Realtor · Warren, RI · Member since 2017 · 96 posts · 52 votes
Good morning BP! This question has been a curiosity of mine since I've purchased my first property this past July! I Used a conventional loan and went in with 20% down already. My question is how do you guys typically structure your loan pay down? I was told by the first lender I spoke with that if you make ONE additional P&I payment a year (whether in one lump sum, or spread out throughout the year), you shave off nearly 7 years of the 30 year mortgage term. Now this honestly my first time ever really financing anything in my life (other than a few years worth of student loans and tool loans for my current job). And I always paid more than the minimum (i.e.: towards the principle) and thus paid off the loan sooner than allowed. In my eyes, this is seemingly a great strategy because you end up paying less in interest / less all together. I'm under the impression that the strategy would follow true with my recent mortgage. Ive made 4 mortgage payments so far, and have paid an additional $500 towards the principle each month. If I were continuous with this pay down method, I feel like I could have this mortgage paid off in nearly 15-20 years instead of 30. Are there any disadvantages to paying a decent amount towards the principle each month? really curious to hear peoples opinions about this, and hear about what they find to be the best strategy in loan pay down! thanks in advance everyone!!! :)
Depending on your current rate and term and what $500/mo means to you overall, I like to punch mortgages in the face a little bit.
I've paid off 19 doors in the past year, BUT- all were above 6%, privately held with older sellers and/or were commercial loans with shorter terms, adjustable rates and were bothering me for my financials every year like I was a child.
I am even leaving my resi's with their sweet fixed rates and long-terms that are under 5% alone, but still punching a monster at 6.5% in the face every month at $7k/mo extra. But I already have reserves and a fully funded acquisition acct (dry powder as @Jerry W. likes to say).
$7k/mo to some is a rounding error. Everybody is different. What is $500/mo to you @Matt Romano? I'd hate to see you accelerate a 4% mortgage, yet miss an opportunity. If you have reserves and a funded acquisition acct already and no other consumer debt, accelerate all you want.
What is the rate and term of the loan you are paying the extra $500/mo on? Do you have cc's, student loans, car payment, etc? Pay those first for sure.
Anything additional is going to help you pay it down faster. If you are doing $500/m then thats $6k a year so depending on how big the loan was you can knock that sucker out real quick. I've only just started listening to these guys podcasts but it sounds like they don't typically do that, they leverage the equity to grab another. If you are treating this as your own home then this is the way to go. Pay it off as fast as you can. Other people might suggest using that additional to purchase another property and get money flowing in though.
If your looking to scale up save your extra money for your next down payment. Assuming it is a decent deal it will return much higher than your trapped equity. If your content with a small low risk portfolio, you have a solid plan.
I personally started with 15s paid extra towards when I could.. In about 10 years I had a heck of a lot of equity and minimal cashflow. Overtime I developed a good relationship with my bank that has allowed me to use equity towards new purchases which allowed me to scale up. Most of mine are 20yr. I do have 2 4plexes locked in at 3.5 for 30.
It really depends on your goals and risk tolerance.
@Matt Romano, I have used this strategy a lot. First get an amortization schedule of your current loan. You can look and see how much of your next scheduled payment is principal and add that amount onto your payment. Then mark a line through that payment because by paying it now all the interest that money would have accrued will be cancelled. You still have to make your next payment, but you will notice that there is more principal in that payment. You can add up principal from several payments if you can swing it. As you get closer to the end of the loan the cost of extra payments are higher as more is going towards principal. The drawback to this is that you have less money to invest. The strategy depends on what your goals are. With interest rates on savings accounts so low I hate to park money in them, except for an emergency fund. I often refinance or take out a second mortgage when I want to buy another rental. Not all banks let you do this. With interest rates rising going with a refinance could cost you a higher interest rate which means a longer time to pay off or more expensive payments each month. There are pros and cons to each strategy.
Personally I do the exact opposite. I take out a loan with the highest possible ltv and find a property that cashflows. If it's making me money I don't care if there is a loan - let the tenants pay that off for me.
Any time I get too much equity in a house I'll use a heloc/cash out refi to get money to buy more properties. You should always think of your ROI per dollar invested. Paying down your loan will give you a 4% ROI (or whatever your interest rate is). The stock market will give you 8% typically. Leveraged real estate (continually buying cash flowing properties using loans) is closer to 20-25% CoC depending on the properties you buy.
**Quick description of your ROI after 10 years in each of those 3 scenarios assuming the $6k in contributions per year:
Pay down mortgage (4% ROI):
60k principal + $12k interest = $72k saved, all as equity tied up in home
No extra payment, invest in stock market (8%):
60k principal + $27k interest = $87k, all as liquid assets
No principal payment, buy more proprieties with mortgages (20%):
60k principal + $95k interest = 155k, paid as monthly income via rent
As others have said it depends on your risk tolerance but personally I'm going to take advantage of the cheap bank/govt money and grow my wealth at as fast a rate as possible. So far my two properties are each yielding >25% ROI.
