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Old 04-14-2015, 01:04 PM
 
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It can be better to take a longer higher interest rate loan from a financial stand point.

With a 15 year loan you will pay around $450 more a month.

Say you take that extra $450 a month and invest it. Assuming a 6% return (Historically the Dow returns around 10%) that $450 a month would be around $425K in 30 years. So you would have the house paid off and $425k in investment income.

Now if you took the 15 year loan, that extra $450 would go to the mortgage payment, however after 15 years you would have no more payment and could invest the total payment going forward. Assuming the same 6% return and investing the full payment each month in 15 years (30 years after purchasing the house) you will have around 385K and the house paid off as well.

So taking the 30 year loan with higher rate could actually allow you to make 40k more after 30 years in the scenario.

Now obviously there is greater risk in investing and no guarantees, just trying to show how it could make more sense.

However I believe you should go with what you feel is right. If you are more comfortable with a 15 year loan then that is what you should do. You are the one making the payments, you know your financial situation the best.

Also something to consider is if you already itemize your taxes you can write off the interest expense each year on a rental property. Thereby reducing the true interest cost by the tax bracket % you are in. So even though you could pay an extra $1500 in taxes the first year, if you are in the 33% bracket you would see about an extra $500 in tax savings. This is only if you itemize.
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Old 04-14-2015, 02:44 PM
 
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Quote:
Originally Posted by MarkinMI View Post
It can be better to take a longer higher interest rate loan from a financial stand point.

With a 15 year loan you will pay around $450 more a month.

Say you take that extra $450 a month and invest it. Assuming a 6% return (Historically the Dow returns around 10%) that $450 a month would be around $425K in 30 years. So you would have the house paid off and $425k in investment income.

Now if you took the 15 year loan, that extra $450 would go to the mortgage payment, however after 15 years you would have no more payment and could invest the total payment going forward. Assuming the same 6% return and investing the full payment each month in 15 years (30 years after purchasing the house) you will have around 385K and the house paid off as well.

So taking the 30 year loan with higher rate could actually allow you to make 40k more after 30 years in the scenario.

Now obviously there is greater risk in investing and no guarantees, just trying to show how it could make more sense.

However I believe you should go with what you feel is right. If you are more comfortable with a 15 year loan then that is what you should do. You are the one making the payments, you know your financial situation the best.

Also something to consider is if you already itemize your taxes you can write off the interest expense each year on a rental property. Thereby reducing the true interest cost by the tax bracket % you are in. So even though you could pay an extra $1500 in taxes the first year, if you are in the 33% bracket you would see about an extra $500 in tax savings. This is only if you itemize.
It is a biased analysis to include the tax deduction for paying interest but not the increase in taxes you have to pay due to the investments. I see this mistake a lot, though.

Secondly, you are assuming staying in the house for the full 30 years. Most homeowners don't hold long enough to get a net gain out of a 30-year compared to a 15-year loan. If you sell in 6 years, for example, you actually would have a higher net worth under the 15 year loan than the 30, even ignoring taxes.
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Old 04-14-2015, 04:19 PM
 
5 posts, read 4,061 times
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Quote:
Originally Posted by ncole1 View Post
It is a biased analysis to include the tax deduction for paying interest but not the increase in taxes you have to pay due to the investments. I see this mistake a lot, though.

Secondly, you are assuming staying in the house for the full 30 years. Most homeowners don't hold long enough to get a net gain out of a 30-year compared to a 15-year loan. If you sell in 6 years, for example, you actually would have a higher net worth under the 15 year loan than the 30, even ignoring taxes.
Once you realize the gains on the investment yes you will owe the tax on them.

As a rental property I have no idea what her intentions were, I made the assumption she would hold the property. Yes if you sell in 6 years you will have a higher return, however you will pay more taxes on the sale of asset too.

There are obviously many variables that could come into play, therefore with the information given one can not assume it is always smarter to do the 15 year loan. I was simply laying out a situation where it was beneficial to do a 30 over 15.
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Old 04-14-2015, 10:18 PM
 
Location: Southern California
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A 15 year versus a 30 year loan will reduce your capacity to get an additional mortgage of you want to buy another investment property.
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Old 04-15-2015, 06:17 PM
 
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Originally Posted by thelopez2 View Post
A 15 year versus a 30 year loan will reduce your capacity to get an additional mortgage of you want to buy another investment property.
For the first 15 years. Later it is reversed, since the 15 year loan will not exist, thus allowing you to more easily qualify. It's sort of a short term vs. long term thing.
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Old 04-15-2015, 09:36 PM
 
Location: Southern California
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Quote:
Originally Posted by MusicHouse View Post
Anyone have experience being a home investor can shed some lights on this would be greatly appreciated...
Quote:
Originally Posted by ncole1 View Post
For the first 15 years. Later it is reversed, since the 15 year loan will not exist, thus allowing you to more easily qualify. It's sort of a short term vs. long term thing.
This is funny considering you always bring up opportunity cost, are you just being argumentative?

