Should I pay off a commercial loan principal monthly or invest the extra capital?
I own a real estate investment property that, after expenses, has a net cashflow every month of about $1,500. I have a mortgage principal balance of approximately $375,000 with a fixed interest rate of 4.5 percent until January 2026 when I have a balloon payment of $262,000. Is it better for me to use the excess cash to pay down the principal by $1,000-$1,500 per month so that when my balloon payment is due I owe much less? Or is it better to take the cash and invest it for the next seven years so I can use that cash to payoff the loan in seven years? Which option would give me a better return?
Without knowing specifics on this property, the market, or your other investment opportunities, I tend to think that you should take the money out of the property now in the form of profit and dedicate those funds to other investments or for a rainy day. In paying down the loan balance you are putting your cash back into this investment and not diversifying away from it. 4.5% debt due in eight years doesn't sound so bad in the world of commercial loans for a cashflowing property.
The best case scenario with healthy real estate is that your down payment is the total amount of YOUR cash invested. From that point on, all expenses are covered by the tenant and you recover your investment through cash flow, appreciation and debt paydown (all paid by rents).
While the balloon might seem daunting, so long as you have solid tenant cash flow it shouldn't be an issue to refinance the property when the balloon comes due. Either way, it sounds like you have options and there's no perfect answer here. Perhaps hedge your bet with paying a little extra, socking some away, and investing some elsewhere hopefully above a 4.5% annual return.
The answer depends on if you have sufficient cash to pay down the balloon loan when it’s due. Investing in a long term definitely produces a better return than having cash stashed in a checking account. However, no one can guarantee you will have the return (principal plus earning) when you need it.
Thus, here are some considerations:
1) Lock in a fixed term so you don’t have to worry about the potential lump-sum due.
2) If you want to get rid of the debt fast, check out a 15-year loan.
3) Make sure you have the emergency funds set up before using the extra monthly cash to pay down the mortgage.
4) Consult with a financial planner to review your cash flow to see if there’s any extra you can put into your retirement account. Ideally you want to have your investments in three different tax locations: a) taxable income, which is your earning and rental income. b) tax-deferred, which is your traditional 401k. c) tax-exempt, which is your Roth IRA. Based on your financial status, ask the planner to recommend what you need to make up and how much. Best!
There are a lot of factors to consider when focusing on real estate investing and decisions should be made carefully. If you used the 1500 every month to payoff principal you would basically cut your balloon payment in half. At roughly $131,000 this is still a relatively high payment and if you do not have the source of funds would need to refinance or sell the asset.
Investing the money can be risky, especially when the money is going to be used to payoff a debt. While investing for the long term is a good thing, but debt complicates the situation.
I would recommend having an analysis done on the investment property and debt profile so that you have the proper information to make the right decision.
This is purely a question of your risk tolerance. If you pay excess cash on the principal each month you are guaranteed a 4.5% return. (Notice the word guaranteed.) Investments are not guaranteed and the greater the amount of risk taken usually the greater potential return you will receive. Stocks have averaged 10% over the long periods of time (20+ years), Bonds have averaged 6% over the long periods of time. You are talking about 7 years. You might do better than 4.5% or you might not. It all comes back to your personal tolerance for assuming risk. Good luck.
I would encourage you to seek out a “Fee only” independent Registered Investment Adviser (RIA). RIA’s are fiduciaries and will have your best interest at heart. Find one who is a Certified Financial Planner professional ™ (CFP®). You can find advisers at the following websites:
National Association of Personal Financial Advisors - https://www.napfa.org/financial-planning/how-to-find-an-advisor
Financial Planners Association - http://www.plannersearch.org/