Paying off rentals early

Caleb Green · 2012-07-06T19:16:42-07:00

I just wanted to get opinions on applying the rents you collect every month to the principle loan amount. I have 2 rentals that are currently rented. The first one I've had for 3 years. I did not escrow the insurance and taxes and pay them once a year when they are due. The monthly payment on a 15 year note is roughly $185. I collect $400 a month for this property and have always applied every dollar of this to the payment. I started with a loan balance of roughly $25,000 as of right now I owe roughly $19,000. With the property being valued at $40,000. My second rental is a little nicer home. The taxes and insurance are escrowed with the payment and the monthly payment runs $380 on 15 year note. Rents for $575. Again I plan to put all rents toward the loan. I owe $35,000 on this property and the value is around $65,000 My goal is to use a snowball effect with these properties since I make a decent salary right now and don't need the extra money that is generated from the rents... For example when my first property is paid for in a say 5 more years I will take that $400 rent and put it along with the second rental of $575 until that property is paid off. I will continue to buy at least one house per year until I am 30 years old. Financing them on 15 year notes I would like at least 10 houses paid for by the time I am 45. I am only 24 right now. Does this sound like an ok business plan? What are the benefits of just pocketing the "extra" money left over from the monthly rents other than having a reserve account for vacancies, repairs, ect... Which by the way I already have an "emergency fund" for these situations. I hope I put this in the correct section of the forum. If not an admin can move it to the correct spot. Thanks in advance for any opinions or insight to this.

Account Closed

Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes

14y

Sounds like a very safe strategy. It sounds like you live well with in your means because you are utilizing your own wages to buy additional properties.

Nothing wrong with this strategy. I would take the time though at some time and map out where you want to be when you retire, at what age you would like to retire and how much might you need at that time. Your young so it will be easier to snowball your retirement nestegg(s).

0 Reply

Caleb Green

OP

CA · Member since 2012 · 2 posts · 3 votes

14y

Charles, thanks for the reply. At what time I want to retire is something I need to figure out. I currently work as an insurance agent for Farm Bureau. I have lots of freedom with my career because I am considered an independent contractor. I know I'm still young but as of right now I couldn't imagine wanting to quit what I do any earlier than 55. We have some agents that are well in their upper 60's and won't retire because honestly it's a great career and as long as you're servicing your book of business it's easy money!

0 Reply

Jeff S.

Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes

14y

Caleb, it sounds like you are going at the pace you are comfortable with. It is great you have the available cash to pay down debt and continue buying. You might consider that as your inventory grows the need for reserves increases to. Vacancies have a way of happening in bunches and having a mortgage paid down if you have a cash crunch is not much of a benefit.

There is a rule of thumb that says half your rent may be used up in overall expenses. That means if you have more than half going to PI (principal and interest) you may be close to a negative cash flow. Just putting that out there. It sounds like you have additional cash available. I would say IMO putting extra toward principal is better than stocks.

All in all it sounds to me that you are doing a fine job and should be commended for starting at such a young age. You should have a great future.

2 Reply

Steve Babiak

Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes

14y

The one caution I would offer has to do with "reserves". When you apply all revenue from the rents to paying the debt service, you will be relying on reserve funds having to come from some other account should some event occur that would normally draw from reserve (some examples are replacing roof, replacing heater, handling an eviction - there are other such events).

Be certain you do have reserves to cover your (somewhat) unexpected expenses. If you think you will be able to draw on the equity accumulated by paying down the loans - well, that is a possibility, but it requires going through the bank to ask for permission in the form of a loan application. When you really need a loan, that's when a bank doesn't want to lend; banks prefer doing loans with those who don't need them.

2 Reply

K. Mitchell

Houston, TX · Member since 2012 · 33 posts · 13 votes

14y

I did exactly what you did--except I used 30 year loans with the intent of paying them off sooner. I even started at the same age. I put just about all of the profits back in at first, and just used my own emergency fund/wages to fund the times when the properties had negative cash flow.

Somewhere along the way I started saving the cash flow and, after building a reserve, using it for down payments on more property.

I now have 11 and the first one will be paid off in a handful of years.

