The Best Way to Pay off A Mortgage

paid-160126_1280-PDI am going to pay off one of my mortgages on my rentals this week in additional preparation for Financial Independence and Early Retirement (FIRE). It is non-owner occupied, so a refinance would only drop the interest a little bit, and cost a few thousand to do it.  Here is how I plan to do it, and I think it’s one of the best ways to pay off a mortgage.

Mortgage Stats:
Current Balance: $188K, Current Interest: 5.5%, P&I Payment: $1,145.51, remaining years ~26.

This is the mortgage for my third four-plex.  Paying off the mortgage would add an extra $13,746 to my bottom line.  Since some of the amount is principal reduction, not all of it would be taxable.  It is about $10,000 in interest I would not have to pay, or write off.  So my taxes might go up ~$3K or so.  My passive income stream would go up almost another $1,000 per month when it is fully paid off.

I am going to use some investment account money that is currently earning .01%, some cash earning 0%, some home equity line of credit (HELOC) money that is on a promotion at 1.9% for about another 5 months or so, and then the HELOC adjusts to prime, which is 3.25%.

So I look at it as similar to buying an annuity with an immediate payout at 5.5%. It would be like an annuity with 100% of principal returned after 26 years. All principal returned at death.  An annuity guaranteed by Real Estate I own, rather than some insurance company.  And I have the option to cash out (by selling) at any time, without penalty. It should decrease the financial risk of retirement, just a bit. It is also sort of like putting money in a 5.5% bond fund, a mortgage bond.

I would deplete my cash balance just a bit, and I would have the HELOC paid off by the time I retired. The goal would be to have it paid off in less than a year.  While the HELOC was in place, it would save 3.6% over the first five months (~$2800), and then save ~$4,200 per year when the promotional period ended. The interest savings would go down as the loan balance dropped.  Currently I am paying over $10K per year in interest on that loan.

Once the HELOC is paid off, it would also give me 12 rental units that I have paid off, plus my residence. FIRE is looking quite a bit better as I get closer to my retirement date and analyze the numbers. Lately, I just do not have the ambition or desire to put up with the Megacorp BS. It’s not that bad, I am just finding that I do not have the time or ambition to do it.

The downside is I will have less cash, but still well over two years of cash reserves. I can generate a bit of cash even quicker without the mortgage payment. I will lose a major milestone that I have accumulated in investable assets for a bit. I find that I have too much just sitting at .01%, so I may as well put it to use. Interest rates should also be low for a few more years, certainly below 5.5%.

Since the HELOC is an adjustable rate, if there is two years at 3.25%, and two years at 7.75% the interest expense would be a wash. Of course it depends on principal balances and the exact interest rate, but in a linear world it’s close.

The downside is by taking out a HELOC, I put another live lien on my personal residence.  Since my house has been paid off multiple times, I always hate to do it.

Once this is done, I will have 2-duplexes and 2-Four plexes paid off.  With 24 renters total and an average rent of just over ~1,000 each, there will be more that goes to the bottom line.  There are still lots of expenses that come out of the rent though…  I will still have three mortgages for the other three 4-plexes.  The total P&I for those are $3,340. It is still not a bad amount owed for 24 units.

I am thinking it is time to begin my ride off into the sunset, rather than climb the next peak. As I think about how much enough is, I may not need much more to live the way I want to live.

Are you planning of paying your mortgage off early?

15 Replies to “The Best Way to Pay off A Mortgage”

  1. Eric,

    This whole deleveraging and paying off rental real estate mortgages nonsense certainly goes against prevailing wisdom. Are you insane?!?!?! Great job! You get debt relief while rewarding yourself with increased cash flow. Sounds like a winning combination to me. 😉

    With more properties paid off you may find you won’t miss the higher cash reserves. You just don’t need as much since you can cash flow unforeseen issues more easily.

    Enjoy, my friend!

    1. There are two schools of thought for mortgages. One is to leverage as much as you can to get the most cash flow. The other is to not leverage as much to get more cash flow. Both increase cash flow, but de-leveraging is less risky. I do not want to take a chance in this point of my career to go broke. I am not going to re-build, I am going to ride off into the sunset and enjoy life.

      Donald Trump had so much leverage that he was worth a negative billion dollars at one point. Then went bankrupt. But even in bankruptcy, he managed to take away a lot of money. Unfortunately, when he ‘little guy’ goes broke, there are still a lot of bills to pay.

