Buy A Rental Property Using A Mortgage Or Cash?
The infamous debate in real estate. Would it be wiser to buy a rental property using cash or mortgage?
If you’re new and unsure what we’re talking about, here’s the deal…There are generally two methods to buy a rental property: you can either use your own cash, or you can take out a loan to purchase the property.
In real estate, deciding which method is better has turned into an infamous debate. In a nutshell, some investors argue that using cash is a great way to avoid debt and interest, while others argue that there’s no point in putting all your cash into something that tenants will end up paying for. Well, both ways are valid; both have solid arguments. To help you decide which method is best for you to buy a rental property, we list the pros and cons for you below.
Pros and Cons for Using Cash to Buy a Rental Property
Using cash to buy a rental property comes with a nice set of pros:
1. Faster deals – Cash real estate investors are able to benefit from closing deals much faster than those using a mortgage because they do not have to wait for the bank’s procedure. Instead, they’ll close the deal as soon as the home inspection is done.
2. More options to choose from – Cash investors have more options to finding deals. All cash investors do not need any real estate financingcontingencies, so they’re usually more attractive for eager sellers, who put out deals and want to close as soon as possible. Those eager sellers are less willing to give financing contingencies for the mortgage type investors that might delay or disrupt the deal if the lender does not approve the loan.
3. Almost all revenue (rent) is profit – If you’re a cash investor, then you have no mortgage payments and no interest to pay. Typically, the largest expense for a property is its mortgage. It’s not uncommon that almost 70% of the property’s revenue goes towards the mortgage payment. But, when you don’t have mortgage or interest to worry about, you’re able to enjoy all the revenue from the rental property as profit.
With that being said, using cash to buy a rental property still has some cons that you need to know about:
1. Your own capital is at risk – When you’re using cash, you are using your own capital. Putting your own capital at risk in an investment property, especially if you don’t have more than you need, is generally riskier if you have other options.
2. Less assets – By using cash, you are basically tying up your own money in an investment property. Every year that money that sits there, tied up in the home, can actually buy you a different asset that might pay you interest and create a growing balance.
3. Can’t take advantage of mortgage interest tax deduction – When you’re using cash to buy a rental property, all of the income is taxable (minus expenses) and you are unable to benefit from the rental property tax reduction that come legally with using a mortgage.
Pros and Cons for Using Mortgage to Buy a Rental Property
Here’s another nice set of pros, but this time for using the mortgage method:
1. More assets – Perhaps the best part about using the mortgage method is that it allows you to buy more properties. With more properties, your cash flow, equity pay down, and tax benefits all increase as well. And with more properties, you also have more diversification. If you have more than one property, then you are less affected when one of them is hurt for some reason (neighborhood changes, storms changes, etc.)
2. Renters pay off mortgage for you – Yes, the mortgage payment is largest portion of expenses as stated before. But, if done smartly, your tenants easily pay off the mortgage for you. You are able to adjust the rent prices to pay off the mortgage payments and keep an additional profit.
3. You can take advantage of mortgage interest tax deduction – Rental properties have many tax benefits. For instance, the IRS allows you to depreciate a percentage of your rental properties every year and write that off as an expense. If you have more than one rental property, your tax deductions increase as well. So, let’s say you have two rental properties, then your tax deduction is double!
And along with the nice set of pros, comes the not-so-nice set of cons to using mortgage to buy a rental property:
1. Banks may not be too willing to help – You might have a rough time before finding a loan. Banks are often more willing to lend money to homeowners, rather than real estate investors because there is less risk involved in these deals.
2. Risk of exposure to foreclosure – When you’re not using your own money to buy a rental property, you have the risk of foreclosure, in which a lender attempts to recover the balance of a loan from a borrower, who has stopped making payments to the lender, by forcing the sale of the asset used as the collateral for the loan.
3. Less flexibility – When you’re using the mortgage method to buy a rental property, you have less flexibility in regards to vacancies. Since you rely on the tenants to pay off the mortgage, you’re less able to keep the property vacant until the right renter comes along or until you make needed repairs.
To Sum Up…
Shall we we answer—cash or mortgage? Well, we choose not to take sides in this heated debate. Instead you should decide for yourself which method is best to use to buy your next rental property. Ultimately, both methods have come with a set of advantages and disadvantages. You just need to choose what is best for you given your resources!
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