Paying off mortgage or increase principal payments?

Question

John Thedford · Answer

@Mick Regan

Use the cash to buy more.

Thomas S. · Answer

What value do you place on cash. Normally investors do not want to pay off rental properties as their goal is to increase their investment income not decrease it.

For a investor it is sacrilegious to have cash lying dead in a property. The reason not to have dead equity in a property is because it is valued higher than that of debt interest.

Equity decreases cash flow if you understand the value of cash. The opportunity value of cash to investors is in the range of 10%, mortgage rates are in the range of 5%. As a investor you must recognise a rental property has two separate income generating streams. The property itself and the equity. A investor must insist that cash earns it's keep and therefor deducts a 10% return of the top of the rental income first to compensate for the fact that dead equity is too valuable to ignore. The remainder pays the debt and expenses. After deducting the opportunity cost of equity most properties will eventually experience negative cash flow. Remember paying off a mortgage is saving you 5% but costing an additional 5% in opportunity value. End result negative 5% return.

For this reason it is understood that equity reduces cash flow on a property it does not increase it. To pay down a property with cash valued at a 10% return to save the 5% cost of a mortgage is financial folly. The perception by novice investors that they are somehow saving money or increasing cash flow actually has the opposite effect.

Cash invested almost anywhere else than in a rental will normally generate a higher return than prevailing mortgage interest rates. If you are a conservative investor put your money in a mutual fund or best option buy another income property.

It is not advisable that you allow equity to suffer the slow costly death of being buried in a rental.

A rental property obviously must be able to cash flow with 100% financing since equity only reduces cash flow. If a property can not cash flow with 100% financing it will never have positive cash flow unless the investor has zero understanding of the value of cash/equity.

Bruce Petersen · Answer

Everyone's personal preference is unique but as Thomas S. mentioned, I would never pay off a mortgage.  Your return on equity drops significantly.  If you take that equity out or use the savings realized by not paying extra on the notes you could continue to expand your "Empire".

The key is to use leverage wisely, don't over leverage yourself but also don't tie up unneeded equity in a property, turn that equity into other rental properties.  This is how you eventually get into apartment complexes and life changes for the better.

Sid Leibowitz · Answer

Mick. You should talk to your accountant. He has more facts. I just paid off my last property. No more interest payments. Interest is very expensive. If you knew how much it would probably disturb you. It did me.

Chris Mason · Answer

I was going to post that ROI on paying down/off any mortgage is equal to the note rate on said mortgage, but @greg s. already covered it.

If you wish to pay off mortgages for other reasons, like peace of mind, @Mick Regan, there are certain scenarios where it is easier to get additional mortgages with fully paid off properties, rather than several properties mostly paid off.

Fannie and Freddie both have criteria that get more stringent when you have 4, 6, and finally 10, financed properties. But they do not look at the loan balances in determining when these criteria kick in, they just look at number of properties with one or more active mortgages of any balance.

So $600k in debt crammed into three or four properties will be better than $600k in debt spread among six or seven properties. To wit, Freddie will not go for a 7th financed investment property at all, meaning Fannie is the only game in town, and if there's something about your finances that Freddie would otherwise go for but Freddie would not (f. ex. 1 year of self employment tax returns), that means this would be a deal breaker.

Clayton Plank · Answer

@Mick Regan, that can really be personal preference. What are your future goals? Are you interested in purchasing more rentals? Could that money be enough for a down payment to expand? Do you have enough to pay off one full mortgage to give you a free and clear property? Does one property have a crazy high interest? There are a lot of variables here.

Ali Boone · Answer

Returns will always be higher on your money if you stay leveraged.

Check out-

https://www.biggerpockets.com/renewsblog/2015/04/1...

So it kind of depends on where your comfort levels are as to what you should or would want to do.

Adam Christopher Zaleski · Answer

If you are done buying property, you can start to pay them off. If you want to acquire more property keep the cash reserves for another purchase. It's really that simple.

Peter Mckernan · Answer

@Mick Regan That is a great question to have as a rental owner! It does come down to your personal goals and what your five to ten year goals are for your life and investing.

I would suggest that you pay off the rentals that you can with the liquid cash, then take the extra income from the zero balance rentals and pay off the other rentals quickly. There is one thing I would say to paying off the other rentals quickly, I would pay off those rentals quickly; however, have an emergency fund setup and once that is done put a savings account together for buying more rentals.

So, in short, pay off all that you can, then pay off the other rentals while building a fund for buying other rentals when the numbers on that purchase are right!

Vern M. · Answer

@Greg S. I now have a headache.

Good info, and I now have to adjust my thinking on my 5 yr plan.

Paying off mortgage or increase principal payments?

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