15 vs. 30 year Financing for Rentals
Member since 2020 · 5 posts · 0 votes
Hey everyone, new to rentals on my end. Im struggling to get my cash on cash over 9% when evaluating 15 year mortgages. I'm looking to build my portfolio of rentals using only 20% down for each. I have solid job income and really don't need any of the actual cash earnings so I just plan on continually reinvesting. My reinvestment capital would be monthly cash contributions from my primary income and my rental earnings combined.
Is it a no no to use 30 year financing to raise my cash on cash to 9-12%?
Thanks,
Michael
@Michael Class, a few thoughts on 30 vs 15.
First, several people have said "you can pay a 30 like a 15". True, but only one has said he actually does that. What that means is most people get comfy with a 30-year payment. Just like tenants go into freak out mode when we propose a sizable rent bump because their budget can't hack it, the same happens with REI's. After 3-5 years of comfortably low payments, few of us are equipped, either mentally or financially, to make larger payments. Our lifestyle grows and sucks up the cash flow. Maybe you're in the 5% who actually bank it and live frugally so you can ramp up the payments later. I don't know your level of discipline or commitment.
Second, most capital expenses happen in a range of 10-20 years. Roofs wear out (20 years). HVAC systems die (15 years). Units need upgrades/freshening (12-15 years). Hardwoods need to be refinished (10-12 years). Carpet wears out (7-10 years). If you rehab a place to decent standards and pay on a 15-year note, you'll most likely be free and clear on that property by the time you have to replace/redo any of those very expensive items. Otherwise, in year 18-22 of your 30 year note, you get clobbered with huge repairs and have to take out HELOCs or use credit cards to finance those costs. Basically erasing years of pay down with new debt.
Third, debt is always a risk. How much of a risk depends on many factors that we cannot control or forecast. Yes, interest rates are still at a historic low, almost 10 years after they trended down below the average for the past 100 years. Will it continue that way in the future? I don't know. You don't know. No one on this board knows. What's the point? The point is with fantastic cash flow from a paid off property you can bank sufficient funds to pay for repairs and upgrades. With debt....who knows if you'll have access to funds needed? What if you need a new roof in year 20, but HELOC / credit card rates are at 18%? You will pay that 18% because you still are in debt and have insufficient cash reserves.
Fourth, and possibly the most important consideration of all, if the property requires a 30 year note today to generate decent returns, I'm guessing it's probably NOT a very good deal. My favorite type of property is one that generates 12% or better and still pays off in 10-15 years, tops. Find a better deal that can support a 15 year note today vs. "maybe I'll get around to paying it like a 15 year someday...." Lengthy debt allows us to overlook the problems with mediocre investments because we "fix" sub-optimal returns with lower payments.
Finally, regarding a growth model: would you rather have 10 paid off units cash flowing like crazy in a short decade and a half or 20 units spitting out a pittance each month for three decades? Which one generates more hassle? Which one means more hustling to fill vacancies?
I started out with 30 year notes. I've since refi'd them all to 15 years or less. Thankfully, because I started in 2005, and it was kind of depressing to see those first note I'd been paying on for FIFTEEN YEARS with so little equity for all that time. I've decided life is too short to give all my money to the bank. The only scenario I can see working well with 30+ year notes is apartment complexes where the idea is to get in, create a ton of value, then exit in 3-5 years for a big payoff. But for long term buy and hold....15 years or less is my vote!
I know others will come back with wanting to use cash flow to own more units, using inflated rents to pay down long term debts using "cheaper" money and that's all fine. My perspective comes from doing this 15 years and knowing I want to be out of the bank's control within the next 6 years. 2 decades of sending money to the bank will be enough for me. I'm 44 and I want to be 100% debt free by 50.
It really depends on your goals. I chose to stick with 30 year mortgages when possible because I am still in the "growth" phase of my investing and I want extra cashflow up front. I want the additional cashflow to be available to me so that I could use that to build reserves, buy additional properties, make improvements, etc.