I fail to understand what is short term thinking, buying multiple investment properties for the long run?

I'd rather be leverage with multiple assets then sitting on cash earning less than 3%
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Old 04-16-2015, 01:32 PM
 
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Quote:
Originally Posted by thelopez2 View Post
This is funny considering you always bring up opportunity cost, are you just being argumentative?

I fail to understand what is short term thinking, buying multiple investment properties for the long run?

I'd rather be leverage with multiple assets then sitting on cash earning less than 3%
How is paying off a 15-year loan and then immediately buying another property at all tantamount to "sitting on cash earning less than 3%"

A lot of lenders don't include payments about to end in calculating DTI, so you could in theory buy the second property 14 years and 6 months after you buy the first, since the payments will be over in 6 months.

The opportunity cost argument applies when you are comparing one investment to another with similar risk characteristics. Buying a house has stocklike risk characteristics and thus should be compared to such. Paying off a loan on a property you have already bought is a bondlike investment, so it should be compared to such, not to buying more real estate, and not to buying stocks either.

Additionally, it is far from obvious that your opportunity cost is higher with a 15-year loan than a 30, if your alternative is real estate with a cap rate below 6%. If you have a 15 year loan, you have to wait longer to buy the next property, but when you finally do buy it, you can qualify for a more expensive property with zero payments on the first property. With a 30 year loan, you can buy the second property sooner, but it will be a cheaper property, since you still have to support both payments.

Which opportunity cost is bigger, (A) waiting 15 years, or (B) settling for less property?

It is far from clear, even if we ignore the differing risk characteristics of paying a loan off vs. buying more property.

Ironically, the exception is precisely when you are going to, as you say, "sit on cash earning less than 3%". This is because if you have extra cash flow from the first two properties (with 30-year loans on each), you could save it for 15 years and then buy a third property in all cash, with no need to qualify for a loan. In this case you might have more real estate than you would in the alternative scenario in which the first property was bought with a 15-year loan.

Last edited by ncole1; 04-16-2015 at 01:57 PM..
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Old 04-16-2015, 08:40 PM
 
Location: Southern California
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Quote:
Originally Posted by ncole1 View Post
How is paying off a 15-year loan and then immediately buying another property at all tantamount to "sitting on cash earning less than 3%"

A lot of lenders don't include payments about to end in calculating DTI, so you could in theory buy the second property 14 years and 6 months after you buy the first, since the payments will be over in 6 months.

The opportunity cost argument applies when you are comparing one investment to another with similar risk characteristics. Buying a house has stocklike risk characteristics and thus should be compared to such. Paying off a loan on a property you have already bought is a bondlike investment, so it should be compared to such, not to buying more real estate, and not to buying stocks either.

Additionally, it is far from obvious that your opportunity cost is higher with a 15-year loan than a 30, if your alternative is real estate with a cap rate below 6%. If you have a 15 year loan, you have to wait longer to buy the next property, but when you finally do buy it, you can qualify for a more expensive property with zero payments on the first property. With a 30 year loan, you can buy the second property sooner, but it will be a cheaper property, since you still have to support both payments.

Which opportunity cost is bigger, (A) waiting 15 years, or (B) settling for less property?

It is far from clear, even if we ignore the differing risk characteristics of paying a loan off vs. buying more property.

Ironically, the exception is precisely when you are going to, as you say, "sit on cash earning less than 3%". This is because if you have extra cash flow from the first two properties (with 30-year loans on each), you could save it for 15 years and then buy a third property in all cash, with no need to qualify for a loan. In this case you might have more real estate than you would in the alternative scenario in which the first property was bought with a 15-year loan.
-When you pay down principal you're only saving the interest rate, in this case around 3% for a 15 year loan. If you paid down the whole loan, it is like the $200,000 is no longer costing you 3% in interest a year.

-Whether is be 15 year 14.5 years 14, year, my argument doesn't change.

