Paying off mortgage?
Foothill Ranch, CA · Member since 2009 · 33 posts · 1 vote
I was wondering if anybody that buy and holds a house if they ever use the positive cash flow to pay off a house faster?? Is this a good startegy?
Lets say you pay it off faster then you get all the rent the tenants pay. Obviouslly you still have to pay insurance and maintenance still. But the money you would normaly use to pay off the loan would just go straight to your pocket.
OK, I just have to say that there are ZERO tax advantages to paying interest. Yes, you can deduct it. Yes, it reduces your tax bill. But, it reduces your tax bill by less than it costs you.
If you pay $100 in interest, and you're in the 28% tax bracket, that reduces your taxes by $28. So, you're out of pocket only $78 and not the full $100 you paid to the lender.
If you didn't pay $100 in interest, you'd be out, uhh, $0!
So, if the choice is to be out $72 or to be out nothing, I'll take nothing.
The advantage of leverage is just what is says. Most real estate, whether held for appreciation of for income, is not that great an investment. Look at the deals we talk about. You pay $25K for a property that generates $500/month in rent. That's would be a good deal based on Mike's 2% rule. You spend half of that in expenses, leaving $250 a month, $3000 a year in profit. You can shelter about $725 of that with the depreciation, so you'll only pay tax on $2275. Thats $637 at 28%. That leaves you $2363 after taxes. That's a pre-tax ROI of 12% and after taxes its 9.5%.
Maybe appreciation adds another 3% per year onto that. That's $750 per year.
If instead you use 20% down payments to get five such properties with that $25K investment, you would get annual before tax cash flow of $7,016 and $5,786 with the same tax assumptions. That's a more impressive 28% pre tax ROI and 23% post tax.
Details: $250 NOI less $133/month payment leaves you $116/month pre-tax cash flow. That's $1403/year. Depreciation is still $727/year, first year interest is $1394, leaving $879 in taxable income. Tax is $246, leaving $1,157 in after tax cash flow.
Note that the depreciation will be subject to depreciation recapture tax (currently 25%) when you sell.
Now, you also get all the appreciation even though you have only part of the money into each deal. You'll get $3,750 appreciation.
That's the power of leverage.
If prices fall, though, you get you hat handed to you. You take all the loss. That can easily each up all your "equity".
Costs cannot be neglected in a realistic analysis. You're going to pay $1000 for each house in buy closing costs, plus loan origination fees for the loans. You'll pay 8% each to sell them.
Hear, hear!
As for exposure, put each house is it own land trust, or llc, simple way to keep tract also,
123 Main St. LLC. Anyone can keep tract of that book keeping.
Dont forget guys, setting up an LLC in CA cost annually $700. So, if you have 10 properites, with 10 LLC, $7,000/annually.
People seems to forget to mention this......
Don't believe me? The rent checks get deposited SOMEWHERE and someone or some entity controls that account. Tax bills get sent SOMEWHERE addressed to SOMEONE and the tax assessor receives payment from SOMEONE or SOME ENTITY. Asset protection is not rocket science but bad asset protection is like strapping yourself to an old Soviet rocket and taking your chances.
You want real asset protection no matter how you choose to hold title? Have a demonstrable record of being a responsible landlord and buy the appropriate amount of insurance to cover your risks. Your friendly insurance agent can help you with that.
[As for exposure, put each house is it own land trust, or llc, simple way to keep tract also,
123 Main St. LLC. Anyone can keep tract of that book keeping.]
[The other thing they forget is it just isn't effective. A single member LLC offers no real asset protection. They are easily and routinely pierced by the courts. Trusts used this way are even worse. They give a false sense of security because the user thinks they are hidden. But, every lawyer knows how to do research, it is part of their training. They can easily figure out the asset lineage within about an hours worth of effort.]
When I said this I was assuming people would have a brain and use it. If done right it would be effective. A $700 a year fee for an LLC would be cheap additional insurance for a property that has a great deal of equity. Remember, this is about paying off a mortgage. I would never recommend going to LLCs.com, if there is a place, and do it on your own. If a person is trusting their future in their real estate, they should have some kind of legal representation. If there is no equity, only the slimmest attorney would attempt a law suit. So why go to the extra effort. But, I know what happens when I assume something...it makes an a$$ out of u and me.
I know we like to laugh about the image of the lazy contingency lawyer looking for the low hanging fruit but I can guarantee if you, an employee, a contractor or anyone on the property on your behalf directly or indirectly causes serious injury to the tenant, or God really help you, a child, the existence of an LLC owning properties mortgaged to the hilt will delight the attorney looking to take the case. Why? Because he/she knows if there is not enough insurance that will be used as proof you failed to operate your business according to acceptable standards. That means if there aren't enough assets in the LLC they can get it pierced and take the assets of the owners.
The absolute best asset protection is to be responsible AND carry adequate insurance coverage. Adequate means what is normal and customary for your business risk profile, your insurance agent can help you.
It works every time, 100% of the time.
Amen TAZ, Let the insurance pay it out.
Thank you Harrison, Jon, and a few others who understand this and answering several questions which were presented after my post. I have been away from this thread for a while, hence the tardy response.
Jon Holdman pointed out via a precise mathematical calculation of how using leverage is beneficial to a certain extent. The ROI is increased, less cash is used therby making it possible to buy more properties. When you add in the appreciation (which we all know is not constant, but over time becomes "the gravy", your investmentS grow in net worth faster than an investment.
As far as the LLC conversations, in CA it is $800 per entity not $700, just to be accurate, and you certainly do not need an LLC for each property you own. I will not argue if an LLC does or does not provide liability protection. Yes the corporate veil can be piecred, but it can also be protected. Yes it does offer proptection, but only when structured and operated accordingly and correctly. Is it a "silver bullet"? Absolutely NOT! Get adequate insurance as Taz pointed out, speak with a competant RE attorney and a CPA on all legal and financial matters above your knowledge.
Wow guys, this is an awesome discussion. I'm not going to agree one way or the other, but I'll just tell my story.
I bought my first rental back in March. I put down 25% and got a 15 year fixed with no problems. We put in renters and everything was great until we had a major plumbing problem. We had to move the tenant out and I had to eat the insurance deductible and mortgage for about 45 days while repairs were done and we found new tenants.
I found another property in August, just as the credit crunch was really snowballing. Stupid me I forgot to pay a parking ticket and it showed up on my credit. Dropped my score to 697 and I couldn't get a loan. I had the cash though, so I just went ahead and bought the house. On Jan 1st we had a cold spell and a pipe burst at the house. Nothing like the other problem, but I still had to eat about $800 in repairs. This time though, getting full rent with no mortgage, there was no real money out of my pocket. That made it a lot easier to sleep at night.
Now that my FICO is back up in 700's I could probably refinance and buy another property, but I'm not going to. Sure, I might not be maximizing my potential, but sometimes the piece of mind is worth it.