Now is NOT the Time to Accelerate Debt Repayment

[Scott Passman]

There are few times in our history where there’s been more uncertainty about what things will look like in the short-medium term future. There have been a lot of posts on BP espousing opinions and predictions about where our economy is heading and what moves are the most prudent right now. One thing we can be pretty certain about though is that the Federal Reserve is going to double and triple down on driving up inflation numbers over the next several years in an attempt to stimulate the economy and drive the recovery as quickly as possible. This is not speculation, Fed Chairman Jerome Powell has said on multiple occasions when asked if he is worried about inflation and thus considering raising interest rates that “we’re not even thinking about thinking about raising rates”. Powell has stated openly that the Fed will adopt a new target to get inflation over 2% annually rather than “up to 2%” and is in the process of developing plans to drive higher inflation in our economy.

The 2% inflation indicator is measured via the Consumer Price Index (CPI) which is controversial (https://www.investopedia.com/articles/07/consumerpriceindex.asp there are many articles on this, but here’s a start) because this tool is believed to do a poor job capturing true inflation numbers and has been “adjusted” by the government numerous times over the past decades because they felt it overestimated inflation despite many other inflationary measurement tools indicating just the opposite, that is grossly underestimates inflation. The government has a lot to benefit from publicizing low inflation numbers so it stands to reason that if there is high incentive to show low numbers that is exactly what they will do. The data compiled into the CPI are not publicly available which adds to the uncertainty of how these numbers are derived.

Considering the current and expected Fed policies to keep interest rates at 0% and continue massive infusions of capital into the economy over the next several years, it creates very little incentive to overpay debt at this time because of the near certainty of higher inflation. No one knows exactly what that will look like and this is often debated here on BP and other sources, but there is an old saying that you don’t fight the Fed and if they say they are going to drive higher inflation then you better plan on it. Some things that would benefit from higher inflation:

-Leverage Debt- Take on low interest long-term debt to acquire hard assets like real estate.

-Don’t Overpay Low Interest Debt- Take advantage of paying more of the debt with tomorrow’s dollars which will be worth less.

-Precious Metals- The current environment is well suited for precious metals to do well. It is something to consider whether adding some to your portfolio would benefit you as a means to hedge against a worst case currency crisis. Keep in mind, precious metals are not really investments but rather tools for wealth preservation against currency fluctuations. 

-Investing in Stocks- The current U.S. market is highly overvalued compared to historical norms and history shows us time and time again that when this happens it will correct itself. The U.S has been driving the global markets the past decade and the cyclical nature of markets suggests that it may be time for foreign stocks to outperform the U.S for a while. So divesting some of your portfolio into some foreign stocks may be a great way to diversify.

-Limit Cash Holdings- In an inflationary environment cash does nothing but lose value. We need to be smart here and find a balance of holding enough to keep reserves high and be ready to take advantage of possible opportunities in the future, but not move so much capital into hard assets that liquidity is compromised in the event of financial hardship with our portfolio.

This post is not meant to portend “doom and gloom” but rather to point out in these uncertain times there is at least one thing we can be pretty certain about and thus plan for. Everything is about finding balance and financially surviving this pandemic takes precedence. So even though there is a possibility of “missing out” on opportunities in a high-inflation environment by holding excessive cash, nobody benefits if reserves are too low to retain current assets. As real estate investors, we are in a great space to use inflation to our advantage with real assets that can retain our nominal values so keep investing!

[Jody Sperling]

I've been considering using a HELOC to accelerate my debt pay-down on my primary residence as I recently bought it with 5% downpayment and carry mortgage insurance. I've run my numbers, and I think I could get to 20% down in six months. That would reduce my monthly payments by a staggering $35 each month! However, at the 20% mark, I could pull a HELOC on my primary of up to 90% rather than using the HELOC on my investment property which is cheaper and has less favorable 70% LTV limits.

If I'm understanding what you're saying correctly, you would say this is a poor allocation of money? The HELOC could be used to flip or BRRRR and increase my cashflow and asset growth.

