Is the Security of a Free & Clear Property Real?

Question

All:

I've been investing for 16 years and am trying to thoughtfully consider the best strategies moving forward in somewhat uncertain times. Most of my career I have been in the "re-fi till you die" camp but have been moving towards the Dave Ramsey team in the last year or so.

However, I have gone through the expenses of one of my average duplexes and it *seems* that a free and clear property may not be as great as it sounds.

Current property expenses are:

$553/month interest

$496/month property taxes

$123/month insurance

$90/month lawn

$50/month water if vacant or $125/month if occupied

$225/month CapEx (est.)

= $1,537

All of the above expenses will still be there after I own the property free and clear with the exception of interest. A total of $984/month at minimum in perpetuity. Perhaps this is (somewhat) specific to my market as South Carolina property taxes are very high but I'm only eliminating 36% of the expenses when I pay it off. I could certainly be missing something. It kind of seems to be that most of the expenses of a property will always be there so what's the hurry to pay off the interest?

So is the security of a free and clear property actually real? It seems there will always be payments due on these other items forever.

Curious to hear some opinions on this topic. What do you think?

Joe Splitrock · Answer

When you are in a situation where interest rates are near or below inflation, it is financially better to have debt than equity. Dave Ramsey won't tell you that, because even if interest rates where 0%, he would tell you that you are a "slave to the lender". The last time Dave Ramsey had a loan was in the 1980's when double digit interest rates where common. Of course the math is different when interest rates are high versus low. Security is an illusion and a mindset. Illusion: Nobody is ever completely secure. Stop paying your taxes and the government will take control of your property. One major lawsuit and you lose everything. One natural disaster and your property is destroyed. Get a major disease and all the money in the world can't save you.Mindset: There are people with millions in the bank that wake up in the middle of the night fearing they will lose everything. There are people about to go bankrupt that have confidence it will all work out. Security is a person choice, feeling and perception. There are people who believe having loans reduces risk, because you have less cash into the deal, therefore less to lose. There is nothing wrong with paying off loans and usually people who are later in their investing journey choose to do this. Who wants to get a 30 year mortgage when you are 70 years old? There is a piece of mind that comes from not owing money to the bank. I have experienced this feeling on my personal residence. Bottom line, there is a logical and emotional component to all decisions. What I choose to do isn't necessarily the right decision for you, given your circumstances. Whenever these discussions come up on BP, I hate it when people on both sides accuse the other of being wrong. It is like asking whether blue or red is a better color.

Jai Reddy · Answer

@Brandon DesprasWhat tax benefits are lost if a property is held free and clear? If you’re referring to loan interest deduction, that is not a benefit. Other than depreciation expense, every other expense on a property is not a benefit. One pays more in loan interest to a bank and that amount is offset at the tax bracket one is in.

Jim K. · Answer

@Will GastonThere's an old joke about a little boy who lives with his single mother. One day, the boy is passing his mother's room and he sees that she's naked in front of the mirror, feeling herself up, saying to herself over and over again, "I need a man! I need a man!" The little boy gets scared and runs back to his room.The next day, he ventured out, and it happens again. There she is in front of the mirror, naked, touching herself, only this time she's loud, "I NEED A MAN! I NEED A MAN!" Again the little boy gets scared and runs back to his room.The third day, he comes out of his room and listens carefully. Doesn't hear anything. He tiptoes down the hall, still nothing. Peeks into his mother's bedroom. She not even up. She's in bed. And...there's a man in bed with her.The little boy stops and stares for a long moment. Then he nods, turns on his heel, and marches back to his own room. He takes off all his clothes, stands in front of his mirror, grabs at himself, and begins to chant:"I need a bicycle! I need a bicycle!"-------------------------Something like this recently actually happened in my life. For the last year, as my wife and I drove to our home from working on our duplex, we passed another, better-looking duplex on the road. Every day, I looked at that duplex and said to myself, "I'd like to own that duplex." Last September, it popped up on Zillow as an FSOB, I called the owner, made my offer, and today, that duplex is mine.As we drive home from that one every night, there's an even nicer duplex that I'm looking at now...-------------------------OK, the real point is this -- the way I bought that duplex was through a 1031 exchange -- sold a property that very conveniently became vacant at the right time, bought the new property with the money five days later. That's not how we usually buy properties, however. We typically buy once a year, and our most common trick is to take money out of our traditional IRA if our all-cash offer well below market value is accepted. Once we acquire the property, we go to a private money lender we know and arrange a loan to pay back the IRA in the required 60 days. And then we go to our bank to borrow money against one or more of our paid-off properties or our permanent residence, which typically takes longer than 60 days to set up. We pay our private money guy back with this money.Having that equity right there in a paid-off property is worth a great deal for us, even though we know it will take some time and effort to tap. The really good deals in this business do not come at predictable intervals, and it's easy to let those high-quality opportunities slip by if you're overextended and can't come up with money. You really don't know when the phone is going to ring, or you're going to see something on Zillow, or you're going to stop a a yard sale and strike up a conversation and be walking through a highly-desirable property twenty minutes later. We have the IRA at the ready, the private lender standing by always eager to luck into a low-risk scenario like the one we offer, and the equity that can be tapped. It's worked well for us over the years.

