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Help! Should I pay off these loans?
Old 08-21-2008, 01:22 PM   #1
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Help! Should I pay off these loans?

I sure would like some opinions from the financial wizards in this group on paying off a couple of rental investment mortgages.

Here are the facts:

Mortgage #1:
Payoff: $43602.73
Interest rate: 7.875%
Interest cost per day: $9.35
Prin. Paid in august: $118.47
Int. Paid in august: $286.84
Escrow paid in august: $173.87
Rent received: $850.00
Approximately 19 years left on mortgage

Mortgage #2:

Payoff: $44487.95
Interest rate: 8.0%
Interest cost per day: $9.78
Prin. Paid in august: $111.86
Int. paid in august: $296.12
Escrow paid in august: $179.21
Rent received: $725.00
Approximately 19 years left on mortgage

Assume the following:

Federal tax rate: 15%
Maintenance: $50/month
Rent: flat for the foreseeable future
Payoff funds: assume I can earn 5.0% with long-term CD

Questions and comments:

  • Should I pay them off and spend the increased cash flow as retirement earnings?
  • Since the value of the dollar is headed down, the real cost of the mortgages will go down also. Should I consider this in the calculation?
  • I plan to defer pension for three more years. This could increase monthly income a little.
  • What would you do?
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Old 08-21-2008, 02:17 PM   #2
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I guess I don't understand rental property, but the first thing that popped out were the high interest rates on the mortgages (7.875%, 8%). Did you ever consider refinancing both loans when interest rates on 15-year fixed-rate mortgages were in the 5% range?
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Old 08-21-2008, 02:21 PM   #3
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"Since the value of the dollar is headed down, the real cost of the mortgages will go down also. Should I consider this in the calculation?"

Can you explain this a bit more? If your money is in dollar denominated assets, wouldn't your funds lose value at the same rate as the mortgage value declines (in real terms)? And you are speculating on the valuation of the dollar that may or may not occur, FYI.

If it were me, I'd pay off the mortgages if I had money invested in fixed income earning less than 7.5-8%.
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Old 08-21-2008, 02:44 PM   #4
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Quote:
Originally Posted by statsman View Post
I guess I don't understand rental property, but the first thing that popped out were the high interest rates on the mortgages (7.875%, 8%). Did you ever consider refinancing both loans when interest rates on 15-year fixed-rate mortgages were in the 5% range?
The rates on rental properties tend to run a bit higher than rates given for an owner occupied home, since the loans are considered higher risk.
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Old 08-21-2008, 06:20 PM   #5
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Quote:
Originally Posted by tightasadrum View Post
I sure would like some opinions from the financial wizards in this group on paying off a couple of rental investment mortgages.

Here are the facts:

Mortgage #1:
Payoff: $43602.73
Interest rate: 7.875%
Interest cost per day: $9.35
Prin. Paid in august: $118.47
Int. Paid in august: $286.84
Escrow paid in august: $173.87
Rent received: $850.00
Approximately 19 years left on mortgage

Mortgage #2:

Payoff: $44487.95
Interest rate: 8.0%
Interest cost per day: $9.78
Prin. Paid in august: $111.86
Int. paid in august: $296.12
Escrow paid in august: $179.21
Rent received: $725.00
Approximately 19 years left on mortgage

Assume the following:

Federal tax rate: 15%
Maintenance: $50/month
Rent: flat for the foreseeable future
Payoff funds: assume I can earn 5.0% with long-term CD

Questions and comments:

  • Should I pay them off and spend the increased cash flow as retirement earnings?
  • Since the value of the dollar is headed down, the real cost of the mortgages will go down also. Should I consider this in the calculation?
  • I plan to defer pension for three more years. This could increase monthly income a little.
  • What would you do?
1) Dunno yet
2) This would not be a deciding factor IMO
3) Dunno yet

Purchase price/time & current market value?
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Old 08-21-2008, 07:17 PM   #6
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Quote:
Originally Posted by FUEGO View Post
"Since the value of the dollar is headed down, the real cost of the mortgages will go down also. Should I consider this in the calculation?"

