30 Year, 20 Year or 15 Year Loan on Rental Properties – Which is Best?
Often we get asked by our friends and loyal followers, “What kind of mortgage should I get on my property? Should I get a 30-year or a 15-year loan?” The prevailing thought is that although the monthly payment is less on the 30-year loan, you will end up paying a ton more interest. Let’s examine in detail the differences and see if we can come up with a plan on which one to use the next time you need to finance a rental property! We will introduce our preferred loan, the 20-year.
Which Type of Mortgage is Best for Rental Properties?
For this exercise, let’s buy a property that costs $125,000 with a loan to value of 80%. That means we will be borrowing $100,000 from the bank. It will rent for $1,350. This gives us a rent-to-price ratio of $1,350/$125,000 = 1.08%. This is less than what The Stealthy Rich usually get, but still a good ratio to use for this example.
30-year Loan Analysis
A 30-year is the standard loan that is the easiest and most common in the rental world. We see it all the time. However, in our portfolio, we only have one of these loans on house #4. The pros of this type of loan include the obvious lower payment per month and the fixed rate for 30 years. So hot. The downsides include the high closing cost typical with Fannie underwritten loans, the fact that you can only have a handful of these loans in your name, the length of the loan (30 years is a long time), and therefore, the total interest paid over the life of the loan is higher. Although in the long run, it is not that big of a deal in our experience.
Loan amount: $100,000
Interest rate: 4.75%
Number of monthly payments: 360 (30 x 12)
Monthly payment: $521.65
Total Interest paid over 30 years: $87,793.04
Cash on cash return after one year: If we assume a $1,350 monthly rent and 50% expense ratio. Our first year will have $1,543 in principal paydown and approximately $1,836 in cash flow. That means $1,543 + $1836 / $25,000 = 13.5%. Decent return, and you have positive cash flow. Each year your return will increase as your principal paydown goes up, plus you’ll have some cash for repairs or whatever you want!
30-year loan visualized
15-year Loan Analysis
This is not a thing in rental real estate. We haven’t seen many landlords opt for a 15-year mortgage, but we wanted to outline it here to show how it would affect your numbers. It pays off the loan too fast and therefore kills your cash flow. The upside is that you are done with the pain in only 15 years :). Therefore, your principal paydown each month is killer; however, to get that paydown, you’ll be bleeding cash the whole time. We don’t recommend that approach!
Loan amount: $100,000
Interest rate: 4.50% (usually 15-year loans are a little less than 30 years)
Number of monthly payments: 180 (15 x 12)
Monthly payment: $764.99
Total Interest paid over 30 years: $37,698.79
Cash on cash return after one year: If we assume a $1,350 monthly rent and 50% expense ratio. Our first year will have $4,777 in principal paydown and approximately -1,080 in cash flow. YES, a negative cash flow. That means $4,777+ ($-1,080) / $25,000 = 14.7%.
Not a bad rate of a return, but having a negative cash flow will mean always having to pay money into this dog for 15 years. NO SIR. This is not the way to build stealth wealth. All of your return is forced into principal paydown and will be trapped in that asset. There’s a better way, a more stealthy approach.
15-year loan visualized
20-year Loan Analysis
Loan amount: $100,000
Interest rate: 5.25% (commercial loans have a little higher interest rate)
Number of payments: 240 (20 x 12)
Monthly payment: $673.84
Total Interest paid over 30 years: $61,722.60
Our favorite type of loan. We have over 50 of them. Most people have never heard of these types of loans. They are commercial loans, not your standard Fannie underwritten product. There are so many pros to this loan. Its typically offered by small regional banks, and in our experience, these banks are the best to work with. The loans are cheap to close (less than $1,000), banks can do them quickly, and they require less scrutiny than Fannie loans, so it doesn’t feel like you are getting a colonoscopy every time you want to buy real estate. The downsides are twofold. The rate is typically slightly higher than Fannie loans, and the rate is only fixed for 5-7 years. This short period is because no bank will take on the risk of promising a fixed rate for 30 years. After five years, our rates just reset to whatever prime is then, and the loan keeps going. We think the benefits far outweigh the downsides.
20-year loan visualized
How Do These Loans Help or Hurt Our Cash Flow on our Rental Property?
Cash flow is the essence of real estate; it’s the lifeblood that makes this whole thing magical. Without it, this wouldn’t be any fun. With that said, let’s analyze how these three loans hold up in the cash flow analysis.