I do know other investors that are more interested in having a fully paid off portfolio in by a certain point in their lives/careers, so for them they weren't concerned with monthly cashflow as much as they were about the final pay off date.
I don't think it's unreasonable to look into 30 year mortgages if that helps you meet your goals. Just make sure you are clear on what those long term goals are and if that 9% CoC is worth the extra 15 years of mortgage payments.
I'm 45 so I'm considering what would be the best play. Thanks for the input, it helps a bunch.
@Michael Class
I'm 41 and would take a 100 year mortgage if they offered it.
But as @Cassi Justiz said, depends on your goals.
I'm 45 so I'm considering what would be the best play. Thanks for the input, it helps a bunch.
What’s the cost savings of a 15 versus a 30 year mortgage? You could always get a 30 year mortgage and pay it off in 15 years. That why if unforeseen issues arise you can drop down to the lower 30 year payment to not bleed cash.
I’m roughly your age and am doing 25 year Commercial Mortgages with 10 year balloons. So in a decade I can make the choice then of what to do. Right now I don’t need the cash flow. So it just gets set aside for other down payments.
30 over 15 any day, any week, any year.
30 yrs. And then Refi (if it makes sense) within 5 years for another 30 yrs.
@Michael Class It depends on your goals, but since you said you’re still looking to build your portfolio of rentals, I’d go with 30 year mortgages.
You'll be better off with the lower payments of a 30 year mortgage. The higher payments with 15 year mortgages will hurt your DTI as you continue and try and qualify for additional mortgages.
Plus, you can always pay extra with 30 year mortgages and pay them off like a 15 year mortgage, but you won’t be obligated to. (You don’t have that flexibility with a 15 year mortgage because there’s no option to pay it off like a 30 year mortgage if you have unexpected expenses or just want a lower payment for some reason.)
Thanks for the advice everyone. Since I live in central NJ, I'm struggling a little to get the cash on cash up. I agree with the 30 year mortgages for now, at 15 years the equity position looks really good so I may build my long term goals around that vs total paydown.
15 year for me. They all cash flow a little so I’m fine with this. And they’ll all be paid off when I retire in 15 years so that’s the goal.
@John Morgan Not to knock your style at all, but have you thought about having twice as many rentals instead of having rentals paid off?
I would go 30 years all day, every day. Let the banks eat the inflation.
@Michael Class my advice, and my process, is slways a 30 year. My primary is a 30 year, but I pay it as a 10 year. That way if I get into a bind, I can make lower payments. You can always pay more, but can never pay less than your monthly schedule. Just my 2 cents
A 30 year will always give you more cash flow which you can reinvest into the next property.
If I was 15 years from retirement and it cash flowed at least 250 after factoring in the 15 year mortgage then I would consider it. So far I haven't found anything that worked for me. I would advise against anything that barely cash flows.
You also have the option to pay extra on the principal if you do 30 year.
@Michael Class
30yr any day.
@John Morgan Not to knock your style at all, but have you thought about having twice as many rentals instead of having rentals paid off?
I would go 30 years all day, every day. Let the banks eat the inflation.
My goal is to have 10 paid off rentals in the next 12 years. They will cash flow me about 12k/month after all expenses and they’re super easy to manage myself so far. I currently have a total of 9 with two paid off I’m only cash flowing $3,400/month now. That’s not great I realize since two are paid off, but I have a W2 job I enjoy and can survive off this extra cash flow ok. Sure, I could double my portfolio and swing for the fences and crush it. Most people here would which is fine. But for me, 12k extra a month with fewer properties is more than enough for me. Most of my money is in the stock market in retirement accounts, so real estate is just a supplemental retirement cash flow for me. It’s more of a hobby to be honest. Maybe I’ll change my strategy though, Lol because I’m having too much fun investing in real estate!
