Rental Properties and Mortgage Payments
June 26, 2018 | Tom Ashworth
Mortgaged rental properties have a significant advantage over normal homeowners when it comes to equity-build up. An average homeowner pays mortgage to their home but for rental properties the tenant pays the mortgage.
Owner of rental property is an investor who gets the rent and pays the expenses. A build up in equity occurs as the principal amount of the loan decreases. Therefore over a period of time it is the tenant who pays the mortgage for the property instead of the investor.
As the loan is paid down equity is built up due to amortization .The process can be expedited through additional payments to the loan every month along with the normal payment. It is considered a good use of cash flows by some investors due to significant difference in interest rates between mortgage and savings accounts.
Consider the example below.
It has a house with costing $125,000 with 80% loan-to-value mortgage at 4.5% for thirty years compared to another one of 3.5% for fifteen years. Let us keep the acquisition cost at $3,000. There is $1,250 monthly rent and $4,800 operating expenses.
In both the houses there is a cash flow that is positive before deducting taxes. Cash on cash return can be calculated by subtracting expenses including debt services from the revenue and dividing it by the initial investment to acquire the house.
The fifteen year mortgage has a lower cash flow and lower cash on cash return but will build up a higher equity.
Therefore it all depends on what the investor wants. If the investor wants to pay off the property and get the highest cash flow then a shorter term mortgage with a lower rate is what is needed.
Investment can be defined as getting more than what you put in today. If an investor sacrifices cash flow today then he can expect to see more cash flow on a later date when he might need it more.
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If you are interested in Real Estate in the Texas Hill Country, please feel free to contact Tom Ashworth (Smart Path Realtor) at (208)830-7991.