Financing a rental with 15 or 30 yr mtg?

27 Replies

It's my first rental property, can afford both 15 yr and 30 yr (with the appropriate down payment) financing. At 15 yr, I anticipate the property will be slightly cash-flow positive, with 30 yr, there's a lot more cash flow obviously. The property is around 200k and I don't anticipate there will be a lot of appreciation in the near future (3-5 years - the time frame I anticipate holding it). The money will otherwise be sitting in a money market account...

Hi Jim....welcome to BP.

There are many, many threads on this if you do some searching. My personal opinion is that you should use the 30-year money because you can always prepay it and pay it off in 15 years. The surplus cash flow is probably better deployed elsewhere in other projects too.

I have to agree with Bryan on this one. I am actually going through the same situation right now with another property I am buying. I was trying to decide between 15 and 30 year loan, either way the property is going to cashflow well. With the 30 year, I have a very low interest rate locked in for a long time if I want it, but I also have the option of paying extra and retiring the loan earlier.

The extra cashflow is nice with the 30 year, plus as long on you do not overleverage yourself, it will actually help with debt to income ratio as payment will be less than with a 15 year loan.

You should always borrow money for the longest term possible. It is far to your advantage to take the 30 year and enjoy the cash flow than go for the 15 year. What is the benefit of the 15 year? The unwise investor says that the property is paid off quicker, while the wise investor who took the 30 year is nowhere to be found because he is enjoy a nice vacation with all the extra income he gets from his rentals.

Learn the time value of money and understand that the average free & clear property only returns about 6% and you will always opt for the longest pay back period.

Definitely go with the 30-year loan. It will give you the best cashflow and manage your risk a little bit better, which is the most important thing in today's climate. If you have significant reserves then you can always pay down some of the note.

May I ask the specifics of the property?

Ie: projected rents, maintenance, vacancy, pm fees etc.

Not trying to insult your intelligence, but it seems the majority of 1st time landlords greatly over estimate their cashflow and underestimate their expenses. Heck, I know I did. The info may help others give you better feedback.

I'm in the 30 yr mortgage camp in general.

Hi Jason,

It's a 200K SFH property, with around 80K in equity, it was my previous residence and I moved 1 mile down the street so I'll be taking care of managing and maintaining it. I just don't want to sell in the current market. I currently have a 3.75% rate 15-yr mortgage on it, I figure it would rent for around $1600. My PITI is $1200 with the 15-yr loan, probably go down by $300-$400 if I refinance to 30-yr loan.

Jim,

Thanks for the info. Your situation actually changes things a bit. I'm guessing based on your equity that your probably 5-10 years into the 15 year note.

You have several interesting options based on your investing goals. Even though you live down the street, I would always recommend budgeting for a pm even if you don't use one. It gives you the flexibility to use a pm if your needs change.

Lets look at the cashflow. My numbers may be different than other investors, but the ideas are the same.
Rent: $1600
15 year note: $1200
Maintenance 12% - $192
Vacancy 8%(1 month) - $128
Cost $1520 total. If you count in PM add 8-14%. If you want to cashflow on the 15 yr note, you will have to manage it yourself. Beware of the learning cost of a 1st landlord. We all have our rookie costly mistakes.

Something to consider with that 15 year note is how long you have had it. With 80k equity, I would say more than a few years. Your plan may call for holding the loan and paying off the house in a few short years.

If you want high cashflow a 30 year fixed would work nicely.

If you want more properties, using some of the 80k equity may be in the cards with a cash out refi or heloc.

You do have some interesting options. Just make sure they fit your investment strategy.

The term in any mortgage product is designed for the portfolio management of the investor.

There are only two instances, IMO, where it makes more sence to take a 15 yr. fixed over a 30 yr.

1. Where someone else is basically paying your mortgage. I'm not talking about a tenant. The militaryand some companies, colleges, churches or other employment contracts provide housing allowances or payments. They may provide payments up to a certain amount and if hosuing costs are less, they only pay the lesser amount. So, if you can take a 15 yr. note and have it paid under those circumsatnces you'll build up equity quicker.

2. The other instance where a 15 yr could be better is when the borrower has no self control and is a poor money manager but has sufficient income to pay the obligation!

In ALL other instances, take the 30yr. The 15 has a lower rate, but the interest is either deductable for most owners or is expensed for investors and the additional principal paid from the difference between the 30 and 15 will reduce the interest costs at a faster rate than paying the 15 yr, everytime.

If you have to look at the property and the cash flow analysis as a deciding factor, the deal is not a deal. If you have to take a 30 yr to squeak by on cash flow, the deal is too thin.

