In my post entitled Term Preferences. How Long is Long?, I recounted the story of a property owner who made a Mortgage Term Choice, electing a 20 year mortgage term, at 18.25%, in the early 1980’s. In hindsight, it’s easy to pass judgement on that particular decision. What is now easily forgotten, but critical at the time, was the owner’s motivation. They were in a highly competitive retail segment. What they needed as much certainty as possible, in their non-core business. They had to concern themselves with their particular product’s market share, import costs, export markets, and the fickle taste of consumers. Worrying about the threat of even higher mortgage rates, a distinct possibility during those turbulent times, was the last thing they wanted to worry about.
What length of term is appropriate for you? Let’s consider 5 important motivating factors:
Are you a property owner/user?
If you own real estate for your business, and its your intended place of business for the long term, select a longer term mortgage if you are comfortable with current rates. You likely have enough to worry about with your operating business. Trying to outsmart the market on mortgage term and interest rates is not what you should be focused on.
Are you an investor with a short term investment horizon?
Consider a short (<5 years) term mortgage. Why? Since you are creating value for the purpose of a quick flip/sale, having a longer term mortgage in place may only present an obstacle to a quick sale. You’ll likely be faced with a prepayment penalty, depending upon where current rates are, relative to your contract rate. As well, your buyer will likely be bringing their own financing to the table. While loan assumptions are possible, they are considered new business by institutional lenders. Consequently lengthy underwriting and processing time, and possibly assumption fees and borrower qualification tests are likely.
Are you looking to access/release your equity?
Perhaps your leases are rolling over and increased income is anticipated. While you may not be a seller, you will be generating additional income and creating value. A short term mortgage will allow you to renegotiate for an increased loan on a longer term, once you’ve solidified rental increases. Opening up an existing loan mid-term, to access and release your increased equity, can be costly or even unavailable. Furthermore, secondary financing, in such a circumstance could be costly or inappropriate.
You’ve got no immediate plan to sell over the medium term.
You may have leases with negligible upside in rents, and consequently only nominal property appreciation is expected. You don’t anticipated requiring an increased mortgage amount. Your leases may typically be 5 years in duration. Consider a 5 year mortgage term. Funds are typically plentiful, and you will have a wide variety of lenders to choose from.
You’ve got a long term investment horizon.
While less common, its tempting to lock in to a longer term loan loan given today’s historically low interest rate levels. The difficulty is that few investors know with any certainty what their plans might be for a property that far down the road. Similarly, locking in for 10 years or longer, would perhaps only make sense if there were reason to believe that significant rate increases were inevitable over the mid term.
Your decision is entirely a function of your motivation. The “sleep at night” factor is a strong motivator for a longer term facility. However if you are “creating value” over the short term, don’t discount the appropriateness of taking a short term facility at the outset, locking in the appropriate financing once you’ve stabilized your property’s income.