Financial Freedom Fighters
Step into the world of real estate investing with your hosts, Jacob and Mike. Join Jacob, a W-2 tech employee trying to escape the rat race, and Mike Magno, a top 1% Cleveland realtor, as they share real stories and valuable insights from their journey towards financial freedom.
Financial Freedom Fighters
EP #25 - The Truth About Paying Your Mortgage Off Early
In this episode, hosts Jacob Sandoval and Michael Magno discuss the nuances of paying off your mortgage early. They explore the pros and cons based on interest rates, investment journey stages, and personal financial goals. Highlighting real-life scenarios and strategies, they emphasize the importance of having a clear vision and making informed decisions for achieving financial freedom.
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This is the Financial Freedom Fighters Podcast
Jacob:Everybody to the financial freedom fighters podcast back with another episode today. I'm your host, Jacob Sandoval. I have with me, my partner in crime, my co host Realtor, Michael Magno, Mike, how's it going? How are you doing on this beautiful Friday?
Mike:I am doing great, Jacob. Um, you know, it's a beautiful, sunshiny day here in Cleveland. little warm, but we'll take it. we had a lot of closings this week. So it's been, uh, been a very good week here, you know, in Cleveland, Ohio. how are things, uh, how are things with you
Jacob:Everything's going well. Everything's going well. I mean, it was a stressful week. I'm, I'm definitely glad it's Friday. Stressful because we are coming down to the wire with our air BNB. Um, so if you've been listening to the past kind of episodes of the financial freedom fighters podcast, several episodes ago, uh, we dove into my latest acquisition. It is a luxury lakefront property in Northern Michigan. Uh, we bought that property. It's the biggest property I've ever purchased. But there was quite a substantial rehab. Component of this before we could launch it as an Airbnb. you know, Mike and I've talked about this several times. Mike is an experienced flipper in Cleveland. And he warned me that rehabs never go according to plan. And so here we are. Our first guest checks in on August 2nd. You know, as we record this today, it is July 26th. It'll probably be released and hopefully all this played out in a positive way, but it's July 26th. Our first guest for the Airbnb checks in August 2nd. but the rehab is not done. Mike, the rehab is not done. We have, we have no furniture in the house yet, but the furniture is on its way. We do have a crew of people, seven to 10 people that are showing up to the property with the furniture, ready to assemble everything in a matter of a few days. my business partner, also my best friend, shout out to Kevin. If you're listening to this, he is at the property right now, just kind of supervising the contractors, asking them every day if we're going to hit the timeline. So I'm not going to lie. I'm not going to lie. And you know, if you're a listener of the financial freedom fighters podcast, Mike and I keep it real. We keep it real with the good, the bad, and the ugly of real estate investing, and I'm not going to lie. I am stressed, stressed out. I'm stressed out and I'm really hoping we hit this timeline. I'm, really, really hoping we hit this timeline. We have to, we have to, it's not an option. The guest has to check in, but yeah, Mike. So that's kind of where I'm at right now with my, uh, with my Airbnb.
Mike:Well, that is quite the revelation, my friend. That's quite the revelation. Um, boy, that's um, that's cutting it close, to say the least. I mean, you know, I've listed properties of mine that I'm rehabbing with like, you know, one or two things that need to be done to it. You know, it's usually stuff that you can't see, right? But the fact that you've got guests that are gonna be showing up here in a matter of, uh, six or seven days, and you don't have any furniture yet? That's a little, uh Little scary, my friend, little scary, my friend. So,
Jacob:Yeah. Yeah. So, uh, I'll have to update everyone. Mike, we'll have to do a future episode, uh, in a couple of weeks and hopefully we'll be celebrating that. We pulled it off. And. That the contractors got it done. The furniture got delivered and assembled and the guests checked in and we've got a five star review. we'll have to update you on a future episode, but that is not what we are talking about today. the episode for today is a great topic. It's a question I get a lot. It's a question I'm sure you might get a lot as well, but the question is. Should I pay off my mortgage? And this is a question that applies not only to, you know, real estate investors, but also to, if you own your primary home, It's just a question of I'm paying the bank. Every single month, you know, I'm paying him principal, I'm paying him interest. And maybe I don't want to wait the full 30 years. Maybe I want to pay that down sooner. And so it is a very nuanced topic, right? I don't think it's very black and white. You're going to meet a lot of people that think this is a black and white answer. And I just don't think it is. And I don't think Mike thinks it's a, that black and white of an answer either. we're going to dive into this topic today. I'm going to kick. It over to you, Mike, first, should you pay off your mortgage?
