I paid off my mortgage. I am not talking about my personal residence; I am talking about paying off my rental mortgage. Why would anyone want to pay off a mortgage on a rental? After all, the interest rate is tax deductible, and everyone knows mortgage debt on a rental is ‘good debt’. Maximize it for all you can, leverage, leverage, leverage to the moon!
Here is why you should pay off your mortgages, even if it is on a rental.
My rentals cash flow like a madman compared to what I spend. I purchased then in the depths of the housing market collapse, they were run down. I fixed them up, created a better neighborhood, and now they rent easily and at about 10% higher rents than they used to. The tenants are quality tenants and lost rent and evictions are few and far between. The easier renting saves vacancy expenses, which is your number one avoidable expense as a landlord.
UPDATE: I am paying off another mortgage, please read about it here.
Emotional Attachment to ‘Cash in the Bank’
When I made the decision to pay off the mortgage, it was not easy from an emotional standpoint. It’s a lot of money to ‘give’ away, and my balance in my investment account was hit pretty hard. From a financial perspective, it was a no-brainer for me. I wrote about some of the analysis in a previous post.
The Mortgage balance was $188,758.33. I had some excess cash that was sitting around earning literally 0.01%. Some of it was from a recent flip I did. I should have put that money to work a bit harder, maybe in the market, maybe in a money market fund, and gotten a better return. The cash sat for about a year, constantly getting larger due to my rental cash flow and making my return in my investment account dismal. I had put some of the cash to work in the market, but it still accumulated. The market is no guarantee over the short run, and I need emergency funds once in a while, so I left most of it sit.
Advantages of a HELOC
Since my own personal home was paid off, I requested a larger Home Equity Line of Credit (HELOC). This is something a real estate investor should always do; get as large of a line of credit as you can. A HELOC is cheap money, and it does not cost anything, IF YOU DO NOT USE IT. I would never advocate using it for any long term venture, not even a remodel on your own home. Use it for a short term property flip or a quick influx of cash that can purchase a property with a great cash flow. Or use it for a fast source of emergency funds while you get longer term funding in place.
Tip: If you are planning on leaving a job, get a HELOC first, as you might not be able to get one after you leave your work and no longer have a salary.
Once I had the HELOC loan, there was less of a need for a sizable chunk of cash in an account. My emergency funds can be taken care of with that source of funding. I still have a bit I can get if I need it, and the rentals are still throwing off cash, so it would not be the first line of defense. It may be the line I access before I sell stocks to generate cash though.
Things to Consider When Paying off a Mortgage
I do not have any other long term debt. No credit cards (other than less than 30 days), no car payments, no student loans, no outstanding debt of any kind. If I had other debt, that would have been a better candidate for my investment of the surplus cash.
I max out my 401K and IRAs. Without a doubt, maxing out my 401K is the best place for my first investment dollar of the year. I get a 4% salary match on contributions. If I put in 4%, my employer puts in 4%. I max out to the limit of $17,500 plus add the extra $5,500 catch up provision. That lowers my taxes and creates an environment where I have to live more frugal. I adjust my contribution rate to 75%, so it’s painful in January but I do get maxed out fairly quick. If I had not already maxed out my 401K, that would have been the place to put money into. Deduct more from my paycheck and replace it with money from my account.
I plan on retiring from my real job in less than two years, so if my Roth IRA was less than five years old, that may have been a consideration. You cannot withdraw money from a Roth, without penalty, if it is less than five years old. My IRA is about 20 years old, I started it when they were first created and the IRS allowed an IRA transfer and let you take 4 years to pay the taxes. So being unable to access my retirement funds was not an issue.
Emergency Funds
I do not need the money immediately for my emergency fund, but by definition I do not know what emergencies are going to happen… I still have a decent emergency fund left, and I generate more cash than I generally need from the rentals. In two more weeks, I collect rent again. Much of my after tax ‘stash’ is in ETF stocks, like IVV and IVW. I do not want to sell them to take a tax hit just to generate some fast cash. I do have the HELOC I can use short term, and have a few other accounts where I have a few extra dollars tucked away if needed. I even have a bucket full of change from throwing in a few coins every day, if it gets that bad… In a few months, I will have replenished even further a decent emergency cash fund, so I will be set soon.
If I would have had a guaranteed place to put the money and earn more than the 5.5% it was costing me on the mortgage, I could have worked the spread. Sure, the stock market may be doing more than 5.5%, but will it continue to do so? If I retire in two years, I will need cash flow then; I cannot wait for some historical average return after a long down slide and I have to wait 10 years to get.
Extra Fees
I had to pay some extra fees. Bank charges are really irritating. I am OK with paying the principal balance. That’s the amount I signed up to pay back. I am even OK with paying a $46 recording fee. The County charges it, and the payoff needs to be recorded.
