Pay down rental housing debt or keep cash for another deal

24 Replies

Hello BP gang,

I have a question for experienced investors on what to do in this situation.  I currently have about 30K cash to invest in my next rental property.  I bought my first SFH rental in feb of this year 2020 with 20% down and conventional financing.  I currently have a tenant in place and am cash flowing after all conservative expenses about $300 per month.  That rental I feel is going well and I am ready for the next.  The problem is I dont really want to throw 20% cash down again for another property, due to this virus thing.  I would like to hold onto my cash as a safety net atleast some of it.  So my question is should I put that cash toward furthering my equity in my first rental property? Allowing me to potentially set up a HELOC on the house so i can draw from it for down payments on my next house?  Or should I just put that cash toward another property when I can afford it. 

So you're asking us if you should take free money (cash) and put it into the floorboards of a rental property to pay down debt (that would then become a cost to you...and that your tenant was already doing for you...as in free new equity), so that at a later date you can pay for the privilege of using that same money (cash now...as in free to use) by establishing an LOC?

Originally posted by @Travis L. :
Hello BP gang,
I would like to hold onto my cash as a safety net atleast some of it.  So my question is should I put that cash toward furthering my equity in my first rental property? Allowing me to potentially set up a HELOC on the house so i can draw from it for down payments on my next house?  Or should I just put that cash toward another property when I can afford it. 

If still in expansion mode and your loan is long term, I'd keep the cash liquid.

I only accelerated mortgages after stocking my dry powder, then focused on higher rate and/or risk loans. 

 

@Travis L. Keep the cash! Cash is king when looking to add to your portfolio and take advantage of any buying opportunities that might be presented. The opportunity cost is likely small - <$1000/year - assuming that you can get 1% interest leaving the $30K in cash and a 4% interest rate on your existing mortgage.

Finding a lender that will do a HELOC on an investment property will be hard. If you really don't want to keep the cash liquid, I would think about paying down your personal debt (ie your primary residence mortgage) and then applying for a HELOC on it. You'd need to consult with your CPA, but many people no longer itemize deductions due to the increased standard deduction, so the mortgage interest on your primary may not be helping you from a tax standpoint. You'll generally get better rate/terms on a HELOC on your primary vs. any other property type.

Even if you have a primary residence, you can get another mortgage and move into the new home, renting out your current home. On BP a number of people have posted about doing that every few years as a way to get more rentals. They move into the new home and rent out the old one.

Originally posted by @Travis L. :

@Joe Villeneuve im saying should i pay down my note on the house enough to establish a HELOC that i can draw from. Essentially getting my money back instead of throwing down 20% on another conventional loan

 NOOOOOOOO!!!!

Yoou're not understanding what I said.  Worse, you're not really understanding what you're trying to do...and I'm not understanding why you're doing what you want to do since all it's really doing is making you pay for the use of your own money...that's free right now.

Follow the bouncing "$" sign.     
                                                     
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Location:   Cash in Bank                       Spend on mortgage                                 Establish LOC                              Use LOC

Status:       Free to use                           Used and Gone                                   Money available                         Costs to use

Worse yet. Just because you are paying down the principle, it doesn't change your monthly payment. You're just adding the LOC payment to it, for no real gain in available cash. Your cash is just changing its location from your bank account (where it costs you nothing to use), to the LOC (which costs you every time you use it).

What's the point?

@Travis L.

In my opinion, you said a couple of times, safety net........

Keep the cash, work and add to it. Your current mortgage is not going to drop if you pay that mortgage down.

Equity is not free money, you pay for it. You can have 10 mil in equity, to me, it means nothing, if you want it you have to sell the asset or pay someone to borrow it.

You have a rental that pays for itself, you have a W-2 income, take the income from both of those and add to your cash. That's a safety net, that rental can be empty for a month or two and you are not stressing how to pay the mortgage.

Get yourself to a safety net you can be comfortable with. I like my 40% occupancy to cover all holding cost. If I don't have that, my W-2 can cover it.

Again....you said it, SAFETY NET, find yours and stick to it until you feel comfortable raising the bar.

I'm sure me comments will cause a firestorm here but from one small owner to another, stick to your gut feelings for the time being.

JC

Hopefully you will have enough to pay cash for your next rental in cash and not have to worry about a mortgage. That rental can be collateral for your purchase after that.

I think it depends on your time horizon. Interest rates are around 4% now which is only about 3% above what you get in a savings account.

I have a longer time horizon so I decided to buy a few affordable condos in good neighborhoods. Double digit returns which is much better than the bank.

@Travis L.

Keep the cash. Putting it into your rental won't make a difference unless you pay it off.

The monthly PITI doesn't drop as you pay down principle like a credit card does.

You'd just lose your chunk of money, having the equity probably won't do much for you.

Real Estate is weird like that.

@Travis L.

Money needs to "move." My vote is to take the cash and move it forward on another property.

@Joe Villeneuve agree. Put another way, it comes down to opportunity cost. That cost can be measured as the difference between the mortgage rate on the existing property and the return on a low risk investment (e.g. money market). There’s also an opportunity cost of missing out on a deal because all your cash is tied up, but that’s hard to measure, so I’m going to stick with the return differential for this analysis. Functionally let’s say it’s 3%. What it buys you is the agility to pull the trigger on a new deal. That agility has business value. If your time horizon is a few months then the 3% is trivial actual problem dollars. If it’s a few years then it matters and paying down debt may be more effective. If you’re unsure then you’re paying 3% for the option to not have to decide. Time horizon is thus key. Paying down the mortgage to then turn around and borrow the money makes that differential cost permanent. It’s like borrowing money to buy bonds.

