Looking into purchasing duplex, what type of loan should I take, what % should I put

Discussion in 'Growing and Managing a Business' started by petmeadow, Aug 1, 2011.

  1. petmeadow

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    May 2, 2011
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    I'm looking at purchasing a duplex. I would live in one half and rent the other. I'm wondering what type of fixed rate loan makes the most sense (15yr, 20yr, or 30yr). I'm confident that I could afford the payments for each type loan (although a 15yr could be risky if I lose my job or something). Im also wondering how much do put down for a down payment. I could put up to 40% down.

    My initial thought would be to put a lot down and take a 15 year loan so that the property is paid off asap.

    However, I wonder if there are financial advantages (tax deductions from interest) that might make me want to consider putting less money down and taking a 30yr loan. If I put less money down and a 30yr loan, I could save money and invest it elsewhere. What are your thoughts?

    In about 7 years, I'll probably be looking into buying a single family house. Should I sell the duplex then, or just rent out the other side?
  2. ArcSine

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    Jun 2, 2010
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    A couple of thoughts, Petmeadow...

    1) A 30-year loan can be made to behave just like a 15-year loan, but the converse isn't true. You're confident your personal cash flow could handle the payments on a 15-year, but the question mark involves the loss of your job. Instead, take out a 30-yr deal, then make the same higher payments every month equivalent to the monthly payment of a 15-year loan. The 30-yr loan will be paid off in 15 years. (This assumes that both loans have the same interest rate, and that the 30-yr deal has no prepayment penalties. Early payment penalties are VERY rare in home mortgage loans.) As a side note, you could in fact pay off the 30-yr note in any number of years you choose (<= 30, of course) merely by adjusting your monthly payment accordingly.

    Playing it that way you've got the early-payoff benefits of a 15-year deal, but with the safety net of being able to drop back to the lower 30-year payment amount in any months in which cash flow is tight. As I mentioned, the converse isn't true. Take out a 15-year loan, then try telling the bank sometime down the road that because you're a bit strapped for cash at the moment, you're just gonna pay the smaller amount this month that would be associated with a 30-yr loan.

    2) The question of how much to put down turns on too many situation-specific variables to be accurately answered here. But very generally speaking, compare your after-tax cost of the loan to the after-tax return you could earn on your money, if you put less down and invested the difference. Suppose, for example, your loan has an after-tax interest cost of 5%, whereas you could get 6.5% after tax in some investment opportunity to which you have access. This scenario would generally favor less down on the house (i.e., borrowing as much as you can) and maximizing the investment play.

    Do keep in mind some follow-on points. For one, your after-tax cost of the loan, and your after-tax return on any given investment, are partially functions of your own particular tax picture (your deductions, income levels and sources, tax credits, and so on). So there might be some value in having your tax advisor (who knows the details of your tax picture) help you quantify these after-tax numbers, in doing this comparative analysis.

    Also, you must only consider your potential return on pretty safe investments. There's a nearly 100% probability that you'll have to make the monthly loan payments, so you must only compare the loan rate to investment opportunities which have a very high probability of actually producing the promised or advertised payoffs.

    Lastly, what I've briefly sketched above is a decision rule that relies solely on a pure economic / financial analysis of the numbers. There are always other qualitative factors to throw into the decision blender as well (e.g., will carrying a higher loan balance adversely affect your ability to finance a car purchase later? Will maximizing the down payment with all your surplus cash put you into a bind should you unexpectedly incur large medical costs shortly thereafter?). If your tax advisor's expertise spills over into the financial-planning arena, he/she can help you with those questions as well.

    Best of luck with it, and I hope that helped a little bit.
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