How Paying Off a Rental House Mortgage Early Creates Options and Wealth
The long-running historically low-interest rates have created many options for landlords. First of all, many more people have been able to get into this investment game because it has been easier to qualify for interest rates as low as 3%. Getting into rental properties was a good move in the first place and became much better as property values jumped to ever higher values. Now established landlords with properties worth considerably more than the purchase price have a huge spectrum of options available.
Positive Cash Flow is a Great Tool for Landlords
Stating the obvious, positive cash flow from rentals opens the door to more options. The three most common options are:
- Using the cash to pay off the mortgages faster to create more positive cash flow.
- Using the cash to make more investments.
- Spending the cash as your personal wealth.
Maybe the best part is that each of these basic options has many more options within each one.
Paying Off the Mortgage
If you have multiple rental properties, you probably don’t want to pay off all the mortgages early at the same time. That would mean spreading your cash too thin. Paying them all off early ties up all your extra cash and prevents you from making more investments such as expanding your property portfolio. If all your properties have positive cash flow, there is no reason to pay them all off early since the monthly rental income will eventually lead to you owning the properties free and clear. At that point, close to 90% of the monthly rental income will be going into your personal bank account.
Instead, consider paying off the mortgage early on one or two properties while letting the monthly rent continue paying the mortgage on other properties. The types of properties that you want to consider paying off early are those with a higher interest rate and those that have the lowest remaining debt. Paying off the property with the lowest remaining debt will enable you to quickly take out a new (small) mortgage that can be used as the down payment on another rental property (or other investment). Adding another property by borrowing against an existing property means that you’ll own that next rental without investing any of your personal money. And then let the rental income pay off both mortgages over time. Eventually, you are going to own a lot of rentals free and clear.
Making More Investments
One good option is making tax-advantaged investments. For instance, you could open a Solo 401k account or a Roth Solo 401k account. These are tax-deferred and tax-free respectively. You won’t find a more tax-advantaged retirement plan for small business owners anywhere. Nor one with more investing options. One of the best things about Solo 401k accounts is that they are well known for growing tax-free by investing in an area that you already know well – rental properties. Then all that rental income goes into your retirement account tax-free.
Another real estate investment worth considering is a tax-exempt 1031 Exchange. In this case, it’s not so much the rental income as it is selling those highly profitable single houses to move up to even more profitable property investments such as apartment buildings. With a 1031 exchange, you do this without paying the capital gains tax. All your profit goes into your next investment.
Spending Your Wealth
If you have 2, 10, or 15 properties, are financially comfortable, and don’t plan to add to your portfolio, you probably shouldn’t be looking to pay off the mortgages early. This also assumes that your retirement is well-financed. If this is your situation, congratulations! Now is the time to let your tenants pay off the mortgages, while you spend the positive cash flow that your investments are spinning off. Take a well-earned vacation or buy a new car. As your renters pay off those mortgages, you’re going to have even more cash flowing into your personal bank account. But seriously, look for ways to reduce your tax obligations because a sizable chunk of your money could start going to taxes instead of paying off mortgages.
One of the best strategies could very well be using a combination of all three mentioned above. If you have enough positive cash flow, you could make extra payments towards paying off the mortgage on the smallest debt while also putting aside some of the cash for other purposes. Maybe taking a vacation in a few months and then funneling the cash towards other investments. Life is incredibly good when a landlord has tenants paying off the mortgages and sending cash to their personal bank account!
Source: Realty Biz News
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