Incidentally, I’m in this exact situation, sitting on some cash parked while I decide if I should invest more or pay down mortgages.

Originally posted by @Kevin McGuire :

@Joe Villeneuve agree. Put another way, it comes down to opportunity cost. That cost can be measured as the difference between the mortgage rate on the existing property and the return on a low risk investment (e.g. money market). There’s also an opportunity cost of missing out on a deal because all your cash is tied up, but that’s hard to measure, so I’m going to stick with the return differential for this analysis. Functionally let’s say it’s 3%. What it buys you is the agility to pull the trigger on a new deal. That agility has business value. If your time horizon is a few months then the 3% is trivial actual problem dollars. If it’s a few years then it matters and paying down debt may be more effective. If you’re unsure then you’re paying 3% for the option to not have to decide. Time horizon is thus key. Paying down the mortgage to then turn around and borrow the money makes that differential cost permanent. It’s like borrowing money to buy bonds.

Incidentally, I’m in this exact situation, sitting on some cash parked while I decide if I should invest more or pay down mortgages.

 You're right about the opportunity cost/loss.  I didn't mention it because I figured that was a given.

However, your example of it really isn't the right application of it, but it's a common one since most people try to use Stocks Market mentality and analysis for REI...and they have very little in common.

You should never compare percentages in REI. Percentage results are linear analysis numbers. REI is exponential...and this is how you apply the opportunity cost/loss when you are analyzing REI.

Comparing mortgage rates of current mortgages to future use of funds doesn't apply. The reason is the REI isn't (shouldn't be) paying the mortgage to begin with. When you replace a current mortgage with cash, thinking you are saving the interest, is not understanding the math...and who pays for what. The mortgage, P and I, is paid from the rent, and thus isn't paid for by the REI. Once the REI uses their money (cash) to pay down the principle (which was already being paid down by the tenant's rent), the REI is actually just adding to their cost of the property. Thinking this is a good way to increase equity is not following the money. When the tenant (rent) is providing the funds for this, the equity is free to the REI. When the REI decides to pay for it, it becomes a cost to that REI. Buying equity, isn't gaining anything financially. All the REI is doing is transferring money from their Bank (cash...and free to use), to the floorboards of the property. It's the same money. The difference is, it was free to use when it was still in the bank.

Now, take that same cash an use it as a DP on the next property, and you are gaining because your are buying 5 times it's face value...and the tenant of the new property is paying for the balance of it...including the interest.  ...and don't forget the added cash flow on top of that.

Like you said, paying down the principle instead of moving forward with that cash, is losing opportunity returns.

@Joe Villeneuve my example of money market was to pick something that was equivalent low risk to make the decision one of value of money versus agility for equivalent risk (low). I was looking to quantify the opportunity cost. As soon as you bring leverage into the discussion you're changing the risk adjusted return. My understanding of the original question was about short term use of funds while leaving the door open (should he hold onto the cash until he feels more comfortable buying another property or use it to pay down the current mortgage then tap the capital later with a heloc). I was trying to show that the actual dollar cost to sitting on cash is small while one makes a decision on how to apply the capital. How leveraged one wants to be brings with it different factors around risk tolerance, etc., and the value of money comparison now becomes one of a margin account. Since the person wasn't seeking to change their risk adjusted return, then to me the most prudent move is to sit on the cash since the dollar cost is low.

@Travis L.

Option C. Keep the cash as cash. There’s only about 500 new threads per day here with people commenting about how the banks are tightening up and their going “BankRRRRupt” servicing private loans that they can’t discharge and tenants aren’t paying rent etc etc ... cash, as cash, is extremely important in the current financing climate. Anyone who underestimated the importance of this is currently paying a “stupid tax”.

Originally posted by @Kevin McGuire :

@Joe Villeneuve my example of money market was to pick something that was equivalent low risk to make the decision one of value of money versus agility for equivalent risk (low). I was looking to quantify the opportunity cost. As soon as you bring leverage into the discussion you're changing the risk adjusted return. My understanding of the original question was about short term use of funds while leaving the door open (should he hold onto the cash until he feels more comfortable buying another property or use it to pay down the current mortgage then tap the capital later with a heloc). I was trying to show that the actual dollar cost to sitting on cash is small while one makes a decision on how to apply the capital. How leveraged one wants to be brings with it different factors around risk tolerance, etc., and the value of money comparison now becomes one of a margin account. Since the person wasn't seeking to change their risk adjusted return, then to me the most prudent move is to sit on the cash since the dollar cost is low.

 You might be over complicating this.  Cash is free...on that we agree.

Thanks everyone for the helpful insights.  I will probably just keep the cash and add to it to buy another property.  Guess I just need to save more or find another angle.  

Originally posted by @Kevin McGuire :

@Joe Villeneuve I’ve definitely been known to over complicate things so you’re probably right!

 You're not alone.  Mt wife ways if you ask me what time it is, I'll tell you how a clock works.

Not true...I have no idea how a clock works.

@Travis L. Also banks like Wells Fargo aren't doing anymore HELOCs because of Coronavirus. If things get worse more banks may stop doing HELOCs so you probably shouldn't lock your cash up in times like these.

@Travis L. This is really not smart.

Your gna waste your hard earned money to pay down on an invstment property (which is not smart to begin with) in hopes that you can draw on a HELOC on that investment property in the future. For one, finding a lender what offers a HELOC on a Non owner occupied property is hard, qnd two, the required CLTVs on investment properties are much muchhh lower than Owner Occs.