Real Estate Investing Basics

3 Reasons to Consider NOT Paying Off Your Mortgage

Expertise: Business Management, Mortgages & Creative Financing, Landlording & Rental Properties, Real Estate Investing Basics, Personal Finance, Real Estate Deal Analysis & Advice, Commercial Real Estate, Personal Development, Real Estate News & Commentary
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Over the years, I’ve noticed that one thing is certain: Markets will go up, and markets will come down. At times, your investments and businesses will follow suit. This is probably why financial planning and asset protection strategies exist—to protect us from those unpredictable market shifts.

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Personally, I can’t stress the importance of risk management enough. It makes so much sense to me that investors or business owners would employ strategies to “sweep” their accounts and periodically take risk off the table by moving their capital into safer investment vehicles.

Despite the very real (for some people) emotional appeal of owning your real estate free and clear, from a risk management perspective, it probably comes as no surprise that most planners frown on the accelerated pay down of mortgage debt and usually prefer seeing their clients separate their cash from their properties.

In other words, planners usually aren’t big advocates for using your real estate as a savings account.

Still, it seems that many real estate investors ignore this concept, and instead they choose to leave their cash tied up in their properties as equity.

So, why the disconnect? Should investors consider adjusting their strategy?

FNMA-homestyle-mortgage

3 Reasons to Consider NOT Paying Off Your Mortgage

1. Risk Management

In 1997, I moved to a nicer area outside Philadelphia and got a good deal on a property for $190,000. Shortly thereafter, it jumped up in value to $250,000 and I refinanced, and then again years later, I refinanced again. Eventually, I had a first mortgage for $354,300 and a home equity line of credit (HELOC) for $118,000. It was at the height of the market, the property had appraised for $525,000, and then BOOM, the market fell like a rock. Suddenly, I was lucky to get $400,000 for the place, and the bad news was it stayed there for almost 10 years.

Related: What’s Better Financially: Paying Off Your Home Mortgage or Investing That Money?

If I hadn’t separated my equity with the HELOC to use for other real estate and note deals or if I had paid down debt and had been forced to sell, I could have lost a lot of money.

A similar scenario happened when I bought a rental property, a cute 2-bedroom row home off an estate for $62,000 that cash flowed nicely, and then the market again dropped dramatically to where it was only worth about $35,000. Luckily, it still cash flowed, and I didn’t need to sell, but what if I did? Or what if my heirs did? They would have taken a pretty good hit.

2. Access and Liquidity

Another strategy is to keep your cash or money from equity in another safe bucket. For example, if you own $3 million in real estate with $2 million in mortgage debt and have $2 million in cash in bank accounts or other liquid investments, isn’t that much safer than using liquid investments to pay off the mortgage debt?

Remember that the bank even more than the borrower is at risk when a property is mortgaged. How does it serve you, from a risk-management perspective, to take the bank’s risk off the table and increase yours by paying down the mortgage?

And if you’re thinking to yourself, “OK, but what if I were to die and leave my heirs with this debt…?” Good question, but couldn’t it be addressed by a $2 million life insurance policy on top of your liquid cash?

3. Estate Planning

If you’re doing your family a favor by thinking ahead about estate planning, ask yourself: Isn’t it better to try to hold onto the real estate until after you pass on, so your heirs get a stepped-up basis? Don’t they have more options with the liquidity or cash in a safer vehicle and any insurance proceeds, as well as the option to keep, sell, or pay off the real estate you’ve left them?

For some crazy reason, my heirs really don’t want my real estate or landlord headaches. What they really want is the money or cash flow. So, does it actually help them when we pay our real estate off?



Related: Are Extra Mortgage Payments Worth It? A Look at the Numbers

After all, aren’t we just renting space on this earth while we’re here, anyway? I’m not so sure we ever really own our real estate. Try to stop paying your taxes and in approximately two years you’ll see who really owns it: the government.

So, when it comes to managing my own portfolio and finances, I’m a pretty firm believer in separating the cash from my real estate by putting my equity in safer, more liquid vehicles. That approach gives me access to the cash rather than some artificial equity number on a spreadsheet because “equity” (an artificial construct based on market psychology as much as anything) will rise and fall.

That said, I’m curious to hear other real estate investors’ thoughts on this topic.

Do you think it’s a good or bad idea to use your real estate as a savings account?

