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.

Deborah BurianPro Member

Rental Property Investor · Oklahoma City, OK · Member since 2013 · 1k+ posts · 412 votes

13y

Well, I am almost twice your age and that certainly affects the calculation... we plan to acquire one more property this year then start to pay off mortgages with the intention of increasing cash flow. All of our properties cash flow on an individual basis and they were all acquired on 15 yr notes. Given the real estate bust, we thought we should buy versus pay off while prices were low.

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David Krulac

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

13y

Caleb Green

Another reason to pay off mortgages would be if the interest rates were high or very high. Today's rates are 2.75 to say 4.5% and if you're paying 12%, yea sure, go ahead and pay off. But if that were the case, then I'd suggest re-fi to 3% or whatever. But in all cases borrow fixed rates while the rates are low and "borrow as much as you can for as long as you can." Because nobody knows how long the low rates will be around.

N/A N/A

We were able to borrow 10 for each spouse. Then we started borrowing portfolio mortgages, (not sold to Fannie and Freddie) and were able to borrow more than 20 mortgages. I looked at local and regional brick and mortar banks and credit unions. The rates were fixed, and were comparable to regular residential rates, slightly higher than residential SFH owner occupied. The shortest term we got was 5 year fixed then adjustable. The longest term we got was 30 year fixed.

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Ali Boone

Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes

13y

Sounds like a great plan to me! Or you could accelerate it, depending on the profits, and just take the money you cash flow from the properties you have now and stash that to be used for a down payment for another property. Then you aren't having to pull it out of the house equity to use.

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Kyle Hipp

Investor · Appleton, WI · Member since 2012 · 1k+ posts · 464 votes

13y

With your goal of acquiring more properties in the future I would and am personally not paying additional principal. I do finance all my properties on 15 year note to accelerate the payoff as opposed to a 30 year note. I usually put a decent amount of cash into the properties to increase their value as well as increase rents. I do the repairs and remodels quickly as those costs will only increase with time as well. Those costs include the actual materials, labor, and personal time spent coordinating and doing the work. As I do more work and coordinate more projects I learn more and develope cost effective strategies for future projects as well. Also if I can do a project that increases rent $100/m but choose to delay a year that cost me $1,200.

I also tend to be risk adverse as you are so I recommend as others have that you analyse where you want to be by certain ages. Once you see where you would like to be you can reverse engineer a plan that works best for you. If you have a good and stable job you can afford a greater growth path. That gives you options down the road if things change whether they be in your job or interest rates or the rental market. I would rather control 8 houses with 30% equity in each with the same or more cashflow than 2-3 free and clear houses. When I already own 8 house I habe developed more contacts and resources and have more options than I do when I just have 2-3 properties. There is a lot to think about and each person will have a different comfort level. Again I recommend taking a long weekend to analysing your longterm goals and developing a detailed game plan. I do this frequently and each year it looks quite different usually to the better as my last year of work has past. It allows me to refine my path and reaccess the direction I go in.

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Mark Ferguson

Flipper/Rehabber · Greeley, CO · Member since 2013 · 2k+ posts · 1k+ votes

13y

I use the snowball strategy for a couple reason.

1. I plan to buy a lot of properties and I don't know if my current portfolio lender will always be okay with giving me as many mortgages as a I want like they are now. If I can pay off properties sooner I will have less mortgages and a better chance to get more if things change.

2. I make enough from my current job to buy more properties and I don't need to save up cash flow right now. Things can always change but I plan on increasing my income not decreasing it.

3. I think having houses completely paid off will give me opportunities to have much stronger lines of credit which are extremely handy when flipping and buy and hold.

4. My portfolio lender only offers 15 year fixed or ARMS. I choose ARMs for the low payments. I want to get those ARMs paid off before they start adjusting if I can.

I have 7 rentals now and bought my first Dec 2010. It is on track to be paid off the end of this year. I had a $72,000 mortgage on it originally.

In a perfect world with 30 year fixed loans and a guarantee I could finance as many as I needed I would not pay down the principle. If I had limited funds to acquire more properties or wanted 10 or less total I would not pay extra either.

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Shaun Reilly

Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes

13y

Caleb Green I think there have been a lot of good posts talking about the positive and negative aspects of your type of plan and that of someone that would want to use a lot of leverage.
I personally see the arguments for both sides and think it is as much of a personal choice about what you feel comfortable doing and your goals as anything else.

So if this is the method you want to do then I think you have a good baseline plan in place and should keep moving towards your goals (While always reevaluating your progress and being open to other options).

