Two questions...... - Posted by db

Posted by Sgt.Sausage on June 19, 2006 at 18:28:18:

Amen brother. We saw the light a few years back. Primary residence is scheduled to be paid off in under 10 years (4 years left on that – extra principal paid on a 15 year load) and we don’t buy our rentals unless they cash flow on a 15 year mortgage.

Say what you will, but I’ll have a house paid off and be retired by 41 (ish) and all current rental units paid for by 45(ish). I’ll have literally decades left to call the “golden years”.

Two questions… - Posted by db

Posted by db on June 12, 2006 at 19:30:00:

We are getting ready to sell our home and move into a 4-unit building we’ve owned for several years. Our goal is to pay the 4-unit off and be debt-free. My question concerns what to do if we don’t make quite enough to do that. Say we still owe 8 or 10k, if we put as much as we could onto the mortgage would we not have to make a payment for several years or still have to make the regular payment every month? And would we end up paying just as much in interest by doing that?

Secondly, if we live in the building for two years and then sell would we owe capital gains on that or not since it’s been our personal residence for two of the last five years? All replies are appreciated. Thanks!


Re: Two questions… - Posted by Dave T

Posted by Dave T on June 14, 2006 at 23:20:18:

I see your “problem” differently. You don’t really want to be debt free, I think you really want to maximize your cash flow. You are just using a debt free solution to get there.

You don’t give us any numbers to work with, so let me just pick some numbers to illustrate another option.

Let’s say that the sale of your current primary residence will net you $150K in tax free profit.

Let’s say that the 4-plex produces sufficient cash flow to comfortably support the property when you have all units rented. Let’s say that the monthly mortgage payment on your four-plex is only $600 per month, and your cash flow is about $200 per unit (or $800 per month for the property when all four units are rented), and you have 15 years left on your current mortgage.

When you move into one of these units as your primary residence, your cash flow drops to $600 per month because you are only getting rent from three units. Paying off your mortgage on the four-plex adds another $600 per month to your cash flow because you have eliminated the mortgage payment, bringing your total cash flow to $1200 per month.

Instead of paying off the mortgage loan, what if you invested the $150K proceeds from the sale of your primary residence into three or four Canadian Royalty Trusts (purchased on the stock market) so that the current yield on your investment will be 10% or better.

An advantage of these Royalty Trusts is that they pay dividends monthly – every month. A 10% return on $150K invested cash is $15000 per year or $1200 per month.

Note, that paying off your mortgage only increases your cash flow to $1200 per month. By investing your sale proceeds instead of paying off your mortgage, you will still have the $600 monthly cash flow from your rentals AND you will have another $1200 per month income from your stock market investments.

If maximizing your monthly cash flow is your true goal, paying off your mortgage is not always the best way to get there. If you have excess cash flow, you can always contribute a little extra each month to debt reduction if you wish.

Look at this strategy from a different perspective. What will you have in 15 years if you pay off your mortgage now – you will have a free and clear property.

If you follow the investment plan I suggest, in 15 years you will have that same free and clear property, but you will ALSO have a stock market portfolio worth about $600K (with only a modest 10% average annual appreciation) that will continue to throw off dividends of at least $15K per year, probably more because successful companies tend to increase their dividends to attract and retain investors.

Just food for thought. In case you are wondering if this really works, my wife and I are doing this now. We invested $180K equally among 20 different stocks that will pay us a total of $18016 in dividends and interest this year (before taxes). The monthly income from the investment completely covers our monthly mortgage payment on our primary residence. If I applied all the income to our loan, I could reduce the term of our mortgage from 26.5 years to 10 years and one month.

My thoughts on paying principal… - Posted by Sam

Posted by Sam on June 13, 2006 at 16:51:40:

Just to add to what Gerald said…
My theory on paying toward the principal: You might as well put that extra money towards something that earns you some interest. Since you can’t pay in advance and skip payments, don’t pay more $ towards the principal- you don’t get anything in return for that- it’s not like the lender gives you extra points or kudos or extra money for paying extra. Thats like leaving your money in a savings account. Put that money you were going to pay towards principal into soemthing like mutual funds, money market or low risk t-bill or something. No, these dont give great returns, but it’s better than letting it sit and gain nothing! YOu could eventually use the money you built up to pay off your 4plex.
I know I didn’t really answer your 2 questions, it was just something extra for you to think about! :slight_smile:
Take care and good luck,

Two answers… - Posted by gerald(tx)

Posted by gerald(tx) on June 12, 2006 at 20:59:40:

Anything extra you pay in addition to your monthly payment is all applied towards the principal. Great, but you still have to make the next month’s payment on time, as it is paying interest. You can’t skip a payment and tell them to go back and take some of the principal overpayment to pay interest.

You would be exempt from the capital gains, as that is your domicile. But only on your unit.

Now, my question – why are you interested in paying it off and selling it? Combined, your two questions do not compute in my mind.


Re: My thoughts on paying principal… - Posted by Sailor

Posted by Sailor on June 13, 2006 at 22:36:20:

Actually, if you pay down principal early you don’t pay nearly as much total interest. (Note: any early pay-off, whether monthly or lump sum, should be documented as payment on principal.) Since interest is compounded you end up saving a bundle. Today’s mutual funds aren’t paying enough to off-set interest savings.


Re: Two answers… - Posted by db

Posted by db on June 13, 2006 at 12:00:26:

Thank you for the response. I want to pay it off so we can be debt-free first of all, and have an income from the other units plus others we own while I finish my degree which should take two years. After two years I am hoping to go to law school so our plan is to sell that building and move.
How would the capital gains be computed for only that unit? Would it just be 25%? This particular unit is a 3BR with an attached garage, deck, fenced yard etc., the others are all 1BR units so obviously this one is worth much more than the others. Thanks again for your input.


Re: My thoughts on paying principal… - Posted by Dave

Posted by Dave on June 14, 2006 at 22:30:39:


I am confused by your statement "Since interest is compounded … "

Since the interest I pay on my mortgage each month is calculated on the loan balance, it can only be compounded if my interest is added to the loan balance as might happen with a negative amortization loan.

I agree that paying extra each month to reduce the principal reduces the number of mortgage payments I need to fully amortize the loan, reducing the total amount of interest I pay as a cost of financing – but compounding the interest is something I don’t see with a traditional amortizing loan.

I hope you just mistyped, or else my understanding of loan amortization is seriously flawed.

Re: My thoughts on paying principal… - Posted by Sailor

Posted by Sailor on June 15, 2006 at 07:42:08:

Check your mortgage to see the compounding term. It could be monthly, daily, or something in-between. Try an interesting exercise: add up all your remaining payments over the life of the loan. then subtract your mortgage balance. Then check your latest statement for the amount your last payment reduced your balance. I did that in 1967 & it changed my life, allowing me to (1) retire much earlier than my colleague; & (2) live mortgage-free for past 15 years. Have fun!