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Financial advisory
Why Interest Only Loans Can Make Sense for Investors
BY CHRISTOPHER MILLER, MBA SPECIALIZED WEALTH MANAGEMENT
Happy New Year! As a real estate investor, you have probably heard of interest only loans. If you haven’t, these loans are exactly what their name implies; a loan where the borrower makes payments of “interest only.”
Most loans, like an auto loan or a traditional home mortgage, are “amortizing loans.” This means that each payment you make will include both an amount that decreases your principal (the loan balance) and an amount that is simply an interest “fee.” This interest charge is what you are paying to “rent” the money.
For example: if you buy an investment property with a $1,000,000 loan, fully amortizing over its 30 year term, at 4%: your monthly payment will be $4,774. During the first year of your mortgage, your payments will total $52,289. As I mentioned earlier; these payments have separate components that represent principal and interest. $17,610 will go to pay down the principal balance of the loan, and you will be charged $39,679 interest to “rent” the money. Change that loan to an interest-only one, and your monthly mortgage payment will drop to $3,333 or
$40,000 annually. Could you use an extra $1,441 / mo. of cash flow?
AREN’T INTEREST-ONLY LOANS RISKIER?
Some in the real estate industry, (often those trying to sell conventional amortizing loans), will dismiss interest-only loans as “risky.” I think a substantial case can be made to support a statement that “interest-only loans can offer less risk than an amortizing one.” How could this be? Let’s use the example above and compare an amortizing loan at $4,774 per month vs. an interest-only one at $3,333 monthly. Which payment will be easier to make every month? When taking out a mortgage, your primary risk is that you won’t be able to make the monthly payment and will lose the property to foreclosure. With which of the above loans is that most likely to happen? The loan with the higher monthly payment is always the harder one to pay.
AMORTIZING LOANS ARE LESS TAX EFFICIENT
Most everyone knows that mortgage interest, just like insurance and property taxes, is tax deductible for your rental properties. Some don’t realize that the portion of their payment that goes towards
Christopher Miller is a Managing Director with Specialized Wealth Management and specializes in tax-advantaged investments including 1031 replacement properties. Chris’ real estate experience includes work in commercial appraisal, in institutional acquisitions for a national real estate syndicator and as an advisor helping clients through over four hundred and fifty 1031 Exchanges. Chris has been featured as an expert in several industry publications and on television and earned an undergraduate business degree and an MBA emphasizing Real Estate Finance from the University of Southern California. Chris began his real estate career in 1998. Call him toll-free at (877) 313 – 1868.
AMM1/6 APARTMENT MANAGEMENT MAGAZINE - JANUARY 2022 63