A few posts ago, right about last year, I wrote about my plan to pay off rental mortgage debt. I had laid out several of my options, and I ignored all of them. Instead, I continued to pay my regular payment, bought a new rental and paid cash for it, and paid extra on my current mortgage that is targeted to be paid off next. If I would have skipped the new rental, and put that money on the rental mortgage, I would almost have this rental mortgage debt paid off. Instead, I have that money as a 15%+ income producing asset.
There are many reasons to pay off rental mortgage debt, those reasons are all against the many pundit’s advice to stay leveraged. Here are my own personal reasons and what I have accomplished in the past twelve months.
My rental portfolio is a rock star rental portfolio in terms of non-leverage. I own 9 properties including my own residence, and have 25 renters. I only have three mortgages. My mortgage payments, principle and interest, are about 10% of rents when 100% collected. It will soon be much less than that.
What Rental Mortgage to pay First?
When you pay off a rental mortgage, or any debt, you should look for the highest interest debt you have, then pay it off as quickly as possible. Make the minimum payment on your other debt, and pound the highest interest rate debt first.
If that high interest debt is insurmountable, pound out the smallest one. Once that smallest debt is paid off, it creates more cash flow, and that allows you to pay off the highest interest rate debt next on your list. It is very simple – on paper.
In my case, both the highest interest rate mortgage and the smallest mortgage is the mortgage. So I have been focusing on that one.
Stay Away from Leverage to Sleep Well
My loan-to-value (LTV) ratio, when you look at realistic selling price, is about 15% of the total value of the properties. It seems like quite a bit of equity, but you cannot even buy a cup of coffee with a paid off building. You can buy many cups of coffee with a mortgage payment though.
Paying off a rental mortgage is frustrating. You pay and pay, and the balance never seems to get where you want it to be anywhere fast. I have been paying an extra $4,000 per month on my mortgage, and the balance is still high.
In the end, until the mortgage is paid off 100%, your cash flow does not change, and your tax deduction is less. So you are actually temporally worse off in the interim, with the extra principle payment scheme. Once you make a commitment to pay down a rental mortgage, you have to be relentless. You need to focus like a laser.
In Retirement, or FIRE, you need less debt – not more income
When you reach FIRE status, you will realize that you do not need as much money as you think. Much of what you earn as a W2 employee goes to taxes and savings. FICA, Medicare, 401K, HSA, IRA, Roth IRA, etc. Factor in extra income taxes due to a higher income, business lunches, commute costs, parking and bus fare, and adding in the cost of going everywhere at prime time and paying high prices, etc. take up a lot of cash.
Once you FIRE, you can fly out on a trip on a Tuesday, and save big on airfare. You can go to a restaurant and save on the Wednesday specials. You can take the time and make something to eat, as your schedule is less hectic. There are many ways to not spend money if you are not working. But working or not, bills must be paid. No matter how much your cash flow is.
If you have debt, it stays on like tree sap in your hair. Debt must be paid. Debt is like a nagging toothache that will not go away. It will destroy your credit rating if you do not pay it. It is the first dollar spent, and your ‘fun’ money comes last. You must defeat Debt when you are ready to FIRE. If you are still building your asset base, ‘good’ debt is OK.
The (new) Plan to pay off a Rental Mortgage
I have access to a HELOC that is an adjustable rate loan, and is 3.49% at the present time. That’s almost 2% cheaper than my lowest balance mortgage. The HELOC could be used it when the mortgage balance is lower.
I had ideas of paying off any remaining balance by 12/31/15 with my HELOC, and then pounding away at the HELOC. I invested in stocks instead.
On my FIRE date of 7/5/2016, I was going to make a larger payment from my investment account, and then pay off the rest with my HELOC, but I invested in stocks instead.
So the plan now is to continue to pay an extra principle payment until the need of the year, and decide what to do at that time. The balance should be ~$81K by then.
Remaining Rental Mortgage Debt
| Property | Balance 08/06/15 | Balance 08/06/16 | Paid Off | Payment (P&I) | Interest Rate | Annuitized return |
| 1 | $181,301 | $176,844 | $4,457 | $1,071 | 4.88% | 7.27% |
| 2 | $218,822 | $213,534 | $5,288 | $1,309 | 5.00% | 7.35% |
| 3 | $160,517 | $103,671 | $56,846 | $960 | 5.38% | 11.12% |
| Total | $560,640 | $494,049 | $66,591 | $3,340 |
I look at annuitized return just a bit. If I put up ~$103,671, which is the remaining rental mortgage balance, I save $960 every month. It’s sort of like buying an immediate payout annuity, that pays $960 every month, sort of…
Historical Mortgage Balances
I have made significant progress on mortgages over the past few years. I was almost a million dollars in debt at one time. That was just a bit over 4 years ago. This list of mortgages is not all my properties, as there are a four others without any mortgage debt at all. Since they were free and clear on 02/18/2012, I did not include them. That makes six total properties without a payment.
