Why You Should Never Opt For A Shorter Loan Term

welcome back to the short-term rental riches podcast I'm happy you're here again and today we've got a topic that comes up all the time all the time and and there's a lot of little details that go into this question and it's should we get a 15-year loan or a 30-year loan or should we get a shorter loan versus a longer loan because we're going to pay less in interest we're going to break that all down today including the math and why a bank would even offer

this to you because spoiler alert it's better for the bank so before we get into the details why it's better for us as Real Estate Investors and and all the little details there there might be one or two situations where people are just better off with the shorter Term Loan now the first one is is if you just psychologically feel better with no debt and I know this is the whole Dave Ramsey school of thought but the reality is the math would tell you not to

do this and so so we're going to get into that but I do understand that there's just some peace of mind of not having to owe anyone for a piece of property you have so that's the first thing the second reason why you might opt for the shorter Term Loan or no loan at all is if you are retired you're not planning on doing anything else with your extra money and you might as well pay off your mortgage loan so that is the only situation really

in my eyes that I think you should go for the short Term Loan and if you've read Rich Dad Poor Dad well then you're probably on the same wavelength as me but I want to break down these actual reasons because there's quite a few so the first reason you would want the longer term mortgage loan for your property is pretty straightforward you're going to have a lower payment and so yes you might be able to afford the 15-year load which might save your interest we're going

to explain why that's not necessarily the case here in just a second but you're going to have a smaller pay payment which means you're going to be prepared for Worse Financial Times right so if you lost your job or if you're invested in the property with your partner and they lost their job and you're going through tougher times well then you're not going to be on the hook for such a large payment the lower your payment is the more money theoretically you should have in your

pocket now if you're a real estate investor and you're buying a property looking for cash flow well then this makes real clear sense as well right because if you're pay payments lower and someone else is paying you rent for a property you're going to earn more cash flow versus a shorter loan term with a higher payment and remember if you've got a investment property that's cash flowing that's the name of the game then you're not actually even paying this loan off anyways right I swear it

almost doesn't even feel fair to me sometimes we can buy a property with other people's money the bank's money for example in this situation and have someone pay it off for for us that's a pretty sweet deal so aside from just simply mitigating more risk and being able to weather more turbulent Financial Times by having a lower payment the second thing that comes up is that you have more opportunity for that leftover money right so whereas you might not be able to save as much each

month with the lower payment more is going in your pocket or more into your bank account hopefully and with that money you have the opportunity to use it on whatever great investment comes your way so I know that interest rates are higher now and so you're probably thinking gosh I feel like now more than ever it makes more sense to pay off my loan faster because I'm paying more interest but that is not the case and one of the reasons why is because of inflation so

we all know about inflation it's been all over the news for the last year year and a half and that's exactly why the FED has been raising their rates right to try to combat inflation in inflation helps us fight our debt Jason Hartman who had on this podcast quite a while ago go back and check out that episode if you missed it he's got a lot of great insights when it comes to the macroeconomics he likes to refer to this process of us paying back our

mortgages with cheaper dollars in the future as in inflation induced debt destructions so what does that mean right now the inflation rat's hovering around 32% that means if we borrow today and we have a fixed payment for 30 years let's just say it's $1,000 a month well if we have a 35% inflation rate that means that each year we're effectively paying back 35% Less in real terms I know that gets a little bit confusing but inflation essentially just erodes purchasing power so we're paying back our

loans in the future with cheaper dollars if our wages increase with inflation for example 3% or 5% a year but our loan payments are staying the same until the end of that loan well that is another way to look at inflation it's helping raise our wages while our loan is staying the same so we're essentially paying this back with cheaper dollars just to go back real quickly too on the lower payment in general remember if we're Real Estate Investors and we're planning on using mortgages in

the future to buy future investment properties the lender is going to look at our income and our debt our debt to income ratio and so if our payment is higher that means we have more debt compared to our income which means we're going to have a more difficult time qualifying for a loan to buy more investment properties in the future so yet another reason why having a lower payment is going to help you out in the long run the third reason why a longer loan is

actually better for us in the long run is that we have higher interest payments I know this sounds counterintuitive but we're able to deduct as Real Estate Investors all of our mortgage interest and so for most people our mortgage interest rate is actually much less than the face value let's just call it 5% when we account for our income tax bracket and so I'm going to jump into the numbers in just a second here so just to recap real quickly a lower payment is not only

helping us mitigate more risk in the future it's helping us qualify for more loans in the future remember if this is a cash flowing property we're going to be earning more cash flow inflation helps us erode this debt each and every year especially in the last couple years where we had 7% inflation those are really big numbers so we're paying back these loans with cheaper dollars and for most people if you're in a higher income tax bracket that means that the effective mortgage rate is actually

much lower than the face value so let's lay out a couple math scenarios here let's say we have a $300,000 loan and we're going to break it down with two different interest rates we're going to take a 5% interest rate and then we're going to take a 4.375 interest rate on a 15-year mortgage the difference between those two mortgage payments is $762 a month so one of the things we want to look at when we look at opportunity cost for example is that if we have