Can you explain this a bit more? If your money is in dollar denominated assets, wouldn't your funds lose value at the same rate as the mortgage value declines (in real terms)? And you are speculating on the valuation of the dollar that may or may not occur, FYI.

If it were me, I'd pay off the mortgages if I had money invested in fixed income earning less than 7.5-8%.
The big thing about rental property to me is the leverage you achieve. You invest a down payment, say 15% of the cost, and then let the tenants pay the note. The thing you have to watch is total cash flow, you want it to always be positive. Having said that, I'm now in a different phase of life ( retirement ) where I need cash every month to pay the bills and do whatever my DW wants to do. The 4 % withdrawal rate on retirement funds is one measure, but if you can lower this to say 2% and still make it, then you're cruising into retirement without worries like, oh I don't know, running out of money?


As CFB mentioned, interest rates are higher for rentals, typically 1% more. So this is really an absolute return issue, not a question about loan cost going forward.


As far as the value of the dollar, this is more of a total return question. I'm not even sure it's relavent to this question, but it occupies my thoughts, so I threw it into the mix.

wildcat, what is it that prompts your "I dunno yet" response? Do you need more data?
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Old 08-21-2008, 07:20 PM   #7
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Quote:
Originally Posted by statsman View Post
I guess I don't understand rental property, but the first thing that popped out were the high interest rates on the mortgages (7.875%, 8%). Did you ever consider refinancing both loans when interest rates on 15-year fixed-rate mortgages were in the 5% range?
Can you explain this a bit more? If your money is in dollar denominated assets, wouldn't your funds lose value at the same rate as the mortgage value declines (in real terms)? And you are speculating on the valuation of the dollar that may or may not occur, FYI.

If it were me, I'd pay off the mortgages if I had money invested in fixed income earning less than 7.5-8%.[/quote]

The big thing about rental property to me is the leverage you achieve. You invest a down payment, say 15% of the cost, and then let the tenants pay the note. The thing you have to watch is total cash flow, you want it to always be positive. Having said that, I'm now in a different phase of life ( retirement ) where I need cash every month to pay the bills and do whatever my DW wants to do. The 4 % withdrawal rate on retirement funds is one measure, but if you can lower this to say 2% and still make it, then you're cruising into retirement without worries like, oh I don't know, running out of money?


As CFB mentioned, interest rates are higher for rentals, typically 1% more. So this is really an absolute return issue, not a question about loan cost going forward.


As far as the value of the dollar, this is more of a total return question. I'm not even sure it's relavent to this question, but it occupies my thoughts, so I threw it into the mix.

******

wildcat, what is it that prompts your "I dunno yet" response? Do you need more data?
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Old 08-21-2008, 07:25 PM   #8
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Yeah sort of. I just think my approach would be 1st determine where could I earn the best yield on my assets and if the decision was to hold the properties I would then assess whether or not it is best to pay the mortgages off vs the continuation of payments. But nothing wrong with holding the properties regardless.
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Old 08-21-2008, 07:27 PM   #9
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What's your exit strategy? Any plan to sell them off, or do you plan to keep your hand in as a landlord? if you plan to sell in the next couple years i wouldn't pay them off - if you plan to hold them for a decade or so maybe it's nice to get those payments gone. OTOH, something to be said for having $88k in the bank these days. We paid off about a $50k note @ 5.75% with some 4.99% Penfed money and i wish i hadn't done it - could have made more than 5.75% - but 8%? If you do plan to sell are the loans assumable? That might make them attractive to keep in place for a buyer in these tough lending times.
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Old 08-21-2008, 07:52 PM   #10
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So basically spend $88K to get a fixed $800 a month over the next 19 years? I sure would not pay it off. If you NEED $800 a month take it from your $88K savings, one month at a time. From what it's earning and the tax write off there won't be much difference now and what happens when there are 9-11% CD's five years from now?

