Everyone else on BiggerPockets is wrong.
That’s right, you read it here first.
Everyone. Even these guys:
“Personally, I prefer the 30-year mortgage, not only due to the flexibility, but also because I’m able to cash flow better with the lower monthly payment. Since I’m financing rental properties, my tenants are basically paying off the property, and I’m able to keep more of the cash flow due to depreciation.” —Dave Van Horn, BiggerPockets Blog, January 5, 2017
“Go with the 30-year mortgage, and especially so in this current market of low interest rates.” —Scott Trench, BiggerPockets Blog, July 28, 2018
With one exception I will discuss in a moment, new and intermediate investors are better served by shorter amortization loans. There are several reasons.
First and foremost, most investors should make an effort to build relationships with smaller, local banks. These banks generally only loan 15 or 20-year money and offer:
- Quicker turnaround
- Flexibility on credit score based on personal relationships
- Knowledge of local markets
- Networks of local attorneys, real estate agents, contractors, insurance agents, and other professionals
- The option of cross pledging
- Ability to keep money local
Private money and hard money sound great, but aren’t all they are cracked up to be. We aren’t talking about friends-and-family money, but companies like CoreVest, LendingOne, Visio, or a brokered loan. Based on my recent experience, some of the challenges for this these loans include:
- Funding can take as long as 60-90 days
- Rigid processes
- High expenses and/or broker fees
- No cross pledging
- Extensive documentation requirements
- Requirement for excellent financial records
Every single item I list for small bank relationships has been a competitive advantage at some point. Quick loan turnarounds let me ink deals that others ponder on. Having a loan officer who knows how to get things done in town is invaluable. That might be getting a repair made or knowing the best agent for flood insurance.
If an investor chooses—or maybe more accurately has to choose private money—the disadvantages can be significant. A partner and I are trying to buy a 6-plex right now and are over 90 days trying to get the deal closed. The private money processes have been arduous. We have had an appraiser back out, a requirement for a property manager’s policies and procedures book, lease reviews by third party legal specialists, and other issues. Not saying that these are necessarily bad—just that local banks don’t have these burdens and are easier for the new or intermediate investor.
Related: What’s Better Financially: Paying Off Your Home Mortgage or Investing That Money?
Lack of reinvestment profit is the basis for most objections to using 15 or 20-year loans. An investor doing a basic analysis might rationally opt for 10-15% real estate returns with a 30-year loan over the alternative 5% mortgage interest savings or 8% stock market gains. But there is a fallacy in this logic—it implies that the cash flow disappears. That cash flow is not available for reinvestment. False news!
That investor has another option. They can use the equity in one property to buy another. This is called cross-collateralization and is possibly the most valuable advantage to using a small, local bank. Cross-collateralizing has two main benefits:
- Additional investments can be made without any money out of pocket as long as you meet the bank’s loan-to-value requirements. These are typically 75-80%.
- Reinvestment of both appreciation and loan principal reductions can be made in short turnaround times. New properties can be bought as often as a buyer likes.
This is exactly the method that I have used to grow to a $11M, 160+ property portfolio in small-town, slow-growth communities. I mentioned above that a partner and I are working with private money right now. That will be the first and only loan of its type that I will have—and it has been an absolute pain. Everything else is financed through a total of four small local banks except a single loan with a larger regional bank.
In December I purchased 24 units in my hometown for $1.6M. Eight units were from one seller, and 16 were from another. Because of my 10+ year relationship with a small local bank, I could close this somewhat complex deal 45 days after the offers were accepted with no money out of pocket.
Shorter amortizations have additional benefits. The first is that it is an automatic savings plan. It is difficult to go out and buy a new Jeep with money that is not in an operating account somewhere. This will help significantly when I am ready to retire. My plan is to sell a portion of my portfolio, pay down debt, and create the cash flow I will need.
Related: 3 Reasons to Consider NOT Paying Off Your Mortgage
The second benefit of this equity-build method is to provide a buffer in the event of an economic downturn. If any of the local economies in which I am invested swoon, I can refinance properties to longer amortizations, lowering my monthly payments.
Lastly, financing with shorter amortization loans imposes financial discipline. Buying only properties that cash flow to your personal target with a higher monthly payment ensures that an investor is not “reaching” for marginally profitable properties.
An Important Exception
This is advice to my 25-year-old self: If possible, a new investor’s first purchase(s) should be a house hack using agency (FHA, VA, etc.) money. Buy as many units as you can this way, up to a 4-plex at a time, up to the loan limits. Low down payment, 30-year amortization. Lather, rinse, repeat every two years.
Are shorter amortizations right for ALL situations? Of course not. But for the vast majority of the BiggerPockets non-expert level community, they are the right choice, and everyone who tells you differently is wrong. Even Dave and Scott. Work with smaller local banks and reap the long-term rewards.
Your turn to weigh in: What do you think about the 15-year vs. 30-year debate?