I know having cash reserves is important, and I feel comfortable with where my current cash reserves are, even if I added a property, but I still waffle between Dave Ramsey's gazelle-like-debt pay-down and using leverage to rapidly grow my cashflow and net worth.

[Theresa Harris]

If you are talking about mortgages, perhaps; but people have other debt (high interest credit cards come to mind) that if you aren't paying them off in full each month, they definitely should keep paying them down as fast as they can. also remember that your debt load affects your DTI and therefore your ability to borrow money to purchase additional rentals.

[Whitney Hutten]

@Scott Passman Interesting insights!  Thanks for sharing :)

[Scott Passman]

@Jody Sperling I'm a little confused, a HELOC is generally a line of credit on the equity of your home. Maybe I'm misunderstanding you, but it sounds like you want to overpay your mortgage in order to build up enough equity to then have access to a line of credit on that very same money? If so, why not just keep the money in cash and use it? If you build up to 20% equity in your home and then can draw up to 90% LTV, then that is only 10% you have access to which is what you would have spent the next 6 months putting in there. The $35/mo savings would be real but you could likely get more return on that money by investing it into another property.

@Theresa Harris yes you are correct about the importance of paying down high interest debt, which is why I made sure to denote that a higher inflation environment would make it less advantageous to overpay low-interest debts.  Credit card debt should always be wiped out as soon as possible so thanks for making that more clear. 

[Jody Sperling]

@Scott Passman, one strategy that I see some people do is using a HELOC to accelerate debt paydown on their mortgage. Because you can apply a lump sum to the mortgage by using the HELOC and paying the HELOC down, you escape the amortized interest at the front end of a loan, significantly shortening the period of repayment.

Then you use the HELOC to pay bills throughout the month, and your paycheck to pay off the HELOC.

If I paid my mortgage at a standard rate without accelerating it using a HELOC, it would take me just under six years to get from 5% to 20%. Whereas if I use the HELOC, I have access to the money, but can pay off principal at the same time. Should I ignore the accelerated pay-down?

[Shannon Goldsmith]

If you ask any investor who lost their butts and their portfolios in the Great Recession due to their properties being leveraged, they would respectfully disagree with your post, Scott. I know several examples of such investors. All smart. All savvy, capable, knowledgeable men and women. The reason they lost their properties? Debt... A few of them started rebuilding eventually. And guess what? The few who have rebuilt their portfolios are now passionate (scratch that... obsessed) about paying off their properties as quickly as possible.

And guess what else? It's still possible to grow and rapidly pay off properties at the same time. I help investors do this everyday. With the help of a financial tool that I show them, investors (and traditional homeowners) are able to rapidly pay off their mortgages (and other debt including credit cards, student loans, tax debt, medical debt, car loans, etc.) in as little as 5 to 7 years. That's without changing their budget or their lifestyle.

And if they want to balance growth with debt pay down, it helps them do that too.

One last thing... we are standing on the precipice of a serious market shift. It's been happening for some time now. There are many more indicators to watch than just interest rates. If you could see what I see, you would know that the Fed's stance on inflation and interest rates represents will do little to overcome the other powerful forces happening right now that will lead us into a major shift. It's coming...

[James Hamling]

@Scott Passman fantastically said and right on point. The Fed is about as predictable as the sun in the sky, no statements of intent needed, it will be liquidity liquidity liquidity followed by QE QE QE, it's just what they do. 

Problem is, 99.7% of people can't comprehend all of this, not that they are idiots it's as Kiyosaki says over and over that the average financial education is at grammar level at best, and what people don't understand they assault and espouse with their "feelings" of how things are.... 

Proof of this ignorance is the roar of people saying stockpile cash.... they just don't grasp how that cash is becoming more and more worthless day by day, leverage and assets is the answer but they are talking about awaiting some mirage of a 50% price reduction coming, again showing their ignorance of what an inflationary cycle does. 

May also be of benefit to clarify when saying stocks that means stocks NOT mutual funds (which are NOT stocks fyi for those not understanding). I am always baffled how fooled most are into confusing the two as anything similar. Personally I keep looking at AAL and feel torn as to pulling the trigger or hold fast...... I am leaning to the former, this is the better placement for excess capital vs any debt paydown.