Plenty of real estate investors are asking this very same question: Should they buy an investment property with cash or buy one with a mortgage?
In this blog, we hope to help you figure out which one works best for you. Real estate investing will cost you a whole lot of money, and you need to ensure that you are financially ready for whichever purchasing option you choose.
Table of Contents:
- Why You Should Buy an Investment Property with Mortgage
- Why You Shouldn’t Buy an Investment Property with Mortgage
- 5 Tips for Buying an Investment Property With Mortgage
- Why You Should Buy an Investment Property With Cash
- Why You Shouldn’t Buy an Investment Property With Cash
- 3 Signs You Should Buy an Investment Property With Cash
- How to Know Whether to Pay With Cash or Mortgage
Probably the most common source of the debate you can find in real estate investing is whether paying cash or using a mortgage is the best way to buy an investment property.
In this case, there are no wrong or right answers. Some real estate investors have more success with mortgages, while others prefer paying only in cash. It really depends on one’s financial situation. This is why it is recommended that investors make an honest assessment of where they are financially before deciding to buy an investment property.
Here’s the thing: both all-cash transactions and mortgage loans have their own pros and cons. In this blog, we will examine the advantages and disadvantages of each, which will hopefully help you make a wiser purchasing decision. We will also discuss how Mashvisor can help you make the best investment decisions in real estate.
Let’s get started.
Related: What Is Real Estate Investing and How Does It Work?
Why You Should Buy an Investment Property With Mortgage
Investing in real estate is generally a very costly investment. A lot of money is usually involved in real estate investing. We’re talking about anywhere between hundreds of thousands to millions of dollars here. The investment costs will largely depend on the property’s location.
Since a lot of money is involved in real estate investing, not everyone keen on investing in properties has enough cash lying around to make the purchase. In most cases, investors need to take out a loan to purchase an investment property.
For this reason, we will examine the advantages and disadvantages of taking out mortgage loans to purchase investment properties. Let’s discuss the upsides of mortgage loans first.
Easy for Beginners
Buying an investment property for sale with a mortgage is much easier—and sometimes more practical—than paying fully in cash.
The fact is that the vast majority of real estate investors don’t have enough cash to pay for a rental property. Is it more practical to pay $300,000, the average price of a real estate property, upfront or through partial monthly payments?
Buying an investment property with a mortgage is easier, especially for beginning investors. By leveraging a loan from a bank, you will slowly pay off your income property in several years, interest included.
Related: The Ultimate Guide to Real Estate Investing for Beginners
Potential for Better Cash Flow and Higher Returns
One of the advantages of buying an investment property using mortgage is a better possibility to receive higher returns and cash flow. By paying for a property in cash, the cash on cash return (CoC return) flow of the rental property is the same as its cap rate. That’s because more money is paid to the investment.
When you put less out-of-pocket cash into an investment property through a mortgage loan, the CoC return will be a lot different. This means that it can generate higher cash flow for the income property. This gives you a better dollar-for-dollar return on your investment.
Calculating cash flow, cash on cash return, cap rate, and other similar return on investment (ROI) indicators is a lot easier with Mashvisor’s investment property calculator. Mashvisor’s calculator allows investors to crunch the numbers using highly accurate data found on the website’s database.
Its database is updated regularly so that ROI projections are as realistic and accurate as possible. This increases investor confidence, which makes the decision-making process faster and more efficient. That is why countless investors who used Mashvisor’s calculator were able to find the best deals on rental properties across all 50 states.
To start using Mashvisor’s investment property calculator and other real estate investing tools, sign up for a 7-day trial.
Mashvisor’s Investment Property Calculator
Tax Deductions
Here’s another reason why buying an investment property for sale with a mortgage is a great idea.
Tax deductions are a blessing to real estate investors. Investors who are in the market for rental properties for sale and purchase them through various loans get to enjoy several tax benefits. Mortgage interests are common taxable expenses, so make sure to take advantage of them when using a mortgage regardless of whether mortgage rates are high or low.
Why You Shouldn’t Buy an Investment Property With Mortgage
Before you start thinking about how to get a loan, you also need to consider what its downsides are so you can make a wiser decision moving forward. Not all loans are created equal. This is why you need to perform a certain amount of due diligence.