Since 2007, Dave Van Horn has served as president and CEO of PPR Note Co., a $150MM+ company managing funds that buy, sell, and hold residential mortgages nat...
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    Jacob Stoecker from Minneapolis, Minnesota
    Replied almost 2 years ago
    If I purchase a property with a mortgage and transfer it to an LLC and after several years want to pull out equity what loan options are typically available to property in an LLC? If I take cash out does that have to be used within that LLC or can I take a distribution out of the LLC? Thanks for the input.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 2 years ago
    Hi Jacob, The risk here is the bank can call the due on a sale clause in certain states meaning they can call the loan in full. You may be able to get a commercial blanket or commercial line of credit in the LLC. In most cases, I hear people transfer it back out of the LLC (or trust), get the financing and put it back in. There’s still a risk any time you change title of them calling the loan though or the state hitting you with multiple transfer taxes. Best, Dave
    Matthew Johnson Rental Property Investor from Houston, TX
    Replied over 1 year ago
    Great article. thank you for taking the time to share this with the community!
    Matthew Koch Investor from Twin Falls, ID
    Replied over 1 year ago
    Well this article does have some excellent points of views from the different contributing members My overall thousand foot view on the subject I can’t help but to think that the strategy I would invoke on a situation such as these is in similar fashion to the way that I play Blackjack down at the casinos cuz I start with $20 and I play a little bit and if I have $5 one I put that aside another $5 one I put that aside but eventually the end of the night I have $100 that I made from $20 and that’s my profit and I go home after that sometimes yes I do lose it all but I’ve only lost $20 so can that same concept be applied with hundreds of thousands for $1000000 and instead of putting the money into another home for Equity values or CDs I personally would consider the Roth IRA or the self-directed IRA that can’t be touched by the government to be pulled out of it only put so much in after your expenses are paid and you have monthly cash flow of a certain amount then take half of that and put it in that Ira so that will always grow you will always have money and it can’t be touched even if the market crashes now again I may be a newbie on this type of subject but I just assumed that’s a more feasible option it’s not even have to worry about equity we’re having money tied up in a property.
    Jason R. Real Estate Investor from Orlando, Florida
    Replied over 1 year ago
    “In 1997, I moved to a nicer area outside Philadelphia and got a good deal on a property for $190,000. Shortly thereafter, it jumped up in value to $250,000 and I refinanced, and then again years later, I refinanced again. Eventually, I had a first mortgage for $354,300 and a home equity line of credit (HELOC) for $118,000. It was at the height of the market, the property had appraised for $525,000, and then BOOM, the market fell like a rock. Suddenly, I was lucky to get $400,000 for the place, and the bad news was it stayed there for almost 10 years.” So in other words, you over levered your debit. And your want others to consider not paying down there debit and leveraging? Where is the logic in that?
    Katie Rogers from Santa Barbara, California
    Replied over 1 year ago
    At the height of the market. appraisers, lenders, agents, homeowners really believed that the house were worth those inflated values, never mind that house value had become unhinged from wage levels even though wages pay for houses. There was plenty of media attention to the fact that houses were unaffordable, but most people ignored what was right in front of them. When you are evaluating your house’s appreciation, it is better to stay on the safe side and figure the appreciation at the historical 2.5% annually. Remember reversion to the mean. At the moment you sell, you might realize a higher appreciation rate. If so, consider it gravy. At least, you did not make leveraging decisions based on ridiculous assumptions like house values can only go up.
    Jason Oberweis from Atlanta
    Replied over 1 year ago
    “A similar scenario happened when I bought a rental property, a cute 2-bedroom row home off an estate for $62,000 that cash flowed nicely, and then the market again dropped dramatically to where it was only worth about $35,000. Luckily, it still cash flowed, and I didn’t need to sell, but what if I did? Or what if my heirs did? They would have taken a pretty good hit.” How is it bad for your heirs to inherit a cash flowing $35k house rather than a $62k house you have no mortgage on? Inheriting something is better than nothing. Also, your first example with the HELOC – a bank can call in your HELOC at any time! They can easily say ” Your interest-only line of credit is ending and payment of the full balance will be due.” This is what happened to many investors back in 2009-2010. How is this scenario safer for you if your whole $118k line is due in 30 days and it’s all drawn? Oh right, you’d have to sell other assets, now worth less than they were because of the same recession that is forcing your credit line due.
    Katie Rogers from Santa Barbara, California
    Replied over 1 year ago
    “Remember that the bank even more than the borrower is at risk when a property is mortgaged.” Not really. All lenders have mortgage insurance, and YOU pay the premium if your down payment was less than 20%.
    Caren E. from Baldwin, Maryland
    Replied 18 days ago
    What an excellent article! Love the point about taking out life insurance so your heirs can pay down remaining debt. I also like the concept of not tying up all of your money in a property. I will add the converse is also true- don’t tie up all your money in the stock market.