I was charged $30 for a ‘Re-Conveyance’ fee. What the heck is that? When they give you a loan, they know that they are at some point going to have to re-convey the property back to you. I paid it, but I did not like it.
There was also a $30 ‘Expedited Payoff Service Fee”. Another bank charge that says “It’s our last chance to screw you, so we will do it for $30.
I paid $10 to Fidelity to wire the money. I saved $20 for the wire transfer fee compared to my own bank, but since I had to ETF my HELOC money over to Fidelity, that took about three days I did not plan on, I paid an extra $28.37 per day for those three days. And, I took my HELOC out for a few extra days while that money was in transit to Fidelity so I had to pay interest on that money. Looking back, paying the $30 to my own bank for the wire transfer would have been cheaper.
The Actual Payoff Benefits
The mortgage loan was ~$188K at 5.5%. The principal and interest payment was $1,145.51 with $28.37 going to interest each day. Of course, that daily interest amount changes every month. Every year, $13,746.12 was going to pay down the mortgage. By paying that mortgage off, I have an additional $13,746 of cash flow in my pocket every year. In a few years it would seem like pocket change if we have inflation, and for some people it may seem like pocket change now, but for me it is a lot of money. I used ~$46K in HELOC money, which is being offered at a promotional rate of 1.99% for another five months or so, and then it goes up to prime, which is at 3.25% today. The HELOC will be paid off before the 1.99% rate expires.
So, paying off a mortgage is like investing money at the underlying interest rate. For me, it’s like buying a bond fund or annuity at 5.5%. A Real Estate secured bond with principal returned when ever I want (to sell). I turned down an opportunity to buy a TX apartment building, that was advertising a ‘guaranteed’ 8% return, so factoring in risk, and the initial 6-month window where no returns were going to be paid, this is probably a better investment. I think it’s safer, and I have 100% control when I get out.
It will take a while to rebuild the payoff amount from just the increased cash flow that I have, so my retirement objective is adjusted down. Ultimately, financial independence is about monthly cash flow, not money in the bank. Money in the bank provides cash flow; it cannot be put to use until it leaves the bank.
UPDATE: I am paying off another rental mortgage! Read the additional analysis.
Have you done the analysis of paying off your own mortgage? Are you paying down your mortgage?
Congratulations! There are plenty who would argue this was a foolish move. I, obviously, would not be one of them. Reading your post was almost like looking in a mirror (except that I make far less than you do).
The secret to successful personal finance is you controlling the finances and not the other way around. I think you’ve taken real control and will reap the benefits. My analysis has been very much along similar lines. When you have excellent cash flow, you don’t need as large of an emergency fund. You can cash flow most any unforeseen issues that arise. HELOC’s are a good backup. In the meantime you put your cash to work and don’t let it sit around getting eaten away by inflation.
Great work, Eric!
Exactly. I like to have the cash, but if it was just earning 0.01%, and some even less (0.00%), it may as well be working.
Paying off a property is great, I like the 5.5% bond philosophy behind it. I don’t totally agree you paid off your mortgage since 46K was put on the HELOC to pay off the debt, feels a little like saying I paid off my credit card with a balance transfer, but I don’t want to rain on anyone’s parade you own that house!
We are currently taking the cash flow from 2 rentals(minus emergency fund) and paying off another rental property, with plans to pay if off in December 2016, so I understand your plan to pay off the mortgage.
You are correct, I still owe $46K. It was $50K, but I paid off $4k right away. Over the next 4 months, it will be 100% paid off. Since my HELOC is only 1.99%, I am immediately saving 5.5% on ~$140K, or $642 per month. And I am an saving 3.51% on the $46K, which is $135. A total savings of ~$776 every month.
Once it is paid off totally, it will be a cash flow difference of $1,145.51.
You bring up a lot of good points here. I think at this point I really need to keep as much of my cash free as possible, so I am paying the minimum on my mortgage.
There are multiple schools of thought on this. The question would be, if you had 2x as much ‘free’ cash as your mortgage balance is, would you pay extra?
Interesting what you said about using a HELOC for a short term project. I have never thought about that before. I am a huge fan of paying off mortgages early on rentals to get that huge stream of cash-flow. Congratulations!
Thank you. As the market heads up, I sometimes second guess the decision, but 5.5% return, guaranteed, is not too bad in today’s environment.
Looks like you looked at all the options and that made the most sense. Hard to see a lot of cash sitting there not making much money. Congrats Eric! Looking forward to your retirement countdown.
