Board Topic: Financing rental property w/Business loan vs mortg
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Financing rental property w/Business loan vs mortg

Posted by: mmarybobarry Aug 28 2003, 07:08 PM
Hi, first of all I love your site. It is so informative. I am trying to decide which option is the smartest when financing rental property. My bank has made two proposals. One would be to pay cash for the property,and then take out a Equity loan. The rates for rental property on this loan is 8.8% for 30 years with a 80% loan. There would be no closing costs. The other option is to take out a normal 30 yr. mortgage and pay $4000.00 in closing costs, but my interest rate is 6.75% The property I am purchasing is $77,000. I have the cash to pay for it, but I want to keep that money free in case I find another property. By the way, my credit is perfect. I just thought 8.8% was outrageous.

I have also talked to a friend who has told me that he takes out a business loan secured by the property. He is paying 6.25 % for 15 yrs. The only thing he is required to present to the bank is an appraisal. I have never heard of this and plan to contact his banker, but thought you could hopefully give me some insight about the best way for me to go. Thanks for your help!!!!

Posted by: loanuniverse Aug 29 2003, 11:32 PM
Well, without doing the numbers, I can see that the winner will probably be the ”business loan” that your friend talked about. Assuming that there are no closing costs, you can probably save a lot of money on this deal. Personally, I have never heard of a loan product like that, but I can see how a bank would offer this kind of product for small rental producing property loans for the benefit of expedience and to serve the small business person / investor.

In order to compare financing options you must take into account not only the rate, but the actual cost of funding. This is similar to the APR concept. I do not deal with APR, so my calculations will not follow the rules for calculating it, but I am sure they are close. Also take into consideration if the property can cash flow to pay the debt service coverage. Also take into consideration what your holding period will be, and the remaining balance on the loan at the end of this period. Personally, I would use five-year term as a holding period, chances are that you will not hold the property for thirty years or that you will have the same loan until maturity. That is why not having prepayment penalties is so important.

Option #1 80% LTV – 8.8% -30 Year Ammortization
Down Payment: $15,400.00
Amount Financed: $61,600.00
Monthly Payment: $486.81
Money spent on interest during the 5-year holding period: $26,576
You will owe $58,968 at the end of the five years


Option #2 80% LTV – 6.75% -30 Year Ammortization ($4,000 closing costs)
Down Payment: $15,400.00
Amount Financed: $61,600.00
Monthly Payment: $399.54
Money spent on interest during the 5-year holding period: $20,199 + $4,000 in closing costs = $24,199.
You will owe $57,827 at the end of the five years


Option #3 80% LTV – 6.25% -15 Year Ammortization
Down Payment: $15,400.00
Amount Financed: $61,600.00
Monthly Payment: $528.17
Money spent on interest during the 5-year holding period: $17,128
You will owe $47,040 at the end of the five years

This is very superficial, in order to do a deeper analysis you would have to take into account the present value of the cash flow during the five-year period and the resulting value at the end of the holding period. In other words, there is a $128 difference between the largest monthly payment and the lowest monthly payment this means that if you go with the option with the highest payment you will not be getting those $128 into your pocket every month. You would need to do a present value calculation of that income stream. At the same time, you would need to consider that under one plan you would owe more than $10,000 than under the other plan at the end of the holding period, that amount would have to be taken back to the present value also.

However, it is my opinion that you don’t need to do that, the 6.25% option is clearly a better choice. As long as your rental income is enough to pay it. No need to overanalyze the deal.

Good luck with the purchase, don't forget to account for all the other expenses associated with running a rental property since financing will not be your only cost.

Posted by: Mary Sonnier Aug 30 2003, 09:38 PM
Man, you made that look easy!! Your right, no need to scrutinize. It is pretty clear what the best option is. A higher payment, but alot more principle, minimum closing costs. I never cosidered looking at 5 yrs down the road. But that is very realistic. Can I ask you something else. Today, I had someone come to me and offer me 89,000 for the home. Would it be profitable to sell it for $12,000 more that what I pd for it, or will my taxes eat me up? I am sure you'll tell me I need to talk to a tax professional, but I thought I'd try. Thanks so much for your help. You are awesome!!

Posted by: loanuniverse Aug 31 2003, 10:09 AM
QUOTE (Mary Sonnier @ Aug 30 2003, 09:38 PM)
Today, I had someone come to me and offer me 89,000 for the home. Would it be profitable to sell it for $12,000 more that what I pd for it, or will my taxes eat me up? I am sure you'll tell me I need to talk to a tax professional, but I thought I'd try. Thanks so much for your help. You are awesome!!

Well if you are going to make $12,000 for flipping the property in a short period of time, I wouldn't mind paying taxes on the profit myself smile.gif

You got to take a look at how much you can make by holding the property and how much you can make by selling it right away. In addition, there are other factors such as not having to be a landlord. While on the one hand, you can end up renting to the perfect tenant and have a wonderful relationship for the next five years, you might end up with a tenant that will cause you problems.

It is all about cash flow:

Cash flow to pay the loan.
Cash flow to come into your pocket every month
Cash flow to come into your pocket when you sell the property {whenever it happens}

is that amount bigger than the amount you would receive if you took the $89,000 offer?

is that amount big enough to compensate for the work involved in managing the property instead of taking the money and run?

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