In retrospect, for me, I wish I would have used the after-reserve cash flow to acquire more property sooner rather than applying it to principal reduction.

The acquisition process has been really really slow. It is just now getting to where the cash flow allows me to buy a one or two new properties per year.

But that is looking back in hindsight.

8 Reply

Harry M.

Real Estate Investor · Dallas, TX · Member since 2010 · 449 posts · 173 votes

14y

Caleb,
I think it's a trade-off between better returns and reducing risk. A good rental can quite easily bring in about 15% cash-on-cash - a lot better than the 5-ish% percent you save by paying down the mortgage. That said, that said there's something to be said for the security of having some free and clear rentals and in general taking it slow and steady - it will just take a lot longer to build up your portfolio.
I also think the benefits of doing 15 rather than 30 year mortgages is very debatable. By taking out a 15 year loan, you are basically committing to making extra payments for 15 years in return for usually around an 0.5% decrease in the interest. Not worth it in my opinion - if a person wants to pay the loan off in 15 years, they can still make extra payments but in exchange for a very slightly higher rate, maintain flexibility if plans change or you have a bad month.
One possible hybrid between the two approaches could be to split your long term plan into two phases - an acquisition phase where you roll all cash flow into your next purchase, and add properties as quickly as is prudent. Then maybe 10 or 15 years down the line have a consolidation phase where you shift your focus to paying down the debt. Except by then you have a good number of properties, and you can really use the cash flow to "gang up" on the mortgage of one property at a time.

14 Reply

J Salter

Multi-family Investor · Shreveport, LA · Member since 2010 · 67 posts · 9 votes

14y

@Caleb, its definitely a trade-off analysis you would have to do. I think a lot of us from the south or a bit more conservative with risk and would prefer to make extra payments.

Your instinct is fine especially since you are so young. There will be plenty of opportunities and traps in the market so take your time. You have time on your side and can afford to be less risky.

Also what town are the properties in just curious?

3 Reply

Ryan M.

West, MI · Member since 2012 · 674 posts · 182 votes

14y

You can finance and cashflow 30 units and be the same as paying off 15 units. I like the latter, there is half as many problems and if things turn you don't have to worry about the note holder coming to get THEIR property. Once paid for there will be more reserves than you know what to do with and that is when it gets fun.

3 Reply

James H.

Investor · Fort Worth, TX · Member since 2011 · 1k+ posts · 450 votes

14y

Couple things to conisder. While it would be nice to have the choice between 30 leveraged properties and 15 free and clear, something tells me you, Caleb Green, do not have the capital to make that decision. I also do not have the luxury. Rather, you are in a similar boat as me. I have one rental that generates 550/ month. It cost 24K. I do have that one paid off, though. My second soon to be rental will come from the converstion of my primary. It will generate about 700-750/month with a PITI of 450/month.

I like that the cheapest property is paid off. However, the second property has a balance of about 54K and I do not foresee paying it off any time soon. I can use 54K to do a lot of other things to make my future better.

The question is not only leveraged vs paid and clear today. It is also a matter of how many paid and clear properties do you want in the future. I want to be at about 10 properties by the time I retire. I want them to be better properties than my paid and clear rental. So, my loose plan is to get to 10 cashflowing and well maintained properties with financing while maintaining a prudent reserve along the way. Once I get to number 10 (or maybe 8 depending on the quality of the locations or how old I am or whatever), then I will start agressively paying down principal. By number 10, I'll have at least a decade of payments on a couple of the first properties and those balances will be easily paid off. With a (hopefully) higher salary from my job, a couple of paid and clear rentals and at least 6 rentals cashflowing, it should be easy to pay the remainder off in a snowball like you are talking about doing now. Thhis process will probably take 10 to 20 years and fuctuations in interest rates among other unforeseen events will likely alter my strategy.

I think the fact that your two properties are very manageable, if not paid off, makes a good foundation from which to build your portfolio. Just my opinion. It boils down to personal comfort.