Even if your money sits in a money market, it is available for other investments. If something in your life goes wrong and you need money for a budget, having an obligation to pay amortized for 30 yeras will be better than one on a 15 year required payment amount. Your obligation to obtain other financing will also be less with the 30 year to obtain other loans, even a car loan!

So long as you have the right to pre pay your loan without penalty, always take the longer obligation. You will generally not see a prepayment penalty in a residential loan, commercial is another issue...especially SBA deals. Good luck.

Jason and Bryan hit the nail on the head. You have more options with a 30 year loan. As Jason said you will be able to draw equity out or put up that house as collateral for another purchase.

I'll differ with the consensus in one other situation. Do you plan to pay this property off? If so, I'd keep the excellent 15 year loan; "I currently have a 3.75% rate 15-yr mortgage on it."

You can borrow against the equity in the future if you need to.

For those who feel strongly about going with a 30 year over a 15 year, do you feel the same way about interest only notes? That they are superior to a term note?

It depends on your goals Jon. I prefer simple self-amortizing notes without balloons. IO notes generally have balloons and thus carry higher interest rate risk if rates are at all-time lows like they are right now.

Jon, I agree that what your goals are need to be taken into considertion. But I have punched a financial calculator thousands of times looking at the difference. At the retail level, rate and points on the street that most borrowers pay, the better deal is the longer term. The rate at par (no points) is generally a half to three quaters of a point difference. The amortization required to payoff the note in half the time requires a greater obligation that you can't change, without additional loan costs.

If you apply the 15 year required payment to a 30 year amortization, it will come close to paying the same amount off within months of each other, at that half or three quarters of one per cent.

The question then becomes what is your cost of capital and opportunity costs for any other opportunity over the next 15 years? Can the money in hand be better utilized than the rate being paid on the loan on an after tax basis?

For someone who actually invests in RE or in anything at all, buying and selling old cars, whatever, can you make more money with a dollar in your investment at a return higher than the after tax rate you are paying on a mortgage?
If the answer is no, then take the 15 year and that will underscore what I mentioned above, not having the financial disipline to better manage your money. It also says, since mortgage money is the cheapest dollars a civilized commoner can get their hands on, that they really are not very successful at investing! They should be doing something else if they can't beat the after tax rate paid on a mortgage.

Now, let's assume you beat that mortgage rate and then apply those earnings to the 30 yr. mortgage, not the "principal amount saved, just the interest earned. Your 30 year mtg. will be paid off quicker than the 15 yr. That additional payment to principal in the early years will save thousands compared to the amortized payment schedule of the 15 yr. Simply paying $100 more will make a significant difference.

Now, consider that your ability to borrow will be greater having the obligation of longer term financing than shorter term contracts. This will impact your ability to borrow and that is an importnat consideration, especially for new investors. What's that worth?

What's it worth to be in a position to take advantage of other opportunities in the future?

There are also drawbacks doing what I proposed. You need to pay attention to your finances. You need to disipline yourself to follow a plan. You need to review your plan and maintain the other investment. It takes an effort, and the question then becomes, not only can I do this, but will I do this? Not everyone can or will.

But, from a responsible and conservative money management view point, the 30 yr is the best option.

A similar analysis can be applied to adjustable rate mortgages. The entry rate (or sucker rate) is used as a teaser, no lender really expects someone to pay additional amounts to reduce principal in the early years, so that equity isbuilt in even faster and when some adjustables actually adjust, the required payment may not be higher than the required at the entry rate!
If you want to make your calculator smoke, look at the entry rates and the cap adjustment later amortized at the remaining period.

Jon you can borrow from equity established from the 15 yr or the 30 yr with additional reductions made, pretty much the same thing. But when you borrow the equity, don't forget to consider the loan expenses of that equity loan. The lender wins every time.

I did not mean to sound so infatic about the 30 that you can't do a 15, what ever floats the boat, I mentioned times when the 15 would certainly be smarter if you can swing a deal like that.

If it makes someone sleep better at night having a 15 yr. mortgage, by all means take the 15!

IMO, interest only notes have their place.

Construction loans. Short term loans, expected to be paid within one year. Interest only payments are a great way to cover these types of obligations, even with a straight accrual loan with no payment required until the balloon. It's simply another way to pay the rent on the money.

I have made I/O loans, but I only made them to individuals who I considered to be more astute borrowers and the longer the loan term, the better the borrower needed to be. That's because an I/O loan over a long term can get you in trouble. The repairs fall short, the expected buyer falls through, the market slows and the expected equity is not there....Oooops!

But they have their place.