Let’s take a quick look at some of the drawbacks of taking out a loan to purchase an investment property for sale:
Interest Payments
Sure, mortgage interest is tax deductible, but it can also severely impact your cash flow. This will depend on your rental income. If your rental income is the same as the monthly mortgage payment, then you are quite literally earning nothing.
Interest rates have been on a wild roller coaster ride as of late. As a rental property investor, you must ensure that your rental income will exceed your mortgage payments even if mortgage rates go higher. Otherwise, your mortgage’s interest can go against you if your rental property is not making much.
Pro Tip: To lower your monthly mortgage payments, we recommend putting a larger down payment on the property, if you can afford it. With a bigger down payment, your monthly mortgage payments will be a lot lower compared to property purchases with the standard 20% minimum down payment.
Risk of Foreclosure
By buying an investment property with a mortgage, a real estate investor is exposed to the risk of foreclosure.
Foreclosures typically happen when the investor fails to make their monthly mortgage payments. The lender will then try to recover the amount on the loan from the investor by repossessing the property and auctioning it off. In contrast, buying an investment property in an all-cash transaction allows a real estate investor full ownership of the income property.
Pro Tip: To avoid foreclosure, on top of making a bigger down payment on a property, be sure to make the monthly mortgage payments on time. A large down payment won’t matter if you’re unable to make your monthly payments on your mortgages.
Not so Easy to Obtain
While saving up for a mortgage payment and a larger down payment is easier than buying a rental property with only cash, it still has its own set of challenges.
To qualify for a loan, an investor needs a good credit score, enough cash reserves for mortgage payments, and other requirements. It is possible to qualify for a loan with bad credit or with little to no money for real estate investing. However, it’s much easier to do so with conventional standards. Even then, it takes time to accumulate the proper requirements.
Pro Tip: If you’re considering taking out a loan but cannot make the minimum 20% down payment, you will need to pay for mortgage insurance. Mortgage insurance lowers the risk on lenders but increases your monthly mortgage payments. So you better think long and hard before proceeding with purchasing a home with less than a 20% down payment.
Related: Paying Off Investment Property Mortgage: Pros, Cons, Tips
5 Tips for Buying an Investment Property With Mortgage
Now that you know some of the pros and cons of buying an investment property using a mortgage, the next step is knowing how to go about it in the most efficient way possible.
Here are a few practical tips that will help get you started:
Tip #1: Prepare the Requirements and Make Sure Everything Is in Order
Before you whip out your calculator to crunch the numbers for your potential ROI, make sure that all the required documents for your mortgage application are complete and in order.
The very first thing you need to secure is your credit report because this is one of the very first things lenders ask for when people apply for a loan. It pays to check your credit score in advance to make sure that the credit report is as accurate as possible to avoid any delays in the application process.
The next step is to secure an application form from the lender and all the necessary documents to quicken the entire process. Coming in prepared will help decrease the chances of delays.
Tip #2: Due Diligence Should Never Be Taken Lightly
Speaking of preparedness, you would want to know all the necessary information and data there is to know about the market you’re considering. Before applying for a loan, do your research on the area first.
How affordable are the properties? What do the average cap rate and cash on cash return look like? Is the occupancy rate high enough to get you a good return on your investment? Are there any properties that can be bought with no money down? Does the neighborhood have a thriving economy? What does the job market look like?
These and many more questions should be answered before you go around town shopping for the best deals from lenders. Due diligence could spell the difference between investing success and failure.
Tip #3: Be Realistic
While it is very understandable that most real estate investors want an ROI in the shortest time possible and a profit as big as possible, you still need to maintain a level of sobriety. Sometimes when you do your research and find out that the market can give you very handsome returns, you tend to get too hyped and lose touch with reality.
As an investor, you should always maintain a sense of optimism that must be balanced with a touch of realism. Being ambitious is good but only to a certain extent as far as real estate investing is concerned.
For instance, you’re looking at a property that can give you about 7.50% cash on cash return as a vacation rental property. The only catch is that it is beyond what you can afford. Even if the seller only requires a 20% down payment on it, if you can only afford to put down 10% then perhaps you should consider other options.
This is the time that you can take out your calculator to see how the numbers turn out and if they are for you or against you. Based on your calculations, make the necessary adjustments before taking out a loan.
