Rates have been very kind to traditional owner-occupied type homebuyers lately. Today they’re just a tick above 3.5%, which will always take me back to my first days, um years, uh, I mean decades in the business. It took me over 30 years to see an interest rate for 30 year fixed rate financing starting with a number lower than 7. Even the rates for real estate investment property remains in the 4-4.75% range. Dad was right. Stay in a business long enough and you might not see everything, but you’ll see plenty.
A quick piece of advice on interest rates and loan terms.
A few times every month somebody asks me why I don’t push 15 year loans vs 30 year loans, cuz the rates are lower. Since the rates are lower and the loan gets paid off in half the time, why wouldn’t I be screamin’ from the mountaintop for investors to take advantage of those two benefits? So glad you asked.
BawldGuy Axiom: With rare exceptions, real estate investors should avoid strategies which severely limit future options and/or flexibility. As a rule, those with the most options at crunch time, tend to win.
In the last 43 years I’ve seen far too many recessions. Then there are the lender crises of one sort or another. Sometimes, a particular local market becomes temporarily overbuilt, causing vacancy rates to rise while rents fall — simultaneously — which is always fun . . . not. There are all sorts of reasons your Net Operating Income (NOI) might fall, even if only for a short while. Problem is, ‘temporary’ and ‘short while’ are sometimes defined as a year or two.
For example, if your fourplex is cruising down the road like a well tuned Corvette, cash flowing like a champ, one of the aforementioned ‘temporary’ hiccups can become problematic. If you have a 15 year fully amortized loan at a 4% rate, with a beginning balance of $300,000 — your monthly payments would be $2,219/mo ($26,630/yr). That works fine as wine when your NOI remains in the range you’ve been used to for years — say $30,000/yr, give or take.
Then it happens
It doesn’t matter why things change, it matters that they can and do.
Due to negative changes in your market, rents fall 20%, faster than you can watch it happen. If that’s not bad enough, vacancy rates go from 5% to 15% at the same velocity, as if Murphy himself synchronized it. Your NOI plummets, as leases expire and new tenants come in at lowered rents. Your NOI stops its free fall when it reaches around $23,000 or so. Due to the 15 year loan, your cash flowing property is now costing you roughly $300 a month to keep it afloat. However, the guy who owns the fourplex just like yours down the street, is still cash flowing — about $350 monthly.
His loan was for the same $300,000, but for 30 years with a 4.75% interest rate. He’d been adding to his monthly payment regularly, but stopped when the downturn hit. You? Well, your options are to either A) Grit your teeth and eat the $300 a month ’til things return to normal. B) Give up and lose the property — not freakin’ likely, right? Or C) Refinance with the same loan your buddy down the street enjoys — IF you can.
All you had to do was figure the difference in payments between the two loans. In other words, get the 30 year loan with the higher interest, and lower payment, but pay it using the same payment you woulda had with the 15 year loan. If you did that without pause ’til the loan was paid off, it would take just 14 months longer than 15 years. Meanwhile, you’ve kept the options on your side of the table in case things change for the worse.
Imagine how many investors have gone through who knows how much emotional turmoil in order to save a lousy 14 months. Isn’t 14 extra months worth eliminating countless sleepless nights? Recent super scientific surveys say it is. As usual, it’s about having a Plan and executing it on Purpose.
Single Family Residence: 20% down’ll get ya 4.75%. 25% down gets ya 4%. Don’t ask, that spread makes no sense to me either.
2-4 units: 25% down results in a 4.5% rate.
Notice there’s never been a 15 year rate quote here?
It’s one thing to strategically keep your options active. It’s quite another to know what all your options are. Call me at 619 889-7100 and find out. Wanna write and not talk? Easy — click on Contact BawldGuy and make it happen. Have a spectacular weekend.