As a rental property owner, if you used leverage to buy, should your goal be to pay the property off as quickly as possible, or let the loan extend and pay off over 30 years? When a property is owned free and clear, that’s when it can really become profitable. Let us share a real-world example of how paying down your principal can help you pay off your mortgage faster and save you thousands of dollars in interest.
Imagine you purchased a property with a loan from the bank in the amount of $200,000. If the interest rate on your loan was 4.375%, then the Principle plus Interest (PI) payment due is month(not including any expenses like taxes, HOA, insurance or repairs) would be $999 on a 30-year mortgage. Step one is to go online and print out an amortization schedule chart. Think of this as your roadmap to payoff. The chart will break down your payment month-by-month over time (30 years!) showing the amount applied toward the principal and interest in each payment. It becomes clear that interest is a penalty and you should view it as such. If you pay your monthly payment for the next 30 years on the property in this example, you will end up paying $159,485 in interest - that is a lot of money! The economic principle at work is called 'compound interest'. Not only is compound interest the way banks make their money, but it's also the key used by savvy investors to pay their mortgages off faster.
Let’s say you scrimp and save and managed to come up with an extra $1,100 that you want to apply towards the loan at the same time you make your very first payment. So when you go to the bank to make this first monthly payment, you also make an additional payment to your principal in the total of $1,100. In paying this $1,100, you have leapfrogged over 5 months of payments by reducing your principal amount. That means you’ve skipped 5 months of payments on the back end of your loan! Any time you can pay down your principal, you'll leapfrog over payments on the back end of your mortgage. If you were able to pay an extra $100 each month towards the principle of the loan, it would cut 5 years off your mortgage, turning a 30 year mortgage into 15 years and saving you $30,481 in total interest over the lifetime of the loan! This is an example of making your money work for you - compound interest!
The next economic to consider is called 'opportunity cost', an economic term that represents the loss of every dollar you spend that could have spent on something else.... anything else. For example, if you buy a $10 pizza, the opportunity cost is everything else that you could have purchased for $10. Opportunity cost sometimes changes the perception of how we spend our money. When looking at an amortization schedule, the opportunity cost on your payment is another month of paying because it wasn’t leapfrogged. The lesson many investor have learned is that by paying down your principal balance through making principal-only payments in addition to your regular monthly mortgage payment over time, you can significantly cut down on the amount paid in interest over the life of the loan and reduce the loan term to reach free and clear status on your property faster.
The team at Grace Property Management is here to help! If you have any questions about paying your mortgage off faster, give us a call at 303-255-1990.
QUESTION: I’m a Thornton rental property owner with a 30-year fixed loan. How can I pay the loan down faster to increase my profits?
ANSWER: Use an amortization schedule to get a visual of your monthly mortgage payment breakdown and use any income to spare to make additional principal-only payments. Each time you do, you will be skipping over interest and lessening your loan term on the back end.