3 Reply

Lynn McGeein

Real Estate Agent · Virginia Beach, VA · Member since 2012 · 2k+ posts · 1k+ votes

14y

Caleb, We paid off a property over 2 years ago. I regret not using those funds to simply put a down payment on another rental. In the long run, it is fine, as it was over 6.75% mortgage, I got my next property at the under- 4 property loan levels as paying it off brought me back to 3 mortgages, and I can always take a loan on it again, although that would mean additional costs to get my money back out, so probably won't. My other properties that have 3.75 to 4.75% loans, I cannot see paying off early as I've now learned that I would rather have funds for the 25% down payments we now need for the over-4 investment loans, and I cannot imagine rates will stay this low for too many more years, so locking in a low rate now for 30 years to come seems a safe bet. Now, instead of paying down the loans, we plan on having enough property to sell a few to pay off the others when we want to retire. I think this is where flipping a few would actually be very beneficial, like flip one, buy one to hold, repeat, but figuring that out as it seems much more risk involved to us as we currently live 5 hours from where we own investment property, and traveling that far to flip a home doesn't seem like a very smart plan.

3 Reply

George P.

Property Manager · Livonia, MI · Member since 2011 · 4k+ posts · 1k+ votes

14y

i do not see the point of getting a 15 year mortgage. i can get a 30 year and pay double and you have roughly a 15 year term.

second, there is a huge debate if you should pay off a mortgage or you should drag out the payments as long as you can.

if i were you, i would not pay any extra towards the principle. i'd put that toward another rental. just think about it. instead of paying it off early, if you could buy another 1-4 rentals within the next 2 years. you get write offs (mortgage) and you get bigger cash flow.

what would you do if you pay off the houses within 3 yrs, but the home prices have doubled (or tripled) by then? i'd kick myself for trying to pay off the mortgage.

i am a fan of leveraging. not 100%, but as much as i can stomach and still sleep at night. kind of like 401k contributions, but in reverse.

that's just my $.02

1 Reply

Wade G.

Houston, TX · Member since 2010 · 150 posts · 159 votes

14y

I have thought about this alot too and came to the conclusion that I would not pay off rentals early. Reasons why:
- lower returns
- I buy for cash flow
- considering loan rates I do not care about paying off a 4.8% loan fixed for 30 years
- If you get sued by a tenant then 100% of the equity could be lost if the house is paid for, versus only 25% or so in a leveraged home
- I like to keep the extra money for reserves or acquiring other rentals

In Texas my primary residence is homesteaded. So if I ever had an itch to pay off a home it would be that one, not a rental. Then again my primary residence is 3.7% for 30 years so again I see no reason to pay off a 3.7% loan. I like the idea of using the money that I would have used to pay off the primary going towards other RE investments or some other kind of investment that pays 8% or 15% or 20% etc.

I also think that paying off a rental would cost you more than you think. Reason why is because you might have the tendency to get lazy. When a unit becomes vacant you may not have the urgency to get it back up and running with new tenants...thereby costing you money each day. Maybe not but I can see how that could happen since there is not that monthly note to deal with.

Really leverage is what makes RE such a good investment. I can see how paying off rentals may give piece of mind but in reality it makes for a poor investment. When I am older I may change my mind but not right now especially with the current loan rates.

14 Reply

Rich Weese

Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes

14y

I really liked the comment from Wade. One thing that I've found as a huge bugaboo has not been mentioned in this thread. INCOME taxes from these free and clear properties hurts your potential income pool. I like having paid off properties, but only down the road for the most part. When your mail job is over, the extra income doesn't hurt your situation. You can obtain more growth in the early stages by controlling more properties-just like Monopoly game. With taxes sure to rise higher, and capital gains getting attacked, you must look at that. Sales taxes, rental taxes etc are probably just down the road, I'm afraid.
There are SO many other concerns that need to be addressed. Risk tolerance, age, strength of current occupation, potential pension, funds available, reserves, meeting of the minds with any significant other, big expenses in future(college maybe for kids), retirement needs, etc. I just hate pouring funds into income taxes if I'm able to use them in MY investment pool of potential funds. Rich

1 Reply

Tyler J.

Member since 2012 · 32 posts · 1 vote

14y

Wouldn't it show more income on a payed off house though? Get a extra $350/month from not having a mortgage?

Plus couldnt you use the payed off houses for like collateral for other houses you plan to purchase?

