Help a Reader: Paying Off Debts

Here's an email I recently received from a reader:

I'd like to get readers thoughts on paying off large debts.  In my case, I own rental properties where I would like to pay off the mortgages for long term income.  One mortgage is around 80k and the other 100k.
 
We live off my salary and I earn quarterly bonuses that range from 5 to 15k a quarter after taxes.  The rental properties also generate significant cash flow and will generate around 10k a year but it could easily be 0 or close to 20k based on the improvements and occupency rate.
 
My problem is that I always have a list of 'to do' items for the bonuses.  These could be home related, replacing a car, buying another rental property, family vacation, or a major family event.
 
If I had 6, 30k loans I bet I would have a much easier time paying them off than these two loans totaling 180k.  I know these amounts seem large to some but I think the same pricinple for would apply for 18k in debt versus 6, 3k debts.
 
I can't seem to commit to sending a fixed amount in to pay off the debt as I feel I may want to use the money for something else.  If I was close, I would have no trouble sending a check for the full amount.  Is this crazy?  Any thoughts?

What's your advice for him?

Comments

[Luis]

Your gut has a good track of telling you what not to do but hardly ever tells you what to do. My guess is that your nerves may be the result of an inadequate emergency fund?

[Question Asker]

@Luis - this has nothing to do with emergency funds. I have 9-12 months of funds and I'd be eligible for all of FMF's other type of interviews. I have a sound finacial house but just want to pay off these investment loans for long term income.

[Laura]

If we were in your shoes, I would probably find a way to pay for the "to do" items out of my regular salary. You never know when your company will stop paying you bonuses or downgrade them to $500, etc. If I couldn't pay for these "to do" items out of my salary I'd take a long hard look at why I'm living beyond my means. In my mind, the bonuses are just that, bonuses! They cannot be counted on.

Once I had my "to do" items accounted for in my regular salary, I would see about paying all of my bills on the first of every month. No matter when they are due, we pay ahead of time on the first. Whatever is leftover is ours to spend. The side benefit is that since we are paid every two weeks, we get an "extra" or third check twice a year. If you're married then you could potentially get four of these a year.

So at that point I'm throwing in all bonuses and all extra checks into the mortgages. My husband and I make about $50k each so our "extra checks" are roughly $3k each. My job still takes retirement out but not medical. So that's $6k extra total. Doing it this way we've paid off almost $300k in debt and major expenses (read surgeries) since the summer of 2007 (when we made $32k each). We have 4.5 months to go! It's hard at first if you go hard core but you get used to it.

This way if you get no bonus you still can apply an extra $6k (or however much you make). These extra checks feel like bonuses to us.

If you will only have $5k from your extra checks that's still $15k a year extra now to your mortgage if you only put in your rental income and extra checks. But it could be $55k a year if each bonus is $10k.

Were i in your shoes I'd probably take a hard look at what's important to me. You have to live your life. But how much of your spending is contributing to quality and how much is habit? Are the to dos more important or are the mortgages? Is the debt keeping you up at night?

If you think $55k a year is reasonable as you usually average 20k in bonuses then make that your goal. Any extra goes to fun -- guilt free!. You could have the loans paid off in 3.5 to 4 years. Then save and pay cash for the next house which would save you tons of money.

That's what we did anyway on two teacher type salaries. Now we own two rental condos free and clear (only worth about 100k total after commissions and fees were we to sell -- which is commensurate with our income level) and we have $120k left on our house. I love seeing the numbers go down. It's exciting.

The hard part for you will be correctly setting your priorities. If you can get that down, then the things you cut back on shouldn't make you feel deprived at all if you are not cutting back hard core. It shouldn't hurt in the least. If the mortgages are burning you up then you could really have them paid off in 2+ years if you really cut back, earn extra and get the higher bonuses.

It's good to hear you are taking steps to get the life you want. Congratulations!!

[Luis]

There isn't a right or wrong choice when you are on solid financial ground. Do it if you feel burdened by debt and like the idea of larger cash flows. Don't if you feel you'd rather focus on higher overall return rates on your investments and are ok with "good" debts.

[William Cowie]

It all comes down to what's REALLY important to you. That's where your money goes. If getting out from under your debt is that important to you, it'll be easy to scrape of a hundred or two to get rid of it.

The key question you have to ask the mirror is how important that is to you.

[Apex]

Questioner:

As a rental property investment business decision, this depends on your future goals for the rental business.

You said that part of what was driving this was a desire to have the mortgages paid off for long term income. That is a fine goal if you have all the rental properties you intend to have and are now moving toward the maximizing income phase of that business plan.

However you also mentioned that one of the other 'to do' items for your money is to buy another rental property. Given that it seems you are likely not satisfied that you have enough rental properties. It seems you like the cash flow they generate and would like to add more.

If that is true then you should most certainly not pay down one extra cent on those loans.

Here is what I would recommend.

Sit down and do some long term planning.

1. What type of passive long term income do you want to have from your rental properties?
2. How many paid off properties will it take to get that?
3. Purchase more properties using your bonus and debt to get that number.
4. Then start paying down the loans.

Alternatively you could decide to just keep purchasing properties and you may get it to the point where even with debt you can get the cash flow you were seeking and then the pay down of the debt is less important.

Either way, the time to buy properties is still now but it is going to pass. If you pay down those loans with your bonus over the next 5 years and then save up and decide to buy more rental properties 5-10 years from now, you will have likely missed the most lucrative time. The properties are still reasonably priced and the debt is still cheap to get. Both of those will likely be less true 5 years from now.

If you want more rental properties, you should not pay down those loans at all.

If however you are done, then paying them down is certainly worth looking at.

