I love the returns rental properties give me, and I am buying as many rentals as I can. In a perfect world I would not pay off my mortgages, I would save my cash flow and buy as many properties as possible. The problem with buying a lot of rental properties is many banks will not finance more than four mortgages. I have a great portfolio lender who will finance as many rentals as I want, but I don’t know how long their policies will last. To be on the safe side, I take all of my cash flow and pay off one mortgage at a time as quickly as possible. This allows me to have less mortgages in my name, and my cash flow increases once I eliminate a mortgage payment. This process is commonly known as the “snowball strategy” by investors.
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Paying off one mortgage at a time is a key strategy to my overall investing model. I discuss other strategies including how to find properties, pay for properties and I give detailed numbers on my current rentals in my complete guide to investing in long-term rentals. Even though I pay off one mortgage at a time, that does not mean everyone should. In different circumstances it might make more sense to save cash flow and keep buying properties or build up your reserves.
Banks don’t like to lend on more than four properties
One of the biggest reasons I pay off one mortgage at a time is I want to limit the number of mortgages in my name. It is more and more difficult for investors to buy properties and get mortgages. Many lenders will only allow an investor to have four financed properties, while some lenders may allow up to 10 financed properties if an investor meets certain criteria. There are banks who will lend on more than 10 properties, but they are very hard to find. The fewer financed properties I have, the better chance I have obtaining a mortgage on a new property.
My current bank is a portfolio lender, and they will lend on as many rentals as I want if I can qualify for them. Luckily my rentals have great cash flow, and they actually help me qualify for more loans. If my bank happens to change their policies, I want to be in a flexible place where I can change strategies quickly. Having houses paid off will give me that flexibility.
I increase my cash flow every time I pay off a mortgage on rental property
The faster I pay off a loan, the quicker I can stop making payments to the bank. I can then take that extra money and apply it to paying off the next mortgage. The more properties I own and the more properties I have free and clear, the faster I can pay off the next mortgages. This snowball effect greatly increases returns because I am realizing returns sooner than I would if I paid off the mortgages in equal amounts. I paid off my first rental property early in 2014.
Having houses paid off give me more options
Having houses paid off free and clear gives you so many options. It is much easier to get a line of credit on the equity in your properties if you have a home paid off. Lines of credit are as good as cash and give you much more buying power. You can use a line of credit to buy properties with cash terms, use it for repairs or down payments on more properties. If you can buy properties on cash terms, you have a huge advantage on certain types of sales and can negotiate a lower price or possibly beat out a higher financed offer.
I have a line of credit on my paid off rental property now that I can use to help with buying more rentals or flipping.
I use ARMs to finance my rental properties
My portfolio lender does not offer a 30 year fixed loan product. I use ARMs (adjustable rate mortgage) to finance all of my properties because that is the best product available from my lender. I have to pay off my properties quickly to avoid a large interest increase in the future. By paying off one mortgage at a time, it allows me to pay off mortgages fast and avoid the increased interest rate of an ARM. I am not too concerned about the rates on ARMs going up because I would still cash flow on the houses with a higher rate, but this is another reason why I like the snowball method.
You gain a lot of freedom when you pay off properties
It feels really good to have a house paid off free and clear! If I ever get in a bind in the future, I know I can sell one of my rentals that is free and clear or refinance it to get cash. In a perfect world where I knew I could get unlimited 30 year fixed loans, I would not use the snowball strategy. However, we are in a time where the lending industry is constantly changing and I need to be able to react quickly to changes.
For more information on financing long-term rental properties, fix and flips or owner occupant homes, check out my E book: How to Finance Multiple Rental Properties. The book explains how to get loans for multiple rentals, for fix and flips or for an owner occupied home. The book is available at Amazon or in PDF format for only $6.99!
If I could buy as many rental properties as I wanted with 30 year, fixed rate loans I would not pay anything extra towards my mortgage payments. However, this is not a perfect world and it is not easy to finance multiple properties and that is why you should pay off your mortgages one at a time.
I mentioned that paying off mortgages is not the right choice for everyone, and I actually stopped paying off my mortgages early in 2014. I decided to use my cash flow to build up my cash to buy more properties and to help with the flipping business. Flipping houses is great, but it takes a lot of capital! At some point I will go back to paying off my mortgages, but for right now I am in aggressive buying mode with 16 rentals.