We compared financing packages the other day for a senior assisted living property we are considering buying. Here are our options:
How do we choose? They both have fixed interest rates for 15 years, and both are due in 15 years. The interest rates are slightly different but one has a 15-year amortization schedule while the other is a 30-year. Let’s make sure everyone knows what an amortization schedule is: It is the amount of time that the loan payments are spread over. So when the loan with the 30-year amortization schedule reaches the term of the loan, a large portion of the principal will still be due. The 15-year one will be paid off in its entirety
Accordingly, the 30-year has a lower monthly payment. For example, a $600,000 loan on the 15-year amortization schedule has a monthly payment $4,692. The same loan on the 30-year schedule has a monthly payment of $3,343. That is a big difference of $1,349 per month. We already know if we pay less per month we will have more money left in our pockets. Is that good or bad?
Cash flow wise, money in the pocket is good. Obviously, paying a lower monthly payment gives the senior assisted living properties a better return. However, we will owe the money for a longer period of time, causing us to pay way more in interest over 30 years than we would over 15 years. In fact, a whopping $358,959 more in interest on the 30-year loan.
Let’s say we invest our $1,349 a month at a 10% rate of return for 15 years. We would have invested $242,820 and received $316,300 in interest for a total in our pocket of $559,120.So how do we decide which loan option to choose? The answer is very simple. If you can consistently invest the money you get to keep each month with the 30-year loan, and receive a higher rate of return than what you are paying in interest, you will be ahead of the game.
A remaining $413,697 would still be owed on the 30-year loan. You would have more than enough to pay it completely off, or better yet, keep the loan and keep investing the money.
So now we know. As long as the rate of return is greater than the interest paid on the loan, the better investment is to have the lower payment and invest the rest.