15 vs 30 year refinance in Temp, AZ. Or Cash-flow vs Pay-down...

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15 vs 30 year refinance in Temp, AZ. Or Cash-flow vs Pay-down...

Nehemias Ponce
Tempe, AZ · Member since 2016 · 40 posts · 8 votes

Hi everyone! We're about to refinance our rental property and I am looking for some advice. Here is some background information first. The property is located in Tempe, AZ and is currently valued at approximately $200,000. The principal balance on the note is $121,500 at 5.25%. Our payments are $950 and we collect $1,100 a month in rent on it. We are definitely going to refinance, however I am not sure what length of a note we should get. Below are two possible scenarios:

1. 15 year note: Conventional wisdom says that paying down the note sooner would save interest and of course lead to a more full cash-flow from the property sooner. 

2. 30 year note: However, currently the property sustains itself in that we do not pay any interest on it at all (out of pocket), the tenant does. So then, a 30 year note would allow us to cash-flow even more than we do now. 

I do not have any numbers as of yet to give a more precise calculation. This is just a general query regarding the benefits of maximizing cash-flow vs faster pay-down in the current and near-future markets. We will also be holding this property. We have no plans to sell. Our future plans do include purchasing another investment property. I'm studying about it right now and hope to begin analyzing properties soon. 

I'm especially interested in hearing from people @Hannah Hammond familiar with the Phoenix market in particular who might weigh in on one note versus the other. However, all help @Mindy Jensen is so very much appreciated. Thank you for any knowledge and guidance you can provide!

-Nehemias

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Rami W.
Rental Property Investor · CA · Member since 2011 · 82 posts · 32 votes
10y

30 year and pay additional monthly towards the principal when you can/want to.

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  • Ryan Craig
    Realtor · Nashville, TN · Member since 2014 · 148 posts · 46 votes
    10y

    @Nehemias Ponce

    For me I go with a 30 year fixed as cash flow is what i am going for. The first thing you have to do is define your goals. Once you have set goals it is much easier to decide which option is best for you. Also, taking it to a 15 year may take your PITI above the $1100 a month you are currently renting the home out for, can you afford to pay a little out of pocket?

    Also keep in mind if the home is vacant for any extended period of time you are responsible for the payment, the lower the payment the less of a hit you take. 

    0Reply
  • Rami W.
    Rental Property Investor · CA · Member since 2011 · 82 posts · 32 votes
    10y

    30 year and pay additional monthly towards the principal when you can/want to.

    4Reply
  • Julie Haveman
    Multi-family Investor · Allendale, MI · Member since 2015 · 121 posts · 51 votes
    10y
    Hi, We also do 30 year loans, but I add an extra $100 to them, which will make them pay off in more like 20-22 years. If ever we are having a tight month, then I can skip it that month.
    0Reply
  • Michael Hacker
    Investor · Phoenix, AZ · Member since 2013 · 167 posts · 127 votes
    10y

    I would also consider a 30 yr. loan with extra payments.  The last time I ran some scenarios I believe a 30 yr loan would be paid off in 15 - 20 if you made the same payment as required by the 15 yr (depends on the rate difference).  So it would take a few more years, but as suggested by others, you get the security of not obligating yourself to the higher payment if you hit a cashflow issue down the road.  You can play around with an online mortgage calculator that allows extra payments to see the difference.  Or if you really want to geek out I have a great excel calculator that will give you all the info you would need plus principal / interest for every payment over the life of the loan.  Feel free to PM me and I can email it.

    2Reply
  • Bob E.
    Queen Creek, AZ · Member since 2014 · 2k+ posts · 1k+ votes
    10y

    I would consider selling and moving to market with better cashflow.  We just bought two rentals in the midwest for a total price of 80K and combined rents are $1600 a month.  given that you have 80k in equity you would have $0 mortgage and one heck of a cashflow.....

    2Reply
  • Nehemias Ponce
    OP
    Tempe, AZ · Member since 2016 · 40 posts · 8 votes
    10y

    Thank you @Julie Haveman@Ryan Craig@Michael Hacker@Rami W.! It seems the consensus is 30 years and reserve the option to pay down on our own. I'll be getting some preliminary numbers here shortly and that alone may dictate our next move. It's just a change of thinking that I'm learning to understand. That is, that carrying debt may not be as bad as I once believed it to be, if the debt is for an asset.  

    0Reply
  • Nehemias Ponce
    OP
    Tempe, AZ · Member since 2016 · 40 posts · 8 votes
    10y

    @Bob E. Are there any resources you would recommend for educating myself on out of state investing? I'm open to it to be sure and being new to investing the thought of going out of state seems daunting. Here is some background on us. Our rental is about 1 mile away. I drive by it every couple of weeks or so. I landscape the yard, manage all repairs (in most cases doing them myself) and we pay the mortgage out of our own account (soon to be remedied by establishing an LLC). So right now we're very mom and pop. But we don't have to stay that way. I'm realizing that my education and time are my most valuable resources, so any suggestions you can give would be very helpful.

