I paid off my mortgage. I am not talking about my personal residence; I am talking about paying off my rental mortgage. Why would anyone want to pay off a mortgage on a rental? After all, the interest rate is tax deductible, and everyone knows mortgage debt on a rental is ‘good debt’. Maximize it for all you can, leverage, leverage, leverage to the moon!
Here is why you should pay off your mortgages, even if it is on a rental.
My rentals cash flow like a madman compared to what I spend. I purchased then in the depths of the housing market collapse, they were run down. I fixed them up, created a better neighborhood, and now they rent easily and at about 10% higher rents than they used to. The tenants are quality tenants and lost rent and evictions are few and far between. The easier renting saves vacancy expenses, which is your number one avoidable expense as a landlord.
UPDATE: I am paying off another mortgage, please read about it here.
Emotional Attachment to ‘Cash in the Bank’
When I made the decision to pay off the mortgage, it was not easy from an emotional standpoint. It’s a lot of money to ‘give’ away, and my balance in my investment account was hit pretty hard. From a financial perspective, it was a no-brainer for me. I wrote about some of the analysis in a previous post.
The Mortgage balance was $188,758.33. I had some excess cash that was sitting around earning literally 0.01%. Some of it was from a recent flip I did. I should have put that money to work a bit harder, maybe in the market, maybe in a money market fund, and gotten a better return. The cash sat for about a year, constantly getting larger due to my rental cash flow and making my return in my investment account dismal. I had put some of the cash to work in the market, but it still accumulated. The market is no guarantee over the short run, and I need emergency funds once in a while, so I left most of it sit.
Advantages of a HELOC
Since my own personal home was paid off, I requested a larger Home Equity Line of Credit (HELOC). This is something a real estate investor should always do; get as large of a line of credit as you can. A HELOC is cheap money, and it does not cost anything, IF YOU DO NOT USE IT. I would never advocate using it for any long term venture, not even a remodel on your own home. Use it for a short term property flip or a quick influx of cash that can purchase a property with a great cash flow. Or use it for a fast source of emergency funds while you get longer term funding in place.
Tip: If you are planning on leaving a job, get a HELOC first, as you might not be able to get one after you leave your work and no longer have a salary.
Once I had the HELOC loan, there was less of a need for a sizable chunk of cash in an account. My emergency funds can be taken care of with that source of funding. I still have a bit I can get if I need it, and the rentals are still throwing off cash, so it would not be the first line of defense. It may be the line I access before I sell stocks to generate cash though.
Things to Consider When Paying off a Mortgage
I do not have any other long term debt. No credit cards (other than less than 30 days), no car payments, no student loans, no outstanding debt of any kind. If I had other debt, that would have been a better candidate for my investment of the surplus cash.
I max out my 401K and IRAs. Without a doubt, maxing out my 401K is the best place for my first investment dollar of the year. I get a 4% salary match on contributions. If I put in 4%, my employer puts in 4%. I max out to the limit of $17,500 plus add the extra $5,500 catch up provision. That lowers my taxes and creates an environment where I have to live more frugal. I adjust my contribution rate to 75%, so it’s painful in January but I do get maxed out fairly quick. If I had not already maxed out my 401K, that would have been the place to put money into. Deduct more from my paycheck and replace it with money from my account.
I plan on retiring from my real job in less than two years, so if my Roth IRA was less than five years old, that may have been a consideration. You cannot withdraw money from a Roth, without penalty, if it is less than five years old. My IRA is about 20 years old, I started it when they were first created and the IRS allowed an IRA transfer and let you take 4 years to pay the taxes. So being unable to access my retirement funds was not an issue.
I do not need the money immediately for my emergency fund, but by definition I do not know what emergencies are going to happen… I still have a decent emergency fund left, and I generate more cash than I generally need from the rentals. In two more weeks, I collect rent again. Much of my after tax ‘stash’ is in ETF stocks, like IVV and IVW. I do not want to sell them to take a tax hit just to generate some fast cash. I do have the HELOC I can use short term, and have a few other accounts where I have a few extra dollars tucked away if needed. I even have a bucket full of change from throwing in a few coins every day, if it gets that bad… In a few months, I will have replenished even further a decent emergency cash fund, so I will be set soon.
If I would have had a guaranteed place to put the money and earn more than the 5.5% it was costing me on the mortgage, I could have worked the spread. Sure, the stock market may be doing more than 5.5%, but will it continue to do so? If I retire in two years, I will need cash flow then; I cannot wait for some historical average return after a long down slide and I have to wait 10 years to get.
I had to pay some extra fees. Bank charges are really irritating. I am OK with paying the principal balance. That’s the amount I signed up to pay back. I am even OK with paying a $46 recording fee. The County charges it, and the payoff needs to be recorded.
I was charged $30 for a ‘Re-Conveyance’ fee. What the heck is that? When they give you a loan, they know that they are at some point going to have to re-convey the property back to you. I paid it, but I did not like it.
There was also a $30 ‘Expedited Payoff Service Fee”. Another bank charge that says “It’s our last chance to screw you, so we will do it for $30.
I paid $10 to Fidelity to wire the money. I saved $20 for the wire transfer fee compared to my own bank, but since I had to ETF my HELOC money over to Fidelity, that took about three days I did not plan on, I paid an extra $28.37 per day for those three days. And, I took my HELOC out for a few extra days while that money was in transit to Fidelity so I had to pay interest on that money. Looking back, paying the $30 to my own bank for the wire transfer would have been cheaper.
The Actual Payoff Benefits
The mortgage loan was ~$188K at 5.5%. The principal and interest payment was $1,145.51 with $28.37 going to interest each day. Of course, that daily interest amount changes every month. Every year, $13,746.12 was going to pay down the mortgage. By paying that mortgage off, I have an additional $13,746 of cash flow in my pocket every year. In a few years it would seem like pocket change if we have inflation, and for some people it may seem like pocket change now, but for me it is a lot of money. I used ~$46K in HELOC money, which is being offered at a promotional rate of 1.99% for another five months or so, and then it goes up to prime, which is at 3.25% today. The HELOC will be paid off before the 1.99% rate expires.
So, paying off a mortgage is like investing money at the underlying interest rate. For me, it’s like buying a bond fund or annuity at 5.5%. A Real Estate secured bond with principal returned when ever I want (to sell). I turned down an opportunity to buy a TX apartment building, that was advertising a ‘guaranteed’ 8% return, so factoring in risk, and the initial 6-month window where no returns were going to be paid, this is probably a better investment. I think it’s safer, and I have 100% control when I get out.
It will take a while to rebuild the payoff amount from just the increased cash flow that I have, so my retirement objective is adjusted down. Ultimately, financial independence is about monthly cash flow, not money in the bank. Money in the bank provides cash flow; it cannot be put to use until it leaves the bank.
UPDATE: I am paying off another rental mortgage! Read the additional analysis.
Have you done the analysis of paying off your own mortgage? Are you paying down your mortgage?