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There's a lot to be gained by buying an investment property. Not only can you take in monthly rental income from tenants, but you can also hold on to that property until its value increases and sell it at a profit.
But many real estate investors can't buy a rental property outright. If you're looking to take out a mortgage for your investment property, you may be wondering whether to opt for a 15-year loan or a 30-year loan.
There are pros and cons to both options. Here's what you need to know.
The 15-year mortgage
The primary benefit of taking out a 15-year loan is that you'll score a lower interest rate on your mortgage than with a 30-year loan. When you combine that with a shorter repayment period, you stand to save a lot of money on interest.
Imagine you're looking at a $250,000 mortgage. With good credit, you might score a 4% fixed interest rate on a 15-year loan or a 4.5% interest rate on a 30-year loan. Over the course of your entire repayment period, you'll save $123,159 in interest by opting for the 15-year option.
But there's a flipside to that, and it's that your monthly payments under the 15-year option will be higher. In our example, the 15-year mortgage results in a monthly payment that's $583 higher than the 30-year option. However, if you bring in enough rental income to cover that additional $583, you'll save yourself money on interest, which is cash you can invest elsewhere.
The 30-year mortgage
The main advantage of a 30-year mortgage over a 15-year loan is that you're not stuck with as high of a monthly payment. That, in turn, will help free up more near-term cash, which you might need if you're looking to buy multiple investment properties or to renovate existing properties.
Another benefit of taking out a 30-year mortgage is that you may have an easier time qualifying for other loans should you decide to buy more than one investment property. A big factor in getting approved for a mortgage is your debt-to-income ratio, which is calculated by taking your monthly debt payments and dividing that number by your gross monthly income. The higher that ratio is, the lower your chances of qualifying are.
A higher monthly mortgage payment, which you'll have with a 15-year loan, will limit your cash flow -- and lenders may not take kindly to that, even if you're able to show that you have rental income coming in to offset that higher payment.
Of course, the downside of the 30-year loan is that you'll spend more money on interest. But if that frees up cash to invest elsewhere, it may be worth it, especially if you’re able to qualify for a competitive interest rate.
What’s the right choice for you?
Ultimately, there are good reasons to opt for a 15-year loan for an investment property, but a 30-year loan can also work to your advantage.
Think about your goals as a real estate investor. Do you intend to buy and finance additional properties in the near term? A 30-year mortgage could make more sense. But if you’re not concerned about your debt-to-income ratio, a shorter loan could save you quite a bit of money in the long run, and that’s always a good thing.
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