Pay off mortgage and snowball?

59 Replies

Hey everyone, I accomplished my goal of getting my first rental property under contract by the end of 2017 and I close on this property soon. I have been calculating the best way to grow my portfolio, but I am curious if anyone else has worked to pay off the mortgage completely and then saved all the additional cashflow for their next property?? Then repeat for a snowball effect. Obviously would be a slower process, but would create very little debt hanging over your head. Let me know your thoughts. Thanks!

@Ryan Crowley some will tell you that you should borrow all you can and put no money in the deal, but most of those people don't have a portfolio of property and therefore don't know what they are talking about. You snowball plan has a very high success rate. A paid off property throws off more cash than a leveraged property. It is a get rich slower scheme, but with less risk.

You could do it your way but I’d recommend a bit of a hybrid model. Acquire 8-10 rentals and then start paying them off, using the combined cash flow to put towards one mortgage. If you have a day job you could combine both and make it go even further

I agree with @Caleb Heimsoth . If you do your idea on one property, you'll be sitting and waiting a long time to pay off that mortgage before you then use that money to buy another property. All the while you could instead be putting that money into a new property (or properties) more quickly. While slow and steady does win the race, your plan would be reeeealllly slooowww. If you just flat aren't comfortable with debt, then that's one thing, but I don't get the impression that's necessarily the case. You don't have to go wild with it, but you can work it a little faster to help yourself along.

Originally posted by @Anthony Dooley :

@Ryan Crowley some will tell you that you should borrow all you can and put no money in the deal, but most of those people don't have a portfolio of property and therefore don't know what they are talking about. You snowball plan has a very high success rate. A paid off property throws off more cash than a leveraged property. It is a get rich slower scheme, but with less risk.

How do you figure a paid-off property throws off more cash (per month, yes, but in comparison to how much you put down?), and how do you figure there's less risk?

@Ali Boone a property that is owned free and clear, has no debt therefore you get to keep more of the gross rent. This means more cash in your account each month than if you pay a mortgage. Not as a percentage, but actual dollars.

Less risk because a house that is paid for cannot possibly be foreclosed on. So, if the tenant doesn't pay, skips out after damaging the property, and it stays vacant for two months it's OK because you don't owe anything on it. As opposed to the same scenario, but you still have to pay the mortgage. See?

Originally posted by @Ryan Crowley :
Hey everyone, I accomplished my goal of getting my first rental property under contract by the end of 2017 and I close on this property soon. I have been calculating the best way to grow my portfolio, but I am curious if anyone else has worked to pay off the mortgage completely and then saved all the additional cashflow for their next property?? Then repeat for a snowball effect. Obviously would be a slower process, but would create very little debt hanging over your head. Let me know your thoughts. Thanks!

 If you were immortal, or the interest rate was obscene, it's not a bad plan because it is lower risk. But if you have to make up time, so to speak, it's hard to do without using leverage. I have a mostly cash portfolio but have, and will continue to use leverage when it makes sense. The key to using leverage is to still have a lot of equity in the deal, have a lot of liquid cash to cover issues, and make sure the property has strong cash flow either way.

Originally posted by @Anthony Dooley :

@Ali Boone a property that is owned free and clear, has no debt therefore you get to keep more of the gross rent. This means more cash in your account each month than if you pay a mortgage. Not as a percentage, but actual dollars.

Less risk because a house that is paid for cannot possibly be foreclosed on. So, if the tenant doesn't pay, skips out after damaging the property, and it stays vacant for two months it's OK because you don't owe anything on it. As opposed to the same scenario, but you still have to pay the mortgage. See?

 Less risk as far as a debt note, that's true, but debt is not the only risk to be managed. Risk entails everything from lawsuits to lack of diversity in investments to low rates of return to high exposure to vacancy (more units theoretically lowers vacancy exposure). There are also some benefits to leverage such as tax breaks that lowers the effective cost of borrowing the money. And a debt note is only part of the cost of owning a property; not paying taxes will get a property foreclosed; not paying insurance can present huge exposure to damages. If the place is vacant, you are still taking that money out of your own pocket.

I don't disagree with having a strong cash position; most of my properties are f&c. But leverage is a useful tool, just know when to use a hammer and when to use a screwdriver.

@JD Martin taxes and insurance are not debt. Those are things you pay regardless of debt. The risk I am talking about is the financial risk to repay a debt. If everything goes perfectly, the tenant pays the debt. This is not a perfect world, therefore increasing your debt increases your risk.

Originally posted by @Anthony Dooley :

@Ali Boone a property that is owned free and clear, has no debt therefore you get to keep more of the gross rent. This means more cash in your account each month than if you pay a mortgage. Not as a percentage, but actual dollars.

Less risk because a house that is paid for cannot possibly be foreclosed on. So, if the tenant doesn't pay, skips out after damaging the property, and it stays vacant for two months it's OK because you don't owe anything on it. As opposed to the same scenario, but you still have to pay the mortgage. See?

