Hey Real Estate Investors! Equity Is Not Cheap!

By Don Daniel
The P.I.L.L. Method

A real estate investment strategy that is becoming more popular is known as the BRRRR method. (Buy, Rehab, Rent, Refinance, Repeat) (Pronounced “burr”) Before refinancing the property must accrue equity by property values increasing due to market conditions and/or paying down the loan on the property.

This is the traditional route by which to accrue equity. Then the idea is to refinance and take out cash to reinvest in additional properties. This could take several years, and tens of thousands of dollars of interest paid to accomplish this goal.

Acquiring equity therefore has unrecoverable costs . . . speaking of . . . the time invested to pay the interest cannot be recovered; neither can the compound interest that could have been made by investing the unnecessary interest that was paid. This is what we refer to as opportunity cost lost. The opportunity cost of not accelerating the pay off of a mortgage can be tremendous. But it goes unnoticed because we are conditioned to ignore interest cost, especially on so-called low interest rate mortgages.

In looking at a typical 30-year mortgage, I have illustrated the amortization schedule of first year of a $350,000 mortgage at 3.5%. Please take notice of the cumulative principal and Interest. It takes 12,142.93 in interest to buy 6,716.99 of potential equity; the total added together is the true cost of this transaction, amounting to $18,859.92!

PmtPrincipalInterestCum PrinCum IntPrin Bal

“Buy and Hold” real estate investors routinely save 20% to 25% of the rents collected as reserve funds for maintenance issues. So, any monies spent from the reserve would be replaced from a percentage of future rents collected. As an example, let’s say we advance $6166.16 from reserve funds to the mortgage as a prepayment; these funds would typically be stored in a bank account making 0% to 1/10 of 1% interest. If we were to prepay this loan with those funds, adding to the first mortgage payment, all the prepaid funds would go directly to principal.

Thereby paying the loan down to the principal balance on line 12 of this schedule, $343,283.01 in just one month! Eliminating 11 monthly payments and $11,140.03 in interest cost we never have to pay! What’s the new true cost to reach the same point in the amortization schedule? $7,737.82!

Due to the law of Diminishing Returns, there is a point at which prepaying a particular loan would not be optimum. The PILL Method’s Opportunity Cost Calculator, along with our Financial Coaching Services, are perfectly suited to optimize the interest savings on any number of loans, so that the interest saved is now a new metric that can be added to profitability calculations.

To find out how our strategies can be used to increase profits and reduce interest costs, contact us at PILL Method International, 256.886.1867 or PILLMethod.com.

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