Epic Real Estate Investing - Should I Pay Off My Rental Property or Make Minimum Monthly Payments | 437

Episode Date: August 3, 2018

Should I pay off my rental property or make minimum monthly payments? Today on Financial Freedom Friday, Matt Theriault explains the pros and cons of both approaches through a practical example! Find out what strategy is better if you want to create wealth, understand the importance of leverage and amortization, and learn how to speed up a debt payoff to preserve and protect what you've built. Learn more about your ad choices. Visit megaphone.fm/adchoices

This is Terio Media. Hey, Matt Terrio here and welcome to another episode of Financial Freedom Friday. It's time for Financial Freedom Friday with Matt Terrio. Okay, so the question that came in this week was, if I buy a rental property, should I pay it off or should I just make the minimum monthly payments? And I'd have to say, like most real estate questions, that's a big fat. It depends. it depends on what your goals are. It depends on what you're looking to accomplish.

Maybe if I'll write out this scenario here and just kind of show you the difference in the outcome of both. And then you can make the decision based on what you want to do. All right. So let's say we've got we'll call this scenario one where we're going to pay off the house. And then we'll call this scenario two where we're going to take out a loan, purchase it and just make the minimum payments. Let's say both houses fair market value is $100,000. Let's say they both rent for $1,000. It's a month. And then let's say the expenses, what does minus say 40%.

That's a good round number, rule of thumb. It's going to stand for your taxes, your insurance, your maintenance, your vacancy, factor and your property management. So we'll say this net all things being equal. Let's, excuse me, net's $600 a month. All right. So now in, uh, if we come over here and we take this, so $600 a month, that's going to give you $7,200 a year. We're going to divide that by the amount of money that you have invested in the property, which is $100,000, right? Divide it by $100,000. And that's going to give you a 7.2% cash on cash return with the cash flow.

Okay? So that's what you have there. Now let's say you come over here and you are going to borrow 80%, so you're going to put 20% down. So we have debt of 80,000. And let's just say we have it at 5%. And so our monthly payment is going to be $4.29. So we still have our $600 a month from over here. We have to pay for the debt on this property.

$429, which gives us $171 a month. So there's our net cash flow there. Okay, so this one pays us $600 a month. This one pays us $171.71. If we look at that over a year, that's $2,025 a year of net income. And we're going to divide that by how much we have invested in the property. Over here we had all $100,000. Over here, since we've leveraged 80%, we have $80,000 that we've borrowed.

We only have $20,000 into this deal. All right, so we're going to divide that by $20,000. Make those equal. and what that's going to give us is just about a 10% cash on cash return. All right. So you can see over here, your cash flow may be bigger. You've got $7,200 a year in cash flow, but your money's not working as harder for you as it could be.

Over here, with the use of leverage, it's working 30% or so harder for you than it is over here. But your cash flow, your actual dollar amount is only $2,025 a year. So that's what I'm saying. It depends on what your goals are. If you really need the cash flow and you don't care about this $100,000 and having that to use in other places, then maybe you do want to pay it off. If you're looking to build wealth and you want to take advantage of all the profit centers of real estate and you know this is a long-term vision, then maybe this is better for you. because let me show you what you can do. What you have over here is you only put $20,000 in.

That means you have $80,000 left to play with, right? So what you could do is go buy four more houses in the same fashion, right? And what that would give you is this $171 times five. And that's going to give you $855 a month. So over here you have the $100,000 working for you on five houses paying you $8.55. And over here you have the $100,000 working for you paying you the $600. Right? So I don't know, you just kind of look at that and then you decide what you want, what it is that you want to do.

One thing that you lose over here, or let me show this, because all the profit centers of real estate, you've got leverage, you've got appreciation, you've got cash flow, you've got amortization. and you've got depreciation. So in this scenario, you have all five profit centers working for you. Over here, what's happening is you're giving up leverage. Probably the biggest wealth-building factor of real estate. The biggest wealth-building factor that's available to the average person that's not available really in any other investment. That's what's really important there.

The other thing that you're giving up, is you're giving up the amortization. Meaning, you paid for this house. That was your money that you used to buy it. Over here, in this scenario, who's buying this house for you? Yeah, you put $20,000 down, but who paid for the rest? The tenant, right? Because you got $600 a month and then you paid $429 from that $600 towards the purchase of the house.

So you lose out on the, over here, you lose out on the leverage and you lose out on the amortization. And then you also lose out because of the interest payments, you lose out a little bit on the depreciation. about us leave that alone. That's a tax question or a tax issue, and that's going to be a little bit different for everybody. But so if you look at that, you can kind of see over here, you miss out on two of the biggest reasons that you want to invest in real estate. And that just kind of makes it like a regular old investment now, like a, I mean like an annuity or something like that. Over here, you've got all this wealth creation happening for you. And you've got it happening for you times five, right? So this is, if you, wealth creation is your,

important to you, a building wealth is important to you, you know, I would definitely look over there. If, you know, you want to be ultra conservative and just park some money and have it spit off a little bit of return and maybe diversify your portfolio a little bit, maybe you do want to pay it off. I don't know. It's totally up to you, but now you know the difference. This is what I would recommend is that, let me find a different color over here. There we go. Rule of thumb, identify what your monthly cash flow goal is, right? Your monthly cash flow. goal that you can live off of and so this is the number here that you're getting right now at this scenario you're getting this 855 keep purchasing houses in

this manner until this number gets to where it's a number that you can live on right so say it was five thousand dollars once you've hit that number of five thousand dollars then circle around and start using the cash flow to pluck off one of these houses one of time and paying off the debt and then once you do that for say let's just say in this scenario If we just use these five houses started paying off this debt, this just went from $8555 a month. And now you come over to go ahead and take $6 times five to $3,000 a month. Now you've got the cash flow and that's a really, that's something that can have a,

have an impact on your life, on your monthly, your livelihood, right? Your lifestyle. So my rule of thumb, and you can choose whatever you want to choose, but my rule of thumb is leverage as much as you possibly can until you reach your monthly financial goal so you can escape the rat race. And once you've built this, start eliminating the debt to preserve and protect what you've built. All righty? So that's it for today's Financial Freedom Friday. Whether you pay off your house or you can make the minimum payments entirely up to you and it depends totally on your goals.

So I will see you next week on another episode of Financial Freedom Friday. Take care. This podcast is a part of the C-suite radio network. For more top business podcasts, visit c-sweetradio.com.