Those who finance investment properties
Denver, CO · Member since 2017 · 142 posts · 104 votes
Those who finance investment properties
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Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votesAlways go with the 30...and the lower payments. Your goal with a rental is cash flow...not the payoff. Your tenants pay off your property for you. You are not saving interest, you are losing cash flow. You are thinking like a homeowner and not like an investor.
110 Replies
- Honolulu, HI · Member since 2017 · 231 posts · 191 votes8y
Hi @Alex Corral
If you end up selling this property after only a few years, there won't be much difference in the amount of interest you've paid. The difference will come into play if you hold the property for a longer period of time.
Time is money and money is time. It takes more time to accumulate funds at $40 per month than at $146 per month.
For illustrative purposes and all else being equal, cash flow over time for each scenario will be:
$146 per month for 15 years = $26,280.
$40 per month for 15 years = $7,200.
Paying more interest on the 30-year loan is the cost of buying yourself more time upfront ($26,280 - $7,200 = $19,080).
The question is: What will you do with the time you've purchased?
- 8yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
Always go with the 30...and the lower payments. Your goal with a rental is cash flow...not the payoff. Your tenants pay off your property for you. You are not saving interest, you are losing cash flow. You are thinking like a homeowner and not like an investor.
- Denver, CO · Member since 2017 · 142 posts · 104 votes8y
Thank you both for replying.
My thinking is this,
the 30 year loan will cost me $49,444 in interest.
the 15 year loan will cost me $22,619 in interest.
I plan on keeping these properties as long as I can. Hopefully at least 15 years, at which point, they will be paid off and my ROI will increase significantly. That's not even factoring in, what rents could be at in 15 years. What's good estimate for what that could be? Yes, I know I can't claim the interest anymore, but the return will be better. I just need to stay prepared in case I have a vacancy, my mtg payment will be an extra $150.
I am very new to being a landlord, and am trying to understand your point, but it's not sinking in.
- Rental Property Investor · Dayton, OH · Member since 2017 · 48 posts · 68 votes8y
@Alex Corral The issue is you think you have to pay the interest yourself. In reality, your tenants will be paying that interest with their own rent money. So how much total interest you pay on the loan really shouldn't matter. What does matter is with a 30 yr loan, you have an additional 1200 a year you are bringing in. You can then immediately reinvest this money into another property.
You can always pay off a 30 yr loan early if you want to.
- Investor · Hillsboro, TX · Member since 2017 · 358 posts · 245 votes8y
Different investors have different plays. As a general rule, take the longest term you can get. You can always make the larger payment to pay off at the 15 yr mark. If Murphy's Law shows up, and he always does at the most in opportune times, you have a smaller payment.
If you have put 10K down, and you are clearing 480 per year cash flow, your return is 4.8 % on your cash. 1200 per year would give you a 12% return on your cash. See the difference.
Hope that helps
- 8yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
Originally posted by @Alex Corral:
Thank you both for replying.
My thinking is this,
the 30 year loan will cost me $49,444 in interest.
the 15 year loan will cost me $22,619 in interest.
I plan on keeping these properties as long as I can. Hopefully at least 15 years, at which point, they will be paid off and my ROI will increase significantly. That's not even factoring in, what rents could be at in 15 years. What's good estimate for what that could be? Yes, I know I can't claim the interest anymore, but the return will be better. I just need to stay prepared in case I have a vacancy, my mtg payment will be an extra $150.
I am very new to being a landlord, and am trying to understand your point, but it's not sinking in.
No, you're missing the point here, through a lack of understanding the difference between a cost and an expense. The 30 year mortgage doesn't cost you anything, as long as you have positive cash flow.
You are not the one paying the mortgage...your tenant is...don't help them. You are losing $150/month with a 15 year mortgage. Follow the money.
