Those who finance investment properties
Denver, CO · Member since 2017 · 142 posts · 104 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.
Two words....Opportunity Cost. Some people have good math skills but don't know how to properly apply them to a situation. If you are proving that you pay more interest at 4% than 5.5% or that you pay more interest on a 15 year amortized loan than a 30 year amortized loan you need to stop because you look dumb. Those are mathematical truths that no one will refute (except for flat earthers). The opportunity cost of capital is what is being argued, not the interest rates or amortization periods of different loan products.
you can just simulate a 15 year by making larger payments if you want
The Truth is that a 15 year mortgage is riskier than a 30 year mortgage because it will give you an inferior current ratio and inferior cash flow from operations. However, if you have a very strong current ratio and very strong operating cash flows, it might not matter. It will enhance earnings but not significantly compared with the effect on the other two ratios mentioned.
That's a great plan..if your end goal is to own 1 rental property. If there's a "next" then not such a great plan. It's very easy to think of amortized interest as a financial opportunity that is lost to the bank..you need to get into the investor's mentality and understand IF time = money THEN 30 yr mortgage > 15 yr mortgage. Similar to the debate of spending 10% of your rent for a property management..don't nickel and dime yourself on things that don't add up instead, focus on where to make the big $. Your goal is to own 5-10 rentals..you can do that in 5-10 years..or you can do that in 20-30 years. Up to you, the price of real estate isn't going to wait for you to save up enough for your next property at $40/mo. If interest was really your main concern then you should look at Yr 1's interest paid vs principle pay down on your amort schedule..15 yr or 30 yr they'll both make you cringe.
You're already ahead with making this investment..why not boost it a little more?
My first loan was a 30 year FHA loan, I then moved to 5 year fixed 20 year am loans, now I have over 95% of my loans at 15 year ams or less. So over time I have become a bigger fan of quicker pay downs. In fact, I am currently refinancing a 40 unit portfolio on a 12 year am/ 12 year fixed loan product. While this lowers cash flow, I am able to increase my line of credit each year for the amount being paid down. Ultimately this means lower interest payments, with the same flexibility on cash availability.(ie paying down 100k of principle results in having my line of credit increased by 100k) While also locking in a fixed rate on a commercial loan product for over 5 years. It seems like most people in this discussion have ignored the fact that even though you pay down principle quickly, that doesn't necessarily mean you lose access to that extra cash. (There is some risk banks won't always extend a larger LOC, but as your balance sheet grows this becomes a smaller and smaller risk) Additionally, if you have a 30 year am and have an extra couple hundred bucks in cash flow each month, that extra cash flow (by itself) is not easily converted into real estate that will get you 15% returns... it takes time for that extra cash flow to grow large enough to take down that next deal which will provide 15% returns or more, so it likely sits in a bank account earning negligible interest until it is large enough to take down the next deal.
@Ben Katt
Why pay it down with a shorter amort and larger monthly payments just to draw from it again and possibly have the LOC cut?
I'm sure the OP wasn't talking about commercial properties that couldn't get a 30 yr fixed regardless of how well one's balance sheet look.
Economy of scale would change this story but would that be feasible with a residential property?
Everyone who uses the tired cliche that tenants pay the rent should try to call their bank when the house is vacant and try to explain that when the mortgage payment is due!
The tenants make the payments. If they don't, you screwed up by buying a house with negative cash flow.
My main point is that you pay less interest, are a stronger borrower in the banks eyes, and don't lose access to the equity you are creating with the accelerated pay down through a LOC. The comments I have read above all make it sound like once you pay down debt, that equity is stuck earning smaller returns, which is not the case.
I was talking about a commercial loan for residential properties, not necessarily commercial properties. 30 year fixed loans through freddie are capped at 10 homes right?
Originally posted by @Joshua Chato:
@Ben Katt
Why pay it down with a shorter amort and larger monthly payments just to draw from it again and possibly have the LOC cut?
I'm sure the OP wasn't talking about commercial properties that couldn't get a 30 yr fixed regardless of how well one's balance sheet look.
Economy of scale would change this story but would that be feasible with a residential property?
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.
Whose money is paying the mortgage? The tenants money...and whatever isn't used on expenses is your money. The more money left over is more money for you. The tenant pays all the bills, as long as you have positive cash flow. Don't help them.
What are you talking about? The sooner I "help" my tenants pay off my mortgage, the sooner they start paying me and not the bank. Why are you trying to trick your own brain??
I'll say it again since you clearly love cash flow: Years 1-15 you cash flow a little less...years 16-30 you cash flow much much more. On top of that, you gain equity much quicker. Hence...full ownership in half the time.
That still doesn't mean it's always the best option as it entirely depends on your strategy for growth. But people need to understand their choices and not just repeat silly catchphrases.
