Rental house, cash-flows over principal pay off?

**rj.phila** · 07-07-2012, 08:18 AM

a loan in which you pay "interest only", and no principal, sounds indistinguishable from a permanent contract for servitude to me. by definition, you would have to hold the loan forever if you are only paying principal. this sounds bat**** crazy to me.

FWIW, i think the exact polar opposite of this approach is the #1 successful way to execute profitability in RE. YMMV.

**Kooshiball** · 07-07-2012, 01:24 PM

I need more information about this.

Interest only loan means that there will be pay off date in most of instances. For example, there will be interest only for 3 years and principal due at end of 3 years etc. What kind of term is this? If there is no pay off date for this interest only loan with low interest rate and you intended to rent this unit out, I would keep this loan forever.

Let me know what kind of term is this interest only loan.

**amarowsky** · 07-07-2012, 06:19 PM

Going to talk to my friend tonight about it. I'll have more details tomorrowhe just presented the idea to me yesterday .

**kv968** · 07-08-2012, 03:55 AM

Originally posted by amarowsky View Post

Thinking about buying a house to rent, so I talked to one of my good friends who just became a loan officer. And he suggested a loan that I had never heard of or considered for buying a rental property. It is an interest only loan. Where you pay a lot less on the loan because you pay no principal. Not certain on exactly how much less it would be, but according to my friend's rough break down it could turn what would be a traditional mortgage interest/principal of $1000 a month, down to $600 a month.

Assuming I buy the house I'm planning on, @ $100k, for the interest only mortgage I could be paying only $600 a month for the mortgage. After looking at the rental rates around I could peg this house at between $1200-1600 a month in rent. This house also sold for roughly $240k in the high market about 8-10 years ago. The benefit im seeing from doing this loan, even though my principal would remain the same, I should have the luxury of selling the home at a profit in 5-10 years or if the rental market remains the same rent it at nearly $600 profit a month.(assuming the low end considering vacancy time and possible repairs).

They still allow these type of loans

This is one of the many types that got people in so much trouble during the housing debacle when "housing prices couldn't go down".

Basically what'll happen with an interest-only (IO) loan is you'll buy the house for $100k and amortize the loan for say 30 years @ 6% (you're going to pay a higher rate than a normal fixed). The first say 5 years you'll just pay the interest associated with that amortization and no principal. After 5 years, the $100k will then be amortized for 25 years (the remainder of the original 30) and you'll go from there. At that point your monthly payment will go up significiantly since you're not only paying principal but also paying it in a time period shortened by 5 years over the original 30-yr.

Some quick numbers for your assumed situation...
$100k @ 6% for 30-yrs with a 5-yr IO option (not including PMI and all that fun stuff)...
Monthly interest payment for the first 5 yrs = $500.00
Monthly payment after 5 years = $644.30 (a 29% increase)
And that's not taking into consideration the total amount of interest that would have been paid over the life of the loan since that's not your intent. That total would be much higher than just a straight fixed mortgage.

Granted with the rental numbers you gave it seems like a winning proposition no matter what although I'd really check into it carefully. One thing to really check is the interest rate they'll give you. They may offer ARM's and all that but I'd stay with fixed (actually I wouldn't really go for an IO loan altogether but that's a different story). If the rate associated with the IO is high, and you have good enough credit, it might actually be cheaper monthly to go with a traditional 30-yr fixed where you WILL be paying off principal also.

For example...
$100k @7% 30-yrs = $583.33 (JUST INTEREST)
$100k @6% 30-yrs = $500.00 (JUST INTEREST)
$100k @5% 30-yrs = $536.82 (Interest PLUS PRINCIPAL)
$100k @4% 30-yrs = $477.42 (Interstt PLUS PRINCIPAL)

So really pay attention to the rates because, even though I don't know what an IO option loan is going for now, I wouldn't be surprised if they're in the 6% range. They may tout lower rates and/or ARM's but I have a feeling the real fixed rate is going to be up there.

**NJDebbie** · 07-08-2012, 05:55 AM

INTEREST ONLY LOAN=RED FLAG in my opinion.

**amarowsky** · 07-08-2012, 10:13 AM

I told him when he goes back to work on monday I told him to ask around at his office so I can get more details.

The whole reason I'm interested in this alternate loan would be for the bonus in cashflows. By lowering the monthly I would have more cash in my hand than instead going towards principal in the house. Then after the house's value goes up from anywhere from 10-50% I would sell at the market price that would be above the loan. Granted I would only get the difference from the sale, and not the equity I put into the house.

Using a fixed loan would be acceptable but it would just lower my cash flows a month by X (the difference in the interest only loan/normal fixed). Basically just holding ownership of the house until it gains in value. And I would not be as interested in this house if I wasn't fairly certain it was dramatically undervalued.

**riverwed070707** · 07-09-2012, 05:41 AM

Originally posted by amarowsky View Post

I told him when he goes back to work on monday I told him to ask around at his office so I can get more details.

