If you are buying rental property as an investment, one strategy is to buy this house for all cash. That will increase your chances of getting a cash flow return from the property because you won’t be paying interest on a mortgage.
Suppose you buy a house for $120,000 in cash and rent it to a tenant who pays $1,200 a month, or $14,400 a year. Further suppose that you pay $7,000 per year for property tax, insurance, maintenance, landscaping, repairs, and so on. You’d be left with $7,400 in net cash flow, a return of over 6% on your $120,000 purchase price.
What if you don’t have $120,000 to invest? You could get a mortgage, if you qualify, but you might have to make a $48,000 (40% of $120,000) down payment to buy a $120,000 property. You’d borrow $72,000, in this hypothetical example.
Assume you can borrow at a 6% interest rate, so you’d pay $4,320 a year in interest, on a $72,000 loan. Instead of $7,400 in net income with an all-cash purchase, you’d net $3,080 after mortgage interest, a return of about 6.4% on your $48,000 down payment.
The bottom line is that either an unleveraged or a leveraged investment in rental property can pay off, if you buy at the right price and receive substantial rental income. Using leverage (borrowed money) will work out better if your property eventually appreciates in value.