Paying off properties early....love it or hate it?

38 Replies

I've read a lot of the forum posts, blogs, and am on podcast 131 (working my way through them), and paying off properties early vs. paying them off over the life of the loan seems to be a fairly divisive topic.  Before I go any further, I'm talking about 30 year conventional mortgages, not hard money, portfolio loans, etc.  I'm also primarily interested in buy and hold investing.

On one side you have the folks that say don't do it.  Reason's I've retained:

  1. Minimize your own cash in a deal.
  2. Use someone else's cash to buy a property (the bank) and another person's to pay off the loan (the renter).
  3. Buy more properties (simplistic example: buy one 100k property cash, or finance four 100k properties).  This is likely the case, though can be more risky.

On the other side, paying off a mortgage early:

  1. Pay off a property and increase cash flow.  I understand some people claim this is a terrible idea.
  2. Less risk.  Jay Hinrichs points out in podcast 222 that one should pay off their properties sooner than later, in case something unforeseen/bad happens, you have multiple (good) exit strategies.
  3. You can leverage your properties. This is something I'm really excited about. I'm in the process of getting a HELOC with PenFed Credit Union, 80% LTV. I'll be able to borrow more cash than I have put into the place.
  4. The no good, terrible, very bad banks (joking) get less of "your" money in interest?

Right now I'm interested in either paying off a property completely, or doing delayed financing and having no cash in a deal. I'd like to buy another house and get it paid off asap, that would give me ~200k in usable HELOC cash between my primary residence HELOC and two investment properties.

That's just me.  What do others like to do, pay it off, or ride the mortgage wave?

It all depends on you , your goals , and your risk tolerance 

Originally posted by @Pat Jackson :

I've read a lot of the forum posts, blogs, and am on podcast 131 (working my way through them), and paying off properties early vs. paying them off over the life of the loan seems to be a fairly divisive topic.  Before I go any further, I'm talking about 30 year conventional mortgages, not hard money, portfolio loans, etc.  I'm also primarily interested in buy and hold investing.

On one side you have the folks that say don't do it.  Reason's I've retained:

  1. Minimize your own cash in a deal.
  2. Use someone else's cash to buy a property (the bank) and another person's to pay off the loan (the renter).
  3. Buy more properties (simplistic example: buy one 100k property cash, or finance four 100k properties).  This is likely the case, though can be more risky.

On the other side, paying off a mortgage early:

  1. Pay off a property and increase cash flow.  I understand some people claim this is a terrible idea.
  2. Less risk.  Jay Hinrichs points out in podcast 222 that one should pay off their properties sooner than later, in case something unforeseen/bad happens, you have multiple (good) exit strategies.
  3. You can leverage your properties. This is something I'm really excited about. I'm in the process of getting a HELOC with PenFed Credit Union, 80% LTV. I'll be able to borrow more cash than I have put into the place.
  4. The no good, terrible, very bad banks (joking) get less of "your" money in interest?

Right now I'm interested in either paying off a property completely, or doing delayed financing and having no cash in a deal. I'd like to buy another house and get it paid off asap, that would give me ~200k in usable HELOC cash between my primary residence HELOC and two investment properties.

That's just me.  What do others like to do, pay it off, or ride the mortgage wave?

I pay mine off early if possible. That way when I need the money it's right there as quick as a refi. 

"On the other side, paying off a mortgage early:"

1. Paying off property reduces cash flow based on it's opportunity value. @10% investors lose $833/month for every 100K in dead equity. High price to pay to purchase phantom cash flow.

2. High risk. If markets turn you lose your cash. IF it's mortgaged you lose their cash. Easier to walk away without loss.

3. Again high risk, better to hold your cash available outside of real estate. Instead of paying down mortgage place money in accessible investment vehicle. Better returns that prevailing mortgage interest rates.

4. If bank account or dead equity is the best you can do with your money you are a terrible investor and should not be risking your money in real estate.

Individuals that park their cash in real estate earn next to no actual returns compared to investors that leverage. A property that can not show positive cash flow with a hypothetical 100% financing will never show true positive cash flow no matter how much cash is thrown at it.

If you are only interested in "playing it safe" put your money in a savings account. 

I️ would say if you take cash flow and pay it towards a mortgage that that would be okay.

I️ know a lot of people love leverage here and a lot say keeping leverage forever is a good idea but eventually you probably want to decrease leverage some.