    1Reply
  • Bob E.
    Queen Creek, AZ · Member since 2014 · 2k+ posts · 1k+ votes
    10y

    We evolved into it.  First we started I started out with Note School buying non performing notes in the Midwest.  They have a lot of support for when you have to take a property back from the borrower.  As the supply of non performing notes dwindled we decided to keep our properties as rentals and we built our team.  Not every PM worked out and we had to make some changes along the way but right now we feel that we have fairly good teams in Milwaukee, Lansing MI, and Jackson MI.  This year we have really hit our stride in terms of being in a position to expand on a solid foundation.

    As we managed our way through growth we got better.  We are now working directly with more people to evaluate more deals and expand.  

    I would note that as long as you are doing your own landscaping your ability to grow will be limited....  I admire your work ethic but would encourage you to grow.  There are a lot of these properties in the midwest that can be bought with owner financing so you can build a portfolio more quickly.

    @Nehemias Ponce

    1Reply
  • Colleen F.Pro Member
    Investor · Narragansett, RI · Member since 2013 · 8k+ posts · 4k+ votes
    10y

    30 year,  interest is low now.  I don't think there is a rule it has to be one or the other.  I bought one house with a 27 year loan because I asked. I had a payment amount I wanted and that was where it landed. 

    0Reply
  • Bob E.
    Queen Creek, AZ · Member since 2014 · 2k+ posts · 1k+ votes
    10y

    Look at the Am schedule when you get your loan and how little goes to printable over the first year.  In the early years one extra payment will usually take close to a full year off the back of your loan.  Do this a few times and you will have a huge impact on when you will cash flow.

    0Reply
  • Nehemias Ponce
    OP
    Tempe, AZ · Member since 2016 · 40 posts · 8 votes
    10y
    Originally posted by @Ryan Craig:

    @Nehemias Ponce

    For me I go with a 30 year fixed as cash flow is what i am going for. The first thing you have to do is define your goals. Once you have set goals it is much easier to decide which option is best for you. Also, taking it to a 15 year may take your PITI above the $1100 a month you are currently renting the home out for, can you afford to pay a little out of pocket?

    Also keep in mind if the home is vacant for any extended period of time you are responsible for the payment, the lower the payment the less of a hit you take. 

    It took me a little while to understand how simple and wise the above is. I guess I should have a better understanding about what our goals are! It would help drive our decisions. Makes total sense. Sorry my friends, slow learner, but trying to get there... 

    1Reply
  • Ciprian L.
    Real Estate Agent · Burbank, CA · Member since 2012 · 271 posts · 79 votes
    10y

    30 year loan with no extra payments. 

    There a lot of investments that can get you more then 4-5% over a 30 year period.

    3Reply
  • Nehemias Ponce
    OP
    Tempe, AZ · Member since 2016 · 40 posts · 8 votes
    10y
    Originally posted by @Ciprian L.:

    30 year loan with no extra payments. 

    There a lot of investments that can get you more then 4-5% over a 30 year period.

     What do you mean? I'm not sure I follow.

    0Reply
  • Jerry W.Pro Member
    Moderator
    Investor · Thermopolis, WY · Member since 2012 · 4k+ posts · 4k+ votes
    10y

    @Nehemias Ponce, what @Ciprian L. means is that if you can get say a 10% return on your money by buying a rental why pay down the principal sooner when you could buy another rental and make 5% more instead of using it to pay down the loan.  There are pros and cons to both ways of thinking.  If you want to expand rapidly you pull as much equity as you can out of properties and keep payments low so you can use extra money to buy more units.  The counter thought is that having a lot of equity gives you a safety margin in case values drop a lot or you need money unexpectedly.  When you plan to retire makes a big difference also.  If you plan to retire in 30 years getting a long tern note will be fine, if you plan to retire in 10 years you may want to pay properties off so you can live off the income.  Think about your goals and when you may plan to quit working or retire and what will you have in payments then.

    3Reply
  • David Dye
    Real Estate Investor · Torrance, CA · Member since 2015 · 186 posts · 45 votes
    10y

    I would go the 30 year all the way, if it were me...  With rates how they are, you can almost certainly make a better return using the bank's money.  Use the extra cash flow to save for another property...  You can always pay it down faster but are not locked into a higher monthly payment just in case things turn for the worse...

    -David

    1Reply
  • Ciprian L.
    Real Estate Agent · Burbank, CA · Member since 2012 · 271 posts · 79 votes
    10y

    You can buy another property or invest the money into some other kind of investments that can get you a better return than the rate of your loan.

    If you have a loan at 5% rate and other investments that can yield 6-7%, if you have $100 extra do you pay down the loan or buy the second investment?