-What about the down payment of such future property in the future, where does it originate from? Now you have to wait more time because your cash flow is lower.


Which opportunity cost is bigger, (A) waiting 15 years, or (B) settling for less property?

- You tell me, would you rather have had cash and a down payment in 2010 to buy real estate or wait to 2014 where the property could have be 20% more.

- Your settling for less property is a weak argument

- It is better to have the cash in hand to be flexible if opportunity aries. Not exactly sure what you mean settling for less property if we are talking about investment property.

-"Cheaper property" "Settling" so what if it is cheaper. During the down turn of market, those with a cash position were in much better position to buy so called cheaper properties.

-Many people are happy doing a 15 year loan and paying less in interest. I pointed out that it will have an impact on obtaining additional mortgages, if the OP has no interest in mortgage that is it doesn't matter. 15 years is a log time and much can happen to employment income.

-Yes I mistyped OF instead of IF the OP wants to obtain additional mortgages, I don't consider getting one mortgage after paying off one an additional mortgage.

-The OP ask to shed light on this, and I'm speaking from what I've seen over the last couple of decades. Lending guidelines change, income and unemployment happen. Rates have been dropping to historic lows and prices have skyrocketed. An investment property should stand on its own and the method of purchasing should be scaleable are reproducible.
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Old 04-17-2015, 08:31 AM
 
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Quote:
Originally Posted by thelopez2 View Post
-When you pay down principal you're only saving the interest rate, in this case around 3% for a 15 year loan. If you paid down the whole loan, it is like the $200,000 is no longer costing you 3% in interest a year.
Are we talking about getting a 30-year mortgage and prepaying to cut term to 15 years, OR are we talking about getting a 15-year loan instead of a 30?

In the first case, what you say is true. However, the second case is NOT equivalent to the first, unless the interest rates of both loans are the same.

Quote:
Originally Posted by thelopez2 View Post

-Whether is be 15 year 14.5 years 14, year, my argument doesn't change.

-What about the down payment of such future property in the future, where does it originate from? Now you have to wait more time because your cash flow is lower.
This would depend on what the limiting factor is - down payment or DTI. If down payment is the limiting factor, then yes. However, if DTI is the limiting factor (as your earlier argument seemed to imply) then it is different.

Quote:
Originally Posted by thelopez2 View Post

Which opportunity cost is bigger, (A) waiting 15 years, or (B) settling for less property?

- You tell me, would you rather have had cash and a down payment in 2010 to buy real estate or wait to 2014 where the property could have be 20% more.
I agree that if you can assume such high appreciation rates, then you'd be crazy to take a 15-year loan. Where I disagree with you would be in your assumption of reliable 5% annual appreciation in the first place.

Quote:
Originally Posted by thelopez2 View Post

- Your settling for less property is a weak argument

- It is better to have the cash in hand to be flexible if opportunity aries. Not exactly sure what you mean settling for less property if we are talking about investment property.
A lower priced property, because your DTI would be computed including both mortgage payments.

Quote:
Originally Posted by thelopez2 View Post

-"Cheaper property" "Settling" so what if it is cheaper. During the down turn of market, those with a cash position were in much better position to buy so called cheaper properties.
I'm just pointing out that, assuming rent roughly proportional to price, having a lower priced property has an opportunity cost as well, since you are forgoing extra rent.

Quote:
Originally Posted by thelopez2 View Post

-Many people are happy doing a 15 year loan and paying less in interest. I pointed out that it will have an impact on obtaining additional mortgages, if the OP has no interest in mortgage that is it doesn't matter. 15 years is a log time and much can happen to employment income.
Have an emergency fund.

Quote:
Originally Posted by thelopez2 View Post

-Yes I mistyped OF instead of IF the OP wants to obtain additional mortgages, I don't consider getting one mortgage after paying off one an additional mortgage.

-The OP ask to shed light on this, and I'm speaking from what I've seen over the last couple of decades. Lending guidelines change, income and unemployment happen. Rates have been dropping to historic lows and prices have skyrocketed. An investment property should stand on its own and the method of purchasing should be scaleable are reproducible.
Why must it be scalable for an individual (NOT institutional) investor?
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Old 04-17-2015, 11:49 PM
 
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An emergency fund does not help when the income is reduced permanently, for example, by the elimination of a highly specialized job. Even not being able to work for a year due to whatever reason will put dramatic stress on the emergency fund.
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