When to Pay Down Mortgage Principal Early?

[David Katz]

Recently purchased my first turnkey rental and started making payments on the mortgage.  Mortgage is about $134,000 at a rate of 4.875%.  The property has a positive monthly cashflow of about $300 before factoring in vacancy, maintenance, and capex.  

Do folks who own turnkey rentals with positive cashflow tend to pay down the principal on an accelerated schedule?   Is it all just a question of whether I can get higher than a 4.875% rate of return in the market?  Or is it a matter of finding a middleground where you can accelerate the paydown, but still retain enough leverage to buy your next property?

[Ben Zimmerman]

If you have $300 left over before factoring in vacancy, maintenance, and capex then you aren't cashflowing.  I would not use this extra 300 towards equity paydown unless you have plenty of other money set aside as a rainy day fund.  If you pay 300 a month for a year you will have gained an extra 3600 in equity, but that equity isn't going to help pay the bills when the tenant moves out and the property sits vacant for a month while you replace the carpet and screen a new tenant.  

However, in general the question of paydown really depends on your investment strategy and risk tolerance.  Paying down a loan is safer, but also generates lower returns thus slowing down your overall growth potential.  The older you are, the more prudent it typically is to go with the safe  option, while the younger you are a more aggressive approach will typically be the best option.  When you are older, taking a 30% or higher hit to your net worth could be devastating, but when you are younger and still able to work, you may not even notice this hit on your net worth, and as long as you don't panic and sell your asset, the market will eventually recover and you will gain that money back and more.  

Personally I like a mix.  I want a few properties that have very high equity while the majority of properties are fully leveraged.  This allows me to use the high equity properties as a store of wealth that 'generates' ~5% interest that I would otherwise be paying the bank.  But more importantly it gives me access via a heloc to a large sum of money should I find another good deal so that I can tackle that deal without needing to use hard money loans and their insane rates.