Bjorn Ahlblad · Answer

@Will Gaston I am retired and own properties so the rents will generate my retirement income. Since I am no longer scaling there is no advantage in having leverage. And since I made a bundle selling California properties there is no point in owing any money on my current portfolio. Some properties are 1031x and in my name, others are in an LLC. Today there is no point trying to be in complete control; politicians have demonstrated there is no such thing. So settle for the compromise that works best for you.I also have cash and other investments so if my properties were to be completely wiped out by some strange twist of fate, I would still survive; but it would not be nearly as much fun!

Jay Hinrichs · Answer

personal choice .. mathematically of course refi till you die is whats best mathematically if revenue stays the same and increases.. were the risk comes in is a down turn in values or income. worse case on a paid for property you can moth ball it and just pay tax's and dont even have to insure it if you dont want to.. on super low end mid west stuff If I owned a bunch of that again and it was paid for I would only have liability insurance I would not insure for fire.. And would bank those premiums. As mentioned above the wealthiest clients I have or have had over the years had significant paid for portfolios as they got older.. Lastly if it gets bad and I experienced this personally.. It SUCKS to have to write checks to sell property like in 08 to 2010.. Paid for property this does not occur as 99% of properties are worth more than tax's owed unless tax's have not been paid in a loooong time. So much more liquidity in a pinch..

Account Closed · Answer

I just hate banks. And any control they have over my life. So I paid off rentals. Plus the cash flow improves (not just the interest but principal payment also). I can't justify it mathematically but the POM (peace of mind) quotient is off the charts! I like not owing anything to anyone. Id rather be the lender than the borrower.

Pat L. · Answer

We found our free & clear niche...Early in REI life we opted to sell those we had as rentals & hold them as CFD or the notes @ 12%+. Many were sold for 2-3x of what we initially invested so the 12%+ is moot. The majority were cash deals as most tax lien/foreclosures needed rehab, none of which we paid for & none of which my wife would ever set foot in. Many have since refi'd & moved on or used it to buy other properties we had. In 35 years we have had a few amicable deed-in-lieu-of take backs, that we 'Washed/rinsed/resold' (as our attorney calls it) & one foreclosure. The latter was paid down beyond our initial investment & we just sold it 'as is' for 3x our initial purchase & now hold that note @ 12%. We also hold the notes on 3 other investment properties for that same investor, 6 for his father (who was able to retire early on the rental income) & 2 more for his other 2 kids & have done so for 15+ years of on-time direct deposits !!!

Ola Dantis · Answer

It all comes down to personal preferences at the end of the day and if you even have the opportunity to pay off your mortgage. Most people don't even think about paying off their mortgages because it is such a far fetched idea. Now, if you are able to pay it off, then it is ONE less bill to pay someone, meaning the govt or the bank. The simple idea of having to pay it off one's mortgage goes a long way mentally as well as financially for some, and that in and of itself brings security, which cannot be brushed off. A metric we must never forget is RoS: Return on Stress. This metric changes from investor to investor, and paying off a mortgage could radically reduce the RoS for some and that is all that matters. Sometimes, we, investors, like to think that we are only looking at these issues from a purely financial lens, but emotions do play a real role in these decisions too.

Pat L. · Answer

"Although, I'd argue that they are predictable as they seem to come at the most inopportune times. The best deal I've ever gotten was a contract on a duplex two days before my wedding. It was incredibly inconvenient but a grand slam."Couldn't agree more & you grab them when you can. We were in Australia for several weeks visiting family & at 2am Aust time I get a call from my agent about a great deal. That morning I had to find a McDonalds for WiFi access to get the documents etc downloaded. We actually did 2 more deals during that trip with the same agent & attorney. I then had to find a phone booth that allowed me to make o/seas calls using a CC as my cell phone wouldn't stay connected. A local coffee shop owner we had been frequenting a LOT then allowed me (for a few $$$) to print, scan then email documents back to the USA. Those deals paid for our entire trip including our 1st class fights.

Will Gaston · Answer

@Jim K. with all due respect to the Bicycle Story this is the most important thing you said:The really good deals in this business do not come at predictable intervalsThis is 1,000% true and a fantastic reminder. Although, I'd argue that they are predictable as they seem to come at the most inopportune times. The best deal I've ever gotten was a contract on a duplex two days before my wedding. It was incredibly inconvenient but a grand slam.