I was doing the same thing as you two years ago until I realized I could get a better return in the market. This year I realized I could get a far better return in REI. I'm 28 now, I'm just investing from my salary - I intend to retire in 5 yrs.
Not understanding why you want to pay off the loan. Investment/business wise that is a reverse strategy. It is presently being paid for by your tenants so why do you want to take your own money and bury it in the property.
Paying $6000 additionally each year out of your own pocket amounts to nothing more than hording cash. It is dead and buried while at the same time, due to it's opportunity value, is reducing the return on your investment. Equity will only result in killing your cash flow and turning what is intended to be a asset into a liability.
It's my opinion that if you make a better return than you are paying in interest, don't pay the loan down. One, the loan is being paid by someone else, not you, so if the property is cash flowing and all of your reserves are in order there is no advantage to paying early. If you can take that cash flow and leverage it to make more than the interest payment on the loan, it will cost you money to pay off the loan. Just my .02....
Depending on your current rate and term and what $500/mo means to you overall, I like to punch mortgages in the face a little bit.
I've paid off 19 doors in the past year, BUT- all were above 6%, privately held with older sellers and/or were commercial loans with shorter terms, adjustable rates and were bothering me for my financials every year like I was a child.
I am even leaving my resi's with their sweet fixed rates and long-terms that are under 5% alone, but still punching a monster at 6.5% in the face every month at $7k/mo extra. But I already have reserves and a fully funded acquisition acct (dry powder as @Jerry W. likes to say).
$7k/mo to some is a rounding error. Everybody is different. What is $500/mo to you @Matt Romano? I'd hate to see you accelerate a 4% mortgage, yet miss an opportunity. If you have reserves and a funded acquisition acct already and no other consumer debt, accelerate all you want.
What is the rate and term of the loan you are paying the extra $500/mo on? Do you have cc's, student loans, car payment, etc? Pay those first for sure.
I would be more interested in getting a shorter term with a better rate. I have never been able to look at life in 30 year clips, even when purchasing my home.
Also, think 2007. "Safe bet- like forced savings...." Equity is not always a constant.
I'm not an expert on this, but I think people are forgetting that even though it's just a 4% ROI right now it will be cash flowing like crazy once paid off. The problem is that paying it off is a long way down the road. If I were you I would try not to tie up all of your free cash it in, but maybe make an extra payment now and then when you have extra cash. Dave Ramsey pays cash and he seems to be doing ok. Not many people have that luxury though
Tons of interesting viewpoints on this matter. I really like the concept of using cash for other purchases, rather than the pay down on this particular property. I'll be living in one of the units for probably 2 years. But once its fully rented, let the tenants pay off my mortgage. Thanks for all the insight!
I'll give you my advice on leverage. I used to be on the bandwagon of pay off the mortgage early. I've rethunk it!
When interest rates were 8 to 12% APR 30 yrs ago, it wasn't such a sacrifice to accelerate mortgage payoff instead of an 8 to 10% expectation elsewhere in stock market, mutual funds. It felt safe to not be in debt, even if it was a slightly conservative yield on my money (and tax effects to boot). Now, I'm trying for 10 to 20% IRR on my real estate investments. Why would I put excess share of my precious capital in a mortgage to save 4% APR, when I could buy another rental and earn way more?
There is a continuum of perspectives on this. On the conservative end, I know of a widow in Denver that put her life savings into buying a $250k duplex for cash. She's thrilled that she has no mortgage payment and the entire rent (less expenses) is her net cash flow. She has benefited in Denver appreciating nearly 10%/yr for the last 8 years or so. So, her duplex may be worth $400k now.
However, a different REI could have taken that same $250k cash, and used it to put 25% down payments on 4 such properties. In our appreciating market, this person has $250k equity in $1 million of property. (75% loans/leverage). They could gain appreciation of value to 4x $400k each....now owning $1.6 million of property. Four tenants are also paying off 4 mortgages over the next 30 years. (granted, in the early days, the monthly cash flow is way less, due to 4 mortgage payments. So, you see, this investor is growing wealth faster with the leverage.