Little things I didn't realize at first:

1) on the one hand, mortgages are expensive (closing costs) PLUS you have to kick in a lot of escrow up front to cover insurance and taxes - this is a downside to the BRRRR strategy in my opinion

2) on the other hand, when you have a mortgage, the company takes care of the insurance and tax payments each month via escrow, so you don't even have to think about it - on my personal residence I'm letting a small balance stay mortgaged out of convenience

Its basic math.

1-inflation makes the loan cheaper the longer you hold it.

2-if the bank loans you money at 4% but you can take that money elsewhere and get >4% you should. 

*bonus-interest write off for tax purposes 

Originally posted by @Thomas S. :

"On the other side, paying off a mortgage early:"

1. Paying off property reduces cash flow based on it's opportunity value. @10% investors lose $833/month for every 100K in dead equity. High price to pay to purchase phantom cash flow.

Thomas, can you elaborate on this math.  You're one of the posters on other forum posts that caused me to really wonder about this question!  

Leverage is more profitable and less risky when you do the math, paying things off just makes you FEEL better, but it's not any safer. Trading 100K in cash for 100K in equity isn't some magic risk mitigation, it's just magic thinking.

"I'll pay my loan off, then if I need the money, I'll just get a loan" - flawless logic.

For me it makes sense to keep equity in the properties UNTIL I need it for a deal. Finding good deals is the hard part, so no sense in pulling my equity out and having to pay principal and interest on it if I don't have good use for the cash.

That is why I like to keep some solid equity in the properties and utilize lines of credit when I come across something good. I'm averaging around 40% equity right now (some at 60 and others at 5!).

I'm not rushing to pay down my loans, but I do like to see them go down. I just like to put down 20% when possible and chip chip chip away at it every month.

"can you elaborate on this math."

Investors value cash above all else. Assuming you assign it a return rate of minimum 10% that is it's opportunity value. The return you could earn on it if invested. Many investors require higher returns.

This means for every 100K in equity you must pay it $833 (10%)/month.

 Equity is reducing your properties cash flow by the 10% it deserves as it's lost opportunity value.

Rent - (return on equity + expenses + debt repayment) = cash flow

True Positive Cash flow is generated only by the property.

Investors that believe paying down a mortgage increases cash flow do not understand the value of cash and as a result lose money on their investment in many cases.

@Thomas S. I just started to follow this post, is your math saying that it would be easier to achieve that $833 a month if you had multiple properties for that 100k in equity. Rather than taking the 100k and spending it in one place trying to achieve the $833 mark? 

You say that the equity is reducing the properties cash flow by the 10% it deserves as the lost opportunity value. How would someone be able to reclaim that opportunity value? Pardon my ignorance, but what is opportunity value, is it just money that could be spent somewhere else, and what does it have to do with the return rate? 

Also, based on your formula, wouldn't owning it free and clear erase the "debt repayment" portion of the equation, actually increase the monthly cash flow. I know that owning it free and clear and paying it down faster are two different things, and that it causes your money to be slow. I am just trying to understand things here a little better. 

Thanks! 

Thanks @Thomas S.

Do you take into account the work/time/hassle to continually acquire more properties?  I totally get what you're saying, but what about the point in many (hopefully me one day) investors life where they want to not do much of anything besides enjoy passive cash flow?  When I'm old and not wanting to do much of anything, I'd rather have fewer paid off properties (higher cash flow) than more financed properties.

I know this isn't what you're arguing, but how do you factor this in?

Perhaps more up your "losing the 10% alley", how do you feel about HELOCs? You can't have a ton of them, but if you have a have a paid off $100,000 property that cash flows $500 a month (rough use of the 50% rule) AND you have a HELOC where you can indefinitely borrow $80,000 and pay ~5% interest only payments for the first 10 years (I'd pay it off more quickly and use it again and again), does this pencil out to be worth it?

I appreciate your detailed response above by the way!

@Pat Jackson - what he was trying to say is that capital you have in the form of equity in a property is not working for you. If you have a property worth 200k, and it goes up in value by $6k in a year, it doesn't make any difference if you have $0 or $100k in equity in the property, it will go up by the same $6k in either case.
Now, for example suppose you are an investor who can earn 10% on your money - you can take $100k and earn $10k per year, which is $833/month ($10k/year divided by 12months). Thus if you choose to leave your hypothetical $100k in the form of equity in your property, you miss out on the opportunity to earn $833/month on this money. That $833 is called the Opportunity Cost of the money - its the difference between the return you are actually making on the money ($0 if you leave it as equity) and the return you could make ($833/m) if you invested elsewhere.

