If you get a conventional loan, you have one big choice to make, and that’s whether to do a 15 year loan or a 30 year loan. Typically 15 year loans have better interest rates, maybe by a half a percent or so, plus you pay off your loan and own the property outright in half the time. With the combination of the lower interest rate and paying the loan off faster, you’ll often end up paying less than half as much interest.
If you’re looking at getting a $500,000 loan, going with a 30 year loan might result in you paying around $300,000 in interest, but with a 15 year loan you’d only pay about $120,000. That obviously sounds attractive. Paying interest feels like throwing money out the window, so with a 15 year loan you’re not wasting so much money.
The downside of a 15 year loan is that your monthly payment is a LOT more expensive. Not quite twice as expensive like you probably thought, but usually around 50% more expensive. With a $500,000 loan, your payment jumps from about $2,200 a month to $3,400 a month, and $1,200 a month can really eat away, or eliminate your cash flow.
So which one’s better? There’s obviously pros and cons to each one, just like everything, but which one is right for you? I feel pretty strongly that 30 year loans are the better option, and I’ll explain why in a bit. First, I want to explain why someone might recommend a 15 year loan.
15 Year Loans
I have a friend that loves 15 year loans. He’s making good money right now, so he doesn’t need the cash flow now. He knows that if he owns a small handful of rental units that are fully paid off, he’ll be set for retirement. So he gets a 15 year loan, and tries to pay it off even faster by putting any potential cash flow back into his mortgage. I totally see the value in this, and it’s a great strategy and he’s going to be set for retirement just like he’s hoping.
But he could be growing his wealth way faster. Let’s consider a few things.
Which One is Better?
First, your mortgage interest rate is probably really low (maybe not as low as everyone who got a loan in 2020 or 2021). For a while they were around 3%. Now in 2022, they’re starting to rise to around 6 or 7%. But even at 7%, after you adjust for inflation being around 3% annually, you’re left with a net 2% interest (even less if you factor in 8% inflation). If you include the future value of money and all the nerdy calculations, a 5% interest rate is really only costing you about 2% per year on your money. Back when rates were only 3%, After adjusting for inflation, you could essentially borrow money for free.
Either way, why would you sacrifice cashflow now to save yourself from paying 1 or 2% net interest. You could invest your cash flow pretty much anywhere else and get at least 6% or 8% or 10% rate of return. After adjusting for inflation on those investments, you’re still at a 3% or 5 % or 7% rate of return. Your money is literally growing 7 times faster if you invest in mutual funds and get a net 7% instead of paying down your mortgage faster to save a net 1%.
Second, any money you spend in loan interest on a rental property is a tax write-off. So if your combined state and federal taxes are 25%, that’s basically like getting a 25% discount on your mortgage interest. Let’s factor this into the equation.
We’ll assume you’re getting a loan with a 8% interest rate so the math is easy. You pay 8% interest, but you get a 25% discount on any interest you pay because of tax write offs, so that’s really like only paying 6% interest. And then after we adjust for inflation, the money you borrow is essentially free (depending on what happens with inflation), even at an 8% mortgage interest rate.
Third, you’d be so much better off maximizing your cash flow and using it to buy more rental properties. We’ve written other articles about how rental properties can bring in huge returns. Some deals will bring 30%, 50%, 100% or even higher rates of return. Real your goal should be to buy as much as you possibly can!
Our Recommendation
I would 100% recommend a 30 year mortgage. I recommend this because net interest rates on mortgages are so low which means the money you borrow is so cheap (maybe even free) when accounting for the future value of money. Plus, with a 30 year mortgage you’ll have much more cash flow sooner that you can use for other investments.
Your real estate coaches
Dallas & Greg