Tip #4: Decide on Which Financing Option Is Best for Your Financial Situation
Once you’ve somehow figured out the numbers and you like the results, it’s now time to shop around for a number of options to choose from. This step is very important as not all mortgages are created equal.
Find out which types of financing are available to you. Don’t be afraid to ask lenders and bankers the hard questions. Keep yourself informed on the latest mortgage rates for the different financing options.
If you want fixed payments, then look for the best fixed-rate mortgage that lenders offer in your location of choice. If you want some sort of flexibility, then an adjustable-rate mortgage might be the one you’re looking for. Either way, shopping around for the best financing options is still a part of performing your due diligence.
Tip #5: “No” Doesn’t Mean “Never”
At this point, given the high interest rates, rising property prices, and inflation, homeownership may not be easily accessible to everyone. Lending companies and banks are far stricter with requirements now that even if you do come prepared with all the required documents, you might still get denied a loan.
But just because you get a “no” now doesn’t mean you won’t ever get to qualify for a loan. Keep in mind that things can still change and your financial situation could improve in the near future. When it comes to real estate investing, timing matters.
Why You Should Buy an Investment Property With Cash
Buying a property with a mortgage can be quite practical in some aspects but also has its fair share of pitfalls. Now let’s take a look at the ups and downs of buying a property in an all-cash transaction.
More Control Over Property
Buying an investment property with cash allows you to have more control over your rental property. You aren’t tied down with monthly mortgage payments or interest. That way, almost all rental income is yours, except for other expenses related to the investment property, like management and property taxes.
Also, there’s no risk of foreclosure. It should feel good owning a rental property without the constant headaches of mortgage payments.
With no interest, all gains in appreciation are tied to the real estate property. That way, if the investment property appreciates greatly, you can sell it and make instant income.
Related: Is It OK to Invest in Real Estate Just for Appreciation?
Quicker Purchase
Yes, buying an investment property with only cash is a much harder purchase than doing so with mortgage loans. However, the transaction will be quicker. The closing can take place right after a home inspection.
Buying an investment property with mortgage loans, on the other hand, takes time. First, you have to find a lender, preferably a direct lender. Then, you must qualify for the loan. And so on and so forth.
If you want to purchase a property quickly with a few questions asked, buying with cash could work.
Vacancies Don’t Hurt as Much
Vacancies really bother real estate investors. When a rental property is vacant, it is wasting money for having no tenants inside.
Vacancies hurt less when you buy a real estate property with cash. That’s because mortgage payments are nonexistent; so if a property is vacant, you don’t lose as much.
Why You Shouldn’t Buy an Investment Property With Cash
While there are certain advantages to buying real estate properties in all-cash transactions, they also come with a few disadvantages.
No Mortgage Interest Tax Deduction
Using cash to buy a property means no mortgage and no mortgage interest. Because of that, real estate investors can’t deduct interest from their tax forms. Having that tax deduction is very advantageous, and not having it by buying with cash is definitely a downside.
Fewer Assets
Buying an investment property with only cash means you will have fewer assets. By spending a lot of money on one property, you can’t diversify your investment portfolio with various real estate properties.
Instead, by using that same amount to buy one property, why not use it over several properties with a mortgage? That way, you can diversify your portfolio, earn more rental income, and have more tax-deductible expenses.
More Risk
Buying an investment property with cash produces more risk. A lot of your capital is placed in only one investment property. If that property depreciates, your investment will suffer mightily. Instead, it is safer to buy an investment property using a mortgage.
If you are ready to search for and buy a property, whether with cash or a mortgage, head over to Mashvisor and start analyzing investment properties in any location of your choice.
3 Signs You Should Buy an Investment Property With Cash
Now, if you’re intent on buying a property with cash, there are some signs you need to look out for to see if you’re ready for it and what it entails. Here are three signs that will tell you if you’re ready for an all-cash transaction:
Sign #1: You Have Enough Cash Reserves to Maintain the Property
As we already mentioned earlier, investing in real estate involves a huge amount of money. According to Mashvisor’s November 13, 2022 location report, the median property price in the US is $475,720. Imagine buying a property in cold cash for that amount. And we’re just talking about the property itself.
Other expenses and costs should be factored into the equation, such as possible repairs or upgrade costs, closing costs, and other fees and charges associated with the purchase.
Once you compute the total amount of money that will go into the investment and you’re still left with enough money to maintain and operate the property, then it might be a sign for you. This is why learning how to compute cash flow is an essential part of the due diligence process.
