When we talk about real estate investing, we almost take it for granted that an investor will use a mortgage to buy the property. After all, many people don’t have the available cash needed to buy or renovate a house or commercial property outright.
But some do. Some investors do have that much cash. So why do so many of them still take on heavy debt to buy their real estate investments?
We don’t like to take anything for granted, so let’s interrogate the assumption — should you invest in real estate with a mortgage? What are the pros and cons?
Pros of Investing with a Mortgage
Less Money Down. For investors who don’t have the money for a 20% down payment or renovation costs, the ability to borrow money to buy investment property is a godsend.
Diversify. What if you do have the cash to buy the investment outright? Should you? Most investors don’t. If they have $200,000, they won’t buy a $200,000 property outright; they might buy five properties with $40,000 down payments.
That way, the risk is spread out. Even if one property underperforms, the others will probably do fine and one might even overperform expectations, pulling up the portfolio overall. But what if you just buy the one property outright and it underperforms? That’s the danger of putting all your eggs in one basket.
Leverage. Investors talk about real estate debt as leverage. It can be a tricky concept to grasp, but once you do it’s extremely powerful. Here’s the gist — you put less money down, but the property still appreciates as much as it’s going to appreciate. If you buy a $200,000 property outright and the property appreciates $40,000, you have increased your wealth by 20%. But if you only put $40,000 down and it appreciates $40,000, you have doubled your money. The property got more valuable, but the debt stayed the same size. You can build wealth incredibly quickly by using a mortgage as leverage.
Deductible Expenses. Your mortgage interest is a deductible expense. Additionally, your depreciation expense is the same size whether you mortgage the property or not, so you might as well get the most property cost basis you can.
Principal Paydown. Over time, your loan balance gets smaller as you pay down the principal with your mortgage payments, increasing your ownership interest in the property even as the mortgage payments stay the same.
Cons of Investing with a Mortgage
More Risk. Once you take on a mortgage, you are responsible for the repayment of the debt. If you hit financial hard times and can’t make the mortgage payment, you risk a total loss of the investment in foreclosure. Investing in real estate always entails risk, but there’s no denying that the less you borrow, the less risk you assume.
Less Cash Flow. Even if you don’t hit hard times, a mortgage payment is a big expense that takes a big bite out of your cash flow. It might still be positive cash flow … but if your goal is financial freedom, it might take longer to achieve with the smaller cash flow. However, this reduced cash flow can often be offset by the tax advantages of leveraging real estate.
Overall, we believe the hype — the pros of leveraging investment property with a mortgage far outweigh the cons. MartelTurnkey can help you identify the right mix of property selection, strategy, and financing to generate cash flow from Day One … and then rinse and repeat until you don’t just have one rental property — you have a whole portfolio!