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What is the Ideal Loan Duration for Rental Properties?

What is the Ideal Loan Duration for Rental Properties?

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If you're a real estate investor, you understand the importance of securing the right loan for your rental properties. Just like deciding on private funding or a traditional loan is a critical aspect of your investing, so is loan duration. Choosing between a 15 or 30-year loan is one critical decision that carries a substantial impact on the profitability of your investment in the long run. But the question remains: which is better for a rental property?

A Close Look at the 15-Year Loan

First, let's dive into the different aspects of a 15-year loan. This type of home mortgage contract requires you to pay off your loan balance in 15 years. Most investors turn to such loans due to their attractive interest rates and the prospect of owning their rental property free and clear in just 15 years. Here are some considerations:

  • Pros:
  • The interest rates of a 15-year loan are generally lower than that of a longer loan.
  • A quicker repayment plan means you can build equity in your property quickly.
  • Saving money! With the shorter loan term and lower interest rates you are paying less in interest overall.
  • Cons:
  • Your monthly payments are significantly higher. This can be a problem for cash flow if the comps in the area show that you won't charge enough in rent to make the payment.
  • Similar to the last con, less cash flow comes through each month, which may strain your budget.

Consider this. A real estate investor took out a 15-year loan. He chose a property in an area where the rental market was strong, and he was able to charge high rents. The high monthly payments were of no concern to him, as his regular income was sufficient. He enjoyed low-interest rates, creating a positive cash flow and accumulating equity fast. Raising private money can often help in such scenarios.

A Glimpse into the 30-Year Loan

Alternatively, a 30-year loan allows real estate investors more time to repay their loans—30 years to be precise. Conventional loans of this period are popular due to their lower monthly payments and flexibility. Here are the factors to evaluate:

  • Pros:
  • The mortgage of the property is spread over twice the amount of time meaning lower payments each month, leaving more room in your budget.
  • Lower payments create a better cash flow, providing additional financial security.
  • Possibility to invest excess funds elsewhere for a higher return.
  • Cons:
  • The longer repayment period means you pay more interest over the term of the loan.
  • Also, the equity in your rental property builds at a slower pace.

Imagine another real estate investor who chose a 30-year mortgage. The lower monthly payments allowed him to invest in more properties simultaneously, diversifying his portfolio. Despite facing higher interest rates and slow equity build-up, the extra cash flow and diversification balanced the equation.

15-Year Loan vs. 30-Year Loan: A Comparison

The choice between a 15 and a 30-year loan greatly hinges on your unique circumstances as a real estate investor, which includes financial goals, cash flow, credit score, and risk tolerance.

On one side stands the 15-year loan with its high monthly payments but faster equity buildup. On the other side, a 30-year loan offers lower payments and potentially better cash flow but slower equity growth and higher interest over the life of the loan.

What is your specific situation? Would you like lower interest or the convenience of only paying that extra on your loan if the numbers work?

Understanding what is ARV in real estate can help make the right choice. With rental properties, they should generally follow the 1 percent rule to ensure they cashflow. Now you might be thinking what is the one percent rule? Well a rental property should be able to be rented for 1 percent of the ARV of the property. So by knowing the ARV and the rental comps in the area, you should know if your deal will cash flow with your different mortgage options.

Expert Opinions and Advice

Industry experts like mortgage loan officers and financial advisors advocate for careful consideration based on your long-term investment goals. It's about finding the balance between maximizing your current cash flow and planning for future growth. Therefore, a careful cultivation of your asset class and understanding of various lenders' offers is a must.

In Conclusion

The debate on choosing between a 15-year or 30-year mortgage for rental properties is long-standing. While the lower interest rates and speedy equity build-up of a 15-year loan might show an attractive facade, the lower monthly payments and better cash flow from a 30-year loan can't be ignored. As real estate investors, your choice hinges on your financial scenario, investment goals, risk tolerance, and other factors. Whatever route you choose, creating wealth through real estate investing is possible.

As you venture onto your real estate investing journey, remember that knowledge is power. Stay informed, plan diligently, and seek professional counsel when required. Whichever route you choose, ensure that it aligns with your investment goals and cash flow requirements.

Samantha Ankney

About Samantha Ankney

Samantha has been a media specialist for DealMachine for 2.5 years. She produces, edits, writes, and publishes all media that is distributed to the DealMachine and Real Estate Investing community.