Conflicted with 15 vs 30 year mortgage for first investment property

30 Replies

Hello all,

I would appreciate any insight / thoughts people have about this topic. 

I grew up with real estate being in my family. My parents currently own four investment properties in addition to the home they live in. Two of those investment properties they own clean and clear and are paying off their residence in 2016. 

That all being said, they took out 15 year mortgages for all of those which is contrary to the popular belief that you read here / almost any blog on the internet. I am sort of in a predicament because I too intend to buy my first investment property myself as I truly do enjoy the business myself and see the amazing benefits of passive income. 

I just can't seem to decide what would be better, the 30 or 15 year mortgage. I see the benefits of positive cash flow from day one as being a huge deal since that can create the snowball effect and thus enable me to purchase more properties faster. But seeing my parents sort of changes that perspective for me since it was almost like they sacrificed that negligible cash flow for a promising guaranteed return.

Real estate would be a side business as it is for my parents, and my strategy as for now is a buy and hold strategy, with the possibility of selling those properties when/if they were to appreciate and convert those earnings into better properties. 

What are all of your thoughts on this common debate?

One of the greatest features of an REI hold is the cash flow. Most SFH are not paid off in 15 years, they are either refinanced or sold between 7 - 10. That means all you are doing with a 15 year mortgage is making the lender more money since your payments are higher. All those faster mortgages, sold under the guise of being an advantage to the buyers is bogus. They are the the advantage of the lender. They involve higher monthly payments, or extra monthly payments. The advantage to the buyer would occur at the end of the mortgage, not the beginning. That means you have to pay it off to get it. Since most mortgages are refinanced within 7-10 years, that advantage is never reached. In the mean time, all you've done is payed more for the house.

Now, having said that, keep in mind you can't pay for a 15 year mortgage in 30 years.  You can however, pay off a 30 yr mortgage in 15...or less, and since the payments (amortization) is based on 30 years, you will be paying less per month this way (than if you had a 15 year mortgage).

For me, If they gave me a 100 year mortgage I'd take it.

Joe Villeneuve
REcapSystem
A2REIC

@Joe Villeneuve   Valid points I agree with your rational in your example, but lets say you are a Buy and Hold investor and your goal is to build life long cash flow. You say most properties are refinanced 7-10 years down the road. Let's say you were that far into a 15 year mortgage, wouldn't it be logical to think, ok I only have 5 some years left of this mortgage to pay therefore I am mainly paying the principle at this point, I will stick out paying it til the end so I can own this property outright and then really benefit from the pure cash flow of having a rental property?

It's the argument of security vrs. risk. a payed of rental has more security, but the returns are low. A highly leveraged property is less secure, but can give the greatest return on investment. Its is your place to decide at what place you are most comfortable. I personally prefer to keep my properties financed at aprox 50% LTV. If one is paid off I would get a HELOC to get access to that equity. So I can reinvest that in other investments. But it is all about math. Right now re-investing in RE is giving me a great return on investment. That may not always be the case.

I think @Joe Villeneuve   point was you can always pay extra if you want to make it a 15 year.  Take the cash flow now, you will need it.  Apply to a new property or principle when you have enough reserves built up if you choose to shorten the loan length. 

I have never financed any properties longer than 10 years.  But, we are not buying high dollar houses. We like 1 1/2% or better payments to cost. If we quit buying now we could be debt free within 10 years. HMMM, I will be 65 in ten years. What a great retirement plan-- 60+ free and clear rental units. 

I started buying houses when I was 43, should have started when I was 23.

@Joe Villeneuve  

The interest on a 15 year loan at 5% on the very first payment is exactly the same as a 30 year loan at 5%.  Absolutely no difference. As we move down the amortization schedule, the interest paid on the 15 years loan drops faster than the interest paid on a 30 year loan.  A $100,000 loan about a year down the road will have the 15 year loan paying about $14 less than a 30 year loan.  In other words, the 15 year loan pays much less interest than a 30 year loan.  In 10 years a $100,000 30 year loan will have paid $46,099.  A 15 year would have paid $36,974.  Almost $10,000 less.  Yes, you pay a higher payment on the 15 year.  But ALL of the money except interest goes to paying down the principal. So at that 10 year mark on the 30 year loan, the principal balance is $81,144, while the 15 year has paid all the way down to $41,288.  So Joe, the bank makes LESS on a 15 year loan.  The only money the bank makes is the interest.  The rest of your payment pays the loan.