Mike:So it's a great question. And yes, we do get posed that question a lot. Um, and I think it just depends, you know, very generically, uh, it depends on the person, uh, depends on where you're at in your journey, depends on the property, right? Depends on what it brings in and rent. Um, I've got mixtures of stuff, right? and when you look at it too, it's like. It can be very, very different. So like I have a property that's at 9 percent right now. I took out a mortgage on it in December. Yeah, but it cash flows 450 bucks a month. So what do I care? Right. Um, I have another property. I have a duplex that I've talked about on the show before. I don't have a mortgage on that property at all. Right. I own it free and clear. I bought it with cash. I spent 45, 000 in renovations in cash. And now it brings in 1500 ish, 1, 600 a month in, um, in revenue. So I don't have a mortgage on that property. Now it's nice. I could go get a mortgage on it if I wanted to and pull cash out. I just haven't needed to do that. So that's another instance where I've got one, uh, my primary residence. I know you guys rent right. In, in the Bay area, you rent. So I have my primary residence as well. we have like a 4 percent mortgage on it. We owe, I don't know, a hundred, uh, maybe 190,000, 185,000, something like that, on a half a million dollars. you know, I, I'm not in a big hurry. I pay a little bit extra on it every month just because, you know, um, I'm not in a huge hurry to pay it off. I don't need to pay it off. Plus, at 4%, like. If I were to put, let's say, you know, the mathematics of it, right. If I wanted to put an extra thousand dollars towards the principal every month, okay, that's well, well, and good. That's 12, 000 in a year. You know, can I go take that 12, 000 and make more than 4%? Probably, you know, can I go make 10, 12, 20 percent on that money? Probably, you know, so that's where you have to kind of, uh, you just kind of, kind of, you know, work through the, the, the, the numbers, the mathematics of it all, and kind of get where you're comfortable.
Jacob:I think there's a lot to unpack here. I think there's a lot of different elements that we can kind of take this conversation, but I think you started at a very logical place, Mike, which is the interest rate, So the interest rate is the logical place to start because as Mike kind of alluded to here, if you pay down your mortgage. Your rate of return on those dollars is effectively equal to the interest rate. And so using that logic, then it can kind of guide you to a framework by which you might assess whether or not it's worth it. Mike already said, Hey, if my mortgage rate is 4%, Which, you know, the mortgage rates are kind of floating, I think in the sevens right now, high sixes, low sevens, depending on if it's an investment property or a primary residence. so 4 percent looks great today. Right. And so Mike is saying if I pay down a 4 percent mortgage. The opportunity cost of doing that is, you know, investing in something else where he can potentially get better than a 4 percent return. it's probably pretty safe to say in today's environment that he can probably invest and get a better return because you can invest in a CD, you can invest in a high yield savings account and get a five and a half percent return right now with interest rates being where they're at. So paying down a 4 percent mortgage, probably not the smartest in today's environment. if you go on the flip side and your mortgage, like Mike said, is at 9%. Eight to 9%, then it gets a little bit more nuanced, right? Mike's property cashflow. So he's not really stressed about the 9%, but using the logic of my interest rate is my rate of return on the dollars that I use to pay down the mortgage. 9 percent is not a bad return. the S and P 500 is probably going to get you anywhere from eight to 10%. So could you. Could you generate something that is going to generate a 9 percent return? I think then it becomes a little bit more debatable, right? Because that paying down the mortgage on a 9 percent return, basically a guaranteed 9 percent return on your money. If you pay down that mortgage versus, I don't know, maybe the stock market's down 5 percent that year, maybe the stock market's up 12%. We don't really know on average, it's usually eight to 10%. but. Paying down a 9 percent interest rate mortgage is a 9 percent return, That's the way that you should think about it. So anyway, on the topic of interest rates, the way that I think about it is anything that is less, that is like a 5 percent return or 5 percent interest or less. My instinct is to say, don't pay that off. Right? My instinct is to say that most of the time you probably can generate a better return if it's, if your interest rate is 5 percent or lower, That's where you probably want to hold on to that. If it's, you know, higher than 5%, you're in the sixes and sevens and eights and nines, then generally speaking, maybe paying that off is not the worst decision in the world, but that is just a very, very narrow view of the interest rate. That's just a very narrow view of the interest rate. But as we know, Mike, Investing is not that black and white. There is more to it than just the math. So you want to kind of comment on, you know, a different way to kind of think about the decision other than just the math.
