Author Topic: How Can Mortgage Be Better Than Cash  (Read 5309 times)

Crazydude

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How Can Mortgage Be Better Than Cash
« on: November 07, 2014, 07:58:42 AM »
My first post in forums! I've found that many of you consistently buy rental properties with mortgages. I've searched here quite a bit on this topic, but wasn't able to find a definitive breakdown of how buying a rental property with a mortgage can turn better profits than with cash. Here's how I've approached it, assuming I have 80K in cash on hand:

Option 1

Mortgage: $80,000
Rent (1% rule): $800
Mortgage (4%) payment: $380 (with taxes and insurance): $580
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Put $80K in cash into VTSAX at 7%.
Contribute $220 monthly (Rent-mortgage payment = $220)

Net worth at 5 years: ($128,448 + $7,800) - $15,500    |    (VTSAX + Equity in property) - Total Interest Paid thus far   =   $120,748
Net worth at 30 years: ($875,813 + $80,000) - $57,500 = $898,313



Option 2

Paid with cash: $80,000
Rent: $800
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Put $800 into VTSAX every month (beginning balance $0)

Net worth at 5 years: $60,193 + $80,000 (VTSAX + Property) = $140,193
Net worth at 30 years: $976,390 + $80,000 = $1,056,390



I know it'll take a couple reads to understand what I've written, but any help is appreciated. Am I missing something here?

Cheddar Stacker

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Re: How Can Mortgage Be Better Than Cash
« Reply #1 on: November 07, 2014, 08:51:17 AM »
Welcome to the forum. Read this:
http://www.mrmoneymustache.com/2011/10/10/lets-buy-a-foreclosure-episode-2-what-is-the-50-2-rule/

This was written by forum member arebelspy. He explains it very well here. Circle back with questions. I'm sure he'll chime in here as well.

Also, there's likely something wrong with your calculations. For one thing, you aren't listing any rental expenses. If you receive $800 in rent, you will not be able to invest it all. At the very least you need to factor in the same $200 of taxes and insurance you used in option 1. There will also be repairs, maintenance, utilities, etc.

In the end, if it's a good rental and you will make a profit, you will make a much bigger profit overall if you use less of your own capital and use the bank leverage to amplify your own profit.

A rental that makes a 10% cash return with no mortgage will net a 20% cash return with a mortgage because you are putting in less capital.

Cheddar Stacker

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Re: How Can Mortgage Be Better Than Cash
« Reply #2 on: November 07, 2014, 09:11:38 AM »
I think I linked the wrong post, maybe. There was one he had where he broke down how it's better to buy 4 rental with financing and 25% down vs. one rental with 100% cash down. I thought this was it, but I didn't see it just now when I skimmed it. Anyway, still a lot of good data there for you to read.

Kingomri

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Re: How Can Mortgage Be Better Than Cash
« Reply #3 on: November 07, 2014, 10:47:27 AM »
Not from MMM, but a great post on this, with numbers, is from a blogger who sadly hasn't posted in two and a half years:

http://dollardisciple.com/rental-property-financing-or-please-dont-pay-cash/

mooreprop

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Re: How Can Mortgage Be Better Than Cash
« Reply #4 on: November 07, 2014, 11:59:47 AM »
The only thing you are missing (other than not allowing enough for expenses for the property) is the number of rentals you can afford to buy.  Obviously, you will be better off financially if you pay no interest vs. paying interest.  However, your ability to buy more properties will be limited by all-cash purchases.  I can make a smaller amount of monthly cashflow on each of 20 mortgaged properties while another investor gets great cashflow on one property purchased for cash.  However, at the end of the day, he just has one house and I have 20.  Also, the income on my 20 houses has gone up each year by 3% so now I have more income than you showed in your calculations.

Second, I would not discount the effect both psychologically and financially of volatility.  For example, when I invested in the stock market in 2000 it seemed like a no-brainer since it had gone up by over 8% per year for the past 75 years on average (at least that's what my advisors said).  However, since then it has been a pretty wild ride.  At no point during this time did my mortgage payments change or my rents take a 50% hit like my "conservative" fund investments did.  Things are looking pretty good now, but when the dust settled I averaged a 3% return over the 14 years.  Meanwhile, my real estate initial investment of $4000 has turned into over $1,000,000 of net worth in real estate.  More properties purchased conservatively = less risk and more income.  (at least for me it did)  Also, with the knowledge gained during that time, I can usually be closer to the 2% rule than the 1% rule.

sammybiker

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Re: How Can Mortgage Be Better Than Cash
« Reply #5 on: November 07, 2014, 06:16:53 PM »
Sorry to derail folks but mooreprop - I'd love to hear/read a quick summary of events in your run up of 4k to 1mm! 

rusty

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Re: How Can Mortgage Be Better Than Cash
« Reply #6 on: November 08, 2014, 05:46:38 AM »
I would be interested in hearing that 4k to 1mm also

Overseas Stache

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Re: How Can Mortgage Be Better Than Cash
« Reply #7 on: November 08, 2014, 12:00:10 PM »
Hey crazy dude,
You made a few errors in your calculation. First, you didn't include any maintenance or management costs this doesn't really affect the comparison because these costs would be the same for each option. Second, you only included Insurance and Taxes in option 1. It needs to be included in option 2 as well because even if you buy with cash you need to pay for taxes and insurance. Third, you counted the interest payments twice in the first example, once in the mortgage payment and then again in your calculation you - interest paid. Here are the numbers I got using a compound interest calculator compounded monthly at 7% and including the insurance and taxes in the second option.

