15 vs. 30 year mortgage
Winona Lake, IN · Member since 2013 · 1 post · 0 votes
Greetings all,
Am new to the real estate investing world and am curious to get everyone's thoughts on whether they finance at 15 years vs. 30 years? Currently looking at both single family and multi-family opportunities.
Thanks!
Here's my 0.02 cents.... When starting out and when you need to borrow, as opposed to paying all cash, then "borrow as much as you can for as long as you can." That means 30 year fixed mortgages. As you progress in the biz, maybe think about a 15 year fixed, and when you best investing years are behind you, then borrow little or no money, pay off some mortgages maybe and strive for properties with no debt.
lisa, my first two properties I purchased on a 30 year mortgage. Then when I decided that I didn't want to delay my retirement until 55, I switched to 15 year notes. My last 5 property purchases, including my personal residence, ended up being financed long term on a 15 year note. The initial purchase included atraditional mls purchase with 25% down in 2010. Most recently my peraonal residence was similiar except that I found the home as a private sale from walking an estate sale. 2 of the other properties were short term land contracts that I upgraded the properties increased value and rent and was able tonrefinance into a 15 year note. The other one was similiar except instead of a land contract I had a private lender front the purchase and I paid the remodel costs then refinanced a couple months from purchase with new value and tenants in place.
I believe having cashflowing updated properties with 15 year financing allows me to purchase more properties faster. If I had 30 year notes, I would have more cashflow but my portfolio would also not be able to weather market fluctuations as well. With more than 50% of my mortgage payment going towards principle right from the first payment my LTV of my entire portfolio gets stronger a lot faster. I can use that equity down the road to leverage from financial institutions and private lenders alike.
your investing goals have to be taken into account. If you are looking for income than 30 year notes are best. If you are looking to build a long tail portfolio (100MM+) then you have to leverage the equity in your properties by cutting the notes down as much as possible. My personal goal is in 10 years I will be able to purchase 2.5 million worth of new property every year in the DFW metro. To have this aggressive of a plan you have to roll your equity from property to property. To do so you need to acquire equity as fast as possible.
The answer is either based on subjective personal preference or on objective financial calculations.
There is little advantage to be gained from a pure maximum return criteria on 15 year financing with today's low rates. In essence you are saying that you can not find a better use for your money that beats the current 15 year interest rate by choosing to pay down principal.
By choosing longer term 30 year financing with low interest rates you can increase current cash flow (which can be reinvested at a higher rate if you are a savvy investor) and reserve the right to pay down early if you can't figure out how to find investments at greater than 4% or 5% ( whichever is the interest rate you can borrow at). Paying a fixed payment with deflated dollars for as long as possible is something I would salivate over.
I concur Ellis and have similar salivation.
Good point, I failed to mention the fact of deflated dollars paying on an old mortgage.
Financially the 30 year is the better choice, but, if you have doubts about sticking to a plan of paying at any accelerated schedule and it's your preference, take a 15, heck, you might get a Yourgage, LOL
I only have one property, but I used a fifteen year. I am very happy with it so far, I like the interest rate, and the equity build up. Also, I took a Dave Ramsey course at my local parish where he made a strong case for the 15 year mortgage from a net worth perspective, which influenced me as well. That said, I am only five months in, still learning, and one of my best friends keeps insisting that he thinks I shoud and will refinance to a thirty, so who knows, maybe I will change my mind.
Not familiar with the DR case for a 15 yr mortgage "increasing" your net worth. do you mean that more of the payment goes to principle every month so you have more equity in that specific property?
Maximizing cash flow is much more important than building net worth early in the wealth building process.
When your passive income exceeds your living expenses you have financial freedom in my book. Once that is achieved you can pursue growing your net worth on your balance sheet with much less pressure.
David, yes but that is not all of it. You also are putting a larger percentage of your income toward that investment, because you interest rate is smaller, and so you pay less in interest.
A calculation of after tax rate of return will dictate the objective choice.
Paying "less" interest is meaningless by itself.
If I told you I could get you $2 billion dollar credit in financing at a fixed 3% interest only, would you say "no thank you, I don't want to pay that much interest over my lifetime?"
Remember also that interest expense is a deduction for investment property.
When you have free & clear property you have less expenses to offset therefore your taxable income is much higher.
My point is not that I encourage leveraging to the hilt, which is extremely dangerous in the wrong hands. But rather to succinctly answer the question based on an educated factual financial comparison vs. personal preference. There is nothing wrong with choosing no or low debt, just realized that it is a personal preference based on comfort level not on objective financial decision making.
Ellis, I don't know you, and I don't mean to come off strong. But I think you have simplified my position, so I want to lay it out in a little more depth, and provide additional elaboration.
If I have a choice between paying someone one dollar, and receiving thirty percent back in a tax deduction, or, paying some one one dollar, deducting sixty percent of it as a business operating expense, and keeping the dollar of net-worth afterwards, I will chose the later. I own a duoplex, where I live in a two bedroom side, and rent out the three bedroom side, and so I understand I will be able to deduct sixty percent of my principle as an operating expense.
