Do you put extra money toward principle or invest that money elsewhere?

[Rene Hosman]

I've had a conundrum the last few years since I bought my first primary residence, I was lucky to get a good interest rate <5% When I purchased this property I was very green and new to real estate but I had heard or seen somewhere on some financial blog or podcast that if you pay an extra $100/mo toward your mortgage in many cases you can accelerate your payoff date 5+ years. Obviously this depends on the amount of your loan, when you start to pay the extra amount, etc. But I did the math and for me personally that was true, I'd pay off my mortgage 5 years early if I paid an additional $100 each month to principle. 

At the time I purchased this condo, I was in my early 20's and the idea of signing a document that committed me to anything for 30 years freaked me out, because I hadn't even been alive for 30 years! The thought of making that a 25 year commitment instead gave me a slight feeling of safety so right away I started paying an extra $100 in principle to my mortgage every month. 

It's been 6 years and I finally realized, maybe I could be putting this money to better work elsewhere? My interest rate is sub-five percent so I could be earning more money on that $100 than I'm spending to keep it in the loan. The emotional attachment to the idea of paying off my mortgage early still looms large in my brain though. So I made a compromise with myself, instead of putting that $100 directly to my principle, I'm opening a brokerage account that will have $100 deposited into it automatically every month and invested in index funds using dollar cost averaging method. This way I have more flexibility with what I want to do with my money, and if I keep it up for another 20 years, who knows, maybe I'll be able to use it to pay off my mortgage as a lump sum at a later date if I choose to do so. And by investing it somewhere it hopefully grows more than 5% per year- I have the possibility of having enough to pay off the mortgage even sooner than my original 25 year timeline. 

What do you think? Do you pay any extra toward principle of your primary or buy-and-hold rentals? Do you take all your cashflow and stick it into your reserves? Do you invest that cashflow in an asset other than real estate? Or maybe your cashflow is just helping you fund your life right now! Let me know what you're doing and why!

[Nathan Gesner]

Your focus should be on expansion until you reach your final goal numbers (if ever). Once you hit those numbers, then you can focus on putting extra income towards paying down principal. Pay off the smallest loan first, then work your way up to the largest. It starts slow, then snowballs.

It's important to understand the power of leverage. I like the Unofficial Guide to Real Estate Investing. Here's a fundamental explanation to get your juices flowing:

Assume a house costs $200,000 and rents for $1,500. The market appreciates 3% per year.

Pay cash for one house and rent it for $1,500. After five years you'll have earned $90,000 in rent income and gained $34,000 in appreciation.

Buy four houses with $50,000 down on each. The mortgage payment is $1,000 on each house, so you earn $500 per house or $2,000 monthly. After five years, you'll earn $120,000 in rent income and $136,000 in appreciation. You've earned $132,000 more by splitting your money and leveraging it.

The real key is setting your goals. If you don't know what you are trying achieve, specifically, then you will never figure out how to get there.