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.
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.
Long term cash flow is my goal, but I don't want to wait for 15 years...I want to spread it out starting now. Also, That added cash flow now can be reinvested in multiple properties, instead of just one. This way, by the time I hit that same 15 year mark, the added CF from my added investments will surpass any added cash flow gained from the one 15 year property. That added CF, that I keep, and you spend on your current property, is more valuable liquid than it is dead in equity. Liquid it's a verb...moving into more investments. Dead equity it's a noun, and is completely dependant on future events neither one of us have control over.
...and, there is nothing more at risk than your cash turned equity, in a fully paid off property.
. 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).
@Jerome K
Are you saying if you pay an extra $158/month on the 30 year loan?
I meant to show it as the difference in minimum payment in a 15 year note vs 30. As you can see that $158 which is a small difference IMO, saves you $53,634 total interest paid. If you decided to pay an extra $158/month to your 30, you will still pay more interest mainly because you had to take the higher interest rate. You still save a lot compared to sticking with the minimum on the 30 year, but still pay a lot more than taking the 15 year rate from the get-go. Hope I understood you correctly.
. 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.
----
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).
@Jerome K
Are you saying if you pay an extra $158/month on the 30 year loan?
I meant to show it as the difference in minimum payment in a 15 year note vs 30. As you can see that $158 which is a small difference IMO, saves you $53,634 total interest paid. If you decided to pay an extra $158/month to your 30, you will still pay more interest mainly because you had to take the higher interest rate. You still save a lot compared to sticking with the minimum on the 30 year, but still pay a lot more than taking the 15 year rate from the get-go. Hope I understood you correctly.
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Your table labeled it as "extra payment", so I assumed it was an extra principle payment made each month (to match your payment on the 15 year mortgage). What I was saying is that there really is no difference (other than the lower interest rate) in the 30 year mortgage and making the payment "as-if" it was the 15 year payment (454+158). Basically, the 15 year mortgage takes what would be your extra cash flow, and forces it into the principle of the asset, making it very difficult to use that money in the future (unless you take out another loan against it). I would say that's a good strategy for a "mature" business looking to pay down debt. But for "growth" businesses, the extra cash flow now is much better put to use.
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.
Yes many are very passionate about their own individual concepts concerning cash flow. This let's us see there are many drivers, motivations, goals, comfort levels, etc. So the bottom line is for each individual investor to have a clear direction concerning how they want each investment to perform, according to their desired short term/long term goals, to make the best decision for their lives.
Use the 1% rule.
If you have a 60k mortgage you need to be above 600 a month cash flow from the tenant. This is before the management company, maintenance fee, insurance, mortgage etc...
Rule 2: Learn to compound, it's why 30 years is always better than 15 years.
. 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.
----
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).
@Jerome K
Are you saying if you pay an extra $158/month on the 30 year loan?
I meant to show it as the difference in minimum payment in a 15 year note vs 30. As you can see that $158 which is a small difference IMO, saves you $53,634 total interest paid. If you decided to pay an extra $158/month to your 30, you will still pay more interest mainly because you had to take the higher interest rate. You still save a lot compared to sticking with the minimum on the 30 year, but still pay a lot more than taking the 15 year rate from the get-go. Hope I understood you correctly.
---
Your table labeled it as "extra payment", so I assumed it was an extra principle payment made each month (to match your payment on the 15 year mortgage). What I was saying is that there really is no difference (other than the lower interest rate) in the 30 year mortgage and making the payment "as-if" it was the 15 year payment (454+158). Basically, the 15 year mortgage takes what would be your extra cash flow, and forces it into the principle of the asset, making it very difficult to use that money in the future (unless you take out another loan against it). I would say that's a good strategy for a "mature" business looking to pay down debt. But for "growth" businesses, the extra cash flow now is much better put to use.
Ok, yeah. I only labeled it "extra payment" for simplicity sake, to match Joe's post. Yes, you can try to pay a 30 in 15, but at the cost of 1% and $10,325.
Use the 1% rule.
If you have a 60k mortgage you need to be above 600 a month cash flow from the tenant. This is before the management company, maintenance fee, insurance, mortgage etc...
Rule 2: Learn to compound, it's why 30 years is always better than 15 years.
You mean, you need to be above $600 RENT from the tenant right?
30 years, is not always better than 15. I think it's been proven in this thread.
Hi Alex, I don't know how to respond directly to your reply to me...so here goes.
Paying down the principal by an amortization schedule makes it more tricky. Even though interest still doesn’t carry over from month to month — and if you skip a payment, you are not charged more interest the next month — the loan no longer behaves like a simple interest loan.
Doubling the interest rate more than doubles the total interest over the life of the loan. The total interest of a 30-year mortgage at 8% is 2.3 times that of a 30-year mortgage at 4%.
Doubling the length of the loan also more than doubles the total interest over the life of the loan. The total interest of a 30-year mortgage at 4% is 2.2 times that of a 15-year mortgage at the same rate.