Mike:I think another big factor on on the math is where you're at in your investment journey. You know, if you're in the twilight and you're getting closer to retirement age, and you just want to have that cash set aside. And have that, you know, almost, I don't want to say guaranteed return because there's nothing guaranteed, but you know, you want to have a larger chunk of, um, monthly income. Then yeah, it probably would make sense for you to pay it off faster, you know, that's a lot of people, you know, if you think about it from that perspective, and when you're taking out 30 year debt, right on properties. You're planning to pay it off over a period of 30 years or the you're planning on having the tenants pay it off over a period of 30 years and, you know, so that's a, that's one way to look at it as well. And then the other, you know, the other thing that a lot of people think about on the other end of it is the, the, the ones that like taking on debt is the fact that debt is, it's basically. it's non taxable income, right? If you refinance a property and you take money out of it because you're not taxed on debt. So there's different, there's different ways to use that debt too. Right? Like I mentioned, I've got that, that duplex, it doesn't have a mortgage on it. You know, eventually I'll probably pull money out of it or sell it. Right. That's what I probably will do with it. I'll sell it and, 1031 it into something bigger. and it'll be a huge down payment for me on another property. But, um, so there's, there's different ways to go about it, but those are, that's kind of where I think about it,
Jacob:Yeah. Yeah, yeah, absolutely. So I think you made a great point, Mike. It's not just the interest rate, right? You have to also take into account. The context of where you are in your investing journey, coach, Chad Carson of bigger pockets fame. He, he wrote the book, small and mighty real estate investor, um, which I think is a great read. he basically talks about kind of two different phases of your investment journey. He calls it the growth phase, and then he calls it the kind of harvesting phase. And I think it is a really nice framework to think about which phase of your investing journey. Are you in, are you in the growth phase? Because if you're in the growth phase, Mike and I are still in the growth phase right now, Then good debt is usually an accelerant. To growth, It amplifies your return because you know, you, when you put down 20 percent on a property and that property appreciates, you know, your return on your actual down payment is accelerated because you only put a portion of the down payment, but you're getting a hundred percent of the gain, right? So most real estate investors in the growth phase are like, how can I take on more debt? You know, that's actually the conversation for them. How can I take on more debt? Which is fine, right? That's the phase that you're in, but there is going to be a time where, look, I bought all these properties. And I don't necessarily want to buy more properties, but I don't necessarily, or maybe I don't yet have the cashflow from my current real estate portfolio that I need to go into retirement. And if the answer is not to buy more properties, because you're kind of tailing into that ender phase or harvester phase, like coach Carson calls it. Then a very logical thing to do is to pay down the mortgage, And that's new in, he's probably one of my favorite real estate influencers. He's based out of Seattle, very, very hilarious, a real estate investor, great content recommend giving him a follow. But he also talks about the fact that, look, if you just buy 10 properties that are paid off free and clear, you pretty much achieve financial freedom, It doesn't need to be any more complicated than that. You buy one property a year. Every single year. And then you spend the next, phase paying them down and you're set. You know, it's, it's really hard to argue with that logic, taking interest rates off the table, taking all that stuff off the table, and you're just 10 properties free and clear. It's really, really hard to lose in that scenario.
