By Dave Van Horn
Over the years, I’ve noticed that one thing is certain: Markets will go up, and markets will come down. At times, your investments and businesses will follow suit. This is probably why financial planning and asset protection strategies exist—to protect us from those unpredictable market shifts.
Personally, I can’t stress the importance of risk management enough. It makes so much sense to me that investors or business owners would employ strategies to “sweep” their accounts and periodically take risk off the table by moving their capital into safer investment vehicles.
Despite the very real (for some people) emotional appeal of owning your real estate free and clear, from a risk management perspective, it probably comes as no surprise that most planners frown on the accelerated pay down of mortgage debt and usually prefer seeing their clients separate their cash from their properties.
In other words, planners usually aren’t big advocates for using your real estate as a savings account.
Still, it seems that many real estate investors ignore this concept, and instead they choose to leave their cash tied up in their properties as equity.
So, why the disconnect? Should investors consider adjusting their strategy?
3 Reasons to Consider NOT Paying Off Your Mortgage
1. Risk Management
In 1997, I moved to a nicer area outside Philadelphia and got a good deal on a property for $190,000. Shortly thereafter, it jumped up in value to $250,000 and I refinanced, and then again years later, I refinanced again. Eventually, I had a first mortgage for $354,300 and a home equity line of credit (HELOC) for $118,000. It was at the height of the market, the property had appraised for $525,000, and then BOOM, the market fell like a rock. Suddenly, I was lucky to get $400,000 for the place, and the bad news was it stayed there for almost 10 years.
If I hadn’t separated my equity with the HELOC to use for other real estate and note deals or if I had paid down debt and had been forced to sell, I could have lost a lot of money.
A similar scenario happened when I bought a rental property, a cute 2-bedroom row home off an estate for $62,000 that cash flowed nicely, and then the market again dropped dramatically to where it was only worth about $35,000. Luckily, it still cash flowed, and I didn’t need to sell, but what if I did? Or what if my heirs did? They would have taken a pretty good hit.
2. Access and Liquidity
Another strategy is to keep your cash or money from equity in another safe bucket. For example, if you own $3 million in real estate with $2 million in mortgage debt and have $2 million in cash in bank accounts or other liquid investments, isn’t that much safer than using liquid investments to pay off the mortgage debt?
Remember that the bank even more than the borrower is at risk when a property is mortgaged. How does it serve you, from a risk-management perspective, to take the bank’s risk off the table and increase yours by paying down the mortgage?
And if you’re thinking to yourself, “OK, but what if I were to die and leave my heirs with this debt…?” Good question, but couldn’t it be addressed by a $2 million life insurance policy on top of your liquid cash?
3. Estate Planning
If you’re doing your family a favor by thinking ahead about estate planning, ask yourself: Isn’t it better to try to hold onto the real estate until after you pass on, so your heirs get a stepped-up basis? Don’t they have more options with the liquidity or cash in a safer vehicle and any insurance proceeds, as well as the option to keep, sell, or pay off the real estate you’ve left them?
For some crazy reason, my heirs really don’t want my real estate or landlord headaches. What they really want is the money or cash flow. So, does it actually help them when we pay our real estate off?
After all, aren’t we just renting space on this earth while we’re here, anyway? I’m not so sure we ever really own our real estate. Try to stop paying your taxes and in approximately two years you’ll see who really owns it: the government.
So, when it comes to managing my own portfolio and finances, I’m a pretty firm believer in separating the cash from my real estate by putting my equity in safer, more liquid vehicles. That approach gives me access to the cash rather than some artificial equity number on a spreadsheet because “equity” (an artificial construct based on market psychology as much as anything) will rise and fall.
That said, I’m curious to hear other real estate investors’ thoughts on this topic.
Do you think it’s a good or bad idea to use your real estate as a savings account?
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