[rick]

Apex did another wonderful job of highlighting appropriate considerations for this investor. My only additional suggestion would be consider to minimize interest rates on existing loans if any are currently over 5%,should the decision be to increase the number of properties in the portfolio

[Question Asker]

Apex - Thanks. I will give some serious thought to the total number of properties that I want to own. That is probably the main reason why I have avoided paying down the remaining mortgages. (I own 4 and have 2 paid off)

One thing that I have thought about is using the rental income to cash flow college. My daughter leaves for school in 7.5 years. On average, one of my paid off properties clears around 6k a year and the ones with a mortgage are only slightly cash flow positive. My thinking is that with all for paid off, I could cash flow college.

On the flip side, I may want to work on building the base first and then paying off later. I am not really worried about paying for college but that sounds like a good plan.

[jim]

Apex's answer is good.

My first thought is that you don't really *need* to pay off the rental mortgages. If for example you wanted to use your cash to buy another rental then that might be better use of your money long term. It really depends on your goals with the rentals. Whats the interest rate on the rental mortgages? If they are >5% then you might just consider refinancing them down to like a 15 year loan instead. I don't know how much the properties are worth but if you have enough equity you might even be able to consolidate them into 1 loan an have one property free and clear.

[Steve]

I think the bigger question always comes back to if you are comfortable with the difference between your income and your spending or do you feel it should be better to meet your overall goals.

Whether the dollars earned and not spent are used to pay down the mortgages or any other debt or instead used toward other investments I think is most often a fairly unimportant question in most instances (unless there are cash flow issues or high cost debt, etc). The difference between putting your bonus into a new investment and paying down a mortgage is probably one you could argue both ways forever and the resulting difference be some small percentage of the sum invested, the difference between paying down the mortgages and spending it on a vacation are around 100%.

[Question Asker]

@Steve - your comment is spot on. What happens after you max out your 401k, save some on top of this and are marching toward a comfortable retirement.

How do you motivate yourself to cut back to be even more aggressive on saving and should you? I find it hard to say no to a home remodel when the rest is on track. I guess hard to get advice on that front but something I have troubles with.

[Jonathan]

One other consideration is that you get to write off your mortgage interest. If you start running numbers, don't forget to take that into account as a benefit of retaining the mortgage.

[Desi Kanjoos (frugal)]

This depends on what your priority is and what is your focus on those.
Is your priority paying off debt?
1st way (faster): You can go radical and sell one property and pay off the other one with that (assuming you have 2 properties), even if you have a little left you can pay that off quickly.
2nd way (slower): You can stop all other todo things (for atleast 18 months more or less - depending on bonus and other savings) and you will be done with the loans.

Is your priority todo things?
Then keep on going with your todo things and keep paying normally on the mortgages and don't pay it off until the loan period. You will eventually pay off the debt and will still be doing other things that you have in your todo.

If I were you I would go with the more disciplined slower approach of pausing all todo things and paying off both mortgages. After 12-18 more or even less months I will have all my income, bonus, and rental income to build wealth (other rental properties) and for todo things.

[Steve]

@Question Asker - "How do you motivate yourself to cut back to be even more aggressive on saving and should you?" - It was easy for me, I wanted to be financially independent ASAP, not so much to retire but to have complete freedom over what I do, how many hours I do it, where I live, etc. How aggressive is up to your priorities...e.g. I think its worth $10K to have a nice dependable car but not worth $50K for a new one with leather, etc, for some the $50K car may be worth it and some can't belive I'm wasting $10K on a car...the key is to make choices that get you where you want to go.

People do retire at 40 when its a big enough priority, and that goes WAY beyond maxing out ones 401k (and I'm not saying its the plan for you, some people could never see themselves leaving their career prior to 62 anyway).

[Kenny]

I also have rental properties and I just paid off all of the debt and it is a great feeling. I had to prioritize in all of 2013 and just adjusted the monthly mortgage amounts so that by Dec'2013, I would be paid off and get a payoff letter from the mortgage companies. Of course, it was a sacrifice since I had to pump all of the cash flow from the properties into the mortgage. Your mortgage and ROI might not be as such to do it in 1 year, but if you can plan it out, paying off is the right magic. THE ROI % WILL COME DOWN AS A RESULT, THE NET-CASH-FLOW WILL INCREASE. Bottom line is NOT to say I make 29.32% on my property, but it is to say, I earn $16,290 per year from my property. %ROI does not buy bread and butter.....$16,390 will buy a lot of bread. These % and $ are just arbitrary numbers to prove my point.

Good luck.

Kenny

[ashley]

I think you should automate your payments so you won't have to consider all the fun things you could do or how small a percentage of your debt you're paying off. If you aren't willing to pay off the debt you should sell a house and pay off what you can on the other. It's possible you can't be a rental property even if you want to because you're not willing to make the upfront sacrifice.

[Megan]

I have this problem too. My student loans are a big number. How I've handled it is I make a list of donations, projects, etc. I fund these at the beginning of the year. Then I put 100% of our surplus for the rest of the year towards my loans, only stopping if I had to tap my efund for an emergency. Then at the start of the new year I focus again on my donations/projects list and then go back to 100% to my loans. It allows us to feel focused on debt repayment and see progress even if it's only for part of the year. It's been working well and in two more years I should have it paid off.

[Peter]

I have read in one of Robert Kiyosaki's blog that we should not be afraid of debts such as GOOD debts. Since you are renting out some flats then that's certainly a good debt since you are earning somethings from it. However, keep in mind that banks have this what you call Payment Protection Insurance which are only optional when you get a loan. If you think that you have been a victim of PPI misselling then act straight away.