Mike:even in a low cost of living area like this. Cleveland, right? Like if you had 10 paid off single family homes that are renting for 1500 bucks a month, do the math. It's 15, 000 in gross revenue. Now you've got taxes and insurance. I get it. Let's say that that's 5, 000. So now you've got 10, 000 a month and just pure net cashflow. not that everyone can't, you know, not that everyone's financially free at 10, 000, but
Jacob:most, most people would be
Mike:Yeah, yeah, the majority of our country. Would be financially free or could be financially free at 10, 000 a month in semi, mostly passive income.
Jacob:Yeah. And so, I mean, it's hard to argue with that logic. So it's like, I think if you were saying, look, I'm in growth mode right now. And growth mode, it should be every dollar going towards acquisition. That's kind of how you should view it. Every dollar that I have, I'm stashing it away. Okay. I'm investing it either in the stock market, or I'm saving up for a down payment of real estate and every single, like all that energy goes into acquisition in growth phase. this is why it's so important to have your goals, Mike, And we always talk about this before you jump into the world of real estate investing, you should have a vision of what you're trying to build towards because you don't want your real estate portfolio to be this Frankenstein portfolio where you were just acquiring without any vision, without any strategy, without any thought to what the end state looks like. If I talk to a real estate investor or Mike, you talk to somebody that wants to invest in Cleveland, You got to start with the vision. You got to start with the goal. And we had a very similar conversation several years ago. When I talked to you first, I was like, look, Mike, I want to buy one rental property year, for the next 10 years. Okay. And then probably start thinking about paying some of those down, you know, and I still kind of have that same view, I still kind of had that same view because it doesn't need to be any more complicated than that. And obviously there's going to be shifts and nuances and different things that you're going to try in that time period. But just having that clarity, the fact that I'm okay to not have. A hundred doors, 50 doors, whatever doors, like, you know, I, that's not my end game here. I want to have actually, and this is what coach Carson says in his book, small and mighty real estate investor as few properties as necessary, but still accomplishing that cashflow goal. What a beautiful thing, right? We don't want to just have properties, just have properties. What we care about is cashflow and paying down your debt unlocks the most Cashflow out of a single property agnostic of the interest rate. And here's another thing too. We aren't robots, you know, we aren't, we don't behave algorithmically. People make emotional decisions. People make bad financial decisions. That's why the stock market is what it is, right? You buy high and you sell low because people are emotional creatures. So the idea that, Hey, I'm not going to pay down my 6 percent mortgage because that's mathematically. A dumb thing to do. Well, what if you actually just spent all that money? Well, because people would do that because people would do that. And so when you compare it to that, people are like, Oh, I'm going to put in the S and P 500, but how many people are actually doing that, Mike? How many people are actually say how many people are actually doing the optimized thing, my, my guess would be the vast majority of people are not. So actually paying that 6 percent mortgage down, it's a great move. If you know yourself and you know that you're actually not going to do something better with that money. Go ahead, Mike.
Mike:actually it's, I'm, I'm chuckling because as you guys know that listen to the show, I, I have a daughter who's almost 17 now. she wants to buy herself a new gaming computer. Right.
Jacob:Okay.
Mike:so so she's been bugging me. She found one, she saved the money. So I sat down with her this morning and I said, I want to show you something before we buy this computer, I said, I want to show you something. I go, you know, we can turn that computer into a million dollars. And she goes, what do you mean? I go, let me show you this. And I had a, I had an investment calculator out to show her starting with a thousand And investing 200 a month for 40 years. So 200 bucks a month, 40 years, never anything more. And I use the conservative 9 percent rate of return over those 40 years, it would turn into just under a million dollars. It was like 960, 000 or 980, 000. I was just like, so this is what you're, you know, this is what you're potentially giving up. Right?
Jacob:What did she say? What did she say?
