Terry Sprouse who is the author of two books, “Fix em Up Rent em Out” and “Carve out Your Niche”, has written a very provocative guest post for me today.
The conventional wisdom has always been to get your rental houses paid off a quickly as you can. But Terry has a very different viewpoint on the subject. He believes that you should hold onto your dollars and let the tenants pay for those houses. What do you think?
Why Not Pay Down your Mortgage?
I know its good advice to never say “never,” or you inevitably wind up doing the very thing that you said you would never do. But, as long as I am investing in real estate properties, I won't shoot myself in the foot by making additional payments to my mortgages.
Here are some reasons why you should not pay down your mortgage:
1. Don't drink your liquid assets.
If you increase monthly payments to a mortgage, you are reducing your liquid assets, one of the most precious resources that investors have. Most real estate investors are property rich and cash poor. We need cash for unexpected repairs, or to replace broken refrigerators or furnaces, or to make the mortgage payments between tenants. Of course, there are techniques for greatly reducing the cost of replacing high-ticket items, like buying ahead of time when something is on sale and utilizing construction equipment recycle stores But we still must be prepared for inevitable financial jolt.
2. Live in the future, not the present.
Why use present-value dollars to pay off your present-value debt? As real estate investors, we want a situation where we put in a little effort and get a big payback. Let inflation work for you. After 10 to 20 years of owning a house, the value of the dollar goes down as the price of your house goes up. Think back to when you were younger, and how much more you could buy for a dollar than you can now. Remember 5-cent packages of chewing gum, gasoline for 15 cents a gallon, a steak dinner for 30 cents? I don't either, we know it was true.
The point is, you can pay your mortgage with future dollars, which will be worth a fraction of today's dollars. Once you have a mortgage locked in, the relative value of that loan will continuously drop.
3. Let tenants be your new best friends.
Why spend your money when someone else is eager to pay it off for you? Provide a nice place to live at a fair price and you can keep tenants in a place for as long you want. And, the longer they live there the closer you are to having that mortgage paid off. In fact, tenants are better than friends. How many friends do you have who don't always tell you how smart their kids are, and they actually help make you rich?
4. Time your pay off.
Rather than make additional payments on a mortgage, it's best to wait and just pay the whole mortgage off one lump sum. It's useful to pay off a mortgage, if you wait until you have a relatively small amount left to pay, and you pay it all off with a chunk of money that falls in your lap (such as when a retirement account matures or when you receive an inheritance).
Or, you can pay down the mortgage when you sell a property and use part of the money you receive from the sale to pay off an existing small amount that you still owe on another property. This way, you actually increase your cash flow.
Don't drain you wallet making extra payments on your mortgage. Why do the casinos make so much money? Because the odds are always in their favor. Put the odds in your favor by letting time and tenants do the heavy lifting for you.
You can find both of Terry’s books on Amazon.
I often have a discussion around this with a coworker. He and his wife are aggressively paying down their mortgage so they can rent out their house and purchase a new one in the near future (3-5 years).
The point I always like to make to him (which he and his wife continue to ignore) is that the current interest rates will not be around forever. I believe it is a huge waste of money to rush to pay off low interest rate loans. If you intend on holding the property, you are much better off locking in as low of a rate as possible for as long of a term as possible.
I still can’t understand why they want to hurry to pay off their 4% loan so that they can get a loan in 2-3 years when rates will almost certainly be higher.
Everyone has a different opinion about this. If you are an investor (and Terry is a very successful investor), you might be better off at this time using that cash to buy more properties. Then you could go to work paying them off in a few years.
Getting those paid off so that you have passive income is a way to build wealth. Think about it for a minute. What if you bought 10 houses and worked hard to pay 5 of your best houses off. In 5 or 10 years you could sell the other five of your houses and pay off the best ones completely.
I don’t know what rents are in your area, but let’s just suppose that they were $1000 per month. Wouldn’t it be great to have 5 paid off houses bring in 5K every month?