Another reason for getting 15 year loans is my bank gives me great rates while only charging me one point. Most of my rates are around 3.5% with the highest at 3.875%. And they can close within 3 weeks. I’ve used other banks and it takes a month to close and the interest rates are over 4%. When I make offers on properties, I tell them I can close within 3 weeks and that has helped me snag a couple properties over other competitive offers due to the quickness of a closing I offer.
And the third reason for only going after 10 properties with 15 year loans is the wife. She hates that I keep buying more and more properties. She thinks it’s too time demanding and risky. I hire out all work so I’m not spending any of my time there. And I show her how much $ we’re making every month. I even told her recently she can retire since she makes about what we’re currently making off our SFRs. However, sometimes you have to keep the wife happy and dial down the real estate expansion. The old saying says “If momma isn’t happy, ain’t nobody happy!” Haha!
@Michael Class Do 30 years if you can get it. You can always increase payments if you want to pay down faster.
@Michael Class, a few thoughts on 30 vs 15.
First, several people have said "you can pay a 30 like a 15". True, but only one has said he actually does that. What that means is most people get comfy with a 30-year payment. Just like tenants go into freak out mode when we propose a sizable rent bump because their budget can't hack it, the same happens with REI's. After 3-5 years of comfortably low payments, few of us are equipped, either mentally or financially, to make larger payments. Our lifestyle grows and sucks up the cash flow. Maybe you're in the 5% who actually bank it and live frugally so you can ramp up the payments later. I don't know your level of discipline or commitment.
Second, most capital expenses happen in a range of 10-20 years. Roofs wear out (20 years). HVAC systems die (15 years). Units need upgrades/freshening (12-15 years). Hardwoods need to be refinished (10-12 years). Carpet wears out (7-10 years). If you rehab a place to decent standards and pay on a 15-year note, you'll most likely be free and clear on that property by the time you have to replace/redo any of those very expensive items. Otherwise, in year 18-22 of your 30 year note, you get clobbered with huge repairs and have to take out HELOCs or use credit cards to finance those costs. Basically erasing years of pay down with new debt.
Third, debt is always a risk. How much of a risk depends on many factors that we cannot control or forecast. Yes, interest rates are still at a historic low, almost 10 years after they trended down below the average for the past 100 years. Will it continue that way in the future? I don't know. You don't know. No one on this board knows. What's the point? The point is with fantastic cash flow from a paid off property you can bank sufficient funds to pay for repairs and upgrades. With debt....who knows if you'll have access to funds needed? What if you need a new roof in year 20, but HELOC / credit card rates are at 18%? You will pay that 18% because you still are in debt and have insufficient cash reserves.
Fourth, and possibly the most important consideration of all, if the property requires a 30 year note today to generate decent returns, I'm guessing it's probably NOT a very good deal. My favorite type of property is one that generates 12% or better and still pays off in 10-15 years, tops. Find a better deal that can support a 15 year note today vs. "maybe I'll get around to paying it like a 15 year someday...." Lengthy debt allows us to overlook the problems with mediocre investments because we "fix" sub-optimal returns with lower payments.
Finally, regarding a growth model: would you rather have 10 paid off units cash flowing like crazy in a short decade and a half or 20 units spitting out a pittance each month for three decades? Which one generates more hassle? Which one means more hustling to fill vacancies?
I started out with 30 year notes. I've since refi'd them all to 15 years or less. Thankfully, because I started in 2005, and it was kind of depressing to see those first note I'd been paying on for FIFTEEN YEARS with so little equity for all that time. I've decided life is too short to give all my money to the bank. The only scenario I can see working well with 30+ year notes is apartment complexes where the idea is to get in, create a ton of value, then exit in 3-5 years for a big payoff. But for long term buy and hold....15 years or less is my vote!
I know others will come back with wanting to use cash flow to own more units, using inflated rents to pay down long term debts using "cheaper" money and that's all fine. My perspective comes from doing this 15 years and knowing I want to be out of the bank's control within the next 6 years. 2 decades of sending money to the bank will be enough for me. I'm 44 and I want to be 100% debt free by 50.