I see. Ultimately I don't agree though. Yes, your stance is true if someone is irresponsible with how they buy- like if they get a mortgage and don't keep money in reserves to cover vacancies or other emergencies. But in smart buying, if someone has enough cash to pay cash for a property, they could easily stash a good chunk of that away to cover downed months and still leverage to increase the overall returns on their portfolio. In general, assuming someone isn't a complete doof when they buy, I don't think leveraging is as risky as people tend to think it is. Details here- 

https://www.biggerpockets.com/renewsblog/2014/01/04/leveraging-really-risky/. 

I disagree about the dollars though. Yes, you bring home more each month but when you compare the amount you bring home versus how much you had to put in, the returns are typically significantly lower on your money when you pay all cash. Your argument would suggest that if I bring home $2k/month in cash flow from a rental property in LA (where I live), that's a good deal, even though I probably had to put $2M cash into it initially. That is, then, a horrible return.

Originally posted by @JD Martin :
Originally posted by @Anthony Dooley:

@Ali Boone a property that is owned free and clear, has no debt therefore you get to keep more of the gross rent. This means more cash in your account each month than if you pay a mortgage. Not as a percentage, but actual dollars.

Less risk because a house that is paid for cannot possibly be foreclosed on. So, if the tenant doesn't pay, skips out after damaging the property, and it stays vacant for two months it's OK because you don't owe anything on it. As opposed to the same scenario, but you still have to pay the mortgage. See?

 Less risk as far as a debt note, that's true, but debt is not the only risk to be managed. Risk entails everything from lawsuits to lack of diversity in investments to low rates of return to high exposure to vacancy (more units theoretically lowers vacancy exposure). There are also some benefits to leverage such as tax breaks that lowers the effective cost of borrowing the money. And a debt note is only part of the cost of owning a property; not paying taxes will get a property foreclosed; not paying insurance can present huge exposure to damages. If the place is vacant, you are still taking that money out of your own pocket.

I don't disagree with having a strong cash position; most of my properties are f&c. But leverage is a useful tool, just know when to use a hammer and when to use a screwdriver.

Totally agree. (and I love your guitar pic!! :) )

@Ali Boone Why would someone need cash reserves for vacancies or emergencies? Because they perceive risk. Being a responsible person has nothing to do with the financial calculation for rate of return or cash flow. 

Maybe the reason you disagree with the dollars is that you are comparing a cash on cash rate of return with actual dollars. This is two different things. I would rather earn $2000 per month at a 12% rate of return than $500 per month at a 1000% return. I can't buy gas with a percentage. Please try not to confuse two totally different aspects of investing when giving advice. In the end, we are all on the same team here.

This is a hot topic, and something I go back & forth on. Having a free & clear property has lots of benefits. The savings on interest alone are huge & why I'd like to pay the properties off asap. On the con, free & clear, you have more to lose in a lawsuit. Also, steering as much cash flow back into the property just to have dead money (aka equity) sitting in the property is not of much use either. One way is not better than the other. Simply what fits your style. I'm still not sure which I prefer.

Comes down to personal values, goals, risk tolerance, and time. If your goal is to get as rich as possible, max leverage will do that for you. Tradeoff is you will have thinner margin for error, maintenance, softening market, etc. You'll have to operate at peak efficiency to make good money, which means more time, stress, and headache. 

I'm someone who values peaceful life and time to the extreme. I like a mixed approach best. Pick the amount of income you want real estate to provide you, and buy the amount of units you'd need, such that if they were paid off, you'd hit your goal. Once you have that amount of units (leveraged), focus on paying those off via snowball method. Going one by one is too slow.

I would definitely acquire more before I started accelerating,  especially if fixed rate resi loans in the 4s.

I heard and liked the idea of getting 5 houses, or 8 like All says, first.  Not every time you want to buy a deal will there be one.  I have found it comes in waves or droughts. 

I paid off 19 units last year - 17 apts, a store and a house. I had a huge opportunity fund earning nothing and my rates were above 6% and/or commercial loans that were callable, adjustable and bothering me every year for my financials. Good riddance. 

Even I keep long term, fixed rate residential loans below 5%. My next couple I'm paying off are seller financed with older folks @ 6 & 6.5% and I still have an opportunity fund  in case something comes up. Enjoy these rates. Not long ago a good rate was 6.5% 30yr fixed!

Originally posted by @Anthony Dooley :

@Ali Boone Why would someone need cash reserves for vacancies or emergencies? Because they perceive risk. Being a responsible person has nothing to do with the financial calculation for rate of return or cash flow. 

Maybe the reason you disagree with the dollars is that you are comparing a cash on cash rate of return with actual dollars. This is two different things. I would rather earn $2000 per month at a 12% rate of return than $500 per month at a 1000% return. I can't buy gas with a percentage. Please try not to confuse two totally different aspects of investing when giving advice. In the end, we are all on the same team here.

