Real Estate Investor: What Mortgage Term Should I Choose?

A lot of real estate investors ask about what type of mortgage to use for best results vs. risk.

Choose a 30 yr mortgage 95% of the time. Here’s why:

Debt Load. You should structure your financing options in accordance with your long-term R.E. Portfolio Objectives. Your money source or money partner is more important than anyone or anything else in the equation. Full document lending will always generate better terms, rates and less expensive fees associated with the transactions. Therefore, Full Doc lending should always be the benchmark. If not now, you should work toward that goal in the future. Having said all of that, plan for your future transactions. In planning, choosing a 30yr mortgage will result in lower debt load. Especially over the course of several properties, which will eventually result in being able to buy one or several more properties on a full doc basis vs. a stated income basis.

Holding Period: Who holds on to a property for 30-yrs these days? Real Estate Investments should be purchased and held for a maximum period parallel to the growth cycles for a given area. Buy in appreciating markets and sell when the market begins to plateau. No need to hold on to dead properties; or properties appreciating at a rate less than state or area averages for the simple idea of owning equity. When the property begins to level off, sell immediately and replace the property with another property likely to grow at a more rapid rate. With that said, why plan to amortize properties? Equity is nothing more than your “Net” stake in a property. Equity can be converted into cash via sale or refinance. Why maintain cash in a vehicle that is no longer growing, when that cash can be used to purchase a property that is growing at a far more rapid rate?

Profit from your property through equity should be realized by appreciation and not principal reductions. If you are realizing equity by means of principal reductions and not appreciation, then you’ve purchased the wrong property!

Interest Savings: Do you really think you are saving all of that interest by paying off a mortgage in 15 years vs. 30 years? Think again. If you are borrowing money at a rate of let’s say 6%, you are probably not, if you manage your finances properly.

Example…. What if you took that $100 difference and applied it toward credit card balances that were generating rates of 8 – 10%?

What if you took that $100 difference and stuck it into a long-term mutual fund and generated an average return of 10 – 12% (And that’s conservative)

What if you took that $1,200 annual difference and used it to acquire another property using a 100% financing program ($1,200 used to pay for pre-paids associated with transaction)

What if you took that $1,200 annual difference and paid cash for items you would normally place on 8-10% credit cards.

Work the numbers, and you will see that forgone interest, like interest paid, works in conjunction with one another. Based on the above hypothetical you will save or earn a lot more than the interest you think you will save by accelerating your am period from 30-yrs to 15yrs. Not to mention, the portfolio advantages of following debt load and holding period rules.

The Unforeseen: If you are in a 15-year note, you must always make the 15-year payment. If you are in a 30-yr note, you must always make the 30-year payment (Less than the 15yr payment). What happens if you run into hard times? Lose a tenant? Lose a few tenants? It is always easier to make the 30-year payment vs. the 15-year payment. If you must/want to amortize your loan in 15 years, why not take the 30-yr note and just make a 15 year payment. This way, in the event you experience a tough month, you can always revert back to the 30-yr payment.

Put a calculator to it and you will always find your answers.

Here’s Why Not: If you don’t have the discipline to do something positive with the difference; and you do not have any intentions on buying additional investment properties; and you do not expect to ever have a difficult month (financially), then you may want to consider opting for a 15-yr mortgage.