15-year loans may appear to save money over 30-year loans because they have a lower interest rate, but I would much rather have the flexibility of a 30-year loan. Buying rental properties is a great investment, especially when you are able to use a mortgage to buy the properties and still get great cash flow. Many investors will get a 15-year mortgage because the rates are a little lower and they can pay off the properties quicker. I use a 30-year loan when I buy my rental properties because I get more cash flow and I can make much more money buying more properties than I can paying off loans.
Why is a short term loan better?
The biggest advantage of a 15-year mortgage is the interest rate is less than a 30-year loan. The difference in rates changes daily and varies with different banks, but a 15 year loan is usually about .5 percent less than a 30 year fixed mortgage. With a lower interest rate, you are paying more towards the principal and less towards interest.
Some people think the biggest advantage of 15-year loans is the shorter length of the loan. I don’t agree because you can pay a 30-year loan off early if you want too. You will have a higher interest rate, but .5 a percent is not a huge rate difference, especially when you consider how much you can make buying more properties.
How much do you save with a lower interest rate?
If you get a 15 year, $100,000 loan on a rental property at a 4 percent interest rate, the payments will be $740 a month (check out bank rate mortgage calculator for calculating mortgage payments). Over the 15 years of that loan, you will pay $33,143 in interest. With a 30 year loan at 4.5 percent interest, the total amount paid in interest over the life of the loan will be $82,406.
On the surface, it looks like you are saving almost $50,000 by getting a 15-year loan. However, you are paying interest over 30 years on one loan and over 15 years on the other, which is deceiving. The payment on a 30-year loan is only $507 a month, which is $233 less a month than the 15-year loan. If you were to take that $233 a month and put it back into the 30-year loan each month, the 30-year loan would cost $39,754 in interest and be paid off in less than 17 years. It definitely costs a little more to have a higher interest rate, but over 15 years that is only $550 more each year. As time goes by that money is worth less and less due to inflation.
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Why is a 30-year loan better?
You will pay less interest on a 15-year loan than a 30-year loan. However, you are paying a higher payment every month on the 15-year loan. If you add up the payment savings with the 30-year loan, you save $2,796 each year and $41,940 over 15 years by getting the 30-year loan.
That extra money can be used for many things that will make you much more money than that $6,000 in interest you save. You can save up the cash flow to buy more rental properties. You can use the money to build an emergency fund. You could also pay extra to the mortgage and if you ever need the extra money later, you can stop putting extra money into the mortgage.
If you have nothing to invest that money into, it might make sense to get the 15-year loan. If you want to keep buying rentals and build your empire, the best bet is to get a longer-term lo0an and buy as many rentals as you can now.
Why does a 15-year loan make it harder to buy more rentals?
Another huge factor when considering whether to use a 15 or 30-year loan, is qualifying for more properties. When banks qualify an investor, they will look at debt to income ratios. A 15-year loan will have a higher payment and increase your monthly debt payments. The higher your loan payments are, the less cash flow you will have, and it will be harder to qualify for new loans. Many banks will only count 75 percent of your rental income when qualifying an investor for a loan. Even if you are cash flowing with a 15-year loan, if you can only count 75 percent of the rental income, you may show a loss each month. If you have many rental properties showing a loss, it will be very hard to qualify for new loans.
A 30-year loan with its lower payments will make it easier to qualify for more properties.
What about an ARM?
When I finance my rental properties, I use 30-year ARMs. An ARM is an adjustable rate mortgage that has a fixed interest rate for a certain amount of time. The interest rate on an ARM can adjust up or down after the fixed time period is up. My portfolio lender offers 5 and 7 year ARMs with a 30-year amortization. The rate will stay the same for the 5 or 7 year term, but can adjust after that term is up. There are limits on how much the rate can adjust each year and a ceiling that it can never go over. The great part about ARMs is they have a lower rate than a 30 year fixed rate loan and even the 15-year fixed rate loan.
If you get an ARM for your rental properties you will have an even lower payment than a 30 year fixed rate loan and save money in interest costs over a 15 year fixed rate loan. To me, it is the best of both worlds.
Why is an ARM less risky than you may think?
There are obviously some risks involved with an ARM, because the rate can go up after 5 or 7 years. I always have plenty of reserves and cash flow to make sure I can afford the higher payment if the rates adjust. Even if I hold the loan well past the initial fixed rate term, it takes a few years for the ARM to become more expensive than a fixed rate mortgage. Chances are rents will increase in the time period as well. If you have enough cash flow and a plan for when rates could increase, you should have no problem with an ARM.
If you don’t have enough cash flow and your payments go up, you could get into trouble with an ARM. Negative cash flow is hard to sustain and it will make it harder to qualify for loans as well.
Many lenders will also only offer ARM loans after you have a certain amount of mortgages in your name. I would suggest getting the fixed rate mortgages when first starting out, and as you advance in your investing career look at the ARM option.
Why is a lower payment more important than a lower interest rate?
ARMs allow a small payment in the beginning of a loan and possibly a higher payment in the future. The nice thing about the lower payment is you have more cash flow and inflation comes into play when you are investing money. If you can pay less money now and more in the future it is a good thing, because inflation will make money worth less in the future. Even though your payment might go up on an ARM; 5 or 7 years later that money will be worth less and your rents could have gone up. If you use the money you save on an ARM to invest in more rental properties or something else with a decent return, you will be way ahead than if you had paid a higher payment with the 15 or 30-year fixed loan.
Why is a 30-year loan safer than a 15-year loan?
Many people have a tough time saving money and the higher your mortgage payment is, the harder it will be to save. Having an emergency fund is very important for financial stability. If you do not have an emergency fund, do not get a 15-year mortgage. Get the 3o-year mortgage, and save up for the emergency fund. Once the emergency fund has enough money (6 months of living expenses) you can pay off your mortgage early if you would like to.
Remember that you see no real benefit to paying off your mortgage early unless you pay off the entire loan, refinance, or sell. Your house payment will stay the same until the loan is paid off in full. If you need to access the equity you have in your house, you cannot ask the lender to give you back what you have paid early. You will have to sell the house or get a brand new loan (refinance or home equity line of credit).
If you get a 15-year loan and have a medical emergency, lose your job, or cannot work, the bank will not lower the payment for you. You have to keep paying that high mortgage payment every month. If you had a 30-year mortgage and were paying more to it every month, an emergency would not be nearly as devastating, because you could stop paying extra.
On the surface, a 15-year fixed rate mortgage may seem like the best way to go. It saves money on interest over the life of the loan and has a shorter term. I believe the 15-year loan is the worst choice because you are tying up your money, making it harder to qualify for loans, and you could be investing that money in something that gives a higher return. If you get a 30-year ARM, the interest rate will actually be lower than the 15 year loan, and you might be able to pay that loan off faster than the 15-year loan.