Now, the usual reason given for wanting a 30 year loan is higher cash flow and, if you had some difficulty paying the loan, the payment on the 30 year is less than a 15 year.  And too, since there is no prepayment penalty, you can pay a 30 year loan off in 15 years and save yourself all that interest.  However, it's also true that typically the rate on a 15 year is less than a 30 year.  In my market today, there's an 87 basis point advantage to a 15 year loan.  So not only does it pay off quicker, the rate is just plain lower.

Funny story....I took over a loan one time back in the early 90s.  The payment seemed really high, and I didn't have hardly any cashflow.  But I was content with the deal because I bought it nothing down.  Within a few years I had raised the rent, so my cashflow had improved.  And about that point I realized one day that I had taken over a 15 year loan that had been about half paid off at the time!  The house just had a few years to go on the mortgage!  You know what?  I think I've owned that house now about 20 years.  Most of that time there's been no mortgage, so it's been a cash cow! 

You know what @Johnnie Smith  ?  You're a young guy.  If you don't really need the cashflow then why not pay the house down?  There's always gonna be someone who proves to you that you could have done better than you did had you kept all your cash flow fully leveraged.  It true...you could have.  But some of those people went out of business a few years ago.  Too much leverage then was a killer.

Whether you have a 15 year or a 30 year is really your preference. You gotta love how quick that 15 year pays down.  But if you were having some trouble, being able to make the smaller payment could potentially help you.  It's really your choice.  But your folks sound pretty  smart to me.  And having a higher equity is going to help you trade to larger properties or more properties at some point if you decide to.

Good luck to you.

If you plan to really grow past 10 properties, you will have to eventually go with commercial bank financing.  They all calculate what is called a Debt Service Coverage Ratio on your portfolio and right now most banks want to see at least 1.25.  If you have lots of properties financed over 15 years you will probably not meet the debt service requirement. 

You are better off to finance over 30 years and make additional principal payments if you would like.  The higher rate and actual interest cost is not that much more.

@Jim Piper  Brings ups a great point I wish I had mentioned. When I am looking for financing I always run the numbers between a 15 & a 30. If the payment is close enough I would go with a 15. Just hasn't ever happened

Originally posted by @Jim Piper :

@Joe Villeneuve  

The interest on a 15 year loan at 5% on the very first payment is exactly the same as a 30 year loan at 5%.  Absolutely no difference. As we move down the amortization schedule, the interest paid on the 15 years loan drops faster than the interest paid on a 30 year loan.  A $100,000 loan about a year down the road will have the 15 year loan paying about $14 less than a 30 year loan.  In other words, the 15 year loan pays much less interest than a 30 year loan.  In 10 years a $100,000 30 year loan will have paid $46,099.  A 15 year would have paid $36,974.  Almost $10,000 less.  Yes, you pay a higher payment on the 15 year.  But ALL of the money except interest goes to paying down the principal. So at that 10 year mark on the 30 year loan, the principal balance is $81,144, while the 15 year has paid all the way down to $41,288.  So Joe, the bank makes LESS on a 15 year loan.  The only money the bank makes is the interest.  The rest of your payment pays the loan.

Now, the usual reason given for wanting a 30 year loan is higher cash flow and, if you had some difficulty paying the loan, the payment on the 30 year is less than a 15 year.  And too, since there is no prepayment penalty, you can pay a 30 year loan off in 15 years and save yourself all that interest.  However, it's also true that typically the rate on a 15 year is less than a 30 year.  In my market today, there's an 87 basis point advantage to a 15 year loan.  So not only does it pay off quicker, the rate is just plain lower.

Funny story....I took over a loan one time back in the early 90s.  The payment seemed really high, and I didn't have hardly any cashflow.  But I was content with the deal because I bought it nothing down.  Within a few years I had raised the rent, so my cashflow had improved.  And about that point I realized one day that I had taken over a 15 year loan that had been about half paid off at the time!  The house just had a few years to go on the mortgage!  You know what?  I think I've owned that house now about 20 years.  Most of that time there's been no mortgage, so it's been a cash cow! 

