People who invest in real estate generally have two options when purchasing a piece of property; pay cash or take out a mortgage. A lot of inexperienced investors assume that the best thing to do is pay cash for their property. By doing this, they assume that they will save a lot of money in interest payments.
In fact, a lot of real estate investors have realized that they can increase their profits by taking out a mortgage on all of their properties. Record low interest rates and several tax advantages have made this a better option.
To understand how this works, assume that there is a single family home that costs $200,000 and rents for $1500 a month. An investor who purchases the home for cash would make $18,000 a year from his or her investment, minus any expenses for the upkeep of the property. This is a nine percent return on the property, and the investor would have all of his or her money tied up in a single investment.
Instead, the investor could take out a mortgage on the property, at the cost of about $800 with no down payment. Subtracting the cost of the mortgage from the gross rent, the investor could make $8400 a year. His or her $200,000 in cash could be placed in another investment.
By taking out a mortgage, the investor frees up his or her cash for a variety of investments, and still makes a profit on the piece of real estate. At the end of the mortgage term, the property is owned by the investor, allowing him or her to decide whether to earn more from the investment or remortgage the property.
Many real estate investors continue to refinance their property, using the cash they take out of the property to buy more properties, improve old ones, or place in a different investment. Depending on the credit market, this method still turns a better profit than a cash purchase, even when the investor has to use some of his or her capital to make a down payment.
Having a mortgage on the property also has several tax advantages. Mortgage interest as well as many of the closing costs can be used as business deductions. This will further reduce the cost of the mortgage.
Big real estate investment firms use mortgages and loan leveraging to maximize the profits on their real estate holdings. By doing the same thing, you can build a bigger and more profitable portfolio.