By Yumna Zahidi The ongoing Covid-19 pandemic has impacted communities around the globe in many…
By Oliver Fair
According to Bloomberg, rent rates for single-family homes in the United States grew by 8.5% in just July alone. This represents the largest increase in rent since 2005 and is a positive indicator that the rental market remains strong. The overall health and positive outlook for the market is bringing more real estate investors into the fold and thus and creating a larger demand for investment lending products. Naturally, more lenders and more options have arrived as a response.
This increased optionality, however, can make it a daunting task for real estate investors when they are trying to secure an investment loan and find a structure that best fits their strategy. Having choices can be beneficial but it can also be stressful. Numerous options are available for each loan, from leverage, to prepayment penalty, amortization structure, and term length. While each option impacts your bottom line, the decision with perhaps the largest number of varying outcomes is the term length.
In investment property financing, the most common term lengths are 5 or 10 years. This differs from conventional loans that tend to have a longer 15 or 30-year term. Interest rates have been historically low over the roughly 10-year bull market the United States has experienced to present day. With interest rates at an all-time low, an increasing number of real estate investors are looking for a chance to lock in these low rates for longer terms. 30-year terms are becoming a hot topic in the space and lenders are debating whether to incorporate them into their product offerings.
The logic makes sense. Why go through the hassle of refinancing in 5 or 10 years when you can forego the entire process with a longer term? Despite the benefits of a longer term, there are many reasons why an investor might be better off securing a loan with a shorter duration. So, what’s best for your investment strategy? To help investors make better informed decisions, the following paragraphs will discuss how longer-term lengths differ from shorter ones.
1. Lower Overall Cost
- a. While short term loans will require higher monthly payments, they tend to result in the loan being cheaper in the end. Borrowers end up paying off principal faster and thus pay less in interest overall. For example, between a 5-year and 10-year loan, an investor is borrowing the same amount, but paying off the loan in twice the amount of time for the 10-year term. The additional 5 years of interest payments will add to the total cost of the loan. Therefore, a shorter-term length will end up costing the borrower less in the long run.
- b. While higher monthly payments lead investors to having less cashflow to invest in other places, many people view the process as a “forced saving.” The borrower is building equity in an asset that will typically appreciate over time.
2. Increased Flexibility
- a. Standard with many investment property loans is a prepayment penalty that the borrower must agree to in the case they pay off the loan before the end of the term. Yield maintenance is the most common form of prepayment penalty and can be very costly for investors. Therefore, a shorter term allows you to have more flexibility overall as you can sell off your portfolio earlier. Investment strategies can change over the course of a few years and having the ability to refinance or sell your portfolio earlier can be advantageous.
Overall, if your goal is to pay off your mortgage as quickly as possible, and you can afford the higher monthly payments, a shorter-term length is most likely the best options for you.
1. Lower Monthly Payment
- a. The biggest advantage of choosing a longer term length is that the monthly payment will be lower. While this can obviously benefit those who might not be able to make a higher payment, it can also help those who can. Even if you can afford a higher monthly payment, the extra cash can help investors build up savings or free up funds to put towards other goals.
2. Refinance Less
- a. With a longer loan term, the need to refinance occurs less. For some investors who have jobs outside of real estate, this is very important as the process can take an extended period. Most lenders will ask for a plethora of documents during the diligence process and compiling them can be tricky at times. Another downside of refinancing is the cost. Overall, a shorter-term loan will be cheaper than a longer term. However, refinancing will create additional expenses from origination fees to appraisals.
If your real estate goal is to be a passive investor with a greater ability to invest in other ventures, a longer-term loan is most likely better suited for you.
Ultimately, the term length you choose should be determined by the specific situation you find yourself in. Everyone’s case is different and there is not one correct answer. Investors should determine what is important to them and what they are hoping to get out of the loan. I hope the characteristics listed above help you determine what term length is more beneficial for you.
Regardless of your term length or investment strategy, CoreVest is here to help every step of the way. Allow us to become part of your team, as your preferred lending partner. For more information about how CoreVest can help you grow your rental and rehab business, please call Oliver Fair at 310.849.1997 or email email@example.com.