You know what @Johnnie Smith  ?  You're a young guy.  If you don't really need the cashflow then why not pay the house down?  There's always gonna be someone who proves to you that you could have done better than you did had you kept all your cash flow fully leveraged.  It true...you could have.  But some of those people went out of business a few years ago.  Too much leverage then was a killer.

Whether you have a 15 year or a 30 year is really your preference. You gotta love how quick that 15 year pays down.  But if you were having some trouble, being able to make the smaller payment could potentially help you.  It's really your choice.  But your folks sound pretty  smart to me.  And having a higher equity is going to help you trade to larger properties or more properties at some point if you decide to.

Good luck to you.

Jim:  great post.  I think I remember you.  Aren't you the same Jim Piper from back in the day on CREonline?  Back when when it was a lot of Bill Bronchick, Ed Garcia, Steve Cook, David Alexander, Hal Roarke, Joe Kaiser, JT ......Maybe I met you briefly at one of the conferences?  Regardless it's GREAT to have you here! I remember you as pragmatic and a deal-maker.  We can always use more of that around here.  Welcome, welcome.

Originally posted by @Jim Piper :

@Joe Villeneuve  

The interest on a 15 year loan at 5% on the very first payment is exactly the same as a 30 year loan at 5%.  Absolutely no difference. As we move down the amortization schedule, the interest paid on the 15 years loan drops faster than the interest paid on a 30 year loan.  A $100,000 loan about a year down the road will have the 15 year loan paying about $14 less than a 30 year loan.  In other words, the 15 year loan pays much less interest than a 30 year loan.  In 10 years a $100,000 30 year loan will have paid $46,099.  A 15 year would have paid $36,974.  Almost $10,000 less.  Yes, you pay a higher payment on the 15 year.  But ALL of the money except interest goes to paying down the principal. So at that 10 year mark on the 30 year loan, the principal balance is $81,144, while the 15 year has paid all the way down to $41,288.  So Joe, the bank makes LESS on a 15 year loan.  The only money the bank makes is the interest.  The rest of your payment pays the loan.

Now, the usual reason given for wanting a 30 year loan is higher cash flow and, if you had some difficulty paying the loan, the payment on the 30 year is less than a 15 year.  And too, since there is no prepayment penalty, you can pay a 30 year loan off in 15 years and save yourself all that interest.  However, it's also true that typically the rate on a 15 year is less than a 30 year.  In my market today, there's an 87 basis point advantage to a 15 year loan.  So not only does it pay off quicker, the rate is just plain lower.

Funny story....I took over a loan one time back in the early 90s.  The payment seemed really high, and I didn't have hardly any cashflow.  But I was content with the deal because I bought it nothing down.  Within a few years I had raised the rent, so my cashflow had improved.  And about that point I realized one day that I had taken over a 15 year loan that had been about half paid off at the time!  The house just had a few years to go on the mortgage!  You know what?  I think I've owned that house now about 20 years.  Most of that time there's been no mortgage, so it's been a cash cow! 

You know what @Johnnie Smith  ?  You're a young guy.  If you don't really need the cashflow then why not pay the house down?  There's always gonna be someone who proves to you that you could have done better than you did had you kept all your cash flow fully leveraged.  It true...you could have.  But some of those people went out of business a few years ago.  Too much leverage then was a killer.

Whether you have a 15 year or a 30 year is really your preference. You gotta love how quick that 15 year pays down.  But if you were having some trouble, being able to make the smaller payment could potentially help you.  It's really your choice.  But your folks sound pretty  smart to me.  And having a higher equity is going to help you trade to larger properties or more properties at some point if you decide to.

Good luck to you.

Jim:  great post.  I think I remember you.  Aren't you the same Jim Piper from back in the day on CREonline?  Back when when it was a lot of Bill Bronchick, Ed Garcia, Steve Cook, David Alexander, Hal Roarke, Joe Kaiser, JT ......Maybe I met you briefly at one of the conferences?  Regardless it's GREAT to have you here! I remember you as pragmatic and a deal-maker.  We can always use more of that around here.  Welcome, welcome.

Consider your overall investing philosophy and goals.  Do you need the cash flow?  

