Should You Pay Cash For Investment Properties?

I have seen this question come up before.  It is a good situation to be in.  There are some people who have done well and resisted the urge to spend.  They have saved enough money to where they could buy an investment property, or even multiple properties, without taking on a mortgage.

Every person’s situation is different.  But I want to run through a couple of examples and tell you what I would do in each particular situation.

Let’s say that someone has saved $100,000.  He wants to buy his first investment property.  He finds a place for $90,000.  With closing costs, most of his savings would be gone.  Should he pay cash (when we say cash, it really means digital money out of a checking account) for the property and own it outright?  Or should he take on a mortgage?

In this example, my recommendation is to take a mortgage, especially with the currently low interest rates.  He could use part of his savings to put down 20% or 25%, which would be enough to avoid mortgage insurance.  Assuming good credit, he should currently be able to get a 30-year loan at under 4% interest.  In this scenario, I think it would be unwise to drain all of his savings.  He may need extra money for an emergency or for repairs on his investment property.

Also, with this example, he could consider buying two or three investment properties, assuming he is getting positive cash flow.  It would still allow enough savings for emergencies and he could build back up his savings slowly with the additional positive cash flow.

For a second example, let’s say that someone has $500,000 in liquid savings.  Should he use this to buy investment properties or should he take out a mortgage?

For this second scenario, I would be more inclined to buy an investment property free and clear, assuming a price of $150,000 or lower.  It would instantly generate significant positive cash flow.  Of course, he should only buy it on the grounds that it still would have generated positive cash flow had he only put down 20%.

But what about multiple properties in this second example?  Maybe the guy could buy 4 investment properties free and clear with his $500,000.  Again, I would not recommend draining all of your liquid savings.

In addition, I think it is good to consider the implications of taking a mortgage or not taking a mortgage.  Taking on a mortgage is a hedge against inflation.  You pay off your fixed payment with depreciating money.  Paying for your property free and clear is more of a deflation hedge.  You are essentially doing the equivalent of locking in an interest rate, even if they are currently low.  It is just like taking a mortgage at 4% interest and then paying it all off.  It is a guaranteed 4% return.

For this reason, in the second example, I would recommend that the person split his money.  He might buy one property at $150,000 (or less) free and clear.  This is a deflation hedge.  He might use $100,000 towards a down payment on another two properties.  By taking on a fixed rate mortgage, this is more of an inflation hedge.

The one other consideration is taxes.  I don’t think you should let taxes keep you from paying off an investment property.  But if you have extra money and it is between paying off an investment property and paying off your primary residence, I think paying off your primary residence makes more sense in most cases.  Most people think of the benefits of the deduction of the interest paid on their primary residence.  But this only applies if you itemize.  For many married couples, they may not pay enough interest to itemize.  And you might be surprised, even if you do itemize, that your mortgage interest is not as big of a benefit as you think.

On the other hand, you can always deduct the interest you pay on an investment property and it doesn’t matter if you itemize.  This is a huge benefit.  So if it is between the two, I would pay down the mortgage on your primary residence before paying it down on an investment property.

In conclusion, each person’s scenario is different, but I generally recommend that you make it an ultimate goal to own some investment properties free and clear.  But you should not do this at the expense of draining all of your liquid savings.

9 thoughts on “Should You Pay Cash For Investment Properties?”

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  3. Why 20% or 25% down? If you have $100,000 and are buying a $90,000 property, you could put down $70,000 (78%) and still have a very healthy $2X,XXX emergency fund. (If you can’t get a loan for that small an amount, get a bigger loan with no prepayment penalty and then immediately pay the difference off before you get the first month’s statement).

    Otherwise you are just wasting a colossal amount of money on interest in order to have an “emergency fund” far bigger than you’re going to need (I am assuming you do have health insurance and insurance on the rental property, right?)

    Let me put it like this: If you owed $20,000 on a $90,000 rental property and had a $25,000 emergency fund, would you take an equity loan out on it in order to have a bigger emergency fund? I certainly would not, that is just a waste of money plain and simple.

  4. Just because you have health insurance and property insurance, doesn’t mean you don’t need a big emergency fund. This could include a job loss or other loss of income or a major repair that insurance doesn’t cover.

    If you are taking out a mortgage, I don’t see much advantage of taking out a $20,000 loan. You pay additional closing costs and fees and you also lose negotiating power on a quick close.

    But I would recommend 20 to 25 percent down, as opposed to something less, because it will save you from paying mortgage insurance.

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