Should I Pay Off My House Early or Invest the Money in Rental Properties?

Row housesMany financial experts advise people to pay off their homes as quickly as possible to reduce debt.  They refer to debt, as a lurking monster that will eventually destroy us if we don’t get rid if it as quickly as possible.  I could not disagree more, and I have found many others that agree with me including Ben Stein!  Debt allows investors and businesses to create much greater returns on their investments than paying all cash.  I discussed how leveraging your money to buy rental properties gives you much higher returns than paying cash on rental properties here.  Rental properties also generate much better returns than most consumer debt including car loans.  I feel as long as my returns on my investments are greater than the debt used to fund those investments then it is good debt and making me money.

Here is my complete guide to investing in long term rental properties which details how debt allows me to get over 24% cash on cash returns on my rental properties.

Home Loans

Let us take a look at your personal residence first.  Most people are able to get a very low interest rate and put little money down on their personal residence.  Right now interest rates are below 4% on an owner occupied, 30 year,  fixed rate loan.  I am getting over 24% rate of return on my rental properties just from cash flow.  Once I factor in tax advantages, principle pay down and appreciation that return is well over 50%!  It makes no sense to me to pay off my house quickly when I have such a low rate locked in for 30 years and I am making so much on rental properties.  I pay the absolute minimum payment I can on my personal home mortgage and save that money to buy more rental properties.  If you have nowhere else to put your money besides a CD or bank account that pays less than 1% interest than yes, it would make sense to pay off your mortgage quickly. If you are willing to work a little harder and find an investment with a better return than your mortgage,  stop paying extra towards your house payments and invest!

Auto Loans

The experts will also tell you how horrible it is to have an auto loan.  Their reasoning is that debt on any item that will depreciate is bad, but I completely disagree with this as well.  I look at it as a numbers game, why would I care what my debt is secured against as long as the debt allows me to buy more rental properties.  The rental properties provide a much higher rate of return than the auto loan interest rate.  I have my current car loans locked in for 6 years at less than 3% interest.  I do not pay one cent extra on them, because I want as much cash as possible available to buy more rental properties.

Credit Cards

There are even some investors who will use credit cards to buy properties!  It may make sense to use a credit card to buy rental property if the return from the rental is higher than the rate on the card and you have no other options.  While I don’t use this strategy, I’m not against it either.  If there is a deal you can’t pass up and cash availability is holding you back, be creative to make it work!

What about the security of paying off my mortgage?

Don’t get me wrong, I am not condoning racking up debt to go on vacation or buy furniture.  A lot of debt can be very, very destructive if you have no assets providing you cash flow or a return on that debt.  People will still ask, what happens if I lose my job and I have all this debt I can’t pay off.  I think you are going to be much better off with cash producing properties than if you had paid off your primary house.

Let’s assume you have a 200k house that you have a $180,000 mortgage on.  If you put all of your extra cash into the mortgage to pay it off early you will eliminate your mortgage payment and save about $900 in principal and interest.  We will assume you paid about $150,000 extra into your mortgage to pay it off early.  I could buy five rental properties with that cash which would cash flow at least $500 a month on each property.  I am making $2500 a month off those rentals, a lot more than the $900 I would be saving on my mortgage.

Not only I am making more money each month with rentals, I also see an immediate return on my investment.  If you accelerate your mortgage pay off, you won’t see that $900 savings until the mortgage is completely paid off.  With rental properties I start seeing immediate cash flow as soon as I rent the first property.

If you are choosing the accelerated mortgage payoff route and lose your income before your house is paid off, you still have the same mortgage payment to make.  The only way to get that money back that you invested in your home is to sell your house or refinance.  You may not be able to refinance with no income and your only option may be to sell.  If you lose your job and you have rental properties you still have income coming in from the rentals.  You could sell a rental property to get immediate cash or refinancing a property would be much easier because you are still showing some income from the rentals.

On the surface it may seem like paying down your mortgage faster will provide more security, but there is actually a much better chance of making it through rough times if you have rental properties producing income to back you up.  I know I would much rather sell off a rental property in bad times than my personal house.

New Information on paying off your mortgage early

I wanted to add this paragraph after hearing from a follower of the blog.  She paid off her mortgage and then decided to retire early and focus her time on investing in Real Estate.  It was a lot of hard work saving and diverting her money towards her mortgage and it felt great when it was finally paid off.  Now that she is actively investing in Real Estate she wanted to tap into the huge amount of equity in her house.  Since she has no job and very little income at this point, she can’t find a bank to refinance her house.  Even though she did what the experts told her to do and worked her butt off to pay0ff her mortgage, she can’t access that money unless she sells her home.  This is another reason to think twice before you start sinking all of your extra money into your principle home.  If she had bought more rental properties with that money instead of paying off her mortgage, the bank may be willing to loan to her because of all the rental income coming in.

Conclusion

Investing your money in Real Estate instead of paying off your consumer debt quicker will leave you thousands and thousands of dollars ahead.  I feel rental properties provide much more security as well and give you more options if you were to lose your income.  Just because the experts tell you to do it, doesn’t mean it is the right choice for you.  Really think about where you are putting your money and what kind of returns you are getting.

Are you paying off your mortgages early or investing that money to bring in higher returns? What are you investing in now?

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22 responses to “Should I Pay Off My House Early or Invest the Money in Rental Properties?

