Paying off debt involves some nasty math, and when you go to pay off investment property, it’s no exception. That’s why it’s so controversial. When I was in college, my university used this kind of math to weed students out, so it should come as no surprise that the lending industry booms, and so many hucksters make a fortune hawking questionable ways to get out of debt.
I have a better way, and you won’t pay me anything for the advice. Read on.
How to pay off investment property
First, gather all of your most recent statements on all of your debts, landlording and otherwise.
Then download a home mortgage calculator spreadsheet, which you can use to determine your effective post-tax interest rate on all of your properties.
Next, download a debt reduction manager spreadsheet, where you can plug in all of your debts. Use the effective interest rates you calculated previously, not the interest rates on your statements.
Now you can explore various strategies for paying off your debt, including making extra payments, and changing payoff order. What I found is that it’s complicated–paying off highest interest rate first isn’t always optimal, and paying off the lowest balance first is rarely optimal.
Odds are that after a few months you will need to revisit the strategy, because once you’ve paid some balances down, your most expensive debt may change.
Don’t obsess over trying to squeeze every penny out. Revisit monthly, or quarterly, whatever you’re comfortable with. But remember this: Even a sub-optimal plan will save you thousands of dollars, and you can adjust any month. Don’t let fear of your plan not being perfect paralyze you. With no plan, you are virtually guaranteed to be in debt for 30 years and pay hundreds of thousands of dollars in interest. Almost any plan, with the required discipline, will get you out of debt in about 10 years. It will also build your credit score, which will save you money if and when you need to borrow again.
Borrow more or pay off more?
Most books tell you to borrow as much money as you can and buy as much property as you can as fast as you possibly can.
There will come a time when you can’t borrow any more–you’ll reach your limit on number of loans or number of dollars borrowed. Or you might have money but there just isn’t any property to buy. When that happens, it makes sense to pay down some debt. Paying off a property improves your bottom line about 75 percent as much as buying a new one does–the exact numbers will vary based on your property tax and insurance rates–so it’s worth doing. The impact to your bottom line is also more immediate, since a new purchase may involve some rehab and a period of vacancy before it starts producing income.
It also doesn’t have to be all or nothing. Established landlords like to pay off one property per year, but they may very well make a purchase that year too. As you build a history of paying off debt and accumulate property, you get more options for financing, which makes tick-tock cycles of repaying and buying possible.