There are times when real estate investors want or need to increase the income generated by properties in their portfolios. It could be that increases in taxes, regulatory fees, or maintenance are cutting into the cash flow. Or it could be that an investor wants to take advantage of an opportunity to expand the portfolio with a property that can bring in greater profits.
One challenge for many investors is how to obtain financing. Applying for a sizeable loan may not be viable these days when banks seem reluctant to lend large amounts of money to anyone other than the “perfect” borrower who has high credit scores, a flawless credit history, and reliable income and assets. Selling a property could be an alternative way to obtain cash, but in today’s market this may take a long time and may not bring in a sum that satisfies the investor.
Investors should not overlook an important source of funds: the money devoted to paying the mortgages on property they already own. In other words, paying off a mortgage early may be an attractive alternative or supplement to conventional mortgage financing.
As appealing as the idea may be, however, paying off a mortgage early should not be taken lightly. It is a decision that requires serious thought and calculation, always with reference to one’s real estate investment plan.
Early Mortgage Payoff Pros and Cons
These are several advantages of paying off a mortgage early. A substantial amount of cash that was devoted to the mortgage is freed up and can be directed to other purposes. There is also the peace of mind of owning a property free and clear of a major debt. In addition, each extra dollar that goes toward reducing the principal of a mortgage loan also reduces the interest that is paid over the life of the loan, resulting in a savings of thousands of dollars.
There are also potential disadvantages to early mortgage payoff, such as:
Payment rejection. In an e-mail to this reporter, Andrew Housser, co-CEO of Bills.com in San Mateo, CA, noted that some borrowers who try to institute their own pay-down schedules by making half a mortgage payment on a biweekly basis may find that their lenders reject the payment for being less than the amount that is due. This could end up costing the borrower late fees. (Housser suggested that it may be better to divide the monthly mortgage payment by 12, add that amount to the monthly payment, and write the extra amount on the “additional principal” line of the statement.)
Prepayment penalties. In some areas of the United States, it is legal for lenders to include a provision for penalties in the event of early mortgage payoff. Lenders include such provisions as protection against the loss of the cash flow that they expect over the life of the loan.
Inflation. Because inflation erodes the value of the dollar over time, mortgage payments made in the future will cost less than at present because the dollar’s actual buying power will be reduced.
Short-term financial hardship. Investors may find it a sacrifice, at least short-term, to reduce the cash flow from a property by the amount sent in as additional principal each month.
Meet Real Estate Operating Expenses, Above All Else
Every investor’s financial situation is different, which is why it is essential to carefully weigh the pros and cons of early payoff of a mortgage. A tax or financial advisor should be consulted, if necessary.
Nonetheless, investors can avoid many problems and hardships through prudence and adherence to their investment plans. This means using only discretionary funds to pay down mortgages on their properties – never the money needed to meet the operating expenses of a property.