Have you read about the BRRRR strategy, that allows you even more leverage? What if a third investor took the same $250k cash, and used it to put 25% down on 4 duplexes that needed renovations....they can be bought and renovated for $250k, but they're really worth $350k ARV. (A fix/hold strategy of trying to buy at 70% of ARV). Because they did the rehab work, and gained $100k per property in the rehab stage, they own $1 million in property (at cost) that appraises for $1.4 million (or $350k each). Then, perhaps after 6 months "seasoning", this investor refinances all 4 properties to 4 new 75% LTV mortgages and get's to have a $262k mortgage on each. It more than pays for $250k each costs....so this investor extracts his original $250k, able to "repeat" and buy four more in the next year....and could actually have $50k extra profit in his pocket. If this is repeated in year 2, 3 and 4....after 4 years, the BRRR investor could have 16 rental duplexes, control $5.6 million in real estate, and have their original $250k back in their pocket. 32 tenants are paying off the mortgages. If 10% appreciation continued....it could be $560k extra equity per year.
Of course, admittedly, nice appreciation on the large portfolio works both ways....you could be subject to losing 10% of the larger portfolio if there was a down turn in your market or nationwide. And other BP investors would caution against having maximum leverage. Many BP investors love to have their rentals paid off early. But, the 75% leverage grows your wealth faster. The BRRRR is the fastest path to wealth.
This all depends on your risk tolerance. Think about 2007-08, when unemployment was 10%. People couldn't pay their rent so property owners were losing their shirts. All of this theory is great in a booming economy and if you are ok with the risk, go for it. But over the next 30 years there will be several market drops and possibly another major recession, if you use history as an example. So just keep that in mind when you leverage these assets.
My focus, as I get into this is to buy 3- duplex/triplex/4plex's, take profit and pay down my personal residence til its free and clear. I'll buy another and then pay off the first unit and so on, maintaining 3-4 loans at a time. Its a long game and not as profitable as a lot of these investors but I can ride out dips, cut my rent to keep good tenants if need be and continue buying in a lousy market, so on the rebound I come out way ahead.
@Thomas S. and @Jim S. hit it right on the nose. but it also depends on your goals, personality and how risk adverse you are. if you want to go big, you need to understand the concept of leverage. good luck
Matt- Looks like you got quite a bit of advice to your question. I was wondering the same thing. Someone mentioned Dave Ramsey and I have taken his Financial Peace courses. I remarried in 2005. Both my wife and I had been through tough divorces and had little money. But we also had no debt. We bought a 180k house and had to borrow the down payment as well. We had a 15 year mortgage but threw every extra penny we had at it. It was paid off in 7 years. We took a risk in 2012 and borrowed money from our HELOC to pay cash on a 93K house that was turnkey. We put both the rent and our regular house payment toward the loan. It was paid off in 26 months. A few months after paying off the first house, we bought a foreclosure for 78K and did 6k rehab. The bank appraised it as 103k. We decided to use the HELOC again as it saved a lot of money on closing and we didn't need a long term loan. With the two rentals income and the money we used to pay on our house, we had a clear title in 18 months. This summer we bought an acreage with a house on it for 2/3 of appraised value. By reinvesting all the rents it will be paid of by the end of this year. Now that is 4 properties bought and paid for in 12 years. The appraised value of all 4 is 630K and generates about 28k per year. I retired this summer at 56 and can live off my retirement. This allows me to buy properties quickly and pay very little interest with almost no debt. I doubt I will ever be a real estate tycoon and I really don't want to be one. I want to spend time with family , friends and enjoy life. The thought of owing 800k on a million dollars of properties scare the hell out of me. I had too many friends in a lot of trouble the last time the market turned. Some will never recover from it. Advice is great if you can learn from others mistakes. In the end, you must know what you want, what it takes to accomplish it and understand the price of success as well as failure. Best of luck!
All of these options hinge on risk tolerance....... if you want to win big, you have to leverage big....but you have to be able to deal with the downturns. The strategy to keep leveraging and taking on more and more debt is all fine and dandy when the market is great...the economy is great...unemployment is great.... your employment is great....rental demand is great....but you have to be prepared when its not. A lot of people were riding that huge wave until 2007/2008 and a majority of them lost everything when the crash happened....so learn from that. I doubt a crash like that is going to happen in our lifetimes, but downturns happen. If you overleverage and cant deal with the bad times, you risk losing everything
I personally worked hard to pay off my own house free and clear....and then opened a HELOC on it..... Was that the best way to grow my wealth?.... probably not..... but its pretty safe and the feeling of having my house paid off is worth it to me....but I have no intention of paying off my rentals quickly. I would rather use their income and equity to buy more. But with my house paid off I can now amass cash quicker to buy other properties too, and use my HELOC. If something bad happens ( get sick, lose my job etc) at least I have a place to live and only have to worry about the taxes etc
So you have to factor in risk....with bigger risk, you have the potential for bigger reward...but also the potential for bigger failure....you have to decide on where in that spectrum YOU want to play