Standard Scenario on 100k Loan
For our “Standard Scenario,” we are assuming a 50% expense rate. That means, on average, you will spend 50% of rent to service your property. Repairs, taxes, insurance, management all fall into this category. With the 30-year loan product, you get the best cash flow; it’s no secret. You are spreading your payments across a longer time, so the amount per month is less. With the 15 year loan, you are cash flow negative… Uh oh, that’s a no go for us, so 15 is out. Now on the 20, you are precisely neutral. Not great either in the very first example.
To get decent cash flow on the 15-year, similar to the 30-year loan, you would need to put down 36% or $42,500. Ain’t nobody got time fo’ dat. One of the best benefits of real estate investing is leverage. It would be foolish in our experience to tie up $42,500 on a $125,000 house. For these reasons alone, We are out on the 15-year loan.
Just for fun, if you did put 36% down, your cash on cash return on that would be $3,942 in principal paydown and $1,836 in free cash flow. That makes your cash on cash return ($3,942 + $1836) / $42,500 = %13.6 The rate isn’t bad; it’s just a crime that you had to tie up 42k to get a 13% return and some positive cash flow. Please don’t do it!
Check out the difference in cashflow across the three loan types.
| Loan Type | Gross Rent | 50% Expense rule | Assumed Interest Rate | Monthly Mortgage Payment (Debt Service) | Cash flow |
|---|---|---|---|---|---|
| 30-year | $1350 | $675 | 4.75 | $521.65 | $153.35 |
| 15-year | $1350 | $675 | 4.5 | $764.99 | $-89.99 |
| 20-year | $1350 | $675 | 5.25 | $673.84 | $1.16 |
The Stealthy Rich Scenario on 100k Loan
Ok, this is where we add our secret stealthy sauce. We manage our entire portfolio on our own, so we will take 10% off the total expense as we don’t pay management fees or lease-up costs, and we have access to very inexpensive contractors (So 40% of gross rents). Also, the main reason we love commercial loans from regional banks is the flexibility they offer. If you read about one of the first time we used a regional bank
| Loan Type | Gross Rent | 50% Expense rule | Assumed Interest Rate | Monthly Mortgage Payment (Debt Service) | Cash flow |
|---|---|---|---|---|---|
| 30-year | $1350 | $540 | 4.75 | $521.65 | $288 |
| 15-year | $1350 | $540 | 4.5 | $764.99 | $45 |
| 20-year | $1350 | $540 | 5.25 | $673.84 | $136 |
Now imagine if you buy the house at even a steeper discount and need only a 90k loan on it instead of 100k? Now we are talking…
| Loan Type | Gross Rent | 50% Expense rule | Assumed Interest Rate | Monthly Mortgage Payment (Debt Service) | Cash flow |
|---|---|---|---|---|---|
| 30-year | $1350 | $540 | 4.75 | $469 | $341 |
| 15-year | $1350 | $540 | 4.5 | $688 | $122 |
| 20-year | $1350 | $540 | 5.25 | $606 | $204 |
Cash on cash return on this scenario is so good. $2,614 in principal pay down in the first year, and $2,448 in cash flow means ($2,614 + 2,448)/ $25,000 = 20.2% Best return yet.
How to Get a “free” Rental House
Now, what if I said there was a way to buy houses without a down payment.
We’ve done this countless times, buying properties under market value and then getting a loan based on appraised value. It’s impossible to calculate a cash on cash return on a zero dollar investment, but let’s pretend we get $90,000 from the bank for a property that cost us $90,000 and end up having to put 3k into the property right after securing the loan. That means we now have 3k in capital improvements. Now, let’s calculate our cash on cash return. It’s $2,614 in principal paydown in the first year and $2,448 in positive cash flow, but now we only divide it by the $3,000 since that’s the only money we have in the deal. ($2,614 + 2,448) / 3,000 = 168%
What Do We Learn From All of These Loan Numbers?
It’s essential to check your cash flow numbers at every step of the process. As you can see from the above examples, the 30 year always wins the cash flow battle, but there are other factors to consider, such as ease of closing, closing costs, access to loans and appraisal options, and how fast the loan is paid off. Paying more in interest over the loan’s life is not necessarily a bad thing if it allows you to maximize your cash flow and improve your cash on cash return. Remember that. Good luck with your financing journey!
Stay Stealthy…
Comment below with any questions, we will answer them as soon as we can.