Making a principal payment early has a compounding effect. If you pay $1,000 extra in month 13, you not only stop paying interest on that $1,000 but you also cause more of your subsequent regular payments to go toward principal, further reducing the interest you pay.
I happen to also be in the minority that agree with the 15 year mortgage however I think it completely has to do with what your goals are. I am an agent who also works with investors and I am in the same boat as @Adam Odom when look at my most affluent clients that use me to purchase or sell their investment properties typically they will own the majority of their real estate free and clear. I always make it a point to ask when I am hired to sell a rental for an owner (especially when they are an older investor who is wealthy). How they purchased it and how long ago. I find it fascinating to see how they have done it. Most have either done them for 15 years or started with a 30 year and paid it off early when the rents increased.
I am in the same boat as @Adam Odom when look at my most affluent clients that use me to purchase or sell their investment properties typically they will own the majority of their real estate free and clear. I always make it a point to ask when I am hired to sell a rental for an owner (especially when they are an older investor who is wealthy). How they purchased it and how long ago. I find it fascinating to see how they have done it. Most have either done them for 15 years or started with a 30 year and paid it off early when the rents increased.
Exactly. Wealthy people look at risk. Because they have more to lose. Poor people dont. Thats somewhat logical. If you have nothing and are trying to acquire properties to build net worth quickly it may be worth high leverage on a lot of properties. If your net worth is in the millions and REI is part of a diversified portfolio and preservation of wealth is important you take another approach of quick pay down. If you are of the super rich class you buy Manhattan condos for cash and sit on them just as a place to park money. The strategy depends on your place on the wealth ladder.
What an excellent topic! While there might be two different strategies to think of - paying off fast Vs more gain now, I have to agree with @Joe Villeneuve There should be the base assumption that in order to maximize profit you need to reduce costs that's simple math. Leverage is used in these cases to perhaps to arrive at 20 mortgaged properties following the 30Y Vs maybe only 10 following the 15Y. The long term reduced cost strategy aligns better with the 1% rule and need for greater ROI, which you might pass up considering the added (15Y) loan costs. In my mind it's a business, which needs to maximize income, those rich enough won't care. I wouldn't run on a shoestring just to pay off when I could leverage and repeat. Actually the banks in both cases (and as mentioned follow the money) are doing this to one extent or another.
I'll keep my 15 vs 30 yr opinion to my self, but in regards to one of the arguments for the 30 year note that you get to reinvest the extra income into more and more properties. Realistically, how rapidly are you able to redeploy $146/month (or whatever it is) into other investments. Someone mentioned taking the extra cashflow and investing it at 4% interest to show the arbitrage of the 30 yr note. I just have a hard time seeing how you invest such a small amount into real estate.
I'll keep my 15 vs 30 yr opinion to my self, but in regards to one of the arguments for the 30 year note that you get to reinvest the extra income into more and more properties. Realistically, how rapidly are you able to redeploy $146/month (or whatever it is) into other investments. Someone mentioned taking the extra cashflow and investing it at 4% interest to show the arbitrage of the 30 yr note. I just have a hard time seeing how you invest such a small amount into real estate.
Your not reinvesting just 146/month. That money accumulates to the amount you can, and it isn't just 146/month...it's an additional 146/month...that adds up over time.
Not really sure there is a right answer to this, but I think it's really what your end goals are and the money game on getting there. I think you have to look at the money game first to see it aligns with your end goals. I think you have to keep in mind about many factors down the road. Appreciation, taxes, expenses, insurance. You may decide to start with a 30yr note and then refinance to a 15 after a few years. Maybe you want to roll extra money from other properties into your smallest mortgage to get it paid off faster, and then on to the next smallest mortgage, like that of paying off credit card debt. Just a couple of thoughts on it.
I'll keep my 15 vs 30 yr opinion to my self, but in regards to one of the arguments for the 30 year note that you get to reinvest the extra income into more and more properties. Realistically, how rapidly are you able to redeploy $146/month (or whatever it is) into other investments. Someone mentioned taking the extra cashflow and investing it at 4% interest to show the arbitrage of the 30 yr note. I just have a hard time seeing how you invest such a small amount into real estate.
Your not reinvesting just 146/month. That money accumulates to the amount you can, and it isn't just 146/month...it's an additional 146/month...that adds up over time.
Since this is a philosophical/strategic discussion, the thought process applies to (hopefully) more than a single property; it applies to the portfolio as a whole. To Joe's point, it's not so much $146 as it is $146x. With "x" being the number of hypothetical properties owned/planned to acquire. $40x would take much longer or much greater scale to allow the investor to amass an equivalent amount of reserves/dry powder for the next purchase.
The time value of money would suggest that investors prioritize obtaining reasonable cash flow up front to be reemployed and creating more value over time (i.e. having your money make you more money).
