When I was just starting out, I didn’t have much money to invest or purchase investment properties. And out of that necessity came creativity. This is probably why 100 percent of the properties in my portfolio I’ve accumulated over my career have involved some form of leverage. The shorthand for this among real estate investors is “OPM,” or other people’s money. Usually this refers to private or hard money, but in my own personal definition, I also throw in traditional bank financing because, after all, it’s not your money. For the most part, I believe mortgage debt or money borrowed to acquire and renovate property has been a wise investment for me on my path to success. I’ve purchased millions of dollars worth of real estate over the years with little cash out of pocket, which in turn has enabled me to achieve financial freedom and to take risks on other ventures and even grow my note business.
But what all this means is—I have some debt. Good debt, in my opinion. Debt that I can leverage, but also debt that can hinder me in other ways (such as qualifying for a traditional mortgage on my personal residence). I’ve come to work around this the past decade or so by renting higher-end properties to live in. But now wanting to settle down and purchase again, I had to sit down and take a hard look at my what I owe. By doing so, I’ve learned and devised some strategies to pay it all down—and some of it rather quickly. So, whether you’re just starting out, looking to minimize your debt, or you’re an old real estate warhorse like me looking to crunch it down quickly, these tips should help you reach your goals while you maintain or are on your way to financial freedom.
1. Send Extra
I’ll start with the simplest of these strategies, and that’s just the idea of sending extra with each payment. “You can do that?” People often ask me, to which I reply “Why not!”
Although some banks and hard money lenders have a per-payment penalty fee if you were to pay extra on the loan, many don’t mind when you pay them extra. By doing so and accelerating the mortgage debt pay-down, it not only saves you money in interest, it increases your available equity and net worth. I picked up this little trick working as a real estate agent and in the mortgage origination/title world. I would see someone send in extra money a month towards principal or use an amortization schedule and send next month’s principal payment with this month’s regularly-scheduled mortgage payment (P+I), and I would see the difference that would make. So like I say, “Why not!”
2. Bi-monthly Payments
An even easier strategy—and one I still use today on a few properties—is a bi-monthly pay schedule. I think this could work for almost anyone. This is simply where you send in half a mortgage payment (P+I) every two weeks. Per Wells Fargo: A 30-year mortgage for $100,000 at 6.5% means the homeowner pays $127,544 in interest over the life of the loan. This includes $100,000 principal for a grand total of $227,544. Paying one half of the regular monthly mortgage in a biweekly schedule makes the interest $97,215, which is a savings of $30,329 or approximately four years of an earlier payoff. It may make more sense today to just send in extra principal as long as there’s no prepayment penalty fee to prevent the mortgage company from holding the money for two weeks before applying it and/or the use of third-party companies that charge fees.
Keep in mind, these strategies can be pretty powerful, whether you keep a loan to term or you’re the normal mortgage statistic as someone who pays a mortgage for five to seven years before refinancing or selling. The advantage of paying more earlier on is that the typical mortgage is front end loaded with interest and very little principal is paid down. In fact, a break point is approximately 19 years into a 30-year loan when the portion of money going to principal passes the amount going towards interest.
3. Sweep Accounts
My favorite strategy of all when it comes to paying down a first mortgage the quickest is by using a sweep account.
Normally, people pay their bills out of their checking account while their money sits idle most of the month. They say it’s estimated on average in a 40-year period a person’s money sits idle for 30 years. This money is leveraged by banks to generate more revenue through what they do best: lending.
What a sweep account does is it enables the borrower to take advantage of the leverage for themselves. This is commonly done by utilizing a HELOC (Home Equity Line of Credit) that’s treated like a checking account. So, instead of putting all of your paycheck into a checking account, you put your income stream into the HELOC. By doing so, you pay your HELOC down over time while you use a HELOC check to prepay your first mortgage thus saving money on a lower interest amount, keeping your money moving as opposed to sitting idle.
By utilizing my third strategy of arbitrage with HELOC’s it has afforded me the utmost form of asset protection and liquidity, as well as tax advantages to offset my earned income.
Now, that I’ve shared some debt elimination strategies with you I’d love to hear what other folks on BiggerPockets have utilized to build their wealth (net worth and cash flow).
What’s your accumulation, preservation, and liquidation or estate plan?