Why Shouldn’t The Real Estate Investor Go With The Interest Only Loan? ‘Cuz
Posted @ 1:41 am - Filed under 1031 Exchanges, Real Estate Investing, Purposeful Planning, Weekend Thoughts, Financing, Retirement Income, Buying Income Property, Investment Lessons, Capital Growth, BawldGuy Axiom
Here’s a poser for ya. This question comes up all the time, ‘cuz folks seem to ‘know’ one way’s better than the other most of the time. Problem is they almost always pick the wrong one. It usually arises when we’re talkin’ about income and expenses — you know, the month in, month out operations of income property.
Here’s the question — usually posed in such a way indicating the obvious answer.
Short Pause For A Note: There’s no way I’m gonna get a cool photo for this, so I’m just winging it with whatever strikes my fancy. I like cool pics, don’t you? Besides, it’s the weekend.
Isn’t an interest only loan a much better way to go when compared to an amortizing loan? You save all that money over the holding period, right? That really adds up. Well, usually not, sorry.
The last comparison I did was about a week ago, and it came out about 2 to 1 against interest only. Why? Simple — The money they saved in monthly payments over a 5 year holding period was around $7,000 using the interest only approach. The principal pay down of the loan balance over the same period using an amortizing loan was just over $14,000 — about twice as much.
Now I now what’s goin’ on out there, so please, step away from the calculator.
Look at it the Purposeful Planning way. At the end of the holding period you have just under $7,000 in additional cash flow banked. An amortizing loan costs a tad more monthly, but it makes more in yield while in the loan. Ah, run that by me again, wouldya? Sure. If the interest rate is 6%, every dollar alloted to the principal is a dollar on which you’re no longer paying that 6%, right? Right. Is the bank giving you 6% on your piddly little break even cash flow? Stop laughing.
Fast forward to your net proceeds at sale, 5 years down the road. Let’s say you originally bought 4 small properties requiring a loan of about $200,000 give or take each. In 5 years you now have just over $70,000 additional net equity to exchange — tax deferred mind you — into around an extra half a million or so worth of property.
Do that over the next 20 years? You’ll have acquired $2-4 Million in ‘extra’ property. The investment lesson to learn here is this — remain prudent, but don’t save nickels and dimes while sacrificing hundred dollar bills. At a modest 6% yield, that $2-4 Million means your retirement income will have been improved by roughly $10-20,000 — wait — here it comes — a month.
BawldGuy Axiom: More is better than less. Sooner is better than later. Best of all? More sooner is much mo betta.
Now yer talkin’. Add all that extra equity buying extra properties over a 15-30 year time span, and you can readily see how your net worth and subsequently your retirement income are maximized. Some folks have come to call this Purposeful Planning. 
So tell me again how interest only loans are so much mo betta?
This entry was posted on Saturday, April 19th, 2008 at 1:41 am and is filed under 1031 Exchanges, Real Estate Investing, Purposeful Planning, Weekend Thoughts, Financing, Retirement Income, Buying Income Property, Investment Lessons, Capital Growth, BawldGuy Axiom. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.