@Alex Corral your principal pay down is very large on a 15 year vs a 30 year. What you lack in cash flow, you gain in principal payoff and then some. Your ROI if you sell within 15 years will be much better with a 15 year mtg. If you sell after 20 or 30 years, your ROI will be less.
15 year:
Cash flow: $40x180 months=$7200
Principal Payoff: $60,000
Total Profit in 15 years=$67,200
30 year:
Cash Flow: $186x180month=$33,480
Principal Payoff: $23,198
Total profit in 15 years=$56,678
Add 2 zeros to that loan amount and you can see the power in a 15 year mortgage. In this instance you will make just over $10k more if you sell in year 15
In general, new folks should do a 30yr to lock in today’s low rates and known terms. A lot will be unknown when you are new.
In this case though, no way I’m doubling the length of my til death, I mean mortgage, for a lousy hundred bucks. Get rid of the thing.
I used to lever up as much as possible but am paying them off quickly now if the rate is over 5 and/or commercial. I don’t miss them. I am on vacation now and bought with mortgage-free cashflow a bunch of amzn stock last week. It has yet to call me with a service request.
When I do buy conventionally now I put at least 20% down on 15 yr terms because I hate PMI and 15yr rates are lower.
As you start amassing paid off rentals you’ll see how little a few hundred or thousand per month in ‘extra cashflow’ you get by stretching out your til death multiple decades really matters.
@Steve Vaughan makes a great point. Motivations and timing are a factor with each deal and are unique to each of us. I paid cash on my first deal so I was only risking my own money. That cash flow allowed me to lever into several more fairly quickly and safely. Now I can go back and refi the first. Each step forward had different circumstances but the discussion on this subject/thread helps me understand that it's ok to shift over time depending on needs. Your first deal is likely going to be a 'whatever you can get' deal. Confidence and motivation shift and you can shape your holdings over time as needed.
I really liked that example it's an easy way to bring the two into it's proper perspectives!
Thanks @Derrick Ward. It's been great to read so many different perspectives on this topic.
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.
Whose money is paying the mortgage? The tenants money...and whatever isn't used on expenses is your money. The more money left over is more money for you. The tenant pays all the bills, as long as you have positive cash flow. Don't help them.
What are you talking about? The sooner I "help" my tenants pay off my mortgage, the sooner they start paying me and not the bank. Why are you trying to trick your own brain??
I'll say it again since you clearly love cash flow: Years 1-15 you cash flow a little less...years 16-30 you cash flow much much more. On top of that, you gain equity much quicker. Hence...full ownership in half the time.
That still doesn't mean it's always the best option as it entirely depends on your strategy for growth. But people need to understand their choices and not just repeat silly catchphrases.
It's only a "silly catchphrase" if you don't understand it.
In addition, the difference between "use" and "spend" has an impact on the value of the value of the returns from that "use" or "spending" action. When you get one use out of your money, you are "spending it", and get a 1 to 1 return. When you get multiple uses out of your money, you are "using it", and get an exponential return on it due to the compounding effect it has,
Taking extra CF and using it once over the course of 15 years, is spending it.
Keeping that extra CF, and investing it multiple times over that same 15 year period, is using it...getting an exponential use and compounded return. If you do it right, you never actually spend it, since every time you try (use it), it comes back to you with friends.
To all the math geniuses crunching the numbers every which way I have one question. Which term in your equation measures risk? Debt=Risk. Im not against debt and use it carefully. But my debt is backed by a solid income and excessive cash reserves that would make @Joe Villeneuve tear his hair out. I do have mortgages on rentals and on the midwest low end ones I pay off on a 10 year schedule. Notice I said I pay the mortgage. Not the tenants. Because if the house is vacant, guess what, bank wants money anyway. Why? I dont need the cash flow now and the cash flow allows this much pay off plus a small cash dividend which I put in reserves. I may need the cash flow later in which case it will be much higher when properties are paid off, or I will sell the properties and bring back the cash from the equity. Is this mathematically optimal? No. And I know its not. But is it risk adjusted optimal for my situation. I think so.
Debt = Risk on your own home. Debt doesn't equal risk on an investment home. Cash you put into the home = risk on an investment home. Just ask the Banks.
Risk is based on what is "at risk" and "who" is THE risk. To define this, all you need to do is follow the direction of the cash...not the debt. Again, just ask the Banks.
When a loan takes place, the "direction arrow" points from the lender to the borrower. Therefor, what is "at risk" is the cash (not getting it back), thus the person taking the risk is the Bank (the source of the cash), and the person who is "the risk", is the REI.
Again, just ask the professional lenders...the Bank. Why do you think they won't give you 100% loans? Why do you think they want you to have 20% cash, or "skin in the game"? The answer is they want you to have something "at risk", and if they gave you 100% funding, they would be the only ones taking a risk.
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.