There are 2 things I would offer up as critiques though.
1) As most people have said I don't see much point in getting the 15yr notes if you can get a 30yr. Very minimal benefit in rates for a big boost in flexibility. Since you are paying the notes off well ahead of maturity you are probably adding very little time of the payoff if you make the same payments month after month. However when you have both places go vacant at once in November and can't rent them until February while paying to heat them and above average turnover costs that exceed your deposit, you will be happy you can make a smaller payment for a little while. :)

2) I'd recommend instead of taking the excess cash flow from each property and paying down that mortgage fast that you pick one and put all the extra payments on one at a time and pay it off as fast as possible then hit the next one. If your rates are vastly different I'd do the one that is more expensive, but if they are pretty close do the one with the smaller balance to get it off the books faster. The problem with paying off multiple ones faster is that until you actually pay one off you aren't getting any cash flow benefit and you can't realize the equity benefit without selling or refinancing prior to actually rid yourself of the mortgage.
If you hit a tough economic time there is some utility in having a free and clear property but not really any help (without selling or doing a cash our refi) to have a 30yr note you plan on having paid off in 2 years that you only took out 4 years ago and another you plan to pay off in 4 years that you took out 2 years ago (or something along those lines).

Your plan isn't going to get you to some big time real estate mogul, but it should get you to a place where you will own a fair number of properties throwing off a great income and without the burden of debt!

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Jon H.

Investor · Birmingham, AL · Member since 2013 · 51 posts · 9 votes

12y

@Caleb Green,
Sounds like a good plan. Here is my suggestion and what i plan to do. I currently just bought my first rental using my HELOC. I plan to save every penny of that money until i accumulate enought to buy a second property. In the mean time I plan to keep marketing to motivated sellers and see if i can pick up a few rentals using seller financing. Also hopefully i can find a house to flip retail/rental(flip to a landlord). Hopefully i will have a private lender lined up shortly to help with the flip. Anyway once i flip the house i plan to use that money to buy 2 rental houses cash. Here in Birmingham AL you can pick up rental houses for 10K-30K. (you should plan to have about 30K into each one when its rent ready). I calculated if i sat back and just collected the rent from my one rental i'll have enough to buy a 2nd in 5years. However if i flip a house and buy 2 more i'll have be able to buy a 4th in a year and a half assuming i don't flip anymore houses. Then i'll be able to buy the 5th after 15months. then the 6th house after a year.
In short I would put the money into an interest bearing account and let it accumulate until you can pay cash for the next one.That way too if you run into any hard times you have a reserve. The low rents you speak of i'm assuming your getting these houses in the 30K range. I would also see if you can buy houses using no money of your own at all. find motivated sellers that are willing to owner finance. You pay them $150-200 a month and rent the house out for way more. Or flip a rental you already own and use that money to buy 2 properties. That is the other option i'm considering with mine.
I'll have about $30K into it when i'm done and i could probably sell it as a rent ready rental for $55 - 60K. I'll use that to buy 2 more and go from there. Good Luck Sir. Let us know what you decide.

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Frank M.

Commercial Real Estate Agent · Sudbury, MA · Member since 2014 · 118 posts · 25 votes

12y

The ROI looks very different based on leverage. Say you have a $100K total cost house. $2000/mo rent (2%rule) and $1000 is clear after expenses (50% rule). $12000/yr on $100K is 12%. Nothing to sneeze at. But, finance 80%, even at a 6% rate, ($600/mo mort) and now you have $4800/yr on your $20k out of pocket. 24%, plus principal pay down, and a leveraged return.

In my opinion, there's risk in being over leveraged of course, but paid in full properties are the opposite of liquidity, and if you are in expansion mode, I'd choose a leverage that let you sleep at night, whether it's 80%, 50%, or if paid off makes you happy, go for it. For multiple properties, you'll know how your occupancy rate is doing, and whether higher leverage becomes too risky.

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Kevin Siedlecki

Investor · Madison, CT · Member since 2014 · 710 posts · 458 votes

11y

Looks like I might be reigniting an old thread here, but I've got a similar question. I just purchased a multiunit place with a 30-year mortgage in the mid 4s. After renovating to a create an additional unit, I've got leases in place to start March 1st that will gross way more than I projected when I decided to make the purchase. I was thinking about refinancing to a 15-year in the mid 3s. It seems like a lot of people in this thread were working with 15-year numbers, anyway. My rate is great, but chopping a whole percent is really tempting.

I'm in my early-30s, and like @Caleb Green, I love my job, so I'm not living off of real estate income. I've got time to build wealth with leverage, but I won't have anything paid off before I'm at normal retirement age. It would be nice to have the option to retire early. If I had 4 or 5 properties like this one paid off, I could live off them very comfortably, whereas it would take twice that many properties if they are all leveraged.

What do you think? @Caleb Green @Peter Lee @Ryan B. @David Beard @Wade G. @Ryan M. - listing a bunch of people here who seemed to have informed, intelligent, but differing opinions.

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Kelly N.

Investor · SE, MI · Member since 2013 · 1k+ posts · 461 votes

11y

Hello Kevin,

How much will it cost you to refinance, and how long before you recover the cost? How much do the payments change?

