Buying Rental Properties Cash vs. Mortgage - picture of tan one-story house with red door

Buying Rental Properties: Cash vs. Mortgage

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I love houses. I love that I can touch them. I love that I can feel them. But most of all, I love that I can make money with them.

Owning rental properties is one of my favorite long-term investment strategies. Holly and I have owned 2 investment properties for close to 8 years now, and they are easily two of the best investment decisions that we have made. Not only will they be able to provide us with a steady income during our retirement, they are also assets that will (hopefully) continue to appreciate over time.

If history holds true, the value of real estate should continue to rise – meaning we make money on the front end (purchasing the homes at a discount), the middle (through rent payments), and on the back-end (on the sale of the property). Personally, I don’t know of a much more perfect investment vehicle.

Of course, not everybody shares my enthusiasm for buying rental properties. Heck, not everybody even agrees on how you should go about purchasing them. Should you get in on owning rental properties? If so, what is the best way to purchase them?

2 Ways to Purchase Rental Property

When it comes to buying rental properties, there are generally two schools of thought on how to do it. Some investors only purchase a rental property with cash, while other real estate investors don’t mind taking out a loan to purchase their properties. Both are valid ways to get exposure to the rental markets, and they both come with their own sets of advantages and disadvantages.

Buying Rental Properties with Cash

Advantages

  • Own the property free and clear immediately
  • No risk of foreclosure
  • No mortgage to meet
  • Can keep the unit vacant until you have the right renter
  • Can keep the unit vacant if repairs are needed
  • Almost all revenue (rent) is profit
  • Not paying any interest
  • Long-term property value appreciation

Disadvantages

  • Harder for beginners to buy
  • All income is taxable (minus expenses)
  • Can’t take advantage of mortgage interest tax deduction
  • Reduces cash flow which could be used for other investments
  • Risk of property value depreciating

Buying Rental Properties Using a Loan

Advantages

  • Easier for young and beginning investors to buy
  • Use the bank’s money to purchase property
  • Renters pay off mortgage for you
  • Allows you more flexibility with your money (better cash flow) to make other investments
  • Can set rental rates high enough to pay your expenses (mortgage, taxes, utilities, etc.) in-full
  • Take advantage of mortgage interest deduction
  • Long-term property appreciation

Disadvantages

  • Large portion of revenue will not be profit and must be paid toward mortgage expenses
  • Risk of exposure to foreclosure
  • Less flexibility in regards to vacancies
  • Income is taxable (minus expenses)
  • Paying interest on the property
  • Risk of property value depreciating

The Best Way to Buy a Rental Property

So, what’s the best way to invest in a rental property? In truth, the answer is different for each individual investor.

Personally, we have always used a mortgage to pay for our rental properties. When we were younger, we didn’t have the money to be able to purchase our investment properties outright. If it wasn’t for being able to borrow the money, we would have missed out on two of the best investments that we ever made.

We also like using mortgages because it has allowed us to put only a small amount of our money at risk, initially. Then, we let the renters pay off the rest of the mortgage through their rent payments. When the houses are paid off, we will own two major assets that have been paid for by other people, costing us very little money out-of-pocket. Sure, it isn’t as fun or a sexy as getting a chunk of additional income from rent each month, but it works with our long-term investment strategy. That seems like a pretty big win for us.

What are your thoughts? Do you think investment properties are worth it? Should real estate investors use cash or loans to pay for their investments? Fire away in the comments below!

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50 Comments

  1. I like this post, because I’ve just looking for my house but for the moment I’m still in the phase of “saving for deposit”, there are alot info in this post, thanks for sharing!!!

  2. You know we are moving cross-country and trying to sell the house we have here. Well, it’s probably not going to sell or rent very quickly. I have made my peace with that. We have to have somewhere to live in the other state, so we decided to rent for several reasons. One of them was that I didn’t want to have two mortgages. There’s not concrete reason that I can point to – I just am risk averse. This goes to your point about the right solution being different for every investor; give me a few years and I’ll probably shrug at the thought of having two or three mortgages! So even with the individuals, the right answer changes over time.

    1. Oh absolutely. As your situation changes, your risk tolerance and your ability to handle risk/cash flow issues/etc. change. I’m not sure I’d really love to own a rental across the country either. Plus, it is always a stressful thing to carry multiple mortgages. I think it is great that you realize your risk tolerance level and made a good decision because of it. You’ll probably be much happier.

  3. Isn’t the key to buy the rental property at the lowest, best price? That’s how you’ll maximize profits over the long run.