Choosing the fifteen year option will allow me to build up equity quicker, so that after less than three and a half years, I will have the over twenty percent equity I will need to refinance into a conventional mortgage, and then can use another FHA owner occupied mortgage to buy another property. The fifteen year mortgage pushes me toward that goal much quicker than the thirty.
It will increase my net-worth quicker, which may not be a goal for everyone, but for me, someone who is in their mid-twenties, creating a larger net worth is an important goal of mine.
I do not have to keep the property without ever refinancing. I am planning on being a buy and hold investor, but I could at a later point, after a certain percentage is paid off, to refinance, and continue to refinance regularly, just at the lower interest rate that comes with a fifteen percent loan. Gary Keller, in his book Millionaire Real Estate Investor, recommends that approach, with regular refinancing to twenty five- to thirty percent down, fifteen year loans, because that is the way to get best interest rate, and achieve strong long term returns.
The last, and perhaps most important point is harder to make, because it is very hard to quantify, but it has to due with risk. There is a large difference in risk for a fifteen year versus a thirty year mortgage. When you build up equity, you are more vulnerable to ending up with negative equity if the economy turns south, or the possibility of negative equity when trying to sell the property, if you need liquid cash. I am very hopeful we are not going in that direction. But because the Fed's loose monetary policy, and the country running a large deficit using debt, there is a chance we are seeing a bubble. Partially mitigating that risk by building up equity, is both a personal preference, and, form where I sit, a careful financial choice. It is tricky, because I cannot quantify it. But I strongly believe, after my personal subjective look at the national climate, that right now, is a time to prudently limit risk.
I hope I did not bore you or come across too strong. One of my best friends takes the other side, and I am open to being persuaded. I am only twenty-six, and I am open to being persuaded. I am here because I want to learn, and become stronger.
But I think my reasons come from the analysis above, and I want to be clear that though my analysis subjective, as opposed to objective, I have studied this, and my perspective comes not just from personal preference, but subjective analysis.
Here is my point regarding this, if you have extra capital, why pay down a mortgage that is costing you around 4% when you as an investor have the ability (or should have) to invest that same capital with a yield of much greater than 4%! Speaking from the investor standpoint, the longer term loan at lower interest rates is far superior than the shorter term loan so long as the added cash flow and capital is invested in other cash producing assets.
You don't come off too strong at all. I truly enjoy an intelligent meeting of the minds, not boring at all to me. If I over simplified your position, it was not my intent.
Also, I would never condone a strategy that is primarily aimed at a tax deduction ,that is a disastrous philosophy. That isn't my point at all. The point I was making is to focus on the numbers (net annual after tax rate of return)
If I have a choice to receive an extra dollar today that I can reinvest at 10% vs. paying down a 4% mortgage with that dollar, I will choose the extra dollar in income today to reinvest. Paying down a 4% mortgage gives you a 4% annual return on your money. This is an extremely important concept to grasp to understand the opposing argument.
I am very familiar with Gary Keller's books, I am am actually affiliated with Keller Williams in California & I have taught numerous investment classes using Gary's books as the class textbooks. (Millionaire Real Estate Investor, SHIFT, & HOLD). I understand his argument for using 15 year mortgages.
There is risk present in a 15 year loan that was not addressed. There is a higher likely hood to have a negative cash flow with a 15 yr mortgage which could cause you to lose the property. If property values goes down in the next few years but the property continues to maintain a healthy positive cash flow do you really care what it appraises for? A 30 yr mtg will amortize at a slower rate and you have the option to pay down principal if you wish. You don't have the same flexibility with a 15 yr. mortgage. When investors lose property to foreclosure is it because of a reduction in value or is it because the property can no longer afford the payments?
You make a great point about not being able to quantify your choice, which is exactly my point. On a purely objective basis there is no question a 30 yr fixed is superior, to choose otherwise is personal preference. The choice is neither good or bad but simply clarifying the nature of the decision is personal not objective.
One of my favorite quotes, " You can't eat equity".
All my mentors advised me to follow these steps:
1) Reduce your living expenses to a minimum & invest early. Time & compounding interest is the path to wealth.
2) Work on maximizing cash flow first to gain financial freedom & to reinvest.
3) Then work on your balance sheet to increase net worth.
You are 26 years old & are asking great questions. I commend you for starting your investing program early. You will no doubt be financially successful if you continue investing wisely.
We own 4 rental properties and our primary residence. I refinanced to a 15 year on one of the rentals because the rent it brings in can cover the extra payments pretty easily. When we made this decision we were only worried about paying down the loan quickly. I also chose to refinance our personal residence to a 15 year mortgage. Fast forward a few years, and we are running into DTI issues. This is something I didn't realize I needed to be thinking about until after we did it. The banks tell us to refinance the two 15 year mortgages into 30 years, but I haven't wanted to do that for a variety of reasons. All of this to say, I wish I would have known this was going to be an issue before we made those decisions. If I had it to do over again, we would do 30 year mortgages on all of our properties.