| Mortgage Balances | ||
| Property | 02/18/2012 | Current |
| 1 | $193,933 | $176,844 |
| 2 | $233,141 | $213,534 |
| 3 | $167,067 | $103,671 |
| 4 | $43,831 | $0 |
| 5 | $196,161 | $0 |
| HELOC | $87,038 | $0 |
| Total | $921,170 | $494,049 |
So away I go. I will keep trudging along, paying an extra $4K a month as I have every month for the past year. Hopefully I can continue this payoff scheme for the rest of the year. I may decide to use some investment money to pay the smallest rental mortgage off – or not. Now that I no longer have a full time job, I will be a bit more careful of the money spent.
Once the rental mortgage paid off, I will have an extra $4,000 + the $960 payment extra in cash flow. That’s almost $5,000 extra per month. Some families with kids live in less than that, and pay rent or their own mortgage payment.
How would you approach the mortgage payoff? Would you use a HELOC to pay it off?
I would probably use the HELOC because the interest rate on the existing loan is 1.9 percentage points higher. Thanks for sharing your mortgage payoff process – it’s inspiring.
It’s fascinating the P&I payment on your mortgages as mine is $1,027.32 from a $260,000 origination balance…but it’s an ARM that started at 2.5%.
Thank you for reading Leigh!
It’s always great to see others pounding out their mortgages too. Being mortgage free is real financial freedom.
Yup, I can’t wait for that feeling! I’ve pounded my mortgage down to $128,000 from its original $286,000, which feels great. I felt especially great when it dropped below my annual base salary!
And when you have been paying extra principle on the mortgage, and finally eliminate the mortgage payment, it frees up not only the mortgage payment, but the extra principle payment money too.
I also liked when my regular mortgage payment finally had more principle than interest. I hate paying money to banks!
It only took me 8 months from purchase for the principal of the regular payment to be higher than the interest! That has been the case for a while. I paid about $270 in interest in August. I might finish paying it off next year – we will see how life goes.
It amuses me when family members are okay with 9% credit card debt and here we are with BF having paid off his 3ish% student loans within a year of graduation and me paying extra on a similarly cheap mortgage. I don’t like owing money to anyone. The ARM has really worked out well for me because rates haven’t turned out to go up much in the last five years and I will have saved at least 1-1.5 percentage points in interest for 5.5 years.
Wow, that is some serious progress! I know you and I are at different points on the retirement trajectory, but you’re making me jealous over here. 🙂
I would use the HELOC to wipe out the highest interest rate mortgage, too. Then I would either pay down the HELOC as fast as possible, or start really chopping away at the next highest interest rate mortgage.
I would also seriously consider taking some of the investment money and using it to wipe out a mortgage, especially if you have a lot sitting in stocks. The markets are just so dang high right now and we’re so overdue for a crash. But I guess that depends on your tax situation, too. If it would result in a lot of capital gains, I might not mess with it.
Nice work! I’ve been paying my house off aggressively, and I’m just about to fall below the $250k mark on my mortgage. It started at about $406k when I bought my house in 2008. From 2008-14 I paid some extra but was slowed down by a cash-flow negative rental property (my old condo) that I got stuck with after the crash. After the condo sold, I was really able to pick up the pace. I’m down to $252k now, and on track to pay it off within 7 years, which will be just shy of the 15-year mark from when I moved into the property. Considering I had a very small down payment and about 6 years of slow progress, I’m going to be happy to still be able to knock out the whole mortgage in 15 years.
Thank you for reading Amy!
I think that is what I am going to do. I was going to pay the mortgage off last year end, but the balance was still a bit high to put on my HELOC. And I was getting ready to retire, so it was a bit of nervousness on my part too. I hate crowding up my HELOC for too long. And I had the new property just purchased. With the balance down significantly since last year, it will be about half of what it was a year ago. Then, putting up a bit of cash, plus some HELOC funds, it will be paid off.
My stock portfolio is strictly a buy and hold index ETF strategy, so I leave that alone and rake in dividends. I should be able to payoff the HELOC in about 6-8 months. Then, I can buy a new truck…
I agree, use the heloc to pay off all that you can. Why wouldn’t you want to save on interest. My wife and I have 25 rentals one state south of you and I just gave my notice to leave on my 35th birthday. I have 15 days to go, can’t wait to try out the easy life! I expect to work harder but no more sitting behind a desk all day! Lots of projects waiting for us.
