Rental Mortgage Payoff in Anticipation to FIRE

[Senator]

I am going to pay off one of my mortgages this week on my rentals in additional preparation for FIRE. It is non-owner occupied, so a refinance would only drop the interest a little bit.

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

This would add an extra $13,746 to my gross income , rather than paying the interest. Some of that amount is principal reduction. After taxes, it may only be another $11,000 or so to my passive income stream which is almost another $1,000 per month. This is because I will not be able to deduct the interest that I am not paying.

I am going to use some investment account money that is earning .01%, some cash earning 0%, some 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 buying an annuity, immediate payout, at 5.5%. With 100% of principal returned after 26 years. Guaranteed by Real Estate. 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. Sort of like putting money in a bond fund.

It would deplete my cash balance just a bit, and I would have the HELOC paid off by the time I retired. It would save 3.6% over 5 months (~$2800), and then save ~$4,200 per year. The savings would go down as the loan balance dropped.

That would also give me 12 units that I have paid off, plus my residence. FIRE is looking quite a bit better as I near 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 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. I will lose my ‘millionaire’ in investable assets status 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%.

Two years below 5.5%, and two years above will be a wash. Of course it depends on principal balances and the exact interest rate, but in a linear world it’s close.

Any downsides that anyone can see?

 

[tryan]

If the heloc is a fixed rate you'll be fine .... if not rates rise .... OUCH!

 

[Senator]

If the heloc is a fixed rate you'll be fine .... if not rates rise .... OUCH!

It is an adjustable rate, fixed at prime. The prime is at 3.25% today. After the promotion period, it would be at 3.25%, unless the prime rate rises. Assuming I would make the same payment as I have now, I save a ton of money. I will make it a goal to pay to off in 18 months or less by paying quite a bit up front, and making sizable payments in the next months.

Assuming the same payments, if the prime rate stayed at 3.25% for two years, then went up to 7.75% for two years, it would be a wash. Actually, it would still be in my favor because of the extra principal paid at the lower rate.

The only thing I worry about is parting from my hoard, and having another live lien on my home.

From a financial perspective, i think it's a no-brainer, unless i am missing something.

 

[Meadbh]

You didn't tell us the breakdown of the $188K you will use to pay off the mortgage. What percentage of it will come from the HELOC?

The benefit of paying it all off now is a big step up in cash flow. The risks include a cash shortfall if there is an emergency (e.g. Major repairs, catastrophic illness) and sharply rising interest rates before you can pay off the HELOC. All the indications are that these are reasonable risks to take, especially as you are still working and have other cash flow coming in.

If you want to avoid taking out the HELOC you could partly pay off the mortgage with the available cash and low return investments now (which I think you should do anyway) and then pay down the remainder as quickly as possible while you are still earning wages. That is a lower risk strategy which greatly increases the ROI on that money, but defers the additional cash flow.

I am impressed that you have already paid off 11 rental properties! I have three. One is paid off and I expect to have another paid off within 5 years. My total debt is significantly lower than your mortgage, but as I am ER I am not in a position to pay it off at one fell swoop. I didn't get into rentals till 2007 and wish I had done so earlier. They are a stable buffer when markets go sour. But now that I am ER I will not be purchasing any more.

 

[Animorph]

You could make 0.9% with your cash using an online savings/MM account, FDIC insured and fully liquid. Not that it changes the decision much. While I don't like the HELOC interest rate adjusting higher, getting rid of the 5.5% fixed loan is good. Refinancing the loan to a lower rate might further narrow the benefit gap.

 

[Livefree]

I actually did this exact same thing with my 2nd Rental. $190k that I had in a cd that matured and earning very little. It saved me $1295 a month and it's been 3 years now. So it's already saved me over 46k in principal and interest to date.

Both Rentals are now paid for as well as my primary residence, and helps me max out my 401k, Roth, and after tax accounts.

 

[Senator]

You didn't tell us the breakdown of the $188K you will use to pay off the mortgage. What percentage of it will come from the HELOC?

I am impressed that you have already paid off 11 rental properties!

I will take $100K from my investment account that is just in a money market status. The other $88K from the HELOC. I have some cash that will quickly knock down quite a bit of the $88K HELOC in the next few months.

I should save $5500 right away from the $100K that is getting .01% interest. The goal will be to pay the HELOC off within 12 months, but I should be able to knock out much of it by the time the 1.9% runs out.

I will still have ~$100K left to use in my HELOC for emergencies, and ~$50K cash in my investment account. And if I want to sell some stocks, plenty more. And I generate quite a bit of income from the properties if I need it.

I had planned on buying another property, but I figured that it might not happen soon. I made an offer that was verbally accepted, but then the guy changed his mind. So I have cash not working hard enough. I can pay off the mortgage and have about as much additional cash flow as another rental.

I will have 12 units, 2-duplexes and 2-Four plexes paid off, so it's not 12 buildings. 24 renters total, average rent is ~1,000 each. Lots of expenses come out of the rent though...

I will still have three mortgages for the other three 4-plexes, total P&I for those are $3,340. But not a bad amount owed for 24 units.

Why am I waiting another 23 months to FIRE?... It is often easier to give advice, than to take it.

