Rental income towards mortgage or somewhere else?

Question

Hi.  I am curious if you buy and hold landlords put more money on your mortgage payments, or somewhere else.  I am talking about cash flow.  After all expenses, say a property is producing $400 monthly cash flow.  The mortgage rate is 3.5%.  Does it make more sense to put an extra $100 monthly towards payments, or to do something else with it?

Steve Babiak · Answer

The first thing you should be doing is funding reserves.  Without adequate reserves, you might not be able to survive as a landlord.

Once a safe level of reserves is in place, then you should put the money into that which best suits your "plan".  If you are closer to retirement, you might want to pay down the loans.  If you are younger, you might consider new acquisitions as a better use for that money.  So I don't think any forum answer will be "right" - just mine the ideas that you get and then pick what best fits YOUR plan.

Jerry W. · Answer

Kelly Williams Another thing to consider is how far you are from retirement.  Use your extra equity early on to get more units, then closer to retirement concentrate on reducing debt.

Jeff S. · Answer

If/when interest rates increase you will regret giving back that money. 3.5% is keeper money IMO.

Matt Devincenzo · Answer

Michael Immordino that is incorrect. Only the interest portion of a mortgage payment is deductible. Said another way the interest portion is pre tax dollars the principle will be post tax dollars so paying down the loan will not benefit you from a tax perspective. If anything it will be negative in that you will reduce your interest expense and therefore your deduction that you could take.

Bill Gulley · Answer

Kelly, the wise use of funds is related to the cost of money which relates to opportunity costs. You can search those three phrases, use of funds, cost of money and opportunity costs. Bascically if you have disposable income that is available to use on anything, you need to consider the possible uses for the money, if the cost of money is higher than the benefits you could receive from other uses then paing off debt quickly is a good choice. Usually the problem is that renatl income is a small monthly amount, you can't go buy another property from a months income so opportunities are limited, unless it is saved for a long period. That leads to other economic issues. It could well be the best use would be to pay down debt, but frankly at todays rates, near an inflationary rate, using that money to go out and eat may provide a better quality of life worth carrying debt, depends on you and your goals and what is most important to you. It's an economic matter. :)

Bill Gulley · Answer

Good point Jerry, your finances need to be in line with the big picture.

And, from a text book and looking at all the strategies available to RE investors, you'd conclude that 500 a month could do something. But can you actually find consistant deals, do you have the time toinvest in doing the deals, what are the tax issues, what is the risk involved and what other costs could be incurred with the alternative?

In 5 years, you'd have saved 30k, that can certainly be another deal, but you could also get a new loan for the other deal if you have equity, leverage the next deal, then as that project cash flows rinse and repeat, you might sell off another project and then payoff your anchor property.

In reality, things don't often work out as they do in a text book, consider the big picture and as Jerry suggested, your personal goals. :)

ps, Jerry, tried to vote up up but my button isn't working!

Roy N. · Answer

Kelly Williams:

Bill Gulley & Steve Babiak provide you good advise.

First use your free cash flow to establish a suitable reserve for your property(ies):  that way if you have an extended vacancy in a unit, or the HVAC needs replaced in another, you have the funds to see you through.

Once you have sufficient reserves, then it all comes down to cost of money / opportunity costs.

Current conventional mortgage rates are very low (2.9% on three of our properties, 5.00% on our commercial mortgage), which, as several folks have pointed out, means accelerated pay-down of those debts may not be the best use of your free cashflow.  However, if you have private financing (vendor carry-back, private mortgagee) at a loftier rate, say 8%, then using your cash-flow to accelerate the pay-down of this debt would likely be a good use of your money.

In our case, our default use for surplus cash-flow is to pay-down debt (most expensive first).  We have also setup the conventional mortgages on our properties paired with an LoC, which allows us to pull capital back out without refinancing.   In practice, this means we dump {most} surplus cash flow onto our mortgages and, when we find another property to purchase, we draw those funds back out via the LoC component.

Pat L. · Answer

Definitely agree
When we started rates were 18% so we dumped cash on the princ 
With today's rates I would lock & load for the long term as higher rates are not if but when!!!

John Thedford · Answer

You might consider doing short term loans with the extra cash...say one year or less. If you can lend it out for 12%-16% that would greatly increase your return and if only for a year or less it would be back in your hands before you miss it.

Ziv Magen · Answer

We (and most of our clients) put rental income towards the next property almost always - at 10-15% net pre-tax, it just doesn't make sense to do anything else with it (except occasionally spoil ourselves silly, of course ;))

Rental income towards mortgage or somewhere else?

Most Popular Reply