Thanks Deb! With a 5.5% guaranteed return, it was a no-brainer. But I still miss the old bank balance…
Congratulations on this pay off. You said it best, ” Ultimately, financial independence is about monthly cash flow, not money in the bank.” I love real estate, but I primarily look for flips for now. I think once I accumulate enough to buy 4 properties at a time, I’d use all cash as well. It’s a great feeling to have 4 rental properties that cash flows 50% over it’s mortgage payment, but it’s a greater feeling to have 4 rental properties that cash flows 100%.
Thank you for the comment!
Accumulate enough to buy one property, then work on another. Use a mortgage first, if you need to, but only allocate 25% of the rents to the mortgage payment. And assume at least 50% of the rents will go to expenses. You should be left with 25% of the rents for your return on investment.
Hi Eric. I enjoy reading your posts, they are very informative. Since you have been in this business longer than me, I would like to ask you a few questions.
I currently have 5 properties that don’t owe a loan. I have a job as well but would like to know how many rental properties should I own so that I can retire and just mnage these properties. My properties are all yielding between $1200 – $1300 per rent. After all my expenses, taxes, insurance , maintainance, fees are done I am getting about 5.5% return average.
Is this a good return and what would I need to do so that I can come close to 8-10%. I like properties with association fees so that I don’t have to deal with the cleaning, etc. I also like to have properties in good neghborhoods.
My goal would be to earn about $12K – 15 K per month. I am just figuring out how tmany more properties( preferable fewer) I would need to meet this target.
I appreciate you input.
Thank you for the comment!
It really depends… After you calculate all your fixed expenses, allocate 10% of rents towards maintenance, 5% towards vacancy and 8 % towards management. Then, just add up how much more you need.
To get a higher return, all you can do is lower expenses, or raise revenue.
First and foremost – congratulations! It must be a huge weight off of your shoulders.
For some reason, I thought that you were a full time landlord. I don’t know if you’re mentioned this before, but what is your day job? If you don’t mind me asking 🙂
Congrats on the payoff. I am also in love with the HELOC on my rentals. We have several of them and our bank offers 2.99% for a full 12 months all the time. We will typically keep a balance completely on one line, then when the promo ends we pay it off with another line and start the 2.99% again for another year. Any BTW, don’t forget the interest on these lines is just as deductible as mortgage interest. Great program..
Thank you!
A HELOC is a great source if funds. And totally tax deductible! Thanks for the reminder!
Hi All, I enjoyed reading this article and the comments after it. It is definitely motivating and I’m glad you’re controlling your finances, rather than letting the government or wall street control yours!
One question about paying off a rental home early..you mentioned paying off the mortgage early is like investing in a bond fund with a 5.5% rate of return. I clearly see this, but aren’t your taxes on your rental income going to increase more now, vs before? Doesn’t this erode the 5.5% rate of return to much lower?
Thoughts?
Thank you for reading!
You are right, I lose the tax deduct-ability of the mortgage interest I do not pay. I now have to pay taxes on that amount.
If I had a bond at 5.5%, it would likely be a corporate bond, not a tax-free bond which pay much less. I would also have to pay taxes on that corporate bond interest amount. It is ALWAYS better to have a $1 in lower expenses, than have $1 more in tax write-offs.
Greetings No Nonsense Landlord!
Excellent article along with so many real stories! I came across your website while research on what to do with my finances. It has become a bit more confusing reading so many personal experiences so I decided to directly as you and your audience to hear your thoughts.
Here is my story and my overall picture and as short as possible.
I am a married dude (15 years) just turned 40. My wife is 38 we have two children, one in school the other one in daycare. We both work full-time but I also do freelance work on the side. We jointly make $117k per year on full-time salary and perhaps $8K-$15K in freelance work.
I have perhaps $2K in 401K (long story why I did not do it). My wife has no 401K but has aside around $50K in pension that she can cash, no penalty if she leaves the company.
We have 3 “good debts”. Our mortgage for the house we live, and two rentals. 1st rental currently own $63K, property is valued (Zillow) at $130K. After expenses it leaves us around $350 cash flow. Second rental we owe $75K and worth (Zillow) $132K. In our primary home we owe $171K and worth about $281K. These properties are finance below the 5% mark and at 30 years fixed.
We have two bad debts. One auto finance still owe $6K and $25K on a HELOC on our primary.
In cash we have $80K, $57K are savings and the rest are savings for emergencies such as problems with the properties, etc.
SO HERE IS MY DILEMMA:
For the past couple of years, the savings have been stuck there not producing money just an insult percentage the produces perhaps $15 dollars per year. So I decide to buy another property. But have been a few months on the search now and no good deal comes across, I am trying to find properties that gives me some cash flow so I can save that money for emergencies. But due to my limitations, I can only afford condos, the issue is that these condos is that HOA starts in the $300 a month leaving me perhaps a mere $100 cash flow.