Mike:She just kind of looked at me and she's like, but I, you know, want, you know, just trying to justify it. Anyway, we made a deal. We made a deal this morning. So here's the deal. She turns, uh, she's still about six, she's 16 and a half basically. Um, so I told her, I said, tell you what, You've saved the money to buy this computer. You can buy the computer. It's your money. I said, but let's do this. Let's, let's make a deal. Um, cause she now has a job too. That's the other thing. She's got a job. So now I'm trying to teach her about taxes and set paying yourself first, things like that. Um, I said, I'll tell you what, I'll make you a deal. We'll, we'll get the computer. If you promise by the time you're 17. So you got six months, you're going to save a thousand bucks. I said, and at 17, we're going to put that thousand bucks into a brokerage account. I said, then you're going to start making those 200 a monthly, uh, Payments into the brokerage account. And from there, you know, you're going to, uh, you know, 40 years, you're gonna be a millionaire.
Jacob:know. I love that. That's such an important conversation and I love that you had that. And I'm glad that you guys struck a deal. I think most 16 year olds would be like, ah, I don't care. Whatever. That's, I mean, it's so hard to get them to think in those terms. Um, so I love that you were able to, you know, have a little bit of an education
Mike:it it's, she's, she's got the, she's got a little bit of entrepreneurial bone in her. It's not when it comes to real estate. You know, she sees her mom and I do this and, you know, she knows that we do really well with it. Um, Obviously the, you know, we've shared a lot of that success with her. but on the flip side, she wants to kind of figure out her own things too. And I've, and I'm good with that. Like I've, I've just told her like, Hey, if this computer is what, you know, it was going to really, really make you happy. Okay, let's do it. Let's go buy it. It's not the end of the world, you know, no big deal. But I just wanted to show her the power of what can become right over time.
Jacob:100%. And so I think we're getting close to the end of the topic today, but I did want to kind of throw out a couple of other things to think about with respect to this topic. And so one of the things that I really like, is this concept of the debt paydown snowball. And the concept of this is look, okay. Say you acquire these 10 rental properties, you buy one rental property a year every year for the next 10 years. And that's kind of your growth phase. And then at that point you're like, look, My gross revenue on this rental property portfolio is kind of where I want it to be. I just need to unlock more cashflow from it. And that's where you shift to the debt pay down strategy. And you could think, Oh, maybe I'm just going to pay a little bit extra on each of my rental properties, but in fact, that's not what you should do. You should take all your excess cashflow from your rental property portfolio and target it at one property. and accelerate the pay down and pay extra payments on one property. And then what's going to happen is you're going to be able to pay that property down pretty quickly, right? Taking excess cashflow, extra payments targeted at one property. And then what happens, all that cashflow from that one property that's freed up from the debt, that's more cashflow. And then what do you do? You point that cashflow snowball to the next property. And then the second property gets paid down and then that payment unlocks more cashflow. And then you go to the third, then you go to the fourth. And that's why it's a snowball. And so that concept, I don't know what it is about it, but, it's always resonated with me, The, the idea of it. And that's where I just really liked that idea. I really liked the idea of the debt snowball. I really liked the idea that at a certain point, you don't need any more rental properties. You just need more cashflow. And. It is the, it is the most logical way to unlock more cashflow out of your rental properties is to pay down the debt. And last thing, Mike, before I kind of pass it to you for any closing thoughts is coach Carson had another way to think about this as well, where he was like, look, I had a scenario and this is coach Carson's example. I had a scenario where he had a hundred thousand dollars of debt left on a property, a hundred thousand dollars of debt left on a property and his total payment for the year, principal interest is 10, if he paid off that hundred thousand dollars, he would unlock 10, 000 of cashflow. Cause that's how much the principle of interest was for the year. That's a 10 percent return. That's a 10 percent return. If you're thinking about if I just put a hundred thousand dollars down, I'm getting 10, 000 of return on that in free cashflow, that's a 10 percent return. So all this to say a different lens for it is at a certain point. Your remaining balance on your mortgage compared to the amount of cash flow. It's going to unlock. There is going to be a point where that ratio starts to flip and starts to make a lot of sense because you could say I could put a hundred thousand dollars into another rental property or into the stock market, or I can de risk my current portfolio and. Unlock 10, 000 of cashflow year, Mike and I are trying to hit on a lot of nuances at the end of the day, too. It's a very personal decision. Do what feels right for you. Do what feels best for you,
