Making These Assumptions:

  • I have $1M, I want to buy a house which costs $1.5M.

  • I want to have a mortgage of $500K.

  • The interest rate on my mortgage is 2.5% annually.

  • Assuming I rent the house and the monthly income from it will be $4,000.

  • Assuming the Yield Curve is flat, meaning there is no change in the interest if I change the period of my mortgage.

For how long should I take the mortgage? As long as possible? As short as possible?

closed as primarily opinion-based by Hart CO, Dheer, JoeTaxpayer Jul 28 at 20:52

Many good questions generate some degree of opinion based on expert experience, but answers to this question will tend to be almost entirely based on opinions, rather than facts, references, or specific expertise. If this question can be reworded to fit the rules in the help center, please edit the question.

  • 1
    In your hypothetical, is there an early-repayment penalty? If not, it would seem best to get as long a mortgage as you can, and pay it back as quickly as you can. – Lawrence Jul 28 at 16:00
  • What about taxes, insurance, maintenance, and other costs associated with owning the house? – chepner Jul 28 at 16:31

It depends on if you can get a better return on your money than 2.5% (adjusting for tax deductibility of the mortgage interest). If so, you should get a mortgage for as long as possible. If not, as short as possible, while still being able to afford the payments.

  • Let's assume that the return on the money is greater than 2.5%, still- Why is it better for me to get a mortgage as long as possible? If I cover it as soon as possible, then I'll be able to enjoy the full return without the interest payments. Isn't it better? – Omer Jul 28 at 17:09
  • In short, leverage. The faster you pay down the mortgage, the less money you have available to put to work earning over 2.5%. If you can borrow money at 2.5% while earning more than that elsewhere, you absolutely want to do that as long as possible. In practice, investments that return more than the mortgage interest rate have risk and volatility associated with them, so it's not a free lunch. – Craig W Jul 28 at 17:27

Assuming taxes, repairs and insurance are covered by the renter, then the internal rate of return depends entirely on your assumptions regarding the salvage value of the home. If you assume the home will have no net value at the end of thirty years, then you will take an annual loss of 2% per annum. If you assume you will recover $1,000,000 nominal dollars then you will earn a two percent rate of return. If you assume a $1,500,000 nominal recovery then your return will be 3%. If you pay taxes, insurance and repairs, you will take material losses in the real world.

  1. Mortgage is borrowing money.
  2. Borrowing is like renting.
  3. Renting short term is cheaper than renting long term.
  4. If the rent rate is fixed but term is not, you want to "return" the rented money as soon as possible.

This means paying off the debt ASAP (even before it's due) to avoid paying interest. Sometimes, mortgages have an early payment clause that allows you to pay less than full interest if you pay ahead of time. Therefore, you should pay the full $4000 you get from rent towards your mortgage.

With this strategy, you will cover 48k of debt every year. Some of this will go to cover the scheduled payment, the rest will effectively remove the 2.5% APR of your remaining payments. Therefore, the part of this 48k that goes to covering a payment x years early is like an investment that will return 2.5% annually (may be less than 2.5% due to early payment fees) and has a fixed term of x years. I won't calculate the actual numbers here (unless you really want me to) because the calculation is tedious; one would use a mortgage calculator online. However, those tend to include also things like tax, which I assume don't apply in your hypothetical.

For how long should I take the mortgage? As long as possible? As short as possible?

As a pure hypothetical: As short as possible if you will have no other investments. However in reality you may not have the option of altering mortgage term, in which case you want the shortest one for which you can afford the monthly payments, and then overpay early on.

If you can invest in other things, you must ask yourself if you can do better than 2.5% annual return with the rent you have left over from required mortgage payments. If yes, then you must take the mortgage as long as possible, pay only the minimum payments, and invest all surplus rent to get the higher return.

In reality: Being a landlord, as well as any investment, has significant risk, requires non-trivial work and is subject to complex regulations depending on your locale. So it's not a simple decision. You also don't get to take the mortgage you want, you get to pick from the options that banks offer you.

As an aside, at 1.5M for 4k rent, you are shelling out 375k (you would pay even more, because you have to pay interest) for each 12k of annual rent. That's a buy-rent ratio of 31.25, which is among the highest in the US - it's between DC and Anaheim, CA. I question the wisdom of buying rather than renting is such renter-friendly market.

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