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What length Mortgage Term
should I choose?
Choose
a 30 yr mortgage 99% 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 that, plan for your
future transactions. In planning, choosing a 30yr mortgage will result in
a lower debt load. Over the course of several properties,
this will
eventually result in the ability to buy one or several more properties on a
full doc basis vs. a stated income basis. In short, the appearance of
profitability and leveraging your excess annualized cash flow will generate
higher dividends for your business than interest savings.
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. Do not hold on to
dead properties; or properties appreciating at a rate less than state or
regional averages for the simple idea of owning equity. When the property
begins to level off, sell immediately and replace the property with a
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!
For the cash
flow minded investor; your rentals should be replaced with other rentals
when your holding reaches a point where the income relative to the cost of
maintenance, repairs and management deem the holding inferior to that of
other properties that can be purchased. As your rental ages, the costs of
maintenance and repairs increase. You should exploit as much cash flow as
you can from the property and then sell……this usually occurs within the
first 5-7 years. Holding on to the property until it is paid off is “Old
school as it is nothing more than an income generating property.
To use an analogy; cash flow properties are
like Bank CD's. They are never kept forever.
A CD is
purchased due to its favorable return. When you can replace
a CD with another CD yielding a higher “Net” return,
it's time
to cash it in
and transfer funds to
the
other CD with a higher yield.
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 charge to 8-10% credit cards?
Work
the numbers, and you will see 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 amortization period from 30-yrs to 15yrs. Not to mention,
the portfolio advantages of following debt load and holding period rules.
These advantages are further explained by clicking
HERE.
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 at least 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.
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
shouldconsider opting for a 15-yr mortgage.
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