Thank you for reading!
I am about 90% sure I will leverage my HELOC at year end and pay off the rental mortgage. I am close enough to being fully paid-off now to reduce my adjustable rate mortgage risk. I also am less in need of any interest rate deductions. Once you pay off a rental, it is harder to get another 30-year mortgage, especially if you put the property in an LLC name. You have to switch it back in your own name, and promise not to revert back to an LLC. A commercial loan is nearly always an option as a fall back, but that is adjustable. Just a year ago, they were talking several interest rate hikes, and potentially that would have raised my HELOC rate to about where the 30-year mortgage rate was.
Since my HELOC will be less than ~50% utilized after the payoff at year end, I still have enough backup for emergency expenses. If the expenses would ever wipe out my other sources of funds.
I am also going to be retired for ~6 months by year end, so my finances will be better known. I have computed them 1000x over, but the ‘real life’ is a better test.
We haven’t ever used an LLC. I’ve spoken with our accountant and he tells us it won’t save us any money. Our lawyer told us it might be better in a lawsuit but it sounds like so much hassle we haven’t ever done it. We keep raising our liability insurance as we buy more properties.
It doesn’t save money from a business standpoint. It does offer some liability protection.
I do my own taxes, so my tax accounting invoice is unchanged. I do think there are some deductions that are OK for a S-Corp and look more suspect for a schedule C (or E) expense. I have both S-Corps and LLCs.
Ok good to know, thanks. With more time on my hands now I may start doing my own taxes as well.
I use TurboTax. LLCs and Corp’s need the $100+ version, but I do all 10 companies with the same installation.
If you can generate a P&L statement, you can do TurboTax. I meet with my Accountant every year to ask questions.
I used my HELOC a couple of years ago to pay off a nosebleed territory (7 percent) mortgage originated back in 2001. Paid the HELOC down but took out more at the beginning of the year to renovate a house for sale. Instead of paying the HELOC down, I used the sale proceeds to pay off three more mortgages. I’m planning to do something similar in the Fall but the renovation cost will be cash flowed. Paying off three more mortgages will get me below 10 and I can refinance a couple using conventional loans to much better interest rates.
Thank you for reading!
A HELOC can be a very flexible for of financing, if used correctly. Buying property is what I have used it for in the past. And temporarily paying off a mortgage, so you can focus on paying off the HELOC. A great low-interest loan.
Hi Eric! I just saw this. You and I have very similar portfolios. I also live off my properties. I’m currently sitting on a pile of cash that would eliminate one of my two mortgages, and almost the whole second one as well….with a $175k HELOC for emergencies. I can’t decide whether to go debt free or buy more…and so I sit, and shop, and think. I’ve been in this mode for 6 weeks, and the money is burning a hole in my pocket.
One other thought — maybe run your numbers based on the sale value of the properties vs. current yield., and if any of them are in the single digits, I’d consider selling the property with the lowest yield to wipe out all the mortgage debt. I’ve sold one this year, and may sell another, because my rental market is becoming saturated and home price appreciation is strong. In my neighborhoods, I’ve been stunned at the nosebleed sales prices, yet the rentals are getting harder to fill. That just speaks solely to market conditions in our unique areas, though.
Otherwise, I like your HELOC idea. More money in your pockets — less to the bank’s.! Good luck! Keep us posted! Enjoy your freedom!
Thank you for reading!
I am seriously considering paying off the rest of the mortgage with my HELOC. After a few more month’s in this retirement thing, and the numbers still prove out, I will likely do it. The HELOC would be ~$60K. Then, I can pound the HELOC out in ~6 months. I should save ~$1500 or so. The cash flow will increase by another $960.
Hi I follow you on the MMM forum too.
Do you have a checking account for each property or do you use a HELOC?
We have a HELOC on our primary paid off residence. It recently came in handy when we were not happy with the mortgage renewal rates on a rental. We just paid it in full from our Primary HELOC.
We are now a “free agent” searching for a mortgage on the rental property. I plan to get the same type of MTG, HELOC. However, this time we will use the HELOC on the rental as our rental checking account. I plan to accumulate $5K. Take out $10K & apply to the mtg. Now build back up from -$5K to + $5K and repeat. Rent will go in & taxes, maintenance, regular mortgage payment will go out. The rental currently nets about $1000/month so every year we will be able to easily make that extra $10K payment. Actually, I think we can squeeze in 8 payments over the 5 year term.
We will also save on checking account fees &/or the need to keep a minimum balance. I feel there is no need to stash an Emergency Fund (new roof recently done) and overdraft charges are never a worry if rent is late (never had to use it but never want to).
