Pay down mortgage or create an emergency cushion?

Question

I have two rental condos, one here in San Diego and the other in Chandler,Az, and I was wondering how to best use the cash flow. Should I use the cash flow to help pay down the mortgages or should I use it to build an emergency cushion or are there other options that mght be a better use of the money?

Thanks, for all your input,

Jon Holdman · Answer

Owning rentals without cash reserves is a good way to have a hiccup turn into a big deal.  Six months PITI for a start, six months rent is better.  Maybe if you have 10 units you don't need six months rent total.  OTOH, @Mark  Ferguson posted just the other day that four (IIRC) of his units were damaged in the same storm.

Beyond that, it depends on your goal.  If you want to have free and clear rentals 15 years from now so you have a larger income stream, then paying extra makes sense.  If you goal is to expand your rental portfolio, using the excess cash for another property makes sense.

Account Closed · Answer

A lot of folks believe you should let the tenants pay down the mortgage - save up your cash to get into another rental deal.  If the asset is paying for itself and then some - don't bother it and let it do it's job.  Your job is to find more deals!

Jim M. · Answer

I look at like this.  Say you own the properties for 15 years and you are getting $100 per month each home so $200.  If you put that towards the mortgage thats a total of 36k.  Now if you invest that money and get a 10% return over the 15 years that money will turn into more than 83k.  What would look better to the banks?  Especially if say you invest the money with one of their investment advisors.  Which way would also pay your mortgage down quicker?  Also, if ever you need cash for a major repair you can take a margin loan against the investments so you don't have to sell them and then you pay that margin loan back with the monthly cash flow.  If you can get a better return investing the money than what your loan rate is at its a no brainer decision.

Jeremiah B. · Answer

Save it.

@Jon Holdman brings up a great point.  Bad things will happen (rental related, job related, health related, family related, etc.), and you will need money to address them.  If all of your extra money is in the form of equity, you can not access it, making your minor issue a rather big one.

One of my investment guidelines is to never be cash poor.  Obviously the correct decision depends on your unique situation, but for 95% of us, I think that saving the money is the responsible and correct thing to do.

Jeff S. · Answer

@Alberto Furet having liquidity will most likely look better to a bank than having paid down the mortgage. Going forward you may well wish you had not paid down the lower rates when you are borrowing again at much higher rates.

Mark Ferguson · Answer

@jon holdman

Turns out at least four, maybe 7 were damaged by the hail. My personal house has 35,000 worth of damage according to the insurance adjuster.  It does have a rather large and intricate roof, which is why it was so much.

I would suggest at least 6 months piti per property as well.  I pay off one property at a time, but mostly because I don't know how long my portfolio lender will keep loaning over 10 mortgages.

Dennis Nemitz · Answer

I like what Dave Ramsey said about real estate. He said that he still thinks it is a good investment even though he went broke in it. He said it was not real estate that broke him, it was debt that broke him. I think it is best not to leverage yourself too much. If the bottom drops out again, you will not regret that emergency fund or extra equity.

Alberto Furet · Answer

Thanks Holly, Ray, Stuart and Robert, you all have very valid points. The reason that I am considering paying down the mortgages is to look more appealling to banks when I walk in looking for another loan.

Ray Orellano · Answer

@Alberto I was always told to create an emergency fund vs paying down the principle, at the end of the day "Cash is King".

Pay down mortgage or create an emergency cushion?

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