Longer Mortgages increase your cash on cash return

Written by Marc on April 24th, 2007

If cash flow is your priority in your real estate investments, you probably have considered many options.  Such things as adding a suite, renting out the garage, or turning a portion of the yard into a parking may have been some options that you have considered.

You probably have tried to lower your expenses as well.  This can be very effective in increasing your cash flow.  Most owners look at reducing their utility costs as a primary means to reduce expenses.  But, have you considered amortizing your mortgage over a longer period of time?

By extending the length of your mortgage over a longer period of time, you can increase your cash on cash return significantly.  Consider the following example for an apartment block with 50 units renting out at $500 each, a down payment of $500,000 and a purchase price of $2,000,000.  Assume a 6% interest rate throughout the mortgage period and that monthly expenses including taxes, utilities and vacancy allowance is $5,000 per month.

10 Year Mortgage

If you took out a ten year mortgage, your monthly mortgage payments would be $16597.65, leaving you with a net income (based on above assumptions) of $3402.35.  If you work out your cash on cash return (the percentage return based on the amount of your money you invested), you would earn a 8.17% yearly return.

25 Year Mortgage

If you took out a twenty five year mortgage, your monthly mortgage payments would be $9597.10, leaving you with a net monthly income (based on above assumptions) of $10402.90.  If you work out your cash on cash return for this scenario, you would earn a 24.97% yearly rate of return. 

40 Year Mortgage

Forty year mortgages are relatively new in Canada, but let’s take a look at this scenario.  In this case, your monthly mortgage payments would be $8176.32, leaving you with a net monthly income (based on above assumptions) of $16823.68.  If you work out your cash on cash return in this instance, you would earn a 40.38% yearly rate of return.

As you can see from the above examples, your cash on cash return increases with an increase in the length of you mortgage.  Obviously, if your priority is to pay off the property, a shorter amortization period will help you achieve your goal.  On the other hand, if you are in a joint venture partnership or if you need the cash to make other investments, a longer amortization period will increase the cash in your pocket significantly.  If you look at the 40 year mortgage example, you recoup your down payment ( or get a 100% cash on cash return) in just two and a half years.  So be sure to consider the length of your mortgage when investing in a rental property.

Read more articles on Real Estate Investing.

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