0 Reply

Will Browm

Investor · Buford, GA · Member since 2012 · 120 posts · 31 votes

14y

I recently bought my two SFRs and have them rented. I paid cash for both and got great deals on both. I am renting well above the 2% rule (3.3% and 2.75%). While I completely understand the cash on cash return principles, I have no regrets. I can cover the expenses of these homes if vacant easily and am already building reserves and/or funds to buy more. I am going to stick with the cash route. I am sure if I want to borrow money in the future, the banks will be glad to hand it out.

In short, I say pay them off. Another recent thread speaks of the comfort of having at least one house paid off.

2 Reply

David Beard

Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes

14y

If there is ever a period of time in which you want to maximize the amount of property that you control, it's now, with the low rates and depressed property valuations. With just modest capital appreciation, the leverage will generate very large gains. Also, controlling more property through leverage maximizes your after/tax income, due to all the depreciation, so you really need to do all your calc's after tax.

As a risk management step, it makes sense to ensure that each property has a minimum $ amount of cash flow that you're comfortable with (using 50% expense guideline), and has a Gross Rents:P&I ratio that is healthy (at least 3.50, possibly 4.00 if you're a bit more conservative). And you might want to cap your leverage at 80% of current market value, for example. Doing these things, I am very comfortable with leverage.

6 Reply

Ryan B.

Investor · -, IL · Member since 2010 · 409 posts · 616 votes

14y

There is no way I am paying a loan off early right now. My bank is literally shoving dirt cheap money towards me so I am taking as much as I can get. As long as I am keeping the amount of leverage I feel comfortable with on each deal I am buying as much as possible.

With using the leverage you will be able to build a huge amount of wealth down the road because you will be controlling more properties. To top it off, your tenants are actually the ones buying you all the houses.

3 Reply

Peter Lee

Real Estate Investor · Member since 2011 · 56 posts · 9 votes

14y

There is a mindset that why pay off the mortgage early, it's a tax deduction right? Well, if it's so great, why don't people ask to pay a higher interest rates? Have you ever hear people say, tax me more please, tax me now!!!

Even if you're interest rate is 4%, you're not really deducting the whole 4% dollar wise when you do your taxes.

Yes, having to pay taxes on you're income on a free and clear property sucks, but you will cash flow more of course and it will allow you to buy more properties.

That said, if I had one million dollars and each home was say $100k. I could either choose to buy 10 homes cash or put 25% down on each and buy 40, I would choose to buy 40 because of the appreciation potential, but I would at least cash flow $200 - $300.

A 15 year loan on $75k @ 4%, PITI is about $800. I can get $1000 on rental in my area. If you rather get more cash flow, then put more $ down, but I'm good with those numbers.

So, let's assume that in 15 years, the homes will have doubles.
Person #1 - Paid all cash for 10 homes.
Home Net $2M+ $1,800,000 on cash flow. ($1k * 10 * 12 *15)

Person #2 - Put 25% down for 40 homes.
Home Net $8M + 1,440,000 cash flow ($200 * 40 * 12 * 15)

Who would you rather be? Sure it's more work and I make it sound easy when I know it's not, but you get the idea. I'm sure I'm missing details like taxes, repairs, vacancy, aliens from Mars landing, blah, blah, blah. :)

As far as being sued because you don't have 100% equity, people can sue for you anything, just because you only have 20% equity or whatever, doesn't mean they can't come after you. Get an LLC, S-LLC (Some States), Land Trust, Umbrella Policy, etc.

5 Reply

Sunil Chowdary

Hyderabad, Andhra Pradesh · Member since 2012 · 1 post · 0 votes

14y

This is very safe strategy... I totally agree with your concept.

0 Reply

David D.

Frisco, TX · Member since 2011 · 17 posts · 5 votes

14y

I would agree with Wade and others that it's better to leverage while you're young and accumulate/control more assets. Yes, it's more dangerous and depends on your circumstances, but in all when you're 50 or so you'll look back and say you you did right thing by controlling 8 properties or so vs. 5 F/C especially in today's low rates. Just remember that in 20 years you may not have a job owing to the global economy and 5 free houses will provide you with sufficient income.

I would rather wager that I own more properties to provide me with the potential appreciation and cash flow.