an extra $762 going in our pocket each month what are we doing with it so let's just say you took that money and you put it in the SNP I I am not recommending stocks here but just to make a simple explanation the S&P on average over the last 100 years I think earned around 7% a year so let's take that $762 each and every month that we're saving it and if we invest that into the S&P over the life of our 30-year loan based on

historic averages versus taking that 4.375 interest rate not being able to invest any of that money for 15 years that extra payment that's left over because it's a higher mortgage payment let's say at the end of that 15 years we take what was our 15-year payment and we invest that in the SNP each year for 15 years the difference here with compounded interest is that you will actually have earned $200,000 more by investing each and every month for the 30 years by using that money and

investing it somewhere else at a 7% annualized return so hopefully that didn't get too complicated but in a nutshell we basically said that we're taking that extra leftover money and we're investing it at a 7% annualized yield and at the end of 30 years compared to the 15-year we've actually earned an extra $200,000 now it gets even better than this now let's break down the numbers just a little bit more let's take that 5% and let's go ahead and subtract today's inflation rate 3 1.2% %

what does that leave us with 1 and 1/2% so our effective interest rate inflation adjusted is 1 1/2% now let's assume that you're in a 22% income tax bracket and after deducting your mortgage expense for that 30-year loan you're actually going to save about another 1.1% effectively so if you don't believe me you can head over to bankrate.com they have a really easy calculator where you can plug in your loan amount the loan term so how long it is and your effective income tax to see

how much effectively you're saving by spending the extra on mortgage interest I know that sounds totally crazy but for those of us in relatively higher income tax brackets having this deduction can be really helpful so that's another 1.1% off the five that leaves us with less than 1% effectively as a mortgage interest rate so this means as long long as you can take that money and earn more than 1% somewhere else you should be going with the 30-year loan so now if we do the same

thing with the 15-year loan yes that effective interest rate is going to be even lower if we take the 4.375 we subtract today's inflation rate 3 and 1.2% and another 1.1% well that's essentially free money but both of those effective interest rates are very very close so the reality is we can earn more than 1% all day long right we can take that money and we can put it into a t- bill for example with the US government perhaps the most stable long-term investment you could

make and that's going to be earning us much more than the effective interest rate on our mortgage so I know this all Probably sounds a little too good to be true right how are we actually having an effective 1% effective tax rate if we adjust for inflation we adjust for our interest write Downs but the reality is if we don't look at any of that if we don't look at any of those things and we just look at the banks and we ask ourselves why would

the bank offer me a more attractive deal if it wasn't more attractive for them and the reality is that they would not they would not do that and here are a few reasons why the first thing is that if a bank gives you a 15-year loan versus a 30-year loan yes they're going to receive a little less interest but they're actually going to have much higher cash flow remember you're paying them a much higher payment in fact it's roughly 30% higher so what is that mean

that means they have 30% more money to work with to lend out to other people versus the 30-year loan so that's Point number one the second point is that if you have a 15-year loan well then you're paying it down faster which means you have more equity in the property right this is better for the bank they have more Equity to secure your property buy which means if you do get into turbulent Financial Times in the future and you can't pay your loan anymore well they

have much more Equity if they were to turn around and sell that property to someone else now we know Banks don't like to sell properties right we saw that in 2008 2009 but that is the reality is that they have more Equity collateralizing your loan which makes it safer less risky for them just a side note here too you might be thinking well it's great to have more equity in our properties but as Real Estate Investors you got to ask yourself are you making any money

on your Equity no you're not you're not in fact uh there is a calculation that you'll see floating around there that a lot of people like to use and that's Roe that's return on Equity so if you have a $10 million portfolio and you have $7 million in equity you have $3 million in loans that $7 million is not doing anything for you right yes it might be comforting py ecologically and yes it might help you get more loans in the future because you have a

lower debt to income ratio but the reality is it's not helping you grow your wealth so I think the key here is for us not to do what the banks want us to do but to do what the banks themselves are doing which is leveraging more right so I hope this gave you a little more insight into why you would really really want to consider that 30y year loan over the 15-year loan is especially in today's high interest rates I know you're probably thinking yep I

should pay this down sooner cuz I got so much more interest going out there in the long run but consider all those reasons consider your effective mortgage rate after you deduct for inflation and after you deduct for your mortgage tax deductions consider the opportunity cost of what you can actually do with that money if it was still going in your pocket consider the security you and your family might have by having more money each month consider the fact that you're going to be able to get

loans easier in the future cuz your debt to income ratio is going to be better consider the fact that if this is a cash flowing investment property which hopefully you're not getting into investment properties that aren't actually cash flowing that it's going to cash flow more with the longer Term Loan and at the end of the day your tenant or your guest is going to be paying that back on your behalf so I hope that gave you a little bit more insight and cleared things up

for you and until next time I hope you have a fabulous week I've dedicated years figuring out how to manage my personal portfolio remotely and it wasn't always easy and it took a long time but now my amazing team can professionally manage my properties without me and good news our team can also manage yours let us save you the stress and headaches and some money by offering you an industry low fee to find out more about partnering with us head to Str riches.com hit the property

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