I would try to get better rates tho even tho 8% is not a bad rate historically. I just got the PenFed 20 year 5.99% Heloc. Is there a way you could do that?
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Old 08-21-2008, 09:23 PM   #11
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Quote:
Originally Posted by tightasadrum View Post
Should I pay them off and spend the increased cash flow as retirement earnings?
  • Since the value of the dollar is headed down, the real cost of the mortgages will go down also. Should I consider this in the calculation?
  • I plan to defer pension for three more years. This could increase monthly income a little.
  • What would you do?
tight,

I can't answer your questions directly...there are too many variables in my mind. You mention the key later, and that's overall cash flow. You need to look at maintenance, the aggravation factor of managing them, attorney fees, and so on.

Who says the dollar is headed down? Are you suggesting you can forecast currency movements? If so, you can be rich in 1 month. First, when talking about the dollar "going down", you must say what it's "going down" relative to. Do you mean it's depreciating versus the pound sterling? or the Euro? or the Yuan? Sometimes it will strengthen vs. one currency, but weaken agains another. I work in a corporation in the Treasury department and we hedge foreign currency exposures. The reason we hedge is that we cannot predict the movement. For the past few months the dollar has been strengthening versus the pound sterling...which is the primary currency we watch since much of our exposure is in the UK.

I'd evaluate cash flow in total on the properties. Divide the cash flow into the amount invested (the payoff) to get a rate of return. If it's lower than you can get in an outside investment, then sell. Otherwise keep.

Dave
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Old 08-21-2008, 09:46 PM   #12
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I plan to hold onto the properties and let DD take advantage I the reset cost basis when DW and I pass into the forever yonder.

Isn't PenFed for federal employees? Except for the years I was in the Navy, I've never been on the federal payroll. But yes, interest rates could, and probably will someday, go up. And that's part of the puzzle. When rates get to 6.8% (at a 15% tax rate), I believe it's a break even point. Anyone care to guess when that might be?

As far as refinancing to a lower rate, no one I've talked to seems to be interested in taking the loan. The principal amount is just too low.

What I think I'm hearing is that it's a marginal decision. It might be in my favor while interest rates are as low as they are right now, but in a few years I could be better off holding onto the loan.

The other possibility might be to pay down the principal a little faster. I could use the well publicized method of making thirteen payment annually instead of twelve using the excess income from rents. All I have to do is make it three more years for the pension and four more years for SS. After that, cash flow should be a slam dunk.

Decisions, decisions. I know!! I could buy an annuity!
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Old 08-21-2008, 10:12 PM   #13
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tight,

I can't answer your questions directly...there are too many variables in my mind. You mention the key later, and that's overall cash flow. You need to look at maintenance, the aggravation factor of managing them, attorney fees, and so on.

Who says the dollar is headed down? Are you suggesting you can forecast currency movements? If so, you can be rich in 1 month. First, when talking about the dollar "going down", you must say what it's "going down" relative to. Do you mean it's depreciating versus the pound sterling? or the Euro? or the Yuan? Sometimes it will strengthen vs. one currency, but weaken agains another. I work in a corporation in the Treasury department and we hedge foreign currency exposures. The reason we hedge is that we cannot predict the movement. For the past few months the dollar has been strengthening versus the pound sterling...which is the primary currency we watch since much of our exposure is in the UK.

I'd evaluate cash flow in total on the properties. Divide the cash flow into the amount invested (the payoff) to get a rate of return. If it's lower than you can get in an outside investment, then sell. Otherwise keep.

Dave
I'm way in over my head on currency questions. The only thing I know about currency is that when I was in Scotland last spring, everything I paid for was X2. DD picked the worst time in recent memory to study abroad. My dollar value question was really about long-term inflation I guess.