We currently have 2 mf properties on 30 yr fixed loans and are about to use the cash accumulated to put help put a down payment on a third property. We will apply the cash from from those and other income towards the next purchase, keeping 6 months reserves just in case- for our own comfort and since the lenders are going to insist on it anyways for the next loans. By using the 30 year fixed option I am able to put more money toward the next purchase than I would be otherwise. I can borrow more money since I have less in payments every month. If I want to pay it off sooner, I have the option of making larger payments.

That being said, I am not against a 15 year loan if it cash flows, and we did refi our home loan to a 15 year fixed a few years ago- between the lowered interest rate and change from 30 yr our payments were about the same!

Kelly

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Oliver Trojahn

Kansas City, MO · Member since 2008 · 143 posts · 41 votes

11y

I am in the mindset of never paying off your rentals early until you have enough of them to provide enough income to live on. I wouldn't want to give up cash for more rentals or the interest deduct each year on all my rentals. If you keep loans on all your properties you will still have 20% equity in each property theoretically.

You need to continue to buy rentals to a point your comfortable with. Paying off the rentals you also lose possible appreciation and depreciation spread over additional rentals you could require if you didn't pay off the mortgages. With conventional financing in the mid 4's for rental properties I don't see any reason to pay them off. It depends on your financing too. Since they are pretty cheap houses it sounds like you may be using a portfolio lender with higher rates.

Leverage is the biggest perk in real estate investing which makes the returns much better. Real estate is a lot less attractive without it. There are many other investments that will take zero of your time that will give you similar gains to paying all cash for a rental house.

Good luck.

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Wayne Smith

Investor · Houston, TX · Member since 2015 · 59 posts · 17 votes

10y

I am 48, and started buying houses when I was 34. I put the minimum down and put most of them on 30 year loans. As I have gotten older, and closer to when I want to retire, I have decided to pay off mortgages. I also have enough income to comfortably quit my job if I wanted to. I have paid off 5 houses in the last 2 months and only have 4 with mortgages, which I plan on paying off within 2 years. I see the advantages to both side of the debate, and I think it all boils down to what you are comfortable with. When I was younger, I was comfortable with more debt. As I approach retirement, I want EVERYTHING paid off, so that is my goal. Sit down and think about what you want out of life, what passive income you want, and at what point in your life, and then make a decision. The good thing is, even if you pay off your properties and later decide you want the cash out of them, you can go get a loan. Good luck, sounds like you are on track to be successful!!

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Kent R.

Investor · Anaheim, CA · Member since 2016 · 1 post · 0 votes

10y

I know this is an old post....for me, rentals are a buy and hold retirement strategy. Those numbers the O.P. put out can't be covering property insurance. Your playing with zero margins, a couple bad tenants could cost thousands. Thick skin is required too the problem in Ca. is properties are too expensive it can be done but takes a long time. Keep those houses too long and you will be roofing them...lol

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Zach Ward

Investor · West Monroe, LA · Member since 2015 · 34 posts · 7 votes

9y

Everybodies circumstances are different. If you are young (I'm 34) and you have a reliable W2 job that can bale you out in a pinch (I'm an RN so have excellent earning potential and job security) then be aggressive with leverage. I shoot for a minimum 20% equity with goal at 30%. Do the math. If spending 10 years paying down one mortgage is only going to increase your cash flow $300 a month was that length of time worth it? I made one 20% DP= 16k I saved,and turned that into 3 more houses that I put nothing down on. Total of 6 now in 2 years cash flowing 2k a month total. You make your money by buying below market and then using equity to absorb more properties. Keep in mind the more properties you have the better you are hedged against a vacancy or repair. 1 property in portfolio means 100% vacancy or 100% repair cost. If I've got 10 then I'm only 10% vacant. Put cash flow back for "rainy day" fund. Then U can start using OPM

(Other people's money) to buy more property instead of working doubles and over time like I did with my first purchase. I want to retire in my 40s with 20 plus doors, not have 2-3 properties paid down in my 60s and just get by. Figure up your R.O.I.!!!

You want 6% or you want 46%? Power of compounding interest is most powerful force in universe said some smart guy way back when ;)

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Steve Vaughan

Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes

9y

I'm paying off all commercial (adjustable and callable) and some older (2003-2008) mortgages in the 6% range. But I have cap ex reserves and a fully funded acquisition account already.

I wouldn't rush out to accelerate sweet, long-term residential mortgages in the 3s and 4s unless I was close to losing PMI. Then I would back off again. Too easy to beat 3 or 4% return about anywhere.

Depends on your goals. Just want a couple houses to supplement retirement? Pay em off. Want to scale up to 10, 20, 100? Keep your cash to expand!

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Felix Arteaga

Nevada, TX · Member since 2017 · 1 post · 0 votes

9y

Originally posted by @Harry M.:

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.

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Paying off rentals early

Paying off rentals early

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