You have been investing in real estate for the last 15 years. During this period we have seen interest rates range from 12% to 5% for the purchase of investment property. Many of us have been coached to believe in the concept of high leverage, so we tend to put the least amount down. By so doing we have fallen into the compound interest trap and paid the banks a lot of interest. With today’s low interest rates, we have an opportunity to adjust our strategy and look at another approach to financing that can save us a significant amount of money.

Suppose you buy a property worth $1,900,000 and you borrow $1,500,000.

First of all keep in mind that typically the longer the term is that you borrow money, the higher the interest rate. I am going to chart the amortization of three interest rate terms for $1,500,000 (A good website to run your own analysis is at amo-mortgage.com/amortization.html)

As you can see, payments increase with a shorter term. On the other hand, you may also notice that you save $923,279 in interest when comparing the 30 to 20 year term. When you consider the loan size at these current low interest rates, you notice that if you are willing to pay an additional $1,000 a month (the difference in payments from a 30 year loan to a 20 year loan), or about $240,000 over a 30 year term, you will save $683,279 ($923,279 - $240,000 = $683,279), plus the payments you don’t have to make for the last 10 years ($1,167,480). So you actually save $1,850,759.

Of course every market place is different. When you pay 25% or the minimum down payment, the banks might argue that you don’t have enough cash flow to cover the mortgage payments (they call this the debt service coverage ratio). With this approach, you might be better off to buy a smaller property and make a larger down payment, have a faster payoff, and earn more equity.

Many people wonder if they will lose the tax shelter (see your schedule E) that the interest write off provides. You need to research your best approach to this issue as every investor’s goals are different. There is a reduction in the interest you pay as the chart below shows:

If you are 50 years old and want your investments paid off by the time you need the income to fund your retirement, you might take a shorter term view of financing and be willing to pass on the tax shelter.

The best way to do this analysis is to print out your own amortization scenarios. Read the detail; look at the savings you have every year from the interest shelter. The key to success in your analysis is to let it help you frame your goals for investing. There is nothing wrong with changing your approach to real estate investing. The additional benefits to shorter term amortizations are that you are more resistant to an economic down turn, potential higher vacancy rates, or higher operating costs for your real estate investments.

Suppose you turn your real estate inventory every 5 years. Is there a benefit to a shorter amortization? Look at the chart below and you will see that there is a significant benefit, as there would be if you turned your inventory every 10 years

As you can see, you can benefit significantly by changing your strategy regarding financing of your real estate purchases.

With the current low interest environment, now is the time to take advantage of not only the low interest rates, but also the chance to reduce the amount of money you pay in interest. These low interest rates will not last forever.

Published: November 22, 2002

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Clifford A. Hockley is the President of Bluestone & Hockley Real Estate Services, one of the larger brokerage and property management companies in Portland, Oregon. Mr. Hockley holds an MBA Willamette University and a B.S. in Political Science from Claremont McKenna College. He is a Certified Property Manager and Bluestone & Hockley Real Estate Services is an Accredited Management Organization (AMO) by the Institute of Real Estate Management (IREM). Mr.Hockley serves as member at large on the Portland IREM board. He has twice been named Certified Property Manager of the Year (2001 and 2003) by the Institute of Real Estate Management and is a frequent contributor to industry newsletters.