Option 1
Net worth at 30 years: ($919,279.05 + $80,000) = $999279

Option 2
Net worth at 30 years: ($7,362,524.96 + $80,000)= $7442525

As you can see using leverage could (using the numbers you put forth that may or may not reality) give you a 25% better return.

arebelspy

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Re: How Can Mortgage Be Better Than Cash
« Reply #8 on: November 08, 2014, 02:28:14 PM »
Welcome to the forum. Read this:
http://www.mrmoneymustache.com/2011/10/10/lets-buy-a-foreclosure-episode-2-what-is-the-50-2-rule/

This was written by forum member arebelspy. He explains it very well here. Circle back with questions. I'm sure he'll chime in here as well.

I think I linked the wrong post, maybe. There was one he had where he broke down how it's better to buy 4 rental with financing and 25% down vs. one rental with 100% cash down. I thought this was it, but I didn't see it just now when I skimmed it. Anyway, still a lot of good data there for you to read.

This is the post you want: http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/

Read strategy 2 on there.  It explains how instead of buying 1 house in 100% cash you put down 25% on 4 houses and come out way ahead.

The basic idea is if a rental is returning you more than the mortgage rate, buying more of them, even paying interest, nets you more dollars.
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Crazydude

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Re: How Can Mortgage Be Better Than Cash
« Reply #9 on: November 09, 2014, 08:55:14 PM »
I simply forgot to add insurance and taxes to option 2.

Kingomri,

The Dollar Disciple article explained it really well. That combined with the more simplified article linked to by AREBELSPY helped me understand the numbers.

So it seems like, using these calculations, the LESS you put down in cash, the MORE your return. From reading the forums, it seems like 25% is everyone's favorite number. I'm curious, to those active investors, is this your typical percentage you put down in cash?

I plan on buying rental property next spring so I'm trying to research, research, research, then develop a strategy.

Thanks again!

jnc

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Re: How Can Mortgage Be Better Than Cash
« Reply #10 on: November 09, 2014, 09:18:52 PM »
25% down is usually required for investment properties, especially if you have 5 or more properties.

Crazydude

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Re: How Can Mortgage Be Better Than Cash
« Reply #11 on: November 10, 2014, 03:59:36 PM »
I see. That being said, the Dollar Disciple advocates HARD MONEY through ARV (after repair value) loans. These have MUCH higher interest rates but as he demonstrates, they are for short term use and at the end of the day provide better returns.

Anyone else have experience with these loans? As a new buyer of rental property, it sounds enticing but at the same time, given my lack of experience I may be better sticking with the typical mortgage from the get-go.

arebelspy

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Re: How Can Mortgage Be Better Than Cash
« Reply #12 on: November 10, 2014, 09:02:53 PM »
I see. That being said, the Dollar Disciple advocates HARD MONEY through ARV (after repair value) loans. These have MUCH higher interest rates but as he demonstrates, they are for short term use and at the end of the day provide better returns.

Anyone else have experience with these loans? As a new buyer of rental property, it sounds enticing but at the same time, given my lack of experience I may be better sticking with the typical mortgage from the get-go.

Hard money is for flips. Even then it should be used with EXTREME caution - all your profits (and then some) may end up going to your financing.  Don't touch it for buy and holds.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Crazydude

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Re: How Can Mortgage Be Better Than Cash
« Reply #13 on: November 11, 2014, 07:57:42 AM »
I see. That being said, the Dollar Disciple advocates HARD MONEY through ARV (after repair value) loans. These have MUCH higher interest rates but as he demonstrates, they are for short term use and at the end of the day provide better returns.

Anyone else have experience with these loans? As a new buyer of rental property, it sounds enticing but at the same time, given my lack of experience I may be better sticking with the typical mortgage from the get-go.

Hard money is for flips. Even then it should be used with EXTREME caution - all your profits (and then some) may end up going to your financing.  Don't touch it for buy and holds.

Ok, thanks for the info. In the market I'm looking in, 80K houses are renting for 1000 per month. That beats the 1% rule so I think I'm good there. I'll be able to put 25% down on two or three houses. Come Spring time I'll post my strategy once I get estimates of costs.

Thanks again!