So, I am considering the idea of taking that savings of $60K and pay off my rental of $60K. From my point of view (probably ignorant of many variables) is that with this property paid off I have one less thing to worry about, use the cash flow to reduce all current small debts, and once that is covered, I can save again and get my $60K back in the next 10 years. I can also consider use that income to pay off sooner the other properties.
The only downside I see, is that I will no longer have a cash cushion for a big emergency (albeit the money is there), I won’t have the power to purchase another property perhaps for the next 5 years or more, tax on generate income would higher (right now I can deduct interest, taxes, and other expenses basically payed by the renter).
BUT there are many people that suggest it is better to get another property for several reasons (I do not recall one now).
So here is my question: Would you or any of of you, would recommend (or not) (and why) to use the cash in the savings to pay off the mortgage on that property.
Apologies for the long post and thank you in advanced for the time to read and answer.
Chuck
Thank you for the comment!
I would guess that paying off the mortgage would get you more cash flow than another rental. You might want to get rid of the HELOC or car payment first, depending on the interest rate. Fire up the 401K too, that is easy money.
Do not buy a property until you get rid of the debt and max out your 401K.
Here is a recent post that may also help determine what percentage of assets you should have in real estate. Real estate is your last dollar investment, not your first. It is RISKY!
Thank you for your comments. Car finance is 3.5% and only $6K balance. Car doesn’t bother me as payment is only $200 per month, I can get rid of it with a couple of freelancing gigs. The HELOC is another story, balance is $25K at 7%. My plan with this is to pay it off in the next two years by using Tax Returns and month additional to the principal.
Part of the plan of paying off the property is that with more cash flow, I can pay off these debts much sooner. Also minimizes the losses when there is no tenant.
Any thoughts on this strategy? I am a simple civilian, I work on computers so I do not know much about finances hence all these questions.
When you say “fire up the 401K”, what do you mean?
So, you agree purchasing another property at the moment it is not of my best interest?
I will be reading your recommended post.
Thank you so much for your advise!
Generally the best debt payment strategy is to pay off the highest interest rate loan first, or the smallest loan. Then, dedicate the loan payments to a different loan.
If you are not contributing to your 401K enough to get any company match, that is the best return on your money. Maxing it out will help you live on less, and save a bunch for your future.
Getting rid of the 7% HELOC loan is a no-brainer BEFORE you buy any future properties. Then hit the car payment. If it will take you two years to pay the HELOC off, with only $25K remaining, do not invest in any more properties until it is paid off. Get your cash flow in order.
Priorities
Get 401K Match
Max out 401K
Pay of HELOC at 7%
Pay off Car at 3.5% (non-deductible interest)
Pay off your home
Pay off a rental
Buy a new rental
Thank you! I will take your comments intro great consideration and I will continue to follow your website. Happy and prosperous 2016!
Hello Nonsense Landlord!
This is a great blog. Lots of real stories. I would like to tell you mine and hear comments.
I bought my first rental in December 2014 and moved my mother-in-law in. She is what I call a low risk tenant. She pays her rent on time…every time…and takes very good care of the property. The property has a positive cash flow of about 300 a month. I charge her about 300 less than I could if I was renting to some else.
The mortgage balance on the rental is 117k at 4.75% in a 30yr fixed loan.
I would really like to purchase another rental but worry of the risks of carrying two rental mortgages. I have a good income, but if it went away and I lost rental income, I would be challenged.
I am purchasing a new home and it brings up an interesting scenario. I am buying the new home with a VA loan at 3.25%. When I sell my existing home, I will profit 100k after all closing costs. Instead of putting the 100k down on my new primary residence, I am thinking of paying off the rental. I will take the additional 17k needed to pay off the rental from a stock account that I have that has been in idle for the last 1.5 years.
My reasons I think this is good are as follows:
1. The rental is then all positive cash flow. I can start saving immediately for my next 20% down payment for the next rental. If I run into a jam in life, I will have this cash flow coming in.
2. The mother in law will be moving into the next rental, so the 2nd rental will regain my low risk tenant! The property that will have a somewhat increased risk will be paid in full. If I run into issues with vacancy, it is not the end of the world. If I loose my job, I can use the cash flow to help me with my bills.
3. With the property paid off, I can establish a LLC and move the property to the LLC adding another layer of protection and minimizing risks.
4. I calculate the paid off investment property to generate a conservative 6% assuming vacancy, operating costs, rental income, conservative estimates on property increases, ect. It may be less than the stock market but I feel it is more robust. I also feel it will accelerate my long term goal to completely own 5 rental properties by the time I retire. I am currently 39.
Thoughts? Thanks in advance.
Thank you for reading!
I too, had similar concerns. Make sure you have plenty of back-up capital. Then, make sure you have the knowledge and determination to succeed. Rentals are all about cash flow. At first, you have a job, then, you are financially independent. Not much different than any other business venture.