Two-thirds of American homeowners take out a mortgage when they buy their home, and even more investors use real estate leverage (other people’s money) to expand their portfolio.
Are they wrong to do so?
Not necessarily, although some people borrow more than they should. You may not even want to pay off your mortgage(s) faster; after all, some mortgage debt is downright cheap. If your home mortgage costs you 3.5% interest, and you can earn a return of 8% from the stock market (or 18% buying a new rental property!), maybe that leverage makes perfect sense.
Even rental property loans tend to cost less in interest than average stock market returns. Check out Credible.com to compare rates on conventional loans, and Visio, Kiavi, and LendingOne as direct portfolio lenders for rental property loans.
But the logic of real estate leverage only works if you’re actually putting aside a big chunk of your income and putting it to work somewhere. With the average savings rate hovering below 5% in America, most people are just paying their minimum mortgage payment and then spending the rest.
Let’s assume that you’re sick and tired of paying interest to banks. Paying off your mortgage(s) is a guaranteed return on investment, which can’t be said for investing in the stock market, or even for real estate investments (more on real estate vs. stocks here).
So how can you ditch your mortgage debt faster? Here are four strategies to pay off your mortgage quickly… enjoy!
1. Several Techniques to Pay Extra
First and foremost, call your lender, and ask about any prepayment restrictions. Some banks are persnickety, even about taking your money.
Biweekly Payments: One option that’s painless is to call your lender and arrange biweekly payments. Every two weeks, you pay half of your regular mortgage payment.
This has two advantages: first, it mimics your paycheck cycle. If you get paid biweekly, you can have your mortgage payments deducted on the same day you get paid. Bada bing, bada boom, no budgeting necessary (at least for your mortgage payments).
Second, you’ll end up making an extra mortgage payment every year, since you’ll be making 26 half-month payments, rather than 12 one-month payments. Painless!
Round Up: No “cute” tricks here, just good ol’ fashioned round numbers. Round up to the nearest hundred, or to the nearest five hundred if you’re feeling more ambitious.
Raise Up: When you get a raise, add the entire raise amount to your mortgage payment. That’s one way to battle lifestyle inflation!
2. Refinance (or Don’t and Say You Did)
Refinancing comes with plenty of drawbacks, and only makes sense in very specific circumstances. But if you drop your 30-year mortgage to a 15-year mortgage, relatively early in your original loan, for a substantially lower interest rate… all right, I agree, it might make sense.
If you have an adjustable rate mortgage (ARM), and your interest rate skyrockets, that’s another scenario where it makes sense to refinance for a lower, fixed interest rate.
You could even pull some cash out to pick up your next investment property, while you’re at it. But I digress – this is supposed to be about reducing debt, not adding more!
Beware though: in addition to all those extra closing costs, refinancing starts your amortization schedule all over again. That means a higher percentage of your monthly payments go toward interest rather than principal. If you’re three years into a 30-year mortgage and refinance to a 15-year mortgage, that may make sense, because you’re accelerating your amortization schedule anyway. But if you’re already ten years into the mortgage, consider just pretending to refinance.
Here’s how interest amortization looks, showing how lenders charge more interest in the beginning of your loan term:
See why lenders are so keen to keep refinancing you, and not let you reach the end of your loan term?
Use a mortgage calculator (there’s one built into our rental cash flow calculator) and look up what your mortgage payment would be if you refinanced to a 15-year loan. Then just start making those higher payments! You still accelerate your amortization schedule, and you don’t have to line some punk loan officer’s pockets by paying a bunch of new lender fees and closing costs.
3. Push Hard to Remove PMI, then Keep Making The Full Payment
Most conforming lenders allow you to petition to have private mortgage insurance (PMI) removed when the loan balance drops below 80% of the property’s value. Hopefully, your property’s value has gone up, even as you’ve paid down your mortgage, so you may not have to wait too long (especially if you scored a good deal).
But why sit around waiting? Make change happen! Every time you get an unexpected windfall, throw it at your mortgage. Got a tax refund? Pay down the mortgage. Got a bonus at work? Pay down the mortgage. Got cash as a gift? Pay down the mortgage.
Call your lender and double check their procedures for removing PMI, and keep an eye on property values in your neighborhood. Be prepared to pounce when you’ve hit that golden 20% equity level!
When your lender does (finally) remove the PMI from your payment, keep making the original payment. The portion of your payment that had been going to PMI will now pay down your principal balance faster, helping you leap forward in your amortization schedule. You’ll quickly skip some of the early, high-interest proportions in your monthly payments, and exponentially speed up your loan term.
4. Sell Off Another Property
Have some equity in another rental property? For that matter, maybe you have equity in your home, and don’t need such a large or extravagant home?
You could always sell the property, and with the windfall of money pay off another property’s mortgage.
There’s a case to be made that it’s better to have five properties that each cashflow $1,200/month than fifteen properties that each cashflow $400/month. Managing more properties comes with more headaches, bookkeeping, accounting, labor, etc., so why not own fewer properties with better cash flow?
Except, of course, that over time your rental properties do tend to appreciate in value. And eventually, you’ll pay off those mortgages, leaving you with dramatically higher real estate cash flow.
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Is There Such a Thing as Good Debt?
All right, that was a rhetorical question. We all know there is.
But “good debt” is uncommon, and narrowly defined. Good debt is any debt that directly helps you earn more money – for example, taking on mortgage debt for a rental property that will generate cashflow.
Even so, debt comes with other strings. It’s easy to over-leverage yourself without realizing it. Having ten rental properties, each mortgaged to the hilt, might work out when all of them are occupied, but what happens when three of them become vacant at the same time by chance? And each of the three needs $4,000 in turnover costs? And another property needs a new roof for $5,000 at the same time?
Over-leveraging aside, there’s a certain psychological freedom that comes with having no – or minimal – debts. It may be less tangible, but the feeling of possibility and positive growth that comes with debt-free investing is powerful nonetheless.
I’m not saying you should never borrow money to buy rental properties. It often makes perfect sense to do so. But take some time to consider whether now might be a good time to start reducing your existing debts.
Don’t forget, paying off debt is a guaranteed return on investment!
How much debt do you take on in your rental investing? Have you had success paying off mortgages early? Spill the beans below, and if you enjoyed this article, share it with other real estate- and personal finance-minded friends!