Equity or Cash flow position?

8 Replies

Sorry if this is in the wrong spot. Might have shot myself in the foot. I have a single family primary that I’m working to get rented out, I refinanced it on a 15 year a 2.375% because that dropped my total interest over $100,000.00 so it was kind of a no brainer to me. Ideally I was planning on just renting it for the mortgage cost which is doable easily in my area, letting it rent for as long as it pays for itself until I have $100,000 in equity and then sell it and distribute that into multiple doors. I’m kind of looking now though and wondering if maybe I should have done a 30 year at 3.000% so I could pocket a few hundred bucks per month? Have any of you went for strictly an equity position over cash flow? If I leave it on a 15 year, over $1,000 per month goes to principle whereas the 30 year only a few hundred bucks, I guess I just figured gaining equity faster was more important to me that a few extra hundred bucks per month.

This is going to be a personal opinion @Jeremiah Lewis .  I personally am a fan of debt so I always go for 30-year mortgages.  If you are having a rough patch for a few months, you don't need to pay the higher mortgage cost for one thing.  Also, you could apply that cash flow towards the mortgage if you wanted, or keep it as reserves. 

Now that you have the 15-year mortgage, I would just move forward with your plan.  Forcast out when you'll have $100k in equity by looking at the amortization calculator and making a plan from there.  

I have some similar posts, I had refinanced to a 15 year mortgage a year prior to me moving out and it becoming my rental. While it's working for my specific goal, it ultimately depends on what you're trying to do. If you refinance and made $300 a month more, would you be investing that money consistently? Or are you like me you know you'd end up buying an extra case of beer here and there, a night out, etc. and rarely save it. For me, I'm escalating payoff, (and I don't need the cash flow right now nor do I have a plan to better invest it), so I can maximize the income in 10 years when it's paid off. I do not plan to expand to other properties. 

IT isn't a matter of liking or not liking debt.  It isn't a matter of wanting less total interest on the loan.

It's about the relationship between your cost (which is ONLY the cash out of pocket), and what that cash is worth (or buys).

When you go to a 15 year  mortgage, that increase in mortgage payment, comes out of your pocket...it isn't a savings because your tenant is paying that for you from the rent.  You're NOT saving money, you're spending more.

As your equity increases, you're losing money because the value of the equity (what it is buying for you), is reduced more and more as the equity increases.  You're buying 5 a property 5 times your cost when you start.  The equity increases at an equal (1 to 1) value to the appreciation.  This is diluting your money because the value of the equity is buying less property value per dollar of equity.

Your cash flow doesn't go up as your property is being paid off...it usually remains the same (or pretty close).  If you sell a property when the equity doubles what you bought as a DP, you can buy two of the same property you originally bought, which means you converted your reduced equity value, back to the 1 to 5 ratio...and, your CF should come pretty close to doubling. 

Originally posted by @Jeremiah Lewis :

@Joe Villeneuve I don’t follow? If I have someone paying the mortgage to live in it even if it’s for a year or 2 that’s $12,000 - $24,000ish off the principle and then I sell It at its current appraised value aside from my half Of closing, how is that costing me money?

 During that short time period, the loan payoff usually covers the closing costs.

It's not about the face value of the money, it's about what you are actually buying...in value.

When you buy a $100k property at 20% down, that property costs you $20k...but the value is $100k.  That's a value that's 5 times what you are paying for it.  If that same property appreciates $20k, that means the PV is now $120k and your equity is equal to $40k.  On the surface that sounds great, however the value of your equity is going down because that increase in equity is equal to the increase in PV...a 1 to 1 ratio.  The end result is your $40k in equity is now only buying you 3 times the face value of the equity.  Leaving your equity in a "frozen" state, is losing you money.

Now, if your sold that property, and used the now "liquid" equity as a DP on another property (or more than one), you are now back to a 5 to one ratio of PV to cost, which means that $40k is now worth $200k in PV...not $120k, like it would be left as is.  If each property appreciates at 5%, then the new PV for the first option (leaving it as is) would be $126k, but the new PV for the 2nd option would now be worth $210k...and the gap increases as time passes because of the compounding effect.

It gets better, or worse...depending on which side you're on.  If the first property cash flowed at $4k per year, when you sold and took the cash out as profit, and it was double what you started with, you can double your CF too.

I would opt for a 30 year. Given the low rates today I like to look at what is called positive leverage. IF your CoC can exceed the cost the money, you're using "good debt". For example, say your rate is 3% and you're pre-tax cashflow is $X, or 5%. There is a 2% delta - making money on borrowed money. There are additional/marginal tax benefits as well on the interest expense. This is just scratching the surface on hold time, but generally the yield curve (hold period) is longer when you're properly leveraged. Remember, the denominator of the calculation is your invested equity. By accelerating paydown on a property, you're shortening the ideal paydown. This is why I try to educate my clients that its not just the dollar amount you're cash flowing in a given year, its the dollar amount TO how much you have invested.

Essentially how to use leverage is the fundamental way to answer and analyze your situation. 

My wife and I did that on our second most recent home in 2005 and paid the loan down quite a bit in 10 years.  It was very useful to have that much equity when we bought an old home and did a major remodel. We now own our personal home plus a duplex outright. I am currently in the market to leverage the duplex into at least 2 more properties.