Rate of return: both houses cost me approximately 70K in 1997. The value in this area would bring about 130000 each right now. After loan payoff and taxes, I figure I'd clear about 50K-60K each if I sold them. That would generate roughly 5500/year at 5% vs. about 1100 minus 367 leaving 733 per month or 8800 annually to hold on. Management of the properties takes very little of my time since they are single-family housing. My apartments are a different story. Ever rented to undergrads? I have considered a 1031 exchange of both to leverage up to a multi-unit property yielding more cash flow, but I'm not sure I want the added management headaches. What to do
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Old 08-21-2008, 10:27 PM   #14
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"Isn't PenFed for federal employees? Except for the years I was in the Navy, I've never been on the federal payroll".

Just by the way - go to the Penfed website and look at how to join - by paying $20, one time, for membership in the Military Family group you can become a Penfed member. About the best return on $20 i've ever made - outstanding creditcard, loans, cd rates... and service.
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Old 08-21-2008, 10:47 PM   #15
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Originally Posted by tightasadrum View Post

Isn't PenFed for federal employees? Except for the years I was in the Navy, I've never been on the federal payroll. But yes, interest rates could, and probably will someday, go up. And that's part of the puzzle. When rates get to 6.8% (at a 15% tax rate), I believe it's a break even point. Anyone care to guess when that might be?

As far as refinancing to a lower rate, no one I've talked to seems to be interested in taking the loan. The principal amount is just too low.

What I think I'm hearing is that it's a marginal decision. It might be in my favor while interest rates are as low as they are right now, but in a few years I could be better off holding onto the loan.

The other possibility might be to pay down the principal a little faster. I could use the well publicized method of making thirteen payment annually instead of twelve using the excess income from rents. All I have to do is make it three more years for the pension and four more years for SS. After that, cash flow should be a slam dunk.

Decisions, decisions. I know!! I could buy an annuity!
OK, first you need to determine what you are trying to decide. First you say you want to increase your cash flow til the pension comes online and now you're talking about increasing your payments to pay down the loan!! An act that won't benefit your cash flow until maybe 12 or more years from now when your rents will be 40%? more but the payments will still only be the same as they are today.

I think you are just looking at what your 88K is earning and what you're paying on the loans and are having debt jitters. Get over it! Nothing wrong with having debt on an income producing asset.

I just joined PenFed and paid the $20 membership since I'm not in the category for membership. Applied for the Heloc online and was approved for $200,000 in less than a week! No muss, no fuss and fixed 5.99% for 20 years. Signing papers tomorrow. Wished I'd got in for the 4.99%. Calmloki, could you get 20 years at that rate?
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Old 08-21-2008, 11:09 PM   #16
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Just another idea, and not necessarily a good one... get a heloc on your house, pay off those loans. Don't worry about paying off the heloc unless you want to free up the cash flow. Same alternative with just paying off one. Basically, you'd be exchanging collateral on your house to secure cheaper debt.

I think what you meant is that, as inflation goes up, the nominal cost of servicing the loan goes down, which is why we all chuckle when we hear our parents talk about how they used to just have to pay $120 a month for their loan. This works well if you think we'll continue with inflation and your investments can keep up.
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Old 08-22-2008, 02:23 AM   #17
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.... Wished I'd got in for the 4.99%. Calmloki, could you get 20 years at that rate?
Think it was actually only a 10 year at 4.99%, which was ok with us as we had 50k due in a couple years and 160k or so at 5.5% due in maybe 12. Wasn't a gigantic savings, but for free, and painless...? The bonus was having them paying us 6.25% on cds at the same time. Beats working for a living or being smart.
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Old 08-22-2008, 08:13 AM   #18
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I wouldn't bother paying off the loans. Re-fi to 15 years and lower the rate ... if possible.

But keep your cash for a future opportunity. Things are begining to cashflow again.
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