Combination of Short Term Mortgage and Low Interest Rate May Be Dangerous

The advantages of paying a low rate of interest are obvious. There is, however, one situation in which a low interest rate may be a danger signal for you. That is in a situation where the mortgage is due in the near future. Suppose that interest on the mortgage is 4% and that a $1,000,000 balance on that mortgage is due now. Interest rates have gone up. When obtaining a new mortgage the syndicate will have to pay 6% interest. The yearly interest payments will amount to $60,000 instead of the $40,000, which were paid in the past. Where is that money to come from?
If you notice that a mortgage at a low interest rate is due in the near future, you must assume that a higher rate of interest will have to be paid when the time for renewal or refinancing comes along. Make sure that the projected distributions of the syndicate have been computed with a "cushion" sufficient to absorb the higher interest rates which are in prospect. Otherwise your distribution may decline sharply.

Good Mortgages Can Add to Profit

Most buildings are sold subject to mortgages. If you read the chapter on leverage, you will know that mortgages play an important part in the growth of real estate equity. Over the years, payments made on the mortgage from the income of the property reduce the mortgage indebtedness. As the indebtedness is reduced, the owner's equity in the building—the value of what he owns over and above the mortgage—increases.

If you want to know whether payments made to reduce the mortgage debt are really income, look at this example. Suppose you have a building for which you just paid $300,000 cash and which has a mortgage of $600,000. This is another way of saying that you owe $600,000 and that the building is security for the indebtedness. If presently you resell this building for $900,000, all you would get is $300,000 in cash. The buyer would purchase it, subject to the same mortgage debt of $600,000. Suppose now that you don't sell but instead hold on the to building, making regular payments on the mortgage until there is no indebtedness left. If you sell the building then for $900,000 you will be entitled to receive the full $900,000. So when paying out money to reduce the mortgage indebtedness, you have been building up your capital.

If a building is owned by a syndicate, the situation is identical. Payments made by the syndicate to reduce the mortgage will increase the syndicate's equity in the building. But whether you get your share of the syndicate's increase in the equity depends on the mortgage refinancing clauses of the syndicate agreement which you signed. More about that in the next chapters on mortgage clauses.

Next: Reasons for Mortgage Refinancing