The whole reason I'm interested in this alternate loan would be for the bonus in cashflows. By lowering the monthly I would have more cash in my hand than instead going towards principal in the house. Then after the house's value goes up from anywhere from 10-50% I would sell at the market price that would be above the loan. Granted I would only get the difference from the sale, and not the equity I put into the house.

Using a fixed loan would be acceptable but it would just lower my cash flows a month by X (the difference in the interest only loan/normal fixed). Basically just holding ownership of the house until it gains in value. And I would not be as interested in this house if I wasn't fairly certain it was dramatically undervalued.

Sounds like a hassle and a gamble. Why not just invest it in the stock market and save yourself the stress and hard work that goes with a rental property? Sorry to break it to ya but there's no guarantee the house value is going to increase.

**LMA** · 07-10-2012, 04:49 AM

You need to look at your numbers carefully because you are being blinded by the fact that all you see is a supposed $600 monthly cash flow.

Also by using an interest only loan you are banking on appreciation to make a profit on this investment. Just because the house sold for $240k at some point does not mean it will EVER (at least not during your ownership) get back to that value.

Rental properties are investments because a tenant is paying the mortgage for you and eventually if you pay that mortgage off now you have an investment that gives you money every month. But if the loan is never paid off then what's the point?

Additionally that $600/month in cashflow is fictitious because you are making interest only payments. You need to base your profit calculations on a real loan that pays interest and principal. IF you then add the monthly cost of property management, taxes, insurance, repairs, vacancies, etc. then I bet your monthly cashflow is going to be a lot less than $600.

My point is that in this market there are better deals than that available. I just got a rental property under contract where the monthly payments will be around $400 and the monthly rent is a $1,000. That monthly payment includes PITI. The expected return on that is about 20%.

If I could find a deal like that then so can you.

**LMA** · 07-10-2012, 04:52 AM

Originally posted by riverwed070707 View Post

Why not just invest it in the stock market and save yourself the stress and hard work that goes with a rental property?

Because you can get a MUCH better return with real estate with less risk and more control.

**parafly** · 07-10-2012, 01:53 PM

Originally posted by amarowsky View Post

...I should have the luxury of selling the home at a profit in 5-10 years...

Originally posted by amarowsky View Post

...after the house's value goes up from anywhere from 10-50%...

And what if the value goes down? In today's housing market, your assumption might be way off base.

In my opinion, not paying any principal on a new mortgage is a recipe for disaster. Don't let your vision of cash flow cloud your judgement and common sense.

**amarowsky** · 07-12-2012, 05:59 AM

Originally posted by LMA View Post

My point is that in this market there are better deals than that available. I just got a rental property under contract where the monthly payments will be around $400 and the monthly rent is a $1,000. That monthly payment includes PITI. The expected return on that is about 20%.

If I could find a deal like that then so can you.

Different risks in different areas. The house I would be considering is in my opinion the best location for dollar value. As far as location/schools/condition of house/quality of neighbors/and close proximity to my house.

And as far as real estate vs. stock debate, to hedge my investments best It would be ideal to invest in real estate. Being a tangible investment has a certain value to me. And the only way this property could loose value if I can get it for what I'd plan to offer, is if absolutly everything went wrong. Which is possible, but if everything went wrong then my investments would be somewhere halfway down a long long list of "oh ****s". The only price I would pay would be rock bottom, so I'm not worried about "if" it'll regain value. More like when.

**LMA** · 07-12-2012, 06:06 AM

If you are confident that it will increase in value then I see how your other assumptions can be valid.

But still you have the lingering fact that the mortgage will not be paid off. So if you want to go into this investment on it's appreciation potential then that's your call.

**amarowsky** · 07-12-2012, 06:20 AM

yea, I'm thinking because of everyone's remarks about the interest only loan I am starting to feel more apprehensive about even considering one. I'll still take the information my buddy has to offer.

When I told my friend I wanted to buy a rental and he suggested that, he just put it in unique perspective. "if you plan on selling the house at a profit in 5-10 years, whats the point of having the money in equity instead of just having the principal you would have paid in an account?". That idea sounded kinda unique.

But I'm sure there's some catch with the loan that you'll wind up paying more, or else people who have been flipping houses for super cheap would all be doing those loans instead. (talking about middle class people who flip not big money folks).

**LMA** · 07-12-2012, 07:00 AM

It's not so much that there is a catch with the loan, unless there is some hidden clause about interest rate adjusting or a balloon payment or something like that. But the fact that the reason that rental real estate has the potential to be a good investments is because somebody else pays down the loan for you (the tenant) and then there is the potential for appreciation. But appreciation is icing on the cake, if you get it great but don't count on it

Back in the early 2000's everyone was counting on appreciation and just bought overpriced real estate and then prices went down instead of up like they were expecting. And because they had financed their properties with loans like the one you are considering they went BOOM when the market crashed.

So the issue with the loan is that obviously it does not build equity. And you really don't know what the market is going to do in the next 5-10 years. Who is to say that it will not go down further?

I have personally met investors who had 15-20 properties and all of a sudden the tenants left (due to unemployment) the value went down (because of the crash)and then they had house after house get foreclosed. Not a pretty sight...

Rental house, cash-flows over principal pay off?