Cash or Finance?

Question

I've been reading alot about how it's better to finance versus paying cash for an investment property.  When will you pay cash for property versus financing?

Doug Shapiro · Answer

Hi Sue,

Since your goal is to have enough cash flow in order to retire and start your own business, then my recommendation is to maximize your cash flow.  So how do you do this?

If you buy a rental property with cash, then you will maximize your cash flow for that property since you won't have a mortgage payment every month.  The downside is that your ROI will be lower and you are tying up your cash in the property.

However, if you buy a rental property with 25% down payment and have a loan for the remaining 75%, then you will have much less cash flow.  The upside is that your ROI will be higher and you aren't tying up a big chunk of your cash.

Basically, you don't want to tie up your money into a property, but at the same time you want to eliminate the mortgage payment because it will give you more cash flow each month.  My recommendation is to finance because it will maximize your ROI and allow you to invest in more rental properties.

If you have a 30-yr mortgage that only has 10-15 years left on it, then you may want to consider paying off the mortgage.  Again, look at the ROI.  If you have $50,000 remaining on your mortgage and paying it off will save you $5,000/year, then that is a 10% return and a significant boost to your monthly cash flow.  If you decided to use $50,000 to buy a new rental property instead that has a 15% return and would make you $2,000/year, then your decision is more difficult.  On the one hand the 15% ROI looks very good compared to the 10% ROI, but on the other hand the 10% ROI results in significantly more cash flow each month.  In the long run, of course the 15% ROI is the best option.  However, your goal is to retire in a few years, so maximizing your cash flow is your priority, even if it means accepting a lower ROI.  Crunch some numbers to see what scenarios would work best for you.

Hope that helps.

Jay

Jeff Trevarthen · Answer

I say leverage for the long term investments. Cash for the short term investments.

Or, pay cash for long term investments like rentals, then cash-out refinance and get some of your money back. There are new loan programs that don't require any seasoning on cash-out refinances.

Good luck.

Sue McWilliams · Answer

Thanks everyone!  I'm looking to use the income from my rentals to pre-retire and start my business.  I just need income coming in before I give up my federal job. My goal is to purchase 2 homes every year for the next 2-3 years.

Luca Gobbini · Answer

If you can pay cash for an investment, make a down payment high enough to minimize the cost of financing, invest the cash and accrue interest. Assuming that you are buying a property at a good value, the leverage will increase your return on the investment. because you still have the cash to cover the investment you do not increase your risk. So shortly anytime your ROI is higher than the cost of money you want to finance.

Mike D'Arrigo · Answer

It all depends on what your short and long term objectives are. If your goal is long term cash flow but you don't need the income today, then it makes sense to finance. If you're near retirement and in a strong cash position but need immediate cash flow, then paying cash makes more sense. It also depends on whether you're trying to build a portfolio. You can build a larger portfolio quicker with financing. The important thing to look at is your debt service ratios and making sure you're not getting over leveraged. In general, money is very cheap right now which favors financing.

Bryan N. · Answer

Leverage is good and bad.  I recommend using leverage, but NEVER exceeding what you can't pay personally without disrupting your personal life.  So, use leverage but make sure you can pay for damages, PITI, and utilities in between tenants without disrupting your personal life.  If you have a vacancy (or multiple vacancies) and can't afford the turnover costs with your income without loosing sleep, you over leveraged.

Bob Green · Answer

Greetings Sue,

It really depends on your strategy.  Are you going to buy 1 or 2 properties per year or do you want to move quickly and accumulate property fast for a long term investment?  If moving fast,  I would pay cash, and leverage the asset.  If you are working with the right lenders who do not have value seasoning requirements, Buy the property, rehab and place tenant, and then leverage the asset to 75% LTV based on fair market value.  Repeat the process over and over and over...

Elizabeth Colegrove · Answer

We love leverage. We buy property that has untaped potential (cosmetic repairs, short sales,etc). We put as little down as possible with the goal of this potential. We don't do refinancing we do the opposite. :)

David Veeder · Answer

If you're holding the asset for rental.  Leverage is best.  It ups your Cash on Cash return rate, and reduces the chance that someone will go after the property in a lawsuit.

Troy Young · Answer

I love debt. I usually use financing when possible but there are times when it is better to pay cash. If a place is not in a condition where a bank will finance you may need cash. If it is a quick flip you may not want to pay extra charges associated with financing. If you need to close this deal asap cash allows you to buy faster. But, If you plan to hold it for a couple years or more and can get financing I would take the financing and invest your money into something making a higher return than what you're paying for the financing. If somehow you can't find a better return pay cash (you should easily be able to find better returns though). The other part is just your personal feelings. Some people hate debt and if it's going to really stress you out pay cash for it.