@Erik W. thank you for sharing your thoughts on this. I’m located in central NJ and there is a housing shortage in our general area driving up the cost of real estate.
I’m 45 now and I’m pretty good to go for my retirement. I would rather take 15 year notes and enjoy the benefits of no payments in my retirement years.
I have to to make a decision if 3% cash on cash is fine for me since I don’t need any income to begin with. I’ve ran scenarios on many properties and keep ending up in the same place.
Case by case, depending on rate and where you're at.
Growing and early into it? Seek a 30, but check on the 15. We're all pretty much 30ers until 15 rates have a 22% discount like they did in '12.
Compare both side by side to know your options.
Well said Erik! I agree 100% with you on all points. I’ve only been investing in real estate for 5 years and do 15 year mortgages as well. Your 15 years of investing in real estate holds more weight to me than a lot of people on here that have been doing this for only 5-10 years when everybody looks like a genius with their strategies.
@John Morgan, thanks! I'm by no means the most experienced person here, but experience is a fine teacher. I used to buy into the "get as much debt as you can and stretch it out as long as you can" school of investing, and in theory that does work out the best. But life doesn't always work according to theory. Robert Burns, the Scottish poet, said it best, "The best laid plans of mice and men gang oft aglee" ... That is, they go wrong often.
I understand all of the stuff the experts and gurus talk about in regard to the time value of money, leverage, etc. But I don't trust anyone who hasn't weathered at least one full investing cycle. Which basically means, anyone with less than 10 years experience at this point is all theory and little practical application. Buy and hold real estate is long term: decades in many cases for the average investor. Those who have rocketed to success since 2010 have had success with cheap, easy-to-get money, but I wonder if when the next down turn happens or inflation hits the fan....will they be able to hold on, or will they be providing me my next bountiful source of good deals?
I'm comfy with my strategy. Right now, I think prices are high and the risk of downturn is also moderately-high. I am still buying, cautiously. The 2% Rule for rentals is about as low risk as one can get. But there are also few properties that qualify according to that formula. I've bought a couple this year that were 1.8%. Still great cash cows that I can lower rents on significantly and still more than cover all my expenses. I get nervous with anything below 1.5%. Seems like a lot of folks are investing on a presumption of the status quo of the past 10 years. But a down turn like we had in 2009 will require very DEEP pockets to survive as rents plummet and renters pull out of the market to move back into Mom and Dad's basement.
Time will tell.
You can always pay more, but you cannot pay less. So if, for some reason, you are unable to make your payments on a 15 year mortgage, a bank isn't going to like it when you start to pay them less money. On a 30 year mortgage, you can always pay more than your required payment. My recommendation, always get a 30 year, and if you want, make monthly payments as it it were a 15 year mortgage.
Agree with you. Gurus and newbies don’t talk about times when vacancies shoot up due to the economy. Or when everything breaks over a short period of time. I had to repair four foundations (at an average of 5k each), replace four HVACs (at $3,500 each) and a roof over a three month period. And one eviction. Ouch. Luckily I had 50k in the bank for things like this. But I spent every penny of my reserves on theses things. Another reason why I don’t over leverage and have a couple properties paid off so I always have decent cash flow coming in each month for when the poop hits the fan.
Good for you on finding deals which give you rent at 2%. It’s super competitive where I’m at and very hard to find deals. I’m in the DFW area and it’s hard to find cash flowing properties with 15 year loans that pay me 1% in rent. I picked up two this year that only pay me 1%, but they are in great appreciating areas I feel.
I'm with John Morgan on having a few paid off properties instead of having a bunch of properties with loans. I would take a 30 year loan and try to pay it off sooner though, so it's easier to cover the mortgage payment during vacancies
@Michael Class This is always an interesting question and I'm sometimes split on it.
However, tomorrow isn't guaranteed so, IRL, I always sway to the CashFlow today end.
Talk about instant gratification income!