When it comes to buying an investment property, there are two schools of thought concerning which investment property financing method is better. The first argues that buying a rental property with cash offers more advantages, while the second argues that mortgage financing is a wiser choice when buying an investment property. This debate has no right or wrong answer since there are pros and cons for each method. In this article, we discuss these differences in depth.
Related: 4 Investment Property Financing Methods
Let us first take a look at the advantages and disadvantages of buying a rental property with cash, so that next time you ask yourself “Should I buy a rental property with cash?” you will have a better idea of what it means for you and your real estate investment.
The Advantages of Buying a Rental Property with Cash
1- No Interest Payments
Buying a rental property with cash means that you avoid paying interest payments. Even at times like now, when mortgage interest rates are historically low, financing a rental property with a mortgage means that you have to pay more in the long run as interest paid on top of the loan.
2- 100% Equity
Owning a rental property outright allows you to have absolute control over your investment property. With no monthly mortgage payments to worry about, almost all your rental income is registered as profit, of course, minus property expenses such as property tax, property insurance, and management fees. Controlling one hundred percent of the rental property’s equity gives you the freedom to invest money in the investment property and increase its value. That way, gains from property appreciation are all yours.
3- More Negotiation Power
The great thing about buying a rental property with cash is having more negotiation power when it comes to making a deal with a property seller. A cash buyer is often given priority over buyers seeking to finance rental properties with a mortgage. Paying in cash gives you the power to lower the sale price or gain extra amenities. Property sellers and their agents prefer not to wait too long on an approval for a mortgage, which can waste time they could spend advertising the real estate property. With an all-cash purchase, the deal can be done with no concerns regarding pending loans.
4- Immediate Cash Flow
Cash flow is king in real estate investing. Buying a rental property with cash means immediate cash flow. Sometimes, real estate investors end up losing money when using debt to finance rental properties, just because their rental income is less than their mortgage payments. Although the opposite can be true, it is more credible to say that a good return on investment and higher cash flow can still be achieved with mortgage financing. Just make sure to use a rental property calculator to evaluate the performance of the investment property.
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5- Lower Risk
As a real estate investor, you lower your risk when you purchase a rental property in cash. Having no strings attached with a lender is a huge relief should something change financially for you. Furthermore, if your rental property goes vacant, you will not see yourself heading towards a short sale or even a foreclosure because you can’t pay your mortgage.
The Disadvantages of Buying a Rental Property with Cash
1- Lower Cash on Cash Return
Cash on cash return is basically the cash return you earn on the cash you have invested. Buying a rental property with cash can mean that your cash on cash return will be lower because you have invested a substantial amount of your own money in the real estate property.
What is a good cash on cash return? Read this blog post to know everything about it.
2- No Tax Benefits
Using debt to finance an investment property comes with a great advantage that you will miss should you buy a rental property in cash. Tax deductions. The money you pay in interest for a mortgage can be deducted against the income of the property. This means that your tax liability is less after all deductions are taken.
3- Less Buying Power
Another advantage you lose when buying a rental property with cash is being able to finance multiple properties at the same time. For example, instead of buying a rental property for $300,000 in cash, you can spend that money on financing multiple properties. This will increase your cash flow as you are receiving monthly payments from multiple tenants. Furthermore, you benefit from increased tax deductions and diversification of your investment portfolio.
4- No Leverage Power
In real estate investing, leveraging means using other people’s money (the bank) to buy income-producing properties that are likely to appreciate in value. Leveraging gives you the advantage of starting a real estate business with little capital and increasing returns on investment much quicker than buying a rental property with cash. Therefore, cash buyers for real estate lose out on the possibility of profiting from leveraged money.
Related: Real Estate Investing for Beginners: Investing with Little or No Money
Final Thoughts: Cash or Debt?
As we have seen above, both methods have their pros and cons. When deciding whether to buy a rental property with cash or debt, it is important to evaluate your personal preferences and financial situation. If you have a lot of extra cash laying around, then buying a rental property with cash does not seem like a bad investment. However, the cons of that are significant as well. On the other hand, financing a rental property using debt can be more beneficial and, if done carefully, a low-risk investment.
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