It is no surprise that buying rental property is a great mean to accumulate wealth and financial security for the long haul.
And finding the financial resources to buy real estate is relatively easy, even for those with little capital or money to afford a house. You certainly don’t need to pay for the rental property fully in cash, and we highly advise against it for several reasons we will explain shortly. With this said, however, if you can afford to pay for a house in cash and have the money available immediately without risking going into debt and losing financial security, then by all means, be our guest, you will most likely save money by not paying interest on a loan. If cash is not an option, applying for a bank loan is the best way to finance rental property to kick start your real estate investment business.
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Why Cash Is NOT the Best Way to Finance Rental Property
Before we start with the cons, we will share a few benefits of paying in full from the get go. Again, there is a high degree of autonomy and discretion in real estate investing, and it is up to you to see what works best for your long-term vision and business plan. Whether it is investing in real estate with no debt in sight, or financing your rental property with a conventional bank loan, it is completely at your own discretion.
The best way to finance rental property: The advantages of paying in cash
1. Paying upfront in cash saves you the headache of applying for a bank mortgage and going through the tedious bank paperwork involved in the process.
2. You don’t have to worry about these two words: loan repayments.
3. You will save money on interest payments.
4. Cash makes you a more appealing buyer, and in turn, you get a better deal on the house.
The best way to finance rental property: The disadvantages of paying in cash
1. Sacrificing liquidity: Paying in cash will constrict and suffocate your savings, i.e., your emergency funds and retirement savings in the short term.
2. You will not qualify for the tax perks mortgage payers receive.
3. You lose financial leverage. When you buy real estate with a mortgage, your potential return is higher, given the asset appreciates in value over time.
For example:
Let’s say you buy a rental property originally valued at $200,000 to be exact. Since you bought the house, the value of your property appreciates and increases by $50,000. Now, this gives you a total net worth of $250,000.
If you paid in cash: ROI = 25% ($50,000/$200,000)
With a bank loan: ROI = 125% (you pay out of your own pocket the down payment of 20%, which is equivalent to $40,000. You gained $50,000 on your $40,000 cash down payment.
Related: Financial Planning for Real Estate Investing 101
Why Mortgage Is the Best Way to Finance Rental Property
1. Financing rental property with a mortgage makes owning an investment property affordable
Getting a mortgage is the best way to finance rental property for many real estate investors because it is affordable and relatively easy to obtain. Given a good credit score, almost anyone can get approved for a bank loan and start investing in real estate. When you get a mortgage, you only have to put 20% down payment on the property, but you still get the benefit of owning the whole property nevertheless. You take advantage of real estate appreciation and accumulate home equity over time. If you have enough equity, you can leverage another loan against the value of the property you actually own.
2. Financing rental property with a mortgage is cost effective
Mortgage is the best way to finance rental property because you avoid the need to exhaust your savings funds to pay for the house from the get go. Paying cash for your rental property insinuates most of your savings and funds will be tied in one asset, leaving less money to invest and grow your real estate investment portfolio. You are also sacrificing liquidity, as noted earlier.
Moreover, the interest rate on a mortgage tends to be lower because the loan is secured with a lien – your investment property. This means that in case you won’t commit to paying off your mortgage, your property is used as collateral to pay back some or all the mortgage debt. With a low interest rate on your investment, you will be able to save more money without putting yourself in financial jeopardy if you were to use your own funds.
Related: Real Estate Investment Strategies: How to Invest in Real Estate With No Money
3. Financing rental property with a mortgage has tax benefits
For investors, leveraged real estate means one thing: getting tax advantages to save more money. Leverage means borrowing money to finance your real estate property. Not only do you get to write off the interest associated with the borrowing, you also can claim tax benefits for depreciation. Mortgage is the best way to finance rental property because of the tax advantages you can claim to save money and use it to grow your real estate business in turn.
4. Financing rental property with a mortgage makes your tenants pay off your mortgage payments
If you keep your tenants happy, you won’t have to worry about paying off the mortgage payments out of your own pocket. Essentially, your rental income is more than enough to cover your mortgage payment obligations each month – another expense you won’t have to worry about, if and only if, you mitigate the risk of vacancy and ensure long-term tenant occupancy. With the mortgage payments taken care of, most landlords opt for the conventional bank loan as the best way to finance rental property.
Conclusion
Without a doubt, mortgage is the best way to finance rental property for most real estate investors. In this way, you avoid fishing into your savings account and putting yourself in a financial rut. Having cash has its advantages, but it is by no means a prerequisite to buying rental property and getting into the real estate business. This is the beauty of real estate investing: almost anyone can do it and qualify for a loan to get started.
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