Steps the money is taking:
1 - Rent is paid by tenant
2 - All expenses are paid from rent, including mortgage...from rent by tenant
3 - What's left over you keep....what's short comes out of your pocket.When you say you are going to keep the property as long as you can, hopefully at least 15 years, you realize that you are losing money during those first 15 years...right? You are spending $27,000 more during those 15 years with the extra $150/month you are spending in higher mortgage payments. In order to actually "save" that supposed ~$27,000 in interest (going with the 15 year vs. the 30 year), you would have to hold the house for the full 30 years. In reality, you break even at 30 years when you figure you had to come out of pocket for the first 15 years. You're not saving an money. This is costing you money...$1,800/year to be exact. You're paying your tenant to live in your property.
Like I said before. It's not your job to pay the mortgage...it's the tenant, through the rent. Don't help them...they do such a great job on their own, and they don't need your help.
Also, whether you had a 15 year, 30 year, or 200 year mortgage, any rent increase, and thus cash flow increase, would be exactly the same.
- 8yPatrick AlstonPro MemberNiskayuna, NY · Member since 2017 · 16 posts · 10 votes
@Alex Corral
"...the 30 year loan will cost me $49,444 in interest."
It's not costing you Alex, It's costing your tenants!!
- Member since 2016 · 13k+ posts · 12k+ votes8y
You need to adapt to a business way of thinking. You are not paying a dime in interest your tenants are. What is most important is your cash flow. Paying down a mortgage will completely kill your cash flow and reduce your ROI to nearly nothing. Cash has a very high opportunity value that when left to rot in a rental property is considered dead and buried.
Opportunity value of cash is 10%+ where as mortgage interest rates are in the range of 4%. This means that for every dollar sitting dead in a rental you are losing 6% return. Pay that 10% return on your dead equity out of your rent and you will likely end up with negative cash flow on the property itself. If cash does not earn it's keep there is no point in having it.
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes8y
Example:
Interest rate on debt = 5%
Return you can get by investing in another property (or other investment) = 11%
11% - 5% = 6% incremental returns by investing the money rather than paying down debt. Cash flow increases on your savings (not decreases) with leverage.
- Denver, CO · Member since 2017 · 142 posts · 104 votes8y
I see your guy's point about the tenant paying the mortgage. I totally agree with that.
Here's another example.
I buy a house at $100k and put down 20%. Mortgage amount is $80k.
$1000 Rent
- $700 (30Y PITI & fees PI $400/ Taxes $100/ Ins $100/ PM $100)
$300 cash flow (years 1-30) $108,000
$1000 Rent
- $850 (15Y PITI & fees PI $550/ Taxes $100/ Ins $100/ PM$100)
$150 cash flow (years 1-15) $27,000 (house is paid off)
$700 cash flow (years 16-30) $126,000
$108,000 total cash flow on 30Y vs. $153,000 total cash flow on 15Y
That is how my brain is processing this. It's not this simple since the more you get into your term, the less interest you pay, but trying to keep it simple. Yes, you can pay more on the 30, but you also pay a higher interest rate.
- Real Estate Broker · Westminster, MD · Member since 2017 · 159 posts · 101 votes8y
Renting homes is a business. The costs are costs to the business not necessarily to you. I always keep that in mind when looking at properties. It is easy to think that you save money with the 15 year option but how long do you REALLY think you will hold this property for?
- Investor · Edwardsville, IL · Member since 2015 · 432 posts · 481 votes8yHere's my take on 15 vs 30 and there are a 1000 different ways to look at it. I got into RE investing in my early 40's and I just turned 60. I didn't need cash from my RE investments and wanted dollars for retirement so I went with 15 year loans which are now paying themselves off. No more debt! Time to retire and sit on a beach sipping on my margarita. Some will say I could have bought more properties using 30 year amortization. My other business kept me too busy to try to add more than 2 - 3 houses a year to my portfolio. I think you need to decide what is it that you are looking for and what is your end goal?
- 8yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
You don't pay an interest rate. You pay dollars. The interest rate is what defines the dollars, and how they are paid. The goal of a rental is cash flow...not total cost since you are not paying it. The only thing that has any impact on you is the net, the cash flow, the money you get to keep.
Money isn't a noun, it's a verb. When it becomes a noun you are losing. Your method it's a noun.