 

[calmloki]

We went a different direction. We were all paid off and had money in Penfed making 4%. We borrowed from Penfed on a 5/5 adjustable for a bit less than PF was paying us. That gave us a wad of cash we could loan out while keeping cash in PF as a security stash. Result is that our equity is making money. Working out thus far.

 

[Senator]

We went a different direction. We were all paid off and had money in Penfed making 4%. We borrowed from Penfed on a 5/5 adjustable for a bit less than PF was paying us. That gave us a wad of cash we could loan out while keeping cash in PF as a security stash. Result is that our equity is making money. Working out thus far.

Where are you loaning it out and making more money?

 

[Meadbh]

I will take $100K from my investment account that is just in a money market status. The other $88K from the HELOC. I have some cash that will quickly knock down quite a bit of the $88K HELOC in the next few months.

I should save $5500 right away from the $100K that is getting .01% interest. The goal will be to pay the HELOC off within 12 months, but I should be able to knock out much of it by the time the 1.9% runs out.

Given that the majority of the money will be coming from low yielding accounts, I would say go for it. That part is just what I would consider rebalancing! Taking on an $88K low interest debt that you expect to eliminate within 12 months seems like a good way to get that $188K mortgage off your back for good!

By the way, you mentioned that this would drive your investment portfolio below $1M. I include income property in my investment portfolio. The way I calculate it, your overall investment portfolio would not change in the short term. You would just have a $100K change in asset allocation from cash and cash equivalents to real estate. The payback will begin when you have paid off the HELOC.

 

[calmloki]

Where are you loaning it out and making more money?

We do hard money loans locally.

 

[Senator]

We do hard money loans locally.

I was actually looking into that myself. I do have one investor that I have done it with. Thanks!

 

[Another Reader]

I did something similar last year. Because I have been investing since before the 4 and 10 property rules were made, I have more than 10 financed properties. Getting refinanced into historically low rates was nearly impossible. I was able to get all except two of the Fannie Mae loans refinanced under HARP in the 4's, but I had a Freddie Mac and a number of private investor loans that were not eligible for HARP. I sold one of the poorer performing properties last year and paid off the highest interest rate loan (over 7 percent) plus I funded a number of capital improvements that were due. I took a HELOC on my house and moved the Freddie Mac that was at 6.875 percent to that. I'm in a race to pay that off before the fixed rate expires. Raised middle finger to Freddie on that one.

I still have a couple of 6 percent loans and one at 6.375 percent, and they are next up on the hit list. I was hoping to substitute a 5 year fixed HELOC for the 6.375 percenter, but haven't found a lender to take that deal yet.

One word of advice, courtesy of my mortgage broker. When you retire, NEVER put your employment status as retired on any credit application or on any piece of paper a bank might see. Put that you are self-employed. If they ask, add you are a real estate investor. I mistakenly put retired on a credit application a few years back and within 90 days, my credit card limits were cut and the offers I got in the mail changed dramatically. When I told the broker, he said that is a red flag to lenders and not to do it again.

Like you, I can't find much worth buying today. I'm a little older, so I'm more inclined to sell another property on the upside of the cycle to pay off higher interest debt than to hoard cash to buy the next time the market goes to hell. At some point, you say enough is enough and declare victory.

 

[Senator]

One word of advice, courtesy of my mortgage broker. When you retire, NEVER put your employment status as retired on any credit application or on any piece of paper a bank might see. Put that you are self-employed. If they ask, add you are a real estate investor. I mistakenly put retired on a credit application a few years back and within 90 days, my credit card limits were cut and the offers I got in the mail changed dramatically. When I told the broker, he said that is a red flag to lenders and not to do it again.

That is great advice!

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 is enough, I may not need much more to live the way I want to live.

 

[msbearkeley]

We did something similar to pay off rentals a few years ago and it made a big impact psychologically (having less mortgages to pay for each month during the bad months) and ultimately, made the right decision from a #s perspective.

We're now planning to ride off in the sunset in less than a year (May 2015!) and sold 2 quads recently and decided to go with owner financing at 7.5% (don't recommend it with SFHs but great for Quads!). Doing better from a cash flow perspective than when we owned the rentals, to be honest, so tempted to do more of it as part of our exit strategy, but then we're not going to be as diversified....

Couple of thoughts....remember to allocate refinanced $s back to the property so you can maximize tax benefits. Got hit hard on the RE demise and decided to cut our losses while we still have jobs and sold at a loss. 1231 losses really make a difference, especially if you had PAL carryovers.

Don't pay off all your mortgages either if you plan to use rental income when you retire. We are keeping a couple of low interest mortgages so when we are ready to travel the world and sell our primary (that has the additional mortgage), we can still benefit from the low rates we enjoy today but yet have something to write off.

 

[jerome len]

You have a good plan so stick with it. You've worked hard, saved your money, bought and paid for property.....now do what you want to do so you sleep good at night, not worried about cash flow. The only item I would look at is income taxes.....with a CPA to make sure you handle everything in a tax efficient way. I sit down with my CPA mid year, every year.....look at my taxes, possible changes in the tax law (Obamacare tax) and then do what I think is best for me.....to sleep good at night. You really have put everything together......now....read all the blogs....do what you are comfortable with and congratulate yourself on financial success!!!!