Archive | November, 2013

Our Investment Property Mortgage Pre-Payment Plan

8 Nov

This month we’re taking the first steps towards paying down the mortgage debt on our rental properties. I’ve been looking forward to doing this for quite some time, but we’ve been focused on building a rainy day savings since purchasing our second property earlier this year.

To Pre-Pay or Not to Pre-Pay?
One financial philosophy discourages the pre-payment of low-interest mortgages if other investments offer higher returns. I agree with the math, but tend to share Dave Ramsey’s concern that it does not reflect the additional risk. If rental rates crash or a unit isn’t habitable for a period of time, I want a stronger financial cushion than what we have now – though a larger emergency fund could serve the same purpose. Truth be told, I get personal satisfaction knowing something is paid in full, so I’d even be willing to take a small financial hit for the peace of mind. I’m also inspired by my earlier calculations on how reinvesting cash flow affects return rate.

Our Mortgage Today
We’re tackling the smaller of the two loans for no better reason than we want to see progress faster. With no pre-payments, the $108,000 loan will cost $83,265 in interest for a total cost of $191,265 (~33% more than the $144,000 purchase price).

Our Mortgage Pay Off Strategy
Over time I’ve built a $10k savings reserve for rental property expenses and emergencies. Instead of following my usual balance sheet, each month I’ll replenish the reserve back to $10k (as needed), set aside HOA and income tax savings, and then apply any additional cash flow towards the mortgage. It should also provide an interesting perspective into what the positive cash flow actually is vs. what my balance sheet says it should be.

The amount will vary depending on income and expenses for any particular month – some months won’t have any pre-payment at all. My first extra payment was a meager $93.72. It doesn’t seem like much, but even small amounts make a noticeable difference for 30-year loans. Every $1.00 now saves $2.46 in interest – though this ratio will decrease over time because of the amortization schedule. Applying $93.72 every month moving forward reduces the mortgage by almost 7 1/2 years and saves $22,734 in interest.

prepay

Not too shabby, but I expect to do significantly better than that. This last month had some irregular expenses like a leasing fee and related costs to prepare the unit for the new tenant. I’ll be documenting my progress with the Vertex42 loan amortization schedule in Excel. I’m a big fan of this file because I can apply different extra payment amounts each month while it keeps a running total of time reduced and interest saved.

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