Mike:the one thing I'll throw out there too, and this goes back to, and I think Chad actually touched on in his book as well. You could also look at, you know, taking one of your properties at the, at, at the end, right? Like, so you buy 10 over the next 10 years and you spend, you know, an additional two or three years paying them off. And then you could look at the appreciation that you've seen in one of your properties and maybe you've got enough equity buildup in one property to then knock out two or three or four different. Mortgages off, off the, you know, off of your ledger altogether. So, you know, that's, that's one way to look at it too. Also, the other thing too, that I tell people oftentimes is you don't have to put the minimum amount down either. Right? Like, I think what happened is we got into such a long period of time in this country with such low interest rates that all the, all the pundits and all the Instagrammers of the world that were like leverage, leverage, leverage, leverage, We're doing the maximum leverage, but the rates were so low, they were artificially low and the cashflow was artificial to, know, I had a conversation with a, with a client today. He's got about, um, 80, 85, 000 he wants to put into play. And he was thinking, well, could I pay cash for a property? Um, you could, or you could split the money up, right? I gave him a scenario where splitting the money up was actually going to make him more money than paying cash for one property, and doing it that way, I mean, he wasn't that heavy, heavily levered, you know, you know, 30 percent down. You know, that's a good loan. It's a good loan to value. Um, you know, you're really getting into maximizing your cashflow at that point. You're going to get better interest rates. So it all really depends on people's, you know, there's a lot of factors involved, risk, risk tolerance, um, you know, and your income, right. Your income. Matters too. Can you pay the mortgage if you don't have a tenant, you know, we're in a point in our lives where, you know, if, if, uh, we don't have a tenant for a month, it's not hurting our way of life. If you're a new investor and you're only make, you know, you're barely making, you know, You know, I don't know, just pick an arbitrary number, 60, 000 a year or whatever. And you've got three rental properties that are, you know, max maxed out leverage and you don't have a tenant for a month. That's going to hurt. That's going to hurt. So that's another, another factor I think that, you know, has to be said, you know, and I, and I have this conversation with people very often, right. Cause I get a, you know, as we've talked on many episodes before in my real estate sales business, we get a lot of people who call us first, first time investors, right. And I, I always ask, you know, that's one of the, one of the parts of the questions in my consultation, I ask them, how much capital do you have to put at risk? Right? Because we want to set you up for success. We don't want you being strapped. Right? So somebody will tell me I've got 50, 000 and I'll say, no, you've got 40, 000 because you want to have 10, 000 set aside. Because oftentimes they'll get pre approved and the loan officer will max out what they can get pre approved for based on the cash that they have, right? They're not taking into consideration that that's a rental property and they need to have rainy day funds and things like that. So that's where oftentimes I'll throttle people down. You know, Oh, I'm pre approved for 250, 000. Well, you don't need to spend 250, 000. Let's maybe spend 150, 000. Right. And less, it's less money for me. Like I get paid a percentage, but at the end of the day, we're setting you up. We're setting you up to be better, more successful with, with what you're doing.
Jacob:Absolutely. A hundred percent, a hundred percent. definitely a massive, massive tip right there. Um, take it from somebody that did, you know, put all their capital at one point in time into a particular deal. And then not having the reserves to kind of back it up when the inevitable thing happens with that rental property, that didn't feel great, that didn't feel great. So you go forward and you make sure to keep a little capital aside. So ladies and gentlemen, I hope you found the episode for today helpful. Again, we just want to arm you guys with the information, the different ways to think about things as you make these decisions in your investment journey, if you enjoyed the episode today. Uh, or any of the other episodes of the financial freedom fighters podcast, Mike and I would really appreciate a five star review. I am Jacob Sandoval. You can find me at all socials at cashflow saga. He is Michael Magno. You can find him on all socials at realtor, Michael Magno. We are the financial freedom fighters podcast. We will see you in the next episode. Peace.
Mike:See ya.
Nancy:Goodbye
