If talking about houses with fixed 15 or 30 year terms below 5%, I'd go with 20 or 25% down only. And I like and have paid-off RE.

Now, if talking commercial 'rental property', you'll want to pay those off as soon as possible.  Adjustable rates, calls, balloons, bothering you every year for your financials. Bleh. 

No financial reason to tie up huge amounts of capital with extra down payment dollars in this rate environment.  That decision is based on emotion. 

If you hate only having 20-25% equity, you can always decide to accelerate it down. You can't decide (without huge costs and hassle) to take 30% out later to take advantage of another opportunity. 

@Account Closed there are thousands of ways to buy real estate. @20% down is a bank's way to make sure they have some margin in the deal in case they foreclose on you. 50% down would make it easy on the lender to approve and increase your cash flow because the debt service is less per month. Some will say to put as little as you can down, but putting money down insulates you from market downturns. It is also instance equity, if you were planning to refinance in the future.

@Account Closed mentioned).  That said, I definitely think there are some points you need to consider:

  • for starters, does 20% down put you in a cash flow positive position?  For the markets that I work in (SF Bay Area and Raleigh NC metro), if 20% works, it's generally going to be by just barely.
  • 25%+ down typically gets you your best rates on investment loans; however, you should do the math to see if it's worth it.  Take a $250k purchase - say, you can get a 4.75% rate at 20% down and 4.5% at 25% down ... the PI difference on that is only $93/mo ($1116/yr) - it's going to take you over 11 years to recoup the extra $12.5k that you had to put into the down payment.  In this example, is shaving 0.25% from your rate worth paying over $12k today? Not for me...
  • I'm not a fan of putting 50% down on your third property when the intention is to simply use the extra income from it to help pay off the loans faster.  Why lock up the money like that?  Why not just keep it in the bank (or stocks, bonds, CDs, etc) and pull from it directly each month to achieve the same goal?  By not sticking it into the property on day 1, you maintain full control over it - you can apply it to the loans, you can use it for an unexpected emergency, you can use it for your next down payment. Cash on hand can be a good thing!
  • You're both working and don't plan on retiring for at least a decade ... you don't need to focus on cash flow today - you should be trying to maximize your capital growth.  As you get closer to retiring, your focus will most likely shift and the cash flow will take priority.  Putting 50% into property #3 today is a cash flow play - splitting it into properties #3 and #4 is capital growth play.  I'm with your husband, I'd be looking at picking up 2 places.

If you want, feel free to email me some more details around the properties that you're considering - I'm happy to run the numbers and give you a second opinion.  I work through scenarios exactly like this every week with clients - we examine the returns based on the full range of down payments (20% to 100%) and then layer in the domino effect you can create by paying off one of the loans early.  Often times, seeing the numbers based off of actual properties (with conservative growth assumptions) will remove the guess work from which decision is right for you guys.

Great info. Thank you everyone!!! We are deciding to hold off on the next purchase for several months  to see what the market does in the next year and likely getting two additional properties.  

I like the 20% down option, especially when a property still has an adequate cash flow buffer at that LTV (which it should before I would even consider buying it). If you're dead set on investing in local markets and self managing I wouldn't buy anything now. Either focus on out of state or wait for a crash.

Also, 20% down is not going to be available to you through conventional financing- rental property loans are 25% down currently w/ conventional lenders. Commercial financing, which my investors and I actually prefer, even on 1-4 unit, is often available at 20% down.

If maximizing your debt feels risky to you right now you're investing in the wrong asset. 

I'm with the hubby. The more you leverage, the higher your returns- and chance for more properties which brings additional benefits. Plus, then the bank holds more of the risk than you do. The more you put in, the more of the risk that's on you. 

The value of a property dropping doesn't matter unless you're trying to sell it or refi it. Assuming you buy a smart property with a lot of demand, the occupancy rates shouldn't suffer and any drop in value doesn't matter if you're just holding it. 

I would say don't put less than 20% down though. Then you have PMI and all that expensive drama.

I think you’ve come to the answer that works for you two.  

I see it as a growing phase versus a stable phase versus the end game. 

When you grow you want to grow at the rate you can comfortably do it for your time commitment and risk level   

Stable phase you’ve hit the number you want to get to your end phase and you are just paying down properties until you maximize your cash flow for YOU.  

The important thing is you guys are on the same page.