- Denver, CO · Member since 2017 · 142 posts · 104 votes8y
Originally posted by @Jim Shepard:
Here's my take on 15 vs 30 and there are a 1000 different ways to look at it. I got into RE investing in my early 40's and I just turned 60. I didn't need cash from my RE investments and wanted dollars for retirement so I went with 15 year loans which are now paying themselves off. No more debt! Time to retire and sit on a beach sipping on my margarita. Some will say I could have bought more properties using 30 year amortization. My other business kept me too busy to try to add more than 2 - 3 houses a year to my portfolio. I think you need to decide what is it that you are looking for and what is your end goal?
@Jim Shepard
This is my thinking as well. I am just trying to set up my cash flow to maximize it as soon as possible. My goal is to have x amount of houses paid off free & clear in 13-15 years so I can retire early. I just don't see the point of paying mortgage companies so much in interest.
If I'm making an extra $150 in cash flow a month, that's $1800 a year. Say I have 5 properties. That's $9000 in 1 year. It would take me about 2-3 years to build enough down payment to buy the 6th house. I see the point for some in that regard as well. To me, paying them off sooner makes more sense.
- Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes8y
@Alex Corral - as you buy more properties your DTI becomes a bigger factor.
A conventional loan with 20% down is equal to $500 / mo for every $100k you finance. So the $150 / mo in extra payment could lower your approval by $30k in the future.
Also keep in mind that if your taxes show a loss on the rental property (does the $40 cash flow take into account vacancy, repairs, capex, ect?) that is deducted from your income and further reduces your approval.
Second City Real Estate4.821 Reviews - 8yJonathan PfluegerPro MemberBen Lomond, CA · Member since 2016 · 338 posts · 337 votes
@Joe Villeneuve is right on the money here - figuratively and literally. I would stick with what he has to say and go from there.
Like was said before, a longer term gives you more options and is less of a liability due to the lower payment. Remember, you can always elect to pay more every month, however you do not have the option to pay less.
Just my two cents. Best of luck.
- Denver, CO · Member since 2017 · 142 posts · 104 votes8yThanks! @Brie Schmidt Excellent point & something I had over-looked. Also, don't you only get 75% of rent towards income?
- Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes8y
Originally posted by @Alex Corral:
Thanks! @Brie Schmidt
Excellent point & something I had over-looked. Also, don't you only get 75% of rent towards income?
For the first year until you do your taxes they will count 75% of rents - once you file they use what you report to the IRS. So if you show a loss of $1200 a year they take $100 out of your qualifying income, and if you show a $1200 profit every year they add $100 to your qualifying income. Each will decrease/increase your approval for the next one
Second City Real Estate4.821 Reviews - Real Estate Agent · Camarillo, CA · Member since 2016 · 40 posts · 36 votes8yKill two birds with one stone in the future. Get a sweet deal on a house that has awesome cash flow on a 15yr mortgage. Have a paid off house in 15 years with great cash flow during and amazing cash flow after the payoff. Anyone who’s thinking long term is lying if they say they wouldn’t take 10 paid off houses over 15 mortgaged ones.
- 8yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
I would take 20 mortgages over 20 paid off houses.
- Investor · Bay Area, CA · Member since 2014 · 165 posts · 45 votes8y
@Alex Corral. What would you do with that extra $100 per month in cash flow?
In your scenario, I think I would take the longer term/amortization if I was able to or planned to use the extra cash flow to invest in other properties/investments in the near term that will provide a return that is greater than the interest being charged on the mortgage. Otherwise, there is nothing wrong in using the cash or making the higher payments to pay down the mortgage faster and building up equity in the property.
- Pleasanton, CA · Member since 2017 · 9 posts · 3 votes8y
Is the new 20% pass through deduction in the tax plan help investors in real estate? Does it make a different if we own real estate SFR as individual or in a LLC?