The important thing is that your investment should not leave you in the negative. It would be pointless to spend all your money on the initial investment but cannot sustain the property in the long run.
Sign #2: The ROI Is Worth It
The next sign to look out for is the return on investment. For very obvious reasons, investors buy real estate in hopes of earning a decent profit and not just breaking even. For this reason, you should take time to perform a thorough investment property analysis and a neighborhood analysis to determine if a possible investment opportunity is worth taking.
If by your research you find that the property does not meet your expectations, consider looking for a different income property. However, if the cap rate, cash on cash return, and cash flow all swing in your favor, then investing in cash might be a good move for you, especially if it is in a hot rental market.
In this case, you won’t have to worry about making monthly mortgage payments. The money that could have gone into mortgage payments can go directly into your bank account or towards other investment opportunities.
Sign #3: It Will Not Mess Up Your Other Priorities
Lastly, only get into an all-cash transaction if it will not mess up your other priorities and financial obligations.
The average American household’s monthly expenses, according to the Bureau of Labor Statistics, is $5,577, or $66,928 annually. Assuming that most average Americans take out mortgages, the amount they spend on housing is $1,885 per month, which makes up about 34% of their expenses.
If you buy in cash, the amount you spend on housing will significantly go down and you can reallocate the money you save onto other expenses or put into savings or investments.
As we also mentioned earlier, not everyone has the capacity to buy in cash because of their other obligations, mainly supporting and sustaining their families.
If you have enough money to go around or at least have a stable income, then a cash transaction might be the more practical option.
How to Know Whether to Pay With Cash or Mortgage
Now the question is: should you buy a property in an all-cash transaction or with a mortgage?
The answer to this question will largely depend on your financial situation. In some cases, it is more practical to buy in cash, while in others, going with a mortgage is the best way to go.
One of the things you should keep in mind is that if you opt to buy in cash, you should still be left with plenty of liquidity. Going with a mortgage gives you this but ties you up with mortgage payments for quite some time.
To know which option works best for you, you will need the help of a mortgage calculator to budget your costs.
Mashvisor’s Investment Property Calculator
Mashvisor has one of the best mortgage calculators out there today. Its investment property calculator allows you to do the math to see if an investment property is worth it or not. It gives you the latest real estate market data you need to come up with an ROI projection.
If you’re buying in an all-cash transaction, Mashvisor’s calculator can give you the average cap rate for the neighborhood you’re looking into. It will give you an overview of how much you can make on your investment, especially if you rent it out as a long-term or short-term rental.
On the other hand, if you choose to go with financing, you can figure out if the mortgage is worth it by taking a look at the estimated rental income and estimated cash on cash return.
When checking out rental properties online, we recommend using the following criteria to ensure profit:
- Property price should not exceed $1,000,000
- Monthly rental income should be at least $2,000
- The cash on cash return rate should not go below 10%
- The price to rent ratio for long-term rentals should be 20 and above
- The occupancy rate for vacation rentals should not be lower than 50%
If your subject property meets all of these, then it’s a good potential investment. The only thing you need to compute is how much your mortgage will cost you monthly and if it will leave you with a positive cash flow once all of the expenses are paid.
To get access to our investment property calculator and other real estate investment tools, sign up for a 7-day free trial of Mashvisor today, followed by 15% off for life.
Wrapping It Up
At the end of the day, the choice is yours to make based on your financial capability. This is why you need to ask yourself the hard questions before deciding to push through with it. Either way, both cash transactions and mortgage purchases have their benefits and setbacks.
We recommend, however, that before you make any final decisions about whether to purchase in cash or with the help of financing, you should talk to a real estate or finance professional first. They can give you a better insight into the subject matter and help you come up with a more informed decision.
Regardless of purchase method, investing with the help of Mashvisor’s database and tools will increase your chances of investment success. Its database is regularly updated to give investors and users highly accurate information and realistic profitability projections.
Its tools like the investment property calculator can help you crunch the numbers easily and point you to the right investment properties that align with your goals and objectives. It will save you plenty of time and energy, which can then use for other equally important pursuits. Give Mashvisor a try and see why tons of real estate investors prefer to use it.
To learn more about our products and how Mashvisor can help you find profitable investment properties, schedule a demo.