It depends on your goals, which is also another way of saying it depends on where you are in life.

If you are young (or young at heart) and still growing your portfolio, I think it makes sense to use leverage to grow it as quickly as is prudent.

If you are getting closer to retiring and/or you are no longer growing your portfolio, it makes sense to start paying everything down.

@Lisa Foreman :

If your loan is less 80%  (it may be higher as it depends on the bank), escrow and insurance as part of the monthly payment are not a given.  You might be given the option to pay directly.  That's been my experience with both a heloc and a mortgage that were less than 80%.  I've only needed to provide the bank with an updated insurance statement each year at renewal.  

@Pat Jackson

Regarding the original post, there are as many answers to the question as there are strategies for investment.  The answer depends on what the investor plans to do next.  

Say the mortgage in this example is a 30 year conventional fixed rate mortgage at 4%.  

Is there a use for the cash that is of greater risk-adjusted benefit to the investor than a guaranteed 4% return?  If so, it may be advantageous to keep the mortgage debt and put the cash to work elsewhere.  

If not, then paying down the debt could be the best return that the investor has available at the moment.  

In 1997 (20 years ago), the 10-year treasury rate was 6.58%.  What if the rate is also 6.58% in 2037 (20 years from now)?  Quickly paying off the 10 years remaining on the 30 year mortgage at 4% may not be as simple of a decision.  

One thing about debt instruments:

Both a HELOC (when drawn) and a mortgage are loans secured by your property. What makes one advantageous over the other is the intended/proper use of the funds.

The saying goes that "time is money".  What should also be understood is that money is time.  Interest paid to the big bad banks is just a fee for the purchase of time.  It's all about how we use it.  

Great discussion!

I agree this is a good discussion.  Does anyone ever see any benefit to paying off a property early to:

  1. Qualify for another conventional mortgage?
  2. Pay off a few then lump them into a portfolio loan, and either do a cash out or HELOC type situation?

I was thinking about this earlier today actually. If I paid off both of mine I would make $4k a month. If I buy another apt building in the next year and pay them all off I could get it close to 6 which is what I would want.

I don’t think it’s a bad strategy but doesn’t use leverage for long term growth!

Jordan Moorhead, Real Estate Agent in MN (#40542303)

I have found myself thinking about this often but I think its because we have been trained to think all debt is bad. In reality leverage is what makes REI worth it. If I was going to pay off a property it would be my primary residence since it is protected by the homestead exemption in Texas. My rentals are not protected and if I was sued for some reason then the paid off rental would be up for grabs possibly. In that situation losing a mortgaged property at 75% LTV would not sting near as much as losing the entire value of the property. Its an asset protection decision as much as it is a return on your money decision. I get the idea of feeling good about paying off a property though, but when I think about paying off a 3.7% interest rate on my primary residence I quickly come to my senses. If I was 65 or 70 perhaps, at my age now nope.

Originally posted by @Pat Jackson :

I agree this is a good discussion.  Does anyone ever see any benefit to paying off a property early to:

  1. Qualify for another conventional mortgage?
  2. Pay off a few then lump them into a portfolio loan, and either do a cash out or HELOC type situation?

 1-My experience is that banks value cash more than equity.

2-Not in my opinion this is the same argument just on a larger scale. 

I've come to the conclusion that it depends on your strategy.

If you want to "build wealth" then leverage yourself to the hilt, pray there isn't a downturn, and "let your tenants pay down the debt".  Keep in mind, this is not a form of financial independence - you are still working for the bank and making money for them. Working to ensure you can pay that mortgage every month, on top of property taxes and insurance and repairs, is a JOB.  (that comment will upset folks - but that's my position on the matter).

If you want mailbox money/extra cash/cash to live on every month, then pay cash or pay off the houses as quickly as you can.  When you're cash flowing $100 per month net because you are leveraged, it takes a lot longer to recover from replacing a roof or a water heater or a furnace, than it does if you're cash flowing $500 per month net.  You'll also sleep better at night when there's a downturn in the market.

(720) 598-0793

If you get rent as cash or equity it goes toward your net worth both ways. You use your net worth to leverage to get more opportunities; cash or HELOC, both accomplish the same thing. There are other factors to consider like liability, interest payments, etc but all "problems" have a solution if you're willing to find it. A robust legal structure can protect from liabilities or savvy tax strategies can make interest work for you.

At the end of the day it's about what processes of transactions you prefer. 

Net worth is nice on paper, but you cant eat it, or put it in your gas tank. Cash flow pays the bills. 

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