Invest in Real Estate or Pay Off Current Mortgage??

Question

Jake Walroth · Answer

If I was in your position, I'd look to rent the Oakley house..... shouldn't be difficult to get young professionals, or grad students from Xavier. And if you've been in the house for more than a year, you could refi/cashout and do another househack, it appears your in a financial position to easily refi and househack again..... Get into another 30 yr 3.5-4.5 % interest loan with 3.5% down payment..... and you still have probably over 150k to play with on an investment property purchase. I don't think this one is that difficult if you're looking to grow your portfolio.

Jim Froehlich · Answer

@Zach Jacob, I'm not an expert on the subject, but have talked extensively with others about this very thing. My opinion is that this is really a personal choice and a factor of you and your wife's outlook on risk vs. opportunity.  I believe that experts can make a case to go one way or the other.  If you own things free and clear, then you're obviously not over-leveraged (or leveraged at all!) and you can more easily weather hard times if/when they come.  However, there is an opportunity cost when you leave money sunk into your property and it's not really returning anything other than appreciation (and likewise depreciation if/when it happens).  I lean toward the idea of never paying more than 50% equity into something if I can utilize than money somewhere else.  Obviously, high percentage credit cards are good to get rid of, but these other areas are up to individual desires and timelines.  I'm 47 and only recently started investing in real estate after a successful career as an Engineer (still my day job!).  I'm not going to spend all my time saving and paying down my personal residence, because the sooner I create another asset (generating passive income), the longer I can build returns from it.  Again, that's a personal philosophy and one many people get from their first reading of Rich Dad, Poor Dad.  I've heard Ramsey bash guys on one side of this equation and other equally-successful guys bash his thinking as if it's got to be one way or the other.  Good luck either way!  I think you will be successful based on your status and mentality!

Paul Caputo · Answer

I'd say take Dave Ramsey with a grain of salt. He's a smart guy and understands how money works, but most people he counsels on his show have a lot of stupid debt, not smart debt. There's a big difference. Stupid debt is a sunk cost such as having 2 cars on 6 year payments that you can't afford. You're never getting that money back. Smart debt is in assets that pay for themselves and then some allowing you to invest in real financial freedom.

It's tough to say what to do or what not to do because every person's situation is different. You have to look at the opportunity cost, what's the best return on your cash all things considered? How long are you going to hold, how much interest are you going to pay over that period and perhaps most importantly is the cash going toward something that you have to pay for or something that will pay you? You have to pay for your personal residence while an investment property will pay you.

Sounds like your new friend was a bit over-leveraged in the crash and paid for it in spades. Learn from his experience, but don't assume you'll make his mistakes. Be smart and look at the numbers. Plan for the downturn because it will come, but don't let that scare you out of starting. Play your cards right and you'll be prepared for it and be able to weather the storm.

Remember the only people who lose money in a crash are those that sell. Hold on and the market will return just like it always has. You just need to be smart about it and go from there.

Edward B. · Answer

@Zach Jacob,

Eh. Dave Ramsey and real estate investor are usually like oil and water. If this guy is a millionaire that may be why he is able to make it work. For the people trying to get to that level, though, in the so called growth phase of their wealth building strategy, leverage is a powerful powerful multiplier. Yes you have to be careful with it and understand what you are doing, but personally I think you will be hamstringing yourself if you follow that strategy. Sounds like this guy got in over his head and got burned so now he is born again. I highly doubt his situation applies to you. Heed his advice, but do what is best for you and your situation.

Zach Jacob · Answer

Great information, I appreciate everyone's feedback!

It's easy to understand the math when comparing APR's and return rates, I suppose it all comes down to commitment to a strategy and risk tolerance. My guy was obviously over leveraged at the WRONG time, and got burnt. Ramsey's strategy will surely work for those with zero risk tolerance, but it's certainly not the only way to financial freedom. I've decided to focus on the learning as much as I can about lending/financing options so I'm well equipped when opportunities come. Then of course focus on the long term strategy, don't scale too quickly through leverage, budget, pay down debt quickly, then eventually see the cash flow snowball once these properties are paid off.

Thanks again, everyone!

Joseph Cornwell · Answer

I believe @Brandon Turner used this example in his Rental Property book, but it is a great and simple way to look at leverage. Would you rather have 1 paid off 100k rental property that cash flows 1000 per month, or would you rather have 5 20% down 100k rental properties that each cash flowed 200 per month? Same exact amount invested, same return. Clearly you have to manage more potentially with 5 homes, more risk, more potential expenses, more time, etc. However, the math is clear, your net worth would literally be at a minimum be 5x better when these notes are paid off. Assuming zero appreciation, lets say you bought these in Oakley 10 years ago, your networth would be double or triple that 5x, so 15x better than 1 home. The tax benefits would be immensely better from being leveraged. Not to mention, 20% down is not highly risky, at least to me.

All in all, my point is this. Leverage when done correctly, having proper cash reserves, etc. Is undoubtedly the best option for growing wealth in real estate. You can invest with less risk by using all cash, you can also have less risk by investing in non real estate assets. The difference is, you have some control of that risk in real estate. Ultimately, you are the only one who can decide what amount of risk makes sense for your life, but there is no argument of which strategy, mathematically, is a better investment.

Best of luck either way!

Joe

Thomas S. · Answer

Owning everything free and clear is not investing it is hoarding. The returns are only 50% of what leverage could produce.

Jay Hinrichs · Answer

you need leverage to scale however I would use cash flow to accelerate pay downs on your rentals your not going to get 3.75 on investment property debt.

so if they are making 100 to 200 a month and you have a good job I see no reason not to snowball those amounts.

but I do think you have to BRRRR and snowball the two is where the wealth generation and scale meets..

as you get older you will appreciate advice of being cautious with debt.

you need to value add to create equity.. 20 to 25% equity in markets that historically have not or do not appreciate is really no equity at all if you were forced to liquidate.

Stephanie P. · Answer

Dave Ramsay is a brilliant guy, but contrary to Dave's way of thinking, all debt is not bad.  If your debt can make you money with a very low interest rate, then do it.  Along with Dave's way of thinking though, have a significant emergency fund. Don't spend all of your cash to dispose of a debt if the debt is still paying you.

Invest in Real Estate or Pay Off Current Mortgage??

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