Originally posted by Jim Stardust:
Hi Jason,

It's a 200K SFH property, with around 80K in equity, it was my previous residence and I moved 1 mile down the street so I'll be taking care of managing and maintaining it. I just don't want to sell in the current market. I currently have a 3.75% rate 15-yr mortgage on it, I figure it would rent for around $1600. My PITI is $1200 with the 15-yr loan, probably go down by $300-$400 if I refinance to 30-yr loan.

It's now a rental, so it's no longer owner occupied. You should inquire of lenders what their loan terms are for investment property being held as a rental. You won't see anything anywhere near 3.75%, so after doing that you'll have a clearer picture of the PITI difference.

How many more years to go on that 15 year loan? Can you tolerate some possible negative cash flow from the rental? If so, how much and for how long?

I find it quite interesting that almost everyone chooses 30 year. Especially given the facts. "The money will otherwise be sitting in a money market account..." a money market account Emphasis mine. Few posters asked about rate. Jon Klaus has my vote... only because he posted and I didn't;)

There is nothing wrong with 15 year terms in this scenario. Jim: "I currently have a 3.75% rate 15-yr mortgage" and I see stuff like "...with 30 yr, there's a lot more cash flow obviously". No. Terms matter. I just did a stated income refi and the 15 year term payment is lower than the comparable 30 with $0 closing costs. Good or bad deal to go 15? I know, I know... the vote will be pay more for the 30.

Wrong answer.

Before you attack, you tell me what money market rates are. Show me. 0.1% benefit. Show me the MM return of all that cash saved.

If growth is the goal then the longer term is the way to go. As someone mentioned before
if you are in your 50's starting to wrap loans up is a very satisfying thing to do.

I have always chosen the 15 yr but have not chosen to buy lots of properties. If I want equity out I use my 3.25 LOC.

I also have a job. If I didn't I would be hoarding cash more. 15 yrs goes by so fast, 30, not so much.

Chris, LOL, if all you can get is .1% on your money, then pay the more expensive debt first on your 15 yr. mortgage. To say "wrong", well that's an opinion, not a financially astute opinion, but it is an opinion. Good luck

The money won't necessarily sit in the money market account indefinitely. I am assuming it will get put to work in other projects at some point. If it stays in a money market account indefinitely it is a toss-up IMO. Note that money market rates won't collect dust indefinitely either.

Yep, here's another idea, if the money will just sit there. Keep some aside so when you get in a pinch, you can make up the difference on the higher obligation you accepted and use the rest as a payment on principal, you'll pay even less in interest and have it paid off alot sooner!

Originally posted by Chris Martin:
I find it quite interesting that almost everyone chooses 30 year. Especially given the facts. "The money will otherwise be sitting in a money market account..." a money market account Emphasis mine. Few posters asked about rate. Jon Klaus has my vote... only because he posted and I didn't;)

There is nothing wrong with 15 year terms in this scenario. Jim: "I currently have a 3.75% rate 15-yr mortgage" and I see stuff like "...with 30 yr, there's a lot more cash flow obviously". No. Terms matter. I just did a stated income refi and the 15 year term payment is lower than the comparable 30 with $0 closing costs. Good or bad deal to go 15? I know, I know... the vote will be pay more for the 30.

Wrong answer.

Before you attack, you tell me what money market rates are. Show me. 0.1% benefit. Show me the MM return of all that cash saved.

Chris,

I think everyone here would agree that an MMA would not yield very much in this economy. Mortgage rates are at an all time and banks are trying to manage their overhead and cost of funds. However, the whole reason behind putting it an MMA if you are an active real estate investor is to have the liquidity available if need be to jump on a deal. You can't do that without penalties if the money is tied up in a CD or bond. We are in a buyer's market and cash is king. Financeexaminer is right. It's better to throw it at principal or re-capitalize and go after another property.

Another thing to think about. Statistically speaking how many of us hold a property for 30 years and pay the minimum payment for all thirty years? I don't think a lot of us on here. Personally, my investment strategy is to get in and out in less than 7 years per property. If the property is yielding a good cap and cash flow I may hold on to it longer. But the point is whether you have a 15 or 30 year the goal is too own as many properties FREE AND CLEAR in the shortest amount of time. You still pay a lot of interest @3.75% over 15 years believe it or not. Leverage is your friend if used properly.

Paying off a rental property is a good strategy because it will mean you'll get maximum cash flow in the future, but in the meantime you need to make sure you're building up a reserve account to handle repairs too. A slightly cash flow positive property probably won't accumulate enough of a reserve for you to replace the roof, AC units, do make-readies, etc. without having to dip into your own pocket. I think a good strategy is to do a 30-year fixed loan, then pay extra on it every month. You can always reduce your payment to the regular payment if you need the extra cash for something else.

Paying off a mortgage early is generally a very poor use of cash IMO. Rates are super low right now and the equity can be placed in better spots.

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