    1. Sure. That is the key to making money on anything (buy low, sell high). But it is only one part of the real estate investment process. You want to make money in 3 phases: purchase at a good price, while you own the property (through rent), and when you sell (sell high)…kind of like a income or growth/income stock.

  4. Buying in cash sounds ideal, but not something many people could manage. I’m curious how long of a mortgage you took on yours, if you’re willing to share? Just how long-term of an investment do you advise?

    1. We have them both at 15-year fixed, but should have them paid off a little bit early. IMO, if you can’t afford the payment on a 15-year fixed, you can’t afford the house – regardless of whether it is an investment or primary residence. Very few people live in a house for 30 years. Since interest in a mortgage is front-loaded, a 30-year mortgage often ends up to be almost a rental agreement.

      1. Love your point on the front loaded interest. I have always paid off my properties early. But for a bit of a safety factor, I get a 30 year and pay extra to the principal. That way if a real emergency hits, I can back down to the lower payment if needed. There is a small difference in interest rates. The cost is minimal if you are aggressive in paying down the principal And it allows you to have flexibility if needed.

  5. You’re scaring me~ Stop it! Oh wait; I’m one of those that doesn’t share your enthusiasm. I had a bad experience quite a few years ago. You know, buying a rental property while I was broke with no money down! Thanks Carleton Sheets! No, in all seriousness I think either way is perfectly fine if you purchase the right property and you’re in a in a good financial position.

    1. I agree. Being in a financially sound position is a must if you are looking to buy investment property.

  6. If I were in the property investment game (which I’m not) I personally would go cash in though intellectually I understand that leveraging to the hilt is probably the “better” way to go in terms of return.

    1. I don’t think that I would ever leverage to the hilt. I’m far too conservative for that. Too much risk. I need the peace of mind to be able to cover the expenses relatively comfortably should anything happen.

  7. We’re cash only, but we always buy off the MLS. Although anyone with a big checking account can handle vacancies, I prefer the ability to be picky.

    I would also rather have the cashflow of a single asset than have to deal with multiple mortgages, leverage helps you build wealth, but not necessarily cash flow which is more important to me.

    1. Yeah, if you are going to use a mortgage, you need to be able to cover the cash flow if there are problems. For us, we’ve always been able to cover it without a problem, even if they go vacant.

  8. I think you’re right that it depends on the situation. I suppose ideally you would pay cash for an investment property, since that makes it cheaper by avoiding the financing costs, but it seems unrealistic for most people. Real estate investing can still be a great deal if you have a mortgage, so if you can make that work I would think it would make sense. I hope to rent out my condo when I eventually move to a larger place, and I will likely maintain the mortgage on it. As long as the rent is higher than the mortgage I should be in good shape.

    1. Ideally, cash would probably be best. There is obviously no risk of default that way, plus the rent money is instantly cash flow. However, I don’t mind using the mortgage at all for the reasons stated.

    2. Ali – you bring up a great point ‘financing costs’. I am surprised that the original well written article does not mention financing costs. In my mind, leveraged returns vs financing costs is the main deciding factor.

      For me and most of my friends, foreclosure/ monthly payments etc are not a factor – we have large portfolios that are well diversified and can sustain medium term down turns.

      1. stockmomma says:

        But if someone is paying the financing cost for you (rental income), then it is a win-win.

  9. I’m glad you are having a positive experience with your properties. I became a reluctant landlord when I acquired several rental properties from my mother and I hated it. One thing that you do need to keep in mind is that unless you are constantly monitoring your tenants, the property can very easily become quite used (i.e. trashed) requiring a lot of repair before selling. It is the rare tenant that cares for a rental the way they would their own place. And the mortgage loan requirements are more stringent for property that is not owner occupied. There are also no real estate tax breaks on rentals- such as owner occupied or senior citizen exemptions. Then there is the vacancy situation which creates no cash flow for the period of time the unit is empty. If you go into the venture with eyes open and knowing all the pros and cons, you can make money. But never think of is as a passive or easy endeavor.

    1. Owning real estate is great when there are no problems. However, I just found out that the water heater died at one of our rentals. These are the days that suck 🙂 As far as exemptions go, those would totally depend on your locality. We still get a county-level “mortgage exemption” as well as being able to write the interest off on our income taxes. These are great things to think about though! Thanks for the comment.

