There are two sides to almost every real estate financial argument. What works for one investor, a fellow investor may have a completely different point of view. In reality, both sides can be right depending on the individual perspective. One of the most often debated real estate topics revolves around what to do with surplus capital. Should you reinvest it, park it in savings or use it to pay down debt?
Many rental property owners are in a race to pay down their mortgage as quickly as possible. They feel that with a reduced, or eliminated, mortgage balance it will open up possibilities with the property and put them in a prime financial position. The opposing view feels they can make a greater return on investment using the extra funds to reinvest elsewhere. The correct answer depends on your current portfolio, investing style and long-term goals. Here are five reasons to consider paying down the balance on your rental property.
- Increased cash flow. The most obvious reason to consider paying down your loan balance is for increased cash flow. With no loan balance, almost all the monthly rents received are profits. The only items you would still be on the hook for are the property taxes and insurance. The surplus capital could be used to increase your reserves, pay down additional debt or make improvements to the property. You will no longer have the burden of paying a mortgage every month and the extra cash flow can feel like a windfall. An extra thousand dollars a month, or more, completely changes your financial picture for the better. It may have been difficult making extra payments or paying down principal when you have extra cash but when the loan is finally paid off it will all be worth it.
- Equity. Equity is always a bit of a moving target. While you can’t necessarily control the market and your property value you can control the balance owed. There is no arguing that paying down your loan provides you with equity. With that equity you can use it in a variety of ways. For starters if your value appreciates to a point where you can cash out of the property and walk away with a handsome profit, you should always consider selling and moving on. If selling is not an option, you can tap into the equity either through a home equity line of credit or a cash out refinance. Either way you can take cash out of your home at relatively low interest rates. You will still have cash flow coming into the property and you will also have your cash out capital to use as you please. The more equity you have the increased number of appealing options you have with the property.
- Rent flexibility. Changes in property taxes, increases in insurance and a shifting rental market can leave you hamstrung with the property. Before you know it, there will be a rent floor you need to charge for you to be happy with the return. With your loan balance eliminated you will be free of all this and be able to run the property the way you want. There are many times when you will come across a great tenant who likes the property and wants to stay there as long as they can. However, over the course of their leases you may have wanted to increase the rent and are forced to make a decision. Do you leave the security of a good tenant who takes care of the property or raise the rent and maximize cash flow? With no loan balance you can stick with good tenants who make your life as easy as possible. Instead of trying to squeeze a few extra percentage points out of the property you can find the best possible tenants.
- Eviction protection. If you own rental property long enough eventually you will be forced to deal with an eviction. A seemingly great tenant will just stop paying out of the blue leaving you to pay the mortgage. Without proper planning and reserves this can put you in a bad position, possibly leading to a mortgage late. A late will pull your credit score down and impact your ability to purchase in the future. Without a mortgage balance you can withstand a missed payment. You can deal with not having rent coming in for a short period of time. This doesn’t mean it will not sting, but it will not have the long-term impact it would if you had to cover the mortgage on your own.
- Property management. With extra cash flow at your disposal, running your rental property should be as easy as possible. Instead of saving money by self-managing you can comfortably afford hiring a dedicated property manager. This doesn’t mean you won’t have any more issues with your tenants, but you will not have to be as involved on a day to day basis. This will free up time you can spend on your business, or simply relax if you want to. After years of being on call every time your phone rings, a property manager will help you run the property on autopilot.
Paying off a loan balance could happen with one big closing or could be the accumulation of years of extra principal payments. Whether this is the best use of additional capital is up for debate but should at least be a consideration.