Do you see any red flags?
Thank you for reading!
I have one business checking account for my corporation. Each property is in an LLC, but does not have it’s own checking account. I should write a post about how I own my properties. I have been planning on doing that for a while. I even have a Visio file I made for it.
I have one HELOC on my primary residence property, $178K. I was not sure you could have one on a non-owner occupied property. I use my HELOC as a source of fast cash for a purchase, or as an emergency fund. I have never used it for an emergency yet, and only two times for a rental need. Once for a purchase, and once to pay off a mortgage.
I may use it at the end of this year so I can get rid of a mortgage. It will likely be a smaller amount, $75K or so, and I will pay that off within ~6 months or so. The interest rate is ~% less that the mortgage, unless the Fed raises rates. If the bank has a special discount for six months, that is the time to do it.
Red Flags would come up if you did not pay off the HELOC, and used it extensively for things you should cash flow for. Or if interest on the HELOC went way high. Or using the HELOC for something that was not rental related. In the right hands, a HELOC is as good as a cash back Visa card.
“I was not sure you could have one on a non-owner occupied property. ” In Canada you can as long as the rental does not require a “commercial” real-estate mortgage. I know someone with 2 HELOCs one on each side of a duplex. You can easily have them on single family rental homes. I believe the limit is a 4-plex. You need commercial for a 5-plex or more.
With a small collection of paid off duplexes etc. you could wither get your self in trouble or have great access to fast cash for a much larger property purchase.
I could definitely cash out and buy more property. At this point, I have enough, and I can manage them effectively. If I get more, it may become a job, something that I wanted to get away from.
Very nice plan. How to follow in your footsteps.
I have struggled with the concept of mortgages vs deb free living. I still find I second guess myself on what the best strategy should be. I currently own five homes. Four are rented and the fifth will be ready in a few weeks. I CF about $400 per month before accounting for maintenance expenses. All are SF homes. With the fifth home I should pull in $2,000 per month after PITI.
My initial goal was to keep borrowing to get to 10 rentals but as I consider current market conditions, higher interest rates expected through 2017 and where I live, a shortage of inventory I am re-thinking this strategy.
I owe about $80,000 each on four properties and $60,000 on the fifth on. Four of them are on 30 year fixed loans with rates between 3.75 and 4.65. One is on a 5 year arm currently at 3.5 and due to reset in 4 years and 4 months.
My wife and I make about $110,000 from our jobs. Our retirement savings is minimal at about $180,000. We also have a 15 year old who will attending college in a few years. We are both 50 years old. Oh and yes we owe another 120,000 on our personal residence. We have paid that down over the years and it is worth about 265,000.
I am curious on how others might approach our situation given the above mentioned facts.
Thanks for the responses.
Thank you for reading!
What would your cash flow look like if you paid one mortgage off, vs. buying another rental. Odds are, if it is a SFH, it may be the same or higher after the mortgage payoff. And less risk.
Good question. I just finished putting everything on a spread sheet. My Principle and Interest are as follows: 424.69, 405.36, 378.63, 373.14, 322.00. So if I pay off one of the mortgages I can make another $322 to $424 per month. My average gross CF is $441.80. I am thinking knocking of my lowest mortgage rental of $60,000 makes sense in that I would feel like I accomplished something. That would generate an additional $322 in cash per month.
I will post my spread sheet but not sure how it will look.
Rate Value Balance Net Worth PITI PI Rent Gross CF Maintenance 25% Net CF
4.875 $115,000.00 $74,714.00 $40,286.00 $670.80 $424.69 $1,175.00 $504.20 $126.05 $378.15
4.25 $115,000.00 $79,229.00 $35,771.00 $638.61 $405.36 $1,060.00 $421.39 $105.35 $316.04
3.5 $135,000.00 $84,320.00 $50,680.00 $716.88 $378.63 $1,195.00 $478.12 $119.53 $358.59
3.5 $119,000.00 $83,069.00 $35,931.00 $643.98 $373.14 $1,050.00 $406.02 $101.51 $304.52
5 $100,000.00 $60,000.00 $40,000.00 $500.00 $322.00 $900.00 $400.00 $100.00 $300.00
$584,000.00 $381,332.00 $202,668.00 $3,170.27 $1,903.82 $5,380.00 $2,209.73 $552.43 $1,657.30
With an average gross cash flow of only $441, you make nearly as much paying off a rental mortgage as you do buying another property. And much less risk.
You sir are a rock star genius. I’m a few years behind you, but I appreciate your insights. I wish I read your words 15 years ago. Thanks for your effort. It has helped me.
b
Thank you for reading and the compliments!
Keep plugging away, you will get there.