Your Tenants ARE paying the mortgage. Where do you think the source of the money to pay that comes from? Your statement about "what if the tenant doesn't pay his rent" actually makes my point. If the tenant doesn't pay their rent, then you have to pay. Doesn't that mean the tenant, when paying the rent, is in fact making the mortgage payments for you...along with the rest of the expenses.
Oh, and if the tenant isn't paying the rent, and you have to pay until the property is rented again, why would you make that situation worse by increasing the mortgage payment that you now have to cover when the property is vacant. I would think you would want to make all of your expenses as low as you could if your property was vacant and you had to cover them now with your money...out of pocket.
. 15 year 30 year
Loan $80,000 $80,000
Term 15 years 30 years
Interest 5.5% 4.5%
Mo Pmt $653.57 $405.35
Extra Pmt N.A. $248.32
Adjusted Payoff N.A. 16yr; 3 mo
Total Interest Paid $37,660.02 $27,269.75
Joe, I think the numbers here are wrong.
This is what I'm getting with an online amortization calculator:
15 year 30 year
Loan $80,000 $80,000
Term 15 years 30 years
Interest 4.5% 5.5% (30 year rates are always higher)
Mo Pmt $612 $454
Extra Pmt N.A. $158
Adjusted Payoff N.A. 16 yr; 3 mo
Total Interest Paid $30,159 $83,523
$53,634 is a HUGE amount of money to be giving the bank.
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I think you may have ran these numbers wrong (total interest paid). If you factor in the extra payment ($158/month), the total interest paid comes to ~43,309. You pay more in interest because the longer term note has a higher interest rate. If both notes had the same rate, the payoff, and total interest would be the same. If less debt is your goal, then this is a good strategy. If you are "ramping up", the higher cash flow is better (just my two cents).
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.
Your Tenants ARE paying the mortgage. Where do you think the source of the money to pay that comes from? Your statement about "what if the tenant doesn't pay his rent" actually makes my point. If the tenant doesn't pay their rent, then you have to pay. Doesn't that mean the tenant, when paying the rent, is in fact making the mortgage payments for you...along with the rest of the expenses.
Oh, and if the tenant isn't paying the rent, and you have to pay until the property is rented again, why would you make that situation worse by increasing the mortgage payment that you now have to cover when the property is vacant. I would think you would want to make all of your expenses as low as you could if your property was vacant and you had to cover them now with your money...out of pocket.
Call it however you like. If saying "the tenants are paying my mortgage" works for you...then by all means say it. I prefer the tenants to pay my salary vs. my mortgage interest.
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.
Your Tenants ARE paying the mortgage. Where do you think the source of the money to pay that comes from? Your statement about "what if the tenant doesn't pay his rent" actually makes my point. If the tenant doesn't pay their rent, then you have to pay. Doesn't that mean the tenant, when paying the rent, is in fact making the mortgage payments for you...along with the rest of the expenses.
Oh, and if the tenant isn't paying the rent, and you have to pay until the property is rented again, why would you make that situation worse by increasing the mortgage payment that you now have to cover when the property is vacant. I would think you would want to make all of your expenses as low as you could if your property was vacant and you had to cover them now with your money...out of pocket.
Call it however you like. If saying "the tenants are paying my mortgage" works for you...then by all means say it. I prefer the tenants to pay my salary vs. my mortgage interest.
That's exactly why I want to keep that extra cash flow. While the tenant pays off the mortgage, they are paying me passive income that substitutes for salary...that I don't have to work for.
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.
Your Tenants ARE paying the mortgage. Where do you think the source of the money to pay that comes from? Your statement about "what if the tenant doesn't pay his rent" actually makes my point. If the tenant doesn't pay their rent, then you have to pay. Doesn't that mean the tenant, when paying the rent, is in fact making the mortgage payments for you...along with the rest of the expenses.
Oh, and if the tenant isn't paying the rent, and you have to pay until the property is rented again, why would you make that situation worse by increasing the mortgage payment that you now have to cover when the property is vacant. I would think you would want to make all of your expenses as low as you could if your property was vacant and you had to cover them now with your money...out of pocket.
Call it however you like. If saying "the tenants are paying my mortgage" works for you...then by all means say it. I prefer the tenants to pay my salary vs. my mortgage interest.
That's exactly why I want to keep that extra cash flow. While the tenant pays off the mortgage, they are paying me passive income that substitutes for salary...that I don't have to work for.
So the only difference then between you and me is you are willing to accept a lower overall total cash flow for 30 years in return for getting more net cash flow than I do during the first 15 years, whereas once my properties are paid off in 15 years I will have considerably less risk of losing them and will outpace your returns over the next 15 years. Sounds like you're happy with your model. I too am happy with mine. I'm a long-term, buy and hold cash flow seeker. Maybe that's not your goal.