What mortgage term should I get?

Question

I have a deal under contract and wanted to get other investors thoughts on the term of the mortgage I should get. The purchase price of the property is 200k and it is ready to be rented so no money will have to be spent in repairs as of right now. With a 30 year mortgage my payments are around $800/month and with a 20 year the payments would be $983. The property is a duplex and net rent per month is at $1800 so either term would be cash flow positive.

Is it better to take the extra couple hundred bucks a month in cash flow with a 30 year loan or take a smaller cash flow with a 20 year mortgage but pay much less in interest. Thanks.

Jim Freeman · Answer

I'd take the lower payment/longer term loan as long as there is an option to make extra principal payments without a penalty.  Having the option to make a lower payment when anything unexpected happens is a great cash flow cushion.  If everything goes according to plan you'll get to decide each month, before making the mortgage payment, how much (if any) extra principal you want to include. You never know when a water heater, HVAC system, etc. are going to take a bite out of your checkbook.

Adam Garcia · Answer

Thanks for all the replies. I will look into an ARM but i think the 30 year, as suggested gives the best flexibility as you can always prepay if needed.

Kevin Siedlecki · Answer

@Adam Garcia - This is a huge debate here, and the right answer depends on your goals. If you have the goal to expand your portfolio, take the extra cash flow. Don't think of it as maintenance and capex money, but money you are saving for your next downpayment. If you are putting that money into the loan, then you have to pay to get it out in a refinance. If you have it in cash, you can make it work for you in other ways, either by buying another house, or putting it in the stock market.

If you have no desire to grow your portfolio further, then paying off the loan earlier can makes sense. It can be like buying time. If the cash flow from a free and clear portfolio will be enough for you to live on, and that's your goal, then that moment of financial freedom is as far away as your amortization lasts, so going with the 20 year makes sense.

On the other end of the spectrum, taking the long amortization and doing a cash-out refi every 7-10 years, depending on appreciation, is another strategy way to go. That would be a way to take out a nice chunk of cash to either buy more or just have that money, while continuing to have cash flow.

Hope that helps!

Franco Li · Answer

My strategy has always been to leverage as much as possible at the best rate, which will typically be an ARM of some sort. Considering the rising interest rate environment and your risk appetite this may be a debatable response. As an investment banker, and my colleagues and I strongly believe that a 15Y or 30Y fixed mortgage is the ultimate bank scandal, since you effectively pay double to triple your purchase price if you include the future interest payments.

By saying that, I also bias since I love ARMs, and I believe that despite the rising interest rate environment, ARMs are still the best choice, although it does take some understanding. Do some due diligence, look up a 7Y ARM that will help you save some money on a monthly basis, opt out of your strategy in 7 years, and move onto the next one. Good luck!

Jeff Rabinowitz · Answer

The lower payment is the safest. During a vacancy, when there is no income is also the time when you are writing checks to prep the unit for the next tenant. Make sure there is no pre-payment penalty (if there is find another lender), then you can pay down the balance anytime that is convenient for you but you will have a smaller obligation when paying is inconvenient.

What mortgage term should I get?

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