A few times a week I talk to investors planning on putting a large down payment on the purchase of a single-family rental home. The goal is to have a better “cash flow”. It may sound logical – the greater the down payment, the smaller the loan, and hence the monthly payments. However, the foundational piece of buying rental homes in the United States is the “gift” called “the 30-year fixed rate loan”. This loan sounds like a miracle to most foreigners, since neither the monthly payment nor the mortgage balance EVER keeps up with the cost of living around the world, while everything else does.
The magical 30-year fixed rate loan
The 30-year fixed-rate loan is at the heart of life transformation for investors when the homes are held for 10 years or more (preferably over 15). The loan keeps getting eroded by inflation (or CPI– the cost of living), while the home, rent, and everything else keeps requiring more dollars to buy (hence in dollars, their value goes up – even without intrinsic appreciation). The 30-year fixed rate loan starts looking quite puny after 12, 14, 16 years. It may be years before it is paid off, but since it never keeps up with the cost of living, inflation hammers the real value of the loan.
These loans are a great financial gift, with future-changing potential. Why, then, would you want to make the gift smaller? Especially at today’s low rates? The answer is, you don’t. A larger down payment will mean the magical loan will be smaller.
May be wise not to exceed 20% down payment
This is not fully utilizing the power of the fixed-rate loan, and it means the borrower has expended more of their scarcest resource: cash! Even very wealthy people, who can afford to put down a large down payment or buy for cash, choose to put down less money. They do this to leverage their cash with the 30-year fixed-rate loan.
I think that in normal cases, a 20% down payment should not be exceeded. The small additional cash flow due to having a smaller loan is insignificant at the present time. Right now, your main “cash flow” should come from your own earnings (salary). It is later in life during retirement that the rental homes can replace your income.
In cases of big 1031 exchanges, with not enough properties to identify, or in cases of not being able to get the FNMA loan anymore, then larger down payments are merited and that is a different blog post. I still think the down payments should be less, rather than more, in any circumstance. Currently, in our Membership area on our website, we have podcasts and a webinar that discuss loans and cash flow in depth. You can learn more about it at icgre.com/members
At the end of March 2019, it became known that the White House is pressuring the Fed to lower its benchmark federal-funds rate by half a percentage point, according to an article in the Wall Street Journal by Nick Timiraos and Kate Davidson. There has been no movement yet.
We now see homeowner rates for mortgages at the 4.1% range; some of the lowest in history. If the White House succeeds, the benchmark federal-funds will not translate to lower mortgage rates right away, but mortgage rates will inevitably drop. Possibly even lower than at any time during the past decade. It is a waiting game and time will tell over the coming months.
This would likely create more buyers, push prices higher in most markets, and create an upward push in strong economy cities (and even not-so-strong).
The magical 30-year fixed rate loan
Since we are aware of the uniquely special anomaly called the 30-year fixed rate loan, (we are the only country that has this type of loan) where neither the monthly PI (principal and interest) payment (not the loan balance) keep up with inflation and the super low rate will be locked for 30 years, we are fully protected.
If you qualify for the best loan, under the FNMA (Fannie Mae, officially the Federal National Mortgage Association, or FNMA is a government-sponsored enterprise (GSE)—that is, a publicly-traded company which operates under Congressional charter—that serves to stimulate homeownership and expand the liquidity of mortgage money by creating a secondary market.) guidelines this is a great time to buy where the numbers make sense. Taking action is important.
Many are not aware that they can purchase up to 10 homes with this type of loan. Married couples (if they qualify separately) can purchase 20. This is already a great time to lock these rates in with the magical 30-year fixed rate loan. If the White House succeeds in lowering rates, the terms will become more attractive.
In my experience, I have seen people look back and lament over not making use of these great circumstances to build a solid portfolio for their future. I hope you are not one of them.
This summer in our Membership area we will have a couple of podcasts where I will talk about this solo and in interviews with experts. I will also be talking about the 30-year fixed rate loan in detail in my show produced for public television called “Remote Control Retirement Riches with Adiel Gorel” that will be airing over the next several days across the country. Take a look at our website here for details and to check for showtimes in your area.
Here is a recent video on the show currently posted on my YouTube channel: https://youtu.be/8eiUYcsOPiQ