  1. Your article is a good reminder to critically think about the best way to utilize each dollar you have. You’re right, I constantly hear recommendations to pay down my mortgage quickly, despite that being the best form of utility.

    I just saw a similar article here: http://homes.yahoo.com/news/pay-down-mortgage-slowly-024029874.html

    • Good find! It can be difficult to break away from the pack when investing. We are bombarded with advice to slowly save up for 30 years and hope we have enough for retirement. Paying off your house early is the same mentality.

    • @Jagesso — How funny that you noticed that Yahoo article — I was quoted in that article! What’s interesting is reading the comments on it. Almost every person is in the “pay down your mortgage ASAP” camp. Some have emotional reasons, e.g. peace-of-mind. Others have risk-management-based-reasons, e.g. what happens in case of a job loss?

      Risk management can be mitigated in a variety of ways — each person’s situation is different, but mortgage payoff isn’t necessarily the only way to risk-manage. As for peace-of-mind, well, there’s value in that. Just be aware that it comes at a potential price.

      • Great comment Paula, I think many people are bombarded with the idea that paying off your mortgage as early as possible is the smart thing to do. I think many times they don’t actually think through the entire situation. If I lost my job and my primary source of income I would much rather have my monthly income coming in from my rental properties than my house paid off. I make well over $3,000 a month off my 6 rentals which cost me about as much cash as my mortgage is on my house ($240,000). My mortgage payment is about $1250, which situation is better?

      • Agreed. It seems like if you’re going to pay off anything in full, it should be a rental, since that will increase your income rather than decreasing your expenses.

        And in a worst-case situation, you can sell a rental house and pocket the money if there’s no note on it. (I’d prefer to hold all my properties, but it’s nice to know you could sell in an absolute worst-case emergency).

      • Yes, it is much easier to swallow selling your invesement property than your personal house in an emergency. I also like to hold my proeprties as well.

  2. Here is an interesting piece of information as well, from none other than Ben Stein, covering how to think about the “rate of return” on your mortgage pay down.

    “Generally speaking, if you have a very low mortgage rate, it is better to invest the money than to pay off your mortgage. It’s an interesting fact — the rate of return on your mortgage is the interest you’re paying on it. If you have a 6 percent mortgage and you’re paying it off, you’re earning 6 percent. If you can earn more than 6 percent in the stock market, you should probably put it in the stock market. But, on the other hand, pay it off in an expeditious way. It’s good to have it paid off, or at least mostly paid off, by retirement time.”

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  4. I began buying multiple rental homes in 2004. After a couple of years they saw a 50% increase. Unfortunately, a couple of years later,those same homes were valued at 50% less than what I purchased them for. Four years later, they are almost back to where I began this journey 9 years ago. I also used OPP (Other People’s Money). Leveraging other funds was great. I purchased many homes in a short time frame.

    Yes, the market corrected and we might not see that again, but trust me, I learned first hand how you can go from a great net worth and within a short period swing to a huge negative net worth from all that leveraged debt. I still have tons of debt on my rental homes.

    Would i still use OPP if I had to do it again? Yes, but not nearly as much as I did and with more down to open up my spread. Keep in mind, when the market tanked, so did the frenzy on cheap rentals due to so many people underwater. Rents plummeted. Make sure your mortgage and expenses can handle a swing during those bad times.

    My biggest advice… proceed with caution. Be prepared for the possible roller coaster ride. 🙂

    • Thank you for the comments and perspective. If you don’t mind me asking, how much did rent drops in your area? Where I am at we did see a drop, but not a huge drop in rents. We also did not see the huge drop in prices that other areas saw, mostly because we never saw the huge increase in prices that preceded the fall. I would estimate some neighborhood’s prices dropped over 50% here, but those neighborhoods are back to where they were before the crash. Most neighborhoods dropped 20% or less and are back to where they were before the downturn. My biggest concern is cash flow, not value. I want a large net worth, that makes me feel good, but cash flow is what affects my bottom line.

      • The rent prices dropped maybe 30 – 40%. Some areas worse. What happened in many cases (including mine), we had so many new homes that became rentals that older homes couldn’t compete with what price would get you. A 1000 sq ft home had no shot for the same rent that a 2500 sq ft would bring.

        I always bought mine for long term so I was ok with the price drop, I just ran into the problem of cash flor drop when I lost a tenant. Plus having older homes, it was tough to find renters when they could go down the street to the new one.

        I read all your stuff last night, good stuff. I love the thought process on the 100 homes. Will you be doing full time management or hire someone do mangage your empire? 🙂

      • Hopefully that doesn’t happen again! Good to know you were able to survive it.
        I am managing them all myself now, but I am going to try to start a property management company this summer/fall. If that doesn’t work I will hire a property manager. I figure once I hit ten I will run out of time to manage them.

      • I manage mine as well. Time does become difficult as you grow. I know I could have done a better job. I wish you the best and I’ll keep stopping by to read and comment.

      • I manage mine as well. Time does become difficult as you grow. I know I could have done a better job. I wish you the best and I’ll keep stopping by to read and comment.

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  7. I prefer paying the house off early, great article!

  8. Good stuff! My primary mortgage is at 3.625%. Paying off such cheap money would be ridiculous. Instead, I own two duplexes and a big chunk of MLP stock that is paying monthly distributions. My net worth is growing much better than if I gambled on paying down my mortgage early.

  9. Pingback: Good Versus Bad Debt? I Don’t Care When Investing | Invest Four More

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