Most of the properties I buy are no money down and direct with owners, however, on the few occasions that I've financed a property I've always gone with the philosophy of go with the 30 year mortgage and lower payment, but pay it as though it's a 15 year to pay the loan off earlier and save some interest in the long run. 

The idea being that you never know what is going to happen in life and having that "required" lower payment may come in handy during times of vacancy, family emergencies and unexpected occurrences.  But when you have a good paying tenant and good cash flow, you can always apply an additional $50 a month or an extra payment a year to the principle and pay it down as though it was a 15 year mortgage.  This will still save you interest, keep you generating cash flow and give you peace of mind for the unexpected. 

Thus, benefiting from both and having more options. :-)

Originally posted by @Johnnie Smith :

@Joe Villeneuve  Valid points I agree with your rational in your example, but lets say you are a Buy and Hold investor and your goal is to build life long cash flow. You say most properties are refinanced 7-10 years down the road. Let's say you were that far into a 15 year mortgage, wouldn't it be logical to think, ok I only have 5 some years left of this mortgage to pay therefore I am mainly paying the principle at this point, I will stick out paying it til the end so I can own this property outright and then really benefit from the pure cash flow of having a rental property?

 If you were cash flowing with the mortgage in place, and you've built up equity, then imagine what you can do by refinancing and getting all the equity back out to invest in the next property...realizing that the first property is now paying for both.  Actually, the tenant in the first property is buying you both properties.

Joe Villeneuve
REcapSystem
A2REIC

Kristine Marie Poe 

Yes, that's me.  And I went to several of those conventions so I could have easily met you.  I think I quit posting around 2001, so it's been a while.  You know, periodically I used go back there and read the posts.  In recent years I noticed someone from the Santa Barbara area who seemed to buy "title challenged" type properties.  It seems like it was a different name than yours...right now I'm not recalling the name.

Anyway, I'm glad to see someone from the old place.  I've noticed your posts here.  I admire the types of deals that  you do.  Smart.

@Jim Piper  - pleasure to read your thoughts indeed!

Johnie - the greatest asset to a real estate investor is options.  In that everything Jim says is correct, you can basically achieve the same effect by taking a 30-year note and making additional payments as you go - at your option.  When the CF is strong, you do it, when you have trouble, you don't...

There is such a thing as time value of money as well. The presumption here is that you wouldn't find a place to stick the difference at higher ROI than simply paying off the mortgage faster. If this assumption is correct, then do 15. But, perhaps you have the discipline and imagination to do something different...

Thank you for all of the responses! They've all been helpful. 

I am quickly learning there are many ways to achieve your goals when it come to real estate investing, and I can admit it's been engrained in me from my parents that paying off the mortgage faster/quicker is the better option, hence when I am trying to educate myself on the alternative. 

Thanks again everyone!

The interesting paradox is that with rates so low, the spread between 15 and 30 yr payments is higher, as a percent.

For a $100K loan, 30yr 4%, the payment is $477. 15 yr, 3.5% (I see an average .5% less for 15) the payment is $715. 50% higher. This is nearly $3000/yr. 

One question for me is whether this cash can be better used elsewhere. If you plan to accumulate more properties, say one per year, by the 3rd year, it's $9000/yr cash you won't see, and won't have available to help you accelerate the next deals. 

If the property has great cash flow, this may not matter to you. But, if after expenses, you have $1000/mo to cover debt, $715 leaves you with little flow, and the 50% rule is long term, any one year can see a heater go or the roof need replacing. I'd rather work to build up the reserves and not have that higher payment due each month. 100 year mortgage? Ha! As long as the rate is fixed, bring it on. 

What is the price range? If you are buying cheapies it could be easy to pay them off quickly and realize bigger cash flow.

Have done 15 yr loans and enjoyed the lower rates and pulled equity when I need it with credit lines. Refinanced more times than I can remember so 15 year better choice. Never needed the cash flow though; thought of it as a forced savings.

Originally posted by @Jim Piper :

@K. Marie Poe 

Yes, that's me.  And I went to several of those conventions so I could have easily met you.  I think I quit posting around 2001, so it's been a while.  You know, periodically I used go back there and read the posts.  In recent years I noticed someone from the Santa Barbara area who seemed to buy "title challenged" type properties.  It seems like it was a different name than yours...right now I'm not recalling the name.