- Real Estate Investor · Miami, FL · Member since 2013 · 474 posts · 214 votes8y
The people acting like it's a no-brainer are wrong. And when they say it's your tenants paying the mortgage for you that doesn't make sense in this context. Your tenants are paying you and you are paying off the mortgage. If your mortgage is paid sooner, then all the money your tenants pay stays in your pocket. Of course that is a positive! Your cash flow is smaller for the first 15 years and then much much higher for years 16-30.
However, the question is whether the higher cash flow in the short term is more beneficial to you in the long run. If you are able to continue leveraging it could be. If you think you would sell in the next 10 years it could be. If you can somehow predict interest rates 15 years from now will be very high then it could be. There's probably many other factors to consider too. It's a good question that is very dependent on your situation. And remember that things don't always go as planned so higher cash flow/lower payments are safer in that regard.
- Columbia, SC · Member since 2014 · 133 posts · 190 votes8y
I'm in the small group that agrees with the 15 year and that's what I do as well. IN THEORY, all of what everyone says is true but in real world practice, I'd love to see the actual numbers on investors that do each of the different strategies and would almost bet the shorter term loan investors have a larger net worth (just my opinion of course). To me, it's a forced savings account and my end game is to retire early with little to no debt. It's like the article that circulates every so often saying renters are better off than home owners. In my banking career, I bet for every 1 renter, I see 50 home owners in our private banking/wealth group. It's also very rare for me to see very affluent clients riddled with multiple mortgage loans but I see many with free and clear properties.
- Real Estate Investor · Springfield, MO · Member since 2017 · 1k+ posts · 2k+ votes8y
I am glad to see that @Maxwell Lee also "get it."
There is a lot of what I consider simple erroneous thinking in the real estate world among home owners, investors and renters. "The tenants are paying your interest/mortgage." Let's swap words around a bit and see if you think the same way. First, pretend I'm a tenant. Now..."I don't pay any taxes or insurance on this house I rent. My land lord pays those." Uh-huh.
The correct way of thinking is the bill is always paid. A cost is a cost. An expense is an expense. Taxes are taxes. Insurance is insurance. Interest is interest. All of it boils down to less money in the INVESTOR's pocket, in a rental situation. It's not who PAYS $$$ that is important: it's who KEEPS $$$ that is key.
There is also risk with prolonging debt. 30 years is a long time to do anything. 15 years is also long, but you cut in half the duration of time where negative events could cause you to lose your property. A lengthy illness. A tough family situation. An injury that puts you out of commission for awhile. All real risks. The bank will take your property away even if you've paid on it faithfully for 16 years if it's on a 30-year note, or you'll have to "fire sale" it to avoid foreclosure. If it was on a 15-year note and disaster strikes in year 16 that note is gone and the property is yours! Just have to get the taxes paid, which are typically a pittance. If you still had to sell, you'd have time and flexibility which typically yields a higher selling price.
"Yes!" to what Maxwell said about rent in the pocket. Goes back to who gets to KEEP $$$. Those who take 30-year mortgages are trading a relatively small extra cash flow for twice as long waiting to get to keep all the money from interest. On a $100,000 note, 4% interest, 30 year term, the payment is $477. Same note on a 15-year term is $740. Difference of $263. That's nice, but keep in mind that we're thinking long-term.
It comes down to dollars and cents. The longer the note, the longer it takes to get to keep more rent, and you pay more for that privilege. The total cost of P&I is $171,869 (30 year note) - $133,143 (15 year note) = $38,726. That's the premium you "pay" for the flexibility of a 30-year note. That is cash that is not in your pocket, nor is it in your tenant's pocket. It is in your banker's pocket. End of discussion about who pays for what. Who cares who paid? Your banker has the money regardless of whether you paid or the tenant paid, and money in the banker's pocket is not the end result we're trying to achieve, is it? If that's what you want to do, fine....but be clear about it. Don't get fooled by "the tenant pays your interest" any more than tenants fool themselves that "The land lord pays my taxes."
As said before, the correct way to think is not about who pays interest...it's who gets to KEEP the $$$. WEALTH is made by keeping money, not playing the middle man who channels interest payments to the bank.
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