Some would prefer to defer the present cash flow in the interest of greater future cash flow/debt free peace of mind/etc.
There's really no price tag on the feeling of being debt free with all that cash flow. Some have pointed out that this is how their wealthy clients' portfolios are characterized presently. The question we are addressing with this topic is: How did they get there? And is that route the best financing philosophy that fits with my individual risk tolerance and goals?
We are all at different points in life and portfolio. I, myself, can see the 15 yr vs 30 yr decision changing as my portfolio does.
...and from the beautiful paradise of Hawaii, @Kiley N. has just written what is very near perfection.
It's not about one property...it's about the system, the long and short range plan, the long and short range goals, what you have to work with now, and how what you "will have" to work with in the future will impact what you do then.
To be successful in REI, you must have a plan, based on a series of achievable Milestones, that are built from your long range financial goals (personal debt payoff, and monthly/yearly passive income), which MUST include the short term financial goals (living NOW) as part of the overall plan.
Those that buy properties one at a time, with focus on that one property, then utter the words "now what do I do", are going to make it very, very hard to achieve any real success. It's the "Plan". It's what really has the greatest impact on the "risk".
I'm really glad to see this discussion, as it's something I've been struggling with as well. I tend to lean toward the 15-year mortgage over the 30-year, and here's why:
With the 15-year mortgage, you pay yourself (via property equity) rather than paying the bank (via interest). The argument for the 30-year mortgage is that you have more cash flow, which is true, but with the 15-year mortgage you build equity faster. With a 30-year mortgage, you could stash that cash flow in a bank account and save it up to deploy elsewhere. With a 15-year mortgage you can tap into your own equity pool via a line of credit to do the same. With a 15-year mortgage you will build your equity pool much faster than you would build your cash reserves with the cash flow from a 30-year mortgage. In your own example using a 15- year over a 30-year, you sacrifice $100 per month in cash flow, but pay yourself $180 more per month in home equity (this changes over the life of the amortization schedule, in your favor).
The only difference between these two loans as far as dollars are concerned is how much the bank makes off of you over the life of the loan.
@John Woodington When you tap into that Line of Credit...how much does it cost you to use it, each time you use it, vs no added cost with the use of the cash flow? Also, if you were building up equity in the property with the higher payments from the 15 year mortgage, it would be less per month than the cash flow you are passing on. Remember, most of the payments in a mortgage, 15 or 30 year, in the first 2/3 to 3/4 of the full term, are interest payments...not equity buildup. You won't see any sizeable equity buildup from the loan payoff until year 10 or so. The only real equity buildup you will see during that time period is from any normal appreciation...which is the exact same whether you have a 15, 30 or 100 year loan.
So many variables, but lets focus on one, why would you take on more risk when the bank is willing to lend to you at historically low rates (at the moment) for an extended period of time.
Rents rise and fall, hedge the possibility with a longer and less costly monthly payment.
...and from the beautiful paradise of Hawaii, @Kiley N. has just written what is very near perfection.
It's not about one property...it's about the system, the long and short range plan, the long and short range goals, what you have to work with now, and how what you "will have" to work with in the future will impact what you do then.
To be successful in REI, you must have a plan, based on a series of achievable Milestones, that are built from your long range financial goals (personal debt payoff, and monthly/yearly passive income), which MUST include the short term financial goals (living NOW) as part of the overall plan.
Those that buy properties one at a time, with focus on that one property, then utter the words "now what do I do", are going to make it very, very hard to achieve any real success. It's the "Plan". It's what really has the greatest impact on the "risk".
Thanks for the kind words Joe. High praise coming from you!
I'll keep my 15 vs 30 yr opinion to my self, but in regards to one of the arguments for the 30 year note that you get to reinvest the extra income into more and more properties. Realistically, how rapidly are you able to redeploy $146/month (or whatever it is) into other investments. Someone mentioned taking the extra cashflow and investing it at 4% interest to show the arbitrage of the 30 yr note. I just have a hard time seeing how you invest such a small amount into real estate.
Your not reinvesting just 146/month. That money accumulates to the amount you can, and it isn't just 146/month...it's an additional 146/month...that adds up over time.
There's really no price tag on the feeling of being debt free with all that cash flow.
"There's really no price tag on the feeling of being debt free with all that cash flow." - EXACTLY!
Not everyone wants to leverage their a$$ to the hilt. Not everyone can deploy their free cash flow straight into 20%+ opportunities. Some just want to create "dividend plays" one by one and very safely. That's how I started. Full cash into my first rental so I could learn the biz, create some cash flow, create some write-offs, etc. Not the highest ROI, but you can be damn sure no bank will ever take that one from me either. And it's still better than cash in the bank.
It's all about the specific goals and the overall plan/portfolio. Everyone has to do their own math, which can be tricky in this business because there are so many variables as someone just said. And it's not all math. Some of it is about risk tolerance.