I don't remember ever giving anyone any advice. And you'll have to specify exactly which two totally different aspects of investing I am confusing because I'm not sure on that one.... cash-on-cash deals directly with actual dollars. It's the cap rates that don't always deal with direct dollars and instead talk in percentages (unless you pay cash for the property).

Okay let's see.... ($2000/month = 12% return) vs. ($500/month = 1000% return). If I convert those monthly nets into annual nets and plug those in to see what amounts of cash in would lead to those results in each case, I come up with:

Scenario 1: $2000/month ($24000 annual) to equal a 12% return means you're in $200,000 cash

Scenario 2: $500/month ($6000 annual) to equal a 1000% return means you're in $600 cash.

So I can put in $600 of my own cash and have a 1000% return, or I can put in $200,000 cash in and have a 12% return.

If I had $200,000 cash and instead of investing it all in one place to get a 12% return, I could buy as many of those $600 deals with 1000% return and make, let's see... with $200,000 I could buy ~333 of those $600 deals that make $6000 annually... so that's 333x6000 = $1,998,000. So basically $2M annually.

So I could spend $200k and make $24,000 in a year, or I could spend $200k and make $2M in a year. We both know the numbers you used (mostly that 1000% return number) aren't practical, but humoring them paints an interesting picture about the financial advantage of leverage. No?

Anywho... I don't think this is the place to dive heavily into the pay cash or leverage debate as it's getting away from the poster's original question. Plus, as everyone knows, everyone has a different stance on whether to pay cash or leverage. To each their own! (I personally prefer $2M/year and I think that cash flow is plenty enough to cover any mortgage risk along the way, but there's no doubt some people would feel more comfortable sticking to the $24,000/year and that's totally cool too!)

Like @Ali Boone said, the ROI or Cash on Cash return diminishes when you don't leverage them. But if that's what it takes to sleep at night, it might be worth it.

The one catch to that is that real estate is not your only option of investing. A very attainable "deal" in my area are houses that would follow the 1% rule. So let's say I get a $100k house that rents for a $1000. If we assume 50% rule, $500 goes to expenses, then I deduct somethign like $250 out for mortgage. I cashflow $250. 

If I assume 20% down, that's about 15% cash on cash return. That's pretty good compared to most opportunities.

Let's now assume I paid all cash. I still have $500/mo on average expenses, but now I cashflow twice as much with $500.  

500x12/100000 = 6% cash on cash return. 

Considering real estate is not actually passive, I'd much rather thrown that $100k into a mutual fund or something that actually is passive and get similar returns.

So basically saying what Ali said, only showing that you could go elsewhere an make similar returns if you're paying all cash. JMO.

Originally posted by @Anthony Dooley :

@Ali Boone @Dustin Beam you also have to pay the mortgage.

 I don't follow what you mean. My example shows the mortgage getting paid.

Why not just keep it simple? Can you outperform you debt by doing something else with it, then let it ride. If your debt is more costly then the return on your investments pay down your debt.

Adjust as needed to operate within your comfort zone....

Originally posted by @Dustin Beam :
Originally posted by @Anthony Dooley:

@Ali Boone @Dustin Beam you also have to pay the mortgage.

 I don't follow what you mean. My example shows the mortgage getting paid.

 Assuming he means worst case... vacancy comes up mortgage still due vs not on cash house.

You can’t really go wrong with having free and clear properties. That’s what I eventually want. I don’t want to be paying interest forever. But if you have free and clear properties you also will pay more taxes. So you can ejther pay your bank or the government. I’d probably rather pay a bit more in taxes.

Debt isn’t bad, but you need to manage it and not over extend it.

Originally posted by @Matt K. :
Originally posted by @Dustin Beam:
Originally posted by @Anthony Dooley:

@Ali Boone @Dustin Beam you also have to pay the mortgage.

 I don't follow what you mean. My example shows the mortgage getting paid.

 Assuming he means worst case... vacancy comes up mortgage still due vs not on cash house.

 Oh ok, and that's true. Just a level of comfort of the landlord, which we know.

For me though, if I'm not getting something around the low teens in cash on cash return, I don't think I'd bother with real estate. Of course, IRR matters too, but you get a better IRR when you leverage as well, so that doesn't strengthen the all cash argument.

My main point, if one is to be taken, is that an all cash investor should really look at their expected ROI. If it's not substantially stronger than other hands off investments, don't do it. REI will come with headaches, pretty much guaranteed. I'd personally avoid the hassle if I wasn't at least hitting double digits on expected IRR (and as I've said, I'd rather be in the double digits with CoC and even higher IRR).

Everyone has different thresholds for risk, expected returns, etc and should only do what they feel is "best".

@Anthony Dooley

Not need to agree with, but the return on equity is always zero (0). Why would you want to keep it "behind the walls"? How about opportunity cost?In addition, when you have leverage you have the other benefits which @Ali Boone mention. Protection from lawsuits is a big item to consider as well, especially in higher price range properties. 

Financially free always betas debt free, and taking on more "smart" debt is not only opposite of risky but actually the goal for the most seasonal investors. 

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