How Loan Amortization Benefits Real Estate Investors

By Author: James Kobzeff
Total Articles: 44
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One of the benefits of getting a mortgage loan to purchase investment property is the ability it gives investors to own an asset without having to fund the entire cost of the asset themselves. When a lender comes on board it effectually means that a real estate investor can own an investment property with less risk at a better return on investment and perhaps leaves enough money remaining in the investor's nest egg to buy one or two more real estate income properties.

Yes, maybe you can write a $1 million check to cover the purchase price of the apartment complex you covet. But how much sweeter if you can write a check for just $300,000 and get a loan for the balance-you become the landlord of that complex with $700,000 left over to invest elsewhere.

Fair enough.

The downside, of course, is that a loan requires payments. The real estate investor is obligated to make monthly or annual payments to the lender (usually monthly) for the money that was borrowed. So how does the amortization for this newly acquired debt service benefit the real estate investor?

Foremost, understand that amortization is ...
... the liquidation of this debt by the application of installment payments over time. Therefore when the loan is amortized (i.e., not interest-only) each mortgage payment includes both interest and principal which in turn reduces the mortgage by the principal amount applied in each payment.

Okay, now consider that with most investment properties rental revenue makes up all or nearly all of the cash inflow required to make the loan payment. In other words, it is your tenants who pay your mortgage.

So when you use a mortgage loan to purchase the income property, it is your tenants that give you the cash needed to pay down that debt, and as a result they are helping you buy the property.

Formula

Debt Service
less Interest Paid
= Amortization

Example

Say during the first year of owning the apartment complex that your annual loan payments total $45,093 of which $34,765 is for interest. Then the amortization for that year would be $10,328 which means that your tenants (by virtue of paying you rent to occupy the property) paid your mortgage down for you that year in the amount of $10,328 and therein increased your equity in that property at least by that amount.
James Kobzeff is the developer of ProAPOD - superior real estate investment analysis software solutions since 2000. Create rental property cash flow analysis and marketing presentations in minutes! Easy to use and affordable. Learn more => www.proapod.com