      1. Water heater? Try sewer line, water line or furnace/AC unit… Then you will know what “suck” really is… lol

  10. We have used mortgages because of the reasons you said. Otherwise, we’d still be saving up for that first property and would have missed years of equity. I think the key is to not over mortgage. Make sure the cash flow covers the mortgage plus expenses, not just barely the mortgage payment. The properties we’ve bought have all been cheap with stuff wrong with them so we’ve been able to cash flow from day one. The first rental, which is the commercial building, will be paid off in about 4 years and then we will probably have the ability to pay off the others pretty quickly, so I think our strategy has worked ,but it would be cool to buy a whole house in cash!

    1. “I think the key is to not over mortgage. Make sure the cash flow covers the mortgage plus expenses, not just barely the mortgage payment.’

      Exactly. If you cut it too close, you’ll be miserable and hate real estate investing. Plus, you could have a financial problem on your hands.

      1. The most important income of a rental property is the passive Income. My business partner and I both have great careers and on the duplex we just purchased we would have $1800 cash flow – $200 into the emergency fund. We also have Home Shield Warranty which is $14 a month and covers everything in the house including appliances. And on average the landlord gets called 3 times a year. Once you’re established and have 6 units you can start looking into property management companies to run your properties.

  11. I live in NYC so I thought it would be impossible to buy rental property. However, after reading some blogs and doing my own research I’ve decided to buy rental properties out of state and have someone manage it. Yes, that cuts into the profit but as long as it still has good cash flow, I’m fine with that. Personally, with the mortgage rates, I think it makes sense to take on a mortgage. I know some people do no like any debt but sometimes you need to leverage your money. I’m hoping to buy multiple properties so paying cash would be near impossible.

  12. We are interested in getting into rental real estate one day. We keep going back and forth about it so right now we plan on just thinking about it for now 🙂 We would probably take out a mortgage on it so that too much of our money wasn’t tied up into rental real estate, especially considering the somewhat low rates that are out there right now.

  13. These are all excellent considerations to understand when buying properties. I have actually encountered every one of them in my history of investing in properties. I think it is important to understant that your perspective may change as you get older, risk adverse, and have built more wealth.

    When you are younger, fearless, and risk taking: It is great if you can find the properties, do your own work on them, and manage them for maximum return. Put as little money down as possible, leveraging Other People’s Money (OPM), refinance later to use funds to buy the next property.

    When you are older, do little or none of the work, and have cash reserves:
    Continue to buy properties leveraging OPM. Aggressively pay of high interest notes and refinance when rates drop or you need cash. Have an entire team that manages your properties. Work toward paying them off so you have your passive income stream secure for life.

    I have moved toward the last phase! 🙂 

  14. Investment properties definitely seem like a fun way to invest your money into something you can actually touch and feel! My Mom is in real estate and has that same passion for investment properties that you do, she loves something tangible to be able to invest in.

  15. Looking forward to buying our first rental property. When we do we\’d like to go the 15 year mortgage route and use a property manager. So you get the leverage, and avoid some of the landlord hassles.

    Ideally, we\’d do periodic 1031 exchanges to grow into larger properties over time – house, duplex, complex. But we still have to take the first step…

  16. We currently own a single family rental that we have a mortgage on. I just think it makes more sense when you are just starting out and don’t have a ton of cash floating around. Our tenants pay the whole mortgage and then some!

  17. I like that you laid out the pros and cons of both choices and that you recognized that there’s not only 1 right answer for everyone. Thanks for sharing Greg!

  18. If only I have enough money to pay cash for my future house, I would definitely paid it with cash. But I also want to make sure that I have extra money and have a solid emergency fund.

  19. Owning a rental property is something that seriously interests me. We live in a city with quite a few universities as well, an airforce base which makes for an appealing market. My husband isn’t quite as keen though as we’ve had friend have tens of thousands of dollars worth of damage done because of renters and it’s just turned him off. Something we’re still considering for the future though 🙂

  20. We are half and half. One we bought in cash, and the other has a mortgage. They are a lot more manageable now. At some point, we had 7 properties and they became a nightmare. Both are empty now, the stress level is so much less as the carrying costs are not bad. We can afford to wait for good tenants, hopefully. I don’t think l would want to own anymore. We are loving the option of just “packing up and go”. It’s especially annoying managing things from another continent :-).

  21. Buying a property with cash anywhere here in Australia would take a LOT of cash. Too much to be practical for most folks.

    I’ve dabbled in rental properties before and been burnt. I’m not sure I’m ready to give it another go anytime soon, but I have a couple of friends who love it as much as you do. So, maybe I was just unlucky. Twice. 🙂

  22. I think leverage can be an amazing asset for turning real estate into an investment. But it can also be very restrictive. I think if I was buying a property with not too much required in the updates department I would put 20% down and pay that mortgage with the rental payments for the next 30 years. If I was buying a complete gut job, I’d consider cash because I have heard how restrictive the banks can be with those type of properties. Also depends on people’s personal feelings towards debt. Debt used to generate income would not bother me at all.