Anyway, I'm glad to see someone from the old place.  I've noticed your posts here.  I admire the types of deals that  you do.  Smart.

Yup, that's me.  I posted under Kristine-CA back then.  Title problems and probate are still a niche, but it's just one tool in the shed now.  I still credit the gang at CREonline (from about 1999-2005 or so) for expanding my mind when it comes to deal making.

This is my 2 cents from my experience.  All my real estate (5 units) are on 30 year loans. I even put 20% down on all the properties. One property I am very close of paying it off.  I only owe $30,000 on a $85,000 rental.  Right now it has been my largest focus.  The reason why it is my focus is with all the new regulations,  I can't get a loan to buy another property!  

I have been to a couple banks with my 775 credit score. $20,000 cash and I can't get a loan or even refi.!!  I don't owe anything on my vehicles and I only have like $1,200 on credit cards.  

So my view is with all the regulations in the financial market.  I feel I need to clean up my books and pay off one property.  At least pay one off and maybe sell one so I can have 2 units free and clear so I can start reinvesting.  Please give any advice on different loan tools that I can research.

Number one, we paid off the house we live in for our peace of mind and security. Later, at our local credit union, we opened a HELOC on that house for $100,000 that we keep open for quick cash needs or emergency purposes. We only pay $25 per year to keep the HELOC open and the rate is variable for it, but has remained steady at 3.5%. This is for short term needs only, so if we borrow from it, we pay it back within a month or two.

On purchases that will be easy to finance, we go for a 30 year fixed and pay it off early, if we can, bringing it down to 15 years or less. For purchases that are more challenging, such as a fixer we bought (estate, short sale, foreclosure with 2 bank liens), we go in all cash and enjoy the cash flow when it is all finished and bringing in rental income.

We have also at times obtained short term private money loans from family to quickly finance a deal and then refinanced later.

In our rental portfolio we have 2 SFRs paid off, 1 SFR with a conventional 30 year mortgage, 2 duplexes paid off, and an 8-plex (really 4 duplexes grouped together on 2 tax lots) with two 30 year conventional mortgages. When we mortgage we always buy with at least 20% down. We refinanced our 8-plex loans when the rates were low and immediately were paying $1,000 less per month.

We maintain our credit scores at about 800, but our loan officers tell us anything above 740 and we will still get the best rates.

We have never had difficulty in obtaining a loan, partly because my husband and I are both gainfully employed in professional careers, plus we have a lot of equity in the real estate we own and our loans are "performing", never missing a payment (all set up on auto pay) and not over leveraged.

If we find a great deal, we are open to mortgaging a property to get the cash out of it to make a new purchase. I call that the "monopoly" strategy.

We take our cash flow and reinvest it into our rental property business. Tax deductions for mortgage interest doesn't amount to much for us because we would prefer to not pay interest at all and instead reinvest the money we save. However, we do enjoy the benefit we get from tax deductions for depreciation.

I always encourage people to go with a 30 year mortgage. You can always pay extra on it to pay it off quickly. But having that 30 year vs a 15 year gives you much more flexibility for when circumstances change.  On my primary home I had taken out a 30 year with the plans of paying it off in 15 years.  5 years into it I was right on track for that 15 year mark when I had a career change.  Being able to drop my mortgage payment by almost half since I had been overpaying it so much gave me so much more flexibility to leave a high paying job for a job I paid more.   

I think this advice goes the same for investment properties.  You may not need the cash flow now, but in the future you might, and that longer amortization schedule give you that flexibility.

@Russell Brazil  Everyone that is thinking about going with a 15 year mortgage would read your post above.  I tell people this all the time.  If I could vote 10 times on that one post I would.

Joe Villeneuve
REcapSystem
A2REIC

Thanks @Joe Villeneuve

In my opinion, the only time it makes sense to pay down mortgage principal is if there are no options to use the cash flow to invest elsewhere, such as in additional properties. If you aren't planning to acquire any more properties, and you aren't planning to invest your money anywhere that you might earn a higher rate of return than the rate of the mortgage debt, than it makes sense to pay down the mortgage debt.

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