1 Reply

Mariah JefferyBusiness Member

Real Estate Agent · Cheyenne, WY · Member since 2009 · 205 posts · 51 votes

14y

You are very young and rates are very low. Both of those things point toward buying more rentals, but only you can determine your comfort level.

I started buying rentals at 26 and I paid only the bare minimum so I could use excess cash flow. This last year, my husband and I got to 28 units (we were 31, now 32). Now we are actually considering paying some of our highest rate mortgages down, simply because we don't think we want to buy more rentals any time soon. We have our hands full with the ones we have, full-time jobs, and our daughter. We're glad we haven't paid anything down before now, though, because we would not have been able to jump on the good deal we took advantage of without significant cash reserves.

Another thing to consider is liability. If your properties are not in an LLC and they are paid off, this makes them a prime target for a lawsuit.

1 Reply

Granville L.

Midland , TX · Member since 2012 · 24 posts · 1 vote

13y

This is all very good information and thank you for posting this topic.

I know for myself, I pay extra every month to the PPI. I am not hurting for the extra money and still have extra to purchase property. Paying the extra money also helps me sleep better at night. I think it all comes down to your comfort level. There is lots of great information here about reasons why not to pay off home early. I agree with all of them, but I am planning my business around the snowball effect. I am not super concerned about interest rates increasing, because I plan on ganging up on mortgages. It sounds like you have taken the best and most important step in your future. You have made a fundamental decision to invest your money and not purchase a new BMW. My hats off to you for planning for your future and not relying on others.

0 Reply

Michael D.

Investor · San Jose, CA · Member since 2011 · 355 posts · 90 votes

13y

Caleb Green, I think this is simple:

It's about having options. Once you pay down the principal you cannot get the money back without some grief (selling, financing, etc). And it's even worse if you actually NEED it for something.

If you're not sure, just put the money in a bank account. You can ALWAYS give it to the bank later if you want to, but maybe you'll think of something else you'd rather do and be glad you have it available.

Keep your options open. You'll be glad you did (but neither one of us knows why - yet).

1 Reply

David Krulac

Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes

13y

Caleb Green

In general, I would disagree with paying off rental mortgages early.
Two factors that i would consider are your young age and the fact that you want to continue buying more rental properties.

Of course there are exceptions and everybody's situation is different. But if you were 65 and were not buying any more rental, then I'd say yes, sure pay off those mortgages to generate more income for your retirement.

But when starting out and still growing your portfolio, I say "Borrow as much as you can for as long as you can." To add to that as a viable plan, the interest rates are at the lowest they've been since they started tracking in like 1960. These low interest rate may be a once in a life time event. Think about it, if you started buying rental property in 1960, that's 53 years ago. And back then you had to be 21 to buy real estate, that's means you are now 64 years old and ready for full social security, and interest rates have never been LOWER in your investment lifetime!

Load up on those low interest rates, get the goods while the getting is good. It won't always be like this. Just ask anybody who bought real estate in 1981 when interest rates were fixed 18% for 30 years.

The caveat to borrowing the max is obviously that too much debt can be your downfall too. But as long as the the property supports the debt service. I'm not suggesting negative cash flow, I'm suggesting max imum debt with positive cash flow.

0 Reply

Jeff Blankenship

Investor · Concord, NC · Member since 2008 · 18 posts · 1 vote

13y

Peter makes an interesting case for the economic benefits to more leveraged properties compared to free and clear. However, how are people doing this? Currently all FANNIE MAE / FREDDIE MAC guaranteed loans only allow 10 mortgages for any individual. To get around this, I guess 10 could be purchased by person 1, and 10 by person 1's spouse for a total of 20 if the bank would approved. Any thoughts on how to make this type of plan work?

I currently have 6 rental properties and banks will not even consider giving me any more money right now. However, mainly due to the high leverage position on each property (90% or more). There are some refi HARP options, but still I'm just curious about the REALITY of being able to purchase and finance 10+ properties. For those of you how have more than 10, how did you do it? Local bank, owner financing?

regards,
jeff

0 Reply

Paying off rentals early

Paying off rentals early

Most Popular Reply

43 Replies