A question that comes up quite often, especially from those looking to buy a new property, is whether to go with a 15-year or 30-year term on their mortgage. While some folks prefer one over the other, it’s not always an obvious choice, whether you’re a new or seasoned real estate investor — or whether you’re an owner-occupant or not.
For the lender, both of these options have pretty clear benefits. With the 15-year term, the loan is paid off quicker, and with the 30-year term, they receive more in interest payments over time, at a higher rate.
But as the real estate investor, how do you decide which option is best for you? And what factors play into this decision?
First, let’s take a look at the difference between these two options.
With a 15-year mortgage, you’re paying a higher monthly payment, but you also have a lower interest rate, and the life of the loan is much shorter.
Your monthly payment is lower with a 30-year mortgage, but your interest rate is higher, and the life of the loan is much longer.
Some of the biggest factors to consider are current interest rates (lowest I’ve seen in decades), time, cash flow needs, and even possible points (prepaid interest) — although points are more common in a higher interest rate environment.
But we should probably consider all of these factors while also looking at the bigger picture.
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Know your goals.
What are your goals for the property? And how does that fit into your overall goals for your portfolio or for retirement?
For me, I’ve only had a 15-year mortgage twice in my life, but in all, I’ve had well over 50 mortgages.
One of the two was when I refinanced an FHA loan on a property that I lived in, and my payment only increased by $10. I was able to knock years off of my loan, and given the fact that interest rates back then were dramatically higher than they are today, I definitely saved money.
The second time was on my vacation home, where I was aiming to pay off the property before retirement.
Even then, there were still times when I regretted the higher payment, especially when looking at my portfolio as a whole, as it did cut into my cash flow a little bit.
Besides paying off a property sooner or saving on interest, there may be other goals that drive someone to choose a 15-year term. For example, someone might start off with a 15-year mortgage with the intent to refinance the property later on and pull equity out to invest somewhere else.
However, if your goal is to build your portfolio quickly, the shorter term loan with the higher monthly payment may be detrimental to your ability to borrow more money for the next property. After all, banks typically look at your amount of monthly recurring debt in order to qualify you for a mortgage.
Plus, it’s a good idea to consider what you may or may not be able to afford in the future.
Be prepared for change.
To be quite honest, I don’t have much incentive to do a 15-year mortgage anymore. Not only are interest rates much lower today, but I also think the 30-year mortgage is safer, and I can usually make additional payments.
For example, you can send the higher monthly payment (15-year) in on a 30-year mortgage. But you can’t send in the lower payment (30-year) on a 15-year mortgage. That’s where the flexibility comes into play.
Also, if, heaven forbid, something bad were to happen — such as job loss, a family issue, or a health problem — could you ensure that you and your family would still be able to afford the higher monthly payment? This is an important consideration, as are other ways to insure your investments or your nest egg (i.e. disability and life insurance, mortgage insurance, etc.).
But what if your goal is still to pay off the property sooner and save on interest?
Pay extra, if you wish.
While you may not be able to get it down to exactly 15 years by making additional payments on a 30-year mortgage, you could still knock years off of the life of the loan.
For example, let’s say you were to sign up for bi-weekly mortgage payments. You would essentially be making 13 monthly payments (26 bi-weekly) instead of 12. That extra payment would go towards the principal of the loan, reducing both the loan balance and the amount interest charged over the life of loan.
Another strategy is actually something we used to recommend at my old real estate office. Since interest rates were high, we would print out an amortization schedule for the buyer and encourage them to continually send in this month’s payment with next month’s principal. Each time, it would almost knock a payment off.
By the way, if you’re looking for a good, free resource for plugging your loan information into an amortization schedule, check out Bankrate.com.
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.
So, which option do you prefer: a 15-year term or 30-year term? What will you do with your next property? Or better yet, which option aligns best with your goals for the property (or properties) this year?
Leave your comments below!