  2. Yes Yes! Great analogies with figures included, thank you. The low trough pricing of 2008-2010 is what sucked me in to REAL estate investing and managing. 3 properties paid for outright in roughly 5 year period. Zero debt. Zero vacancies. A slowly but steadily growing cash reserve, now at mid 5 figures & easily able to pay outright for virtually any repair or maintenance issue that may appear. Yeah, tax burden is too high, but I just budget for it and pay it. Life, creeping socialism and massive unlimited govt. excepted, is indeed good.

    1. Thank you for the comment!

      Rental property was readily available, if you have access to cash, in recent years. The low priced properties have mostly dried up, but are still available if you look hard enough.

  3. Sounds like a great plan. Do u have an opinion on buying property in a 100 yr flood zone or properties with some foundation issues? Should I totally avoid it or it should be case-by-case basis and how much of a discount I can get?

    1. Thank you for the comment!

      I think buying each property is a separate analysis. They must cash flow. They must have the desired return after all expenses. That includes initial fix-up, maintenance, management, and vacancy. It must be a return with a risk multiplier that coincides with the risk of RE. If you can get 2% on a C/D, you need more on RE. I like 15% cash on cash.

  4. I am not experienced in rentals, but I am not a huge fan of leveraging going into retirement. As you said, it is just more risk to have more cash flow. I would rather have my expenses by at a minimum by eliminating debt which would work better in a worst-case-scenario.

    1. Thank you for the comment.
      That is exactly my take. If I was younger, I may leverage and risk more. But safety as you get older is better. No one wants to go back to work after you retire. Using a withdrawal rate of 4%, my money in the bank would only net ~$7,500. By paying off the mortgage, I increase my cash flow by $13,700. Over $500 a month I can have fun with, or save.

  5. I am a fan of paying off mortgages early to have complete financial freedom and avoid paying more interest than necessary. I also get that sometimes it doesn’t make sense to do so. I currently only have one rental property. I am putting the money I earn in rental income, after I pay the mortgage, into an index fund. This way I can still have the money, grow the money and eventually pay off the mortgage with this fund. Also, if something major happens, I can use this as a second emergency fund for that home.

  6. This is awesome! Sure, your cash reserves will go down, but 1) like you said, you’ll still have 2 years worth of cash reserves, which is a GREAT amount of money; and 2) the less debt you have, the less cash you’ll need. This is a great plan! Good for you!

  7. Good creative thinking on using the HELOC with the special low rate to help pay-off the mortgage. I use my HELOC (2.75% at TDBank) as hard money. I lend it out for 15-16% and currently pay only 2.75%. Obviously this is a higher risk proposition, but so far it has worked well. A few extra % return on your money is a huge difference over a 5-10 year period. So, I’m a little worried that paying off such cheap money (on your mortgage) is NOT the best use of your capital right now, but I still like the creative way you are thinking about it.

    We are all at different ages and at different risk levels, so if you feel like you don’t want to take the extra risk to make more than 5.5% on your money, than your approach is perfect for your particular situation.

    1. Thank you for the comment!

      I have not had the opportunity to do any hard money lending. I have done a property flip though. And I have an investor that has inquired but I have not done any deals. How did you get started in hard money lending?

  8. I got into hard money through my real estate lawyer. He would constantly be hearing at closings of people needing hard money. He also knew I had some extra cash so he started throwing my name out there. I was shocked at how many people need hard money. I can’t even remotely keep up with all the deals coming way. Hard money is a real need for professional flippers. They can’t go to banks and they don’t have enough cash because the good ones have multiple properties going at the same time.

    Obviously, there are some downsides. When the economy tanks again (which it will because that is what economies do) my money can stuck in the property. Also, some of the borrowers can over-extend themselves and get into trouble that way.

    But, there are some good upsides. It can be a win-win situation. If the borrower does it right, then I can win and they can win. Also, the property wins because it goes from a broken, unlivable property into a livable, renovated property. Also, I can use borrowed money from the HELOC (as long as Prime stays nice and low…..once Prime moves back up to a more historically normal number than I will have to charge my borrowers a higher interest rate to cover my higher expenses which will lead to less business).

    It’s been a nice side business for me while I have grown my rental properties by locking in very low 30 year mortgages. Things will change…..rates will go up…..and I think it is our job as investors to use our money in the best possible way based on the current environment. If banks are willing to give me 4.75% for an investment property for a 30 year mortgage, I might as well lock that in. If banks are willing to give me a HELOC at Prime -.50 (or in your case at 1.99% for 5 months) then we might as well use that ridiculously cheap money in the best possible way.

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