    0Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    10y

    I have not read all the responses, so apologies if this is a repeat ... in my mind this is a false dilemma. You can pay a 30 year mortgage off in 15 years, but you can not pay a 15 year mortgage off in 30 years. The only thing the 15 year buys you is a slightly lower rate, but that comes at the cost of being locked into 15 year terms. If you want to pay down early, I would keep a separate pay down account, ideally something that yields the same or more than the 30 year interest rate and yet is still relatively safe and liquid, and fund it with excess cash flow every month. Then, when this account exceeds the principal amount on the 30 year loan, you can pay it off in one lump sum, perhaps even sooner than 15 years. Otherwise, in the meantime, if you hit a major financial emergency where you need to tap this money or you find other more attractive investment options that you choose to divert this money to instead, you have that option. Of course, all of this assumes that you have the financial discipline to stick with the plan and not blow the account on a nice new sports car or something like that ... if this is not the case and you do not have this discipline, then you probably should not be investing in RE in the first place.

    3Reply
  • Nehemias Ponce
    OP
    Tempe, AZ · Member since 2016 · 40 posts · 8 votes
    10y

    Thank you for the explanation @Jerry W. I am in a position where I can retire in 15 years so your response resonates with me. It would be nice to have my primary residence and the rental paid off in 15 years. It's just a matter of how to get there. 

     @David Faulkner Do you have any examples of what kind of an account you might be referring to? I'm very much intrigued by that idea of yours. 

    0Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    10y

    What kind of account depends on just how "sporty" you want to get in trying to offset the interest on the 30 year mortgage. An aggressive option would be a brokerage account holding, for example, blue chip stocks that have a dividend payments (with DRIP set) around the same percentage as the rate on the 30 year. Or perhaps a low fee large cap stock index fund. You would have to be ok with the volatility involved, but after 15 years or so you'd likely come out ahead of if you'd just payed down the 30 year in 15 since the returns would likely be more than the 30 year interest rate.

    A more conservative approach may be short term corporate bonds or TIPS. These would be less volatile and more liquid than the option above, but the interest would likely just barely offset the rate on the mortgage or come close.

    Finally, the most conservative would be something like a money market account. The interest almost certainly would not offset the interest on the mortgage, but this would be the most liquid and lowest volatility option. You would not likely come out ahead financially this way, but it would offer you the highest liquidity and safety in case you chose or needed to use the funds for something else along the way.

    Many other options are possible, but this hopefully gives you some ideas ...

    0Reply
  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Bob E.:

    I would consider selling and moving to market with better cashflow.  We just bought two rentals in the midwest for a total price of 80K and combined rents are $1600 a month.  given that you have 80k in equity you would have $0 mortgage and one heck of a cashflow.....

    Dude, how many YEARS before you see a return of your equity?   

    0Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    10y

    Holding equity in a rental property is a poor use of cash. There is no reason to pay off a rental as it does not increase real cash flow.

    As your rental shows having a $200,000 property and  paying 5.25% on $120,500 is costing $950/month. The equity you have in the property is $78500. At your mortgage rate of 5.25% your equity is saving you $343.43/month meaning that amount of your rental income is attributed to your equity value. 

    $950 + $343.43  = $1293.43

    $1100 - $1293.43 = ($193.43)

    Your rental property after attributing a return to your cash equity is negative $193.43/ month.

    Not a good investment.

    1Reply
  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Thomas S.:

    Holding equity in a rental property is a poor use of cash. There is no reason to pay off a rental as it does not increase real cash flow.

    As your rental shows having a $200,000 property and  paying 5.25% on $120,500 is costing $950/month. The equity you have in the property is $78500. At your mortgage rate of 5.25% your equity is saving you $343.43/month meaning that amount of your rental income is attributed to your equity value. 

    $950 + $343.43  = $1293.43

    $1100 - $1293.43 = ($193.43)

    Your rental property after attributing a return to your cash equity is negative $193.43/ month.

    Not a good investment.

    I can agree with you up to the last line.  If he bought this 0% down and the $80,000 equity is appreciation then IT IS A VERY GOOD INVESTMENT!  

    0Reply
  • Bob E.
    Queen Creek, AZ · Member since 2014 · 2k+ posts · 1k+ votes
    10y

    I guess I just don't understand the "Borrow all you can crowd".  When you are leveraged to the hilt and your renter loses their job and stops paying leverage can really hurt you.  You are getting no rent, have to pay legal fees, then rehab the unit and re rent it....  All while paying the mortgage(s).  

    There is a down side to debt.  Remember the last recession!  

    1Reply
  • Dan Schwartz
    Real Estate Investor · Tempe, AZ · Member since 2012 · 874 posts · 648 votes
    10y
    I get "that crowd," Bob E. , but I don't agree with them. That's cool. Their markets probably didn't drop 70% in the crash like ours did!
    1Reply
  • Bob E.
    Queen Creek, AZ · Member since 2014 · 2k+ posts · 1k+ votes
    10y

    @Dan Schwartz  Probably not.  People that were leveraged were crushed.  Those that weren't could buy amazing deals.

    1Reply
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