  23. Buying property in cash is ideal, but I can’t afford or do it. So, that leaves me with mortgage. And, I think that there is potential here especially in long-term investment.

    1. I live in Australia and that’s really only true if you insist on buying in the capital cities. We’re looking at investing in a regional town. The town has a depressed property market, but a very low vacancy rate and very low unemployment and lots of business and industries moving in. We’ve passed on two great properties with a guaranteed 4% return for the first couple of years (the renters are keen to stay and both take great care of their properties) because of the area they’re in – it’s a lower socio-economic area so the houses will only ever increase with the market. We’ve put an offer in on the stereotypical “worst house on the best street” – with about $2000 in materials and a few weekends of work we can increase its value by about $35,000, and then get about a 7% return through renting it out. The house is a foreclosure so we’re still waiting to hear from the bank. We only have normal, middle-class jobs but we can afford to pay it outright, which helps because, the shape it’s in, we’re not sure a bank would loan us the money! But the plan is to buy it outright and fix it up and then take out a mortgage to free up some cash for other investments. I don’t want to go too heavily into property; I want to diversify. My BIL owns more than a dozen homes in a regional town where both the rental market and property market have seriously declined; all heavily mortgaged, at least half of them are valued at less now than when he bought them, and he’s struggling to find renters. I would not be comfortable with that level of risk. I’d rather have some diversification.

  24. I bought three rentals during the downturn, when the prices were great. Then I refinanced two years later and got the money out, so they ended up costing me absolutely nothing, and I can invest that money elsewhere. I don’t have a high cash flow, but in 30 years (when I’m 65) my tenants will have have bought me three houses! That’s going to be a great retirement!

    Personally the mortgages are a great way to do it (and I couldn’t afford it otherwise), and I can make money at a higher rate than their interest. It’s not hard to manage once the auto payments are set up. The most important thing is to run the numbers before you buy so that you know the rent will be higher than your expenses each month.

  25. These are some great considerations to make in regard to cash vs. mortgage rental property purchases. My wife and I are currently evaluating rental properties in our area. We’ll probably end up going the mortgage route to free up our cash flow, but the risk of a mortgage payment is definitely something that we’re concerned about.

  26. A very timely post for us. We have been considering buying a rental property and I am leaning towards borrowing. My problem is it is a first for us and am still gun-shy pulling the trigger and committing to do it. I have nightmares about bad renter stories that make me wonder if I have the temperament to be a landlord.

  27. I’d prefer using mortgage as well only because I have no funds to pay cash. Your investment strategy of letting other people pay for your properties is just brilliant and would work even for those with not much funds to invest in property.

  28. suvra mitra says:

    thank you Greg for the clear explanation. Wondering if you could advise how /where to look at to buy investment properties.

  29. Lyle Gentry says:

    Who cares if the rental property increases or decreases in value? Why would you ever sell it? To me, a rental property is like a cash cow — it keeps generating that cash flow month-after-month. Selling it (especially after it’s paid off) would be like killing the goose that laid the golden egg. Keep the goose!

  30. So if I buy a home cash and rent it out. The amount I paid, can I deduct that as an expense?

    1. That’s probably a question for an accountant or lawyer, but in my experience no. You can not write off the purchase as an “expense” because that forms the “basis” in the property. However, you should write off the depreciation over 27.5 years. Certain closing costs may also be deductible as expenses. But again, check with your accountant/attorney.

  31. StillLearning says:

    Do you have any experience in owner finance properties or done any comparisons? I know it depends on the market as to if too many of these are available but we stumbled upon a few investment properties we owner financed from someone. We flipped one and owner financed out the other one since it was in too bad of shape to fix to flip or rent. We have now sold that property 3 times. Taking it back each time after default was not fun but each time produced a down payment which ads to your cash flow and the payments each month were made through an escrow company and were profit. We loved the flexibility to do payments, interest and terms we drew up. We have always wanted to do rentals and after this happening, we are thinking about trying to acquire more through this process we stumbled on since it requires no maintenance or responsibility like a rental and the income is still there. Long-term you would lose the money if they do indeed pay off the property but the income now and the fact that there is no loan might give you cash flow to get into more properties- at least that is what were are thinking. Any ideas/expertise in this? (We do think if it defaults again we might just rent it and keep it since every owner has fixed it up a bit and it is in much better shape then when we got it.)

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