Moving to One Income: Payoff Rental Property to Improve Cash Flow?

[Standard Staples]

So, here's my situation, and I'm curious about other opinions.

We have two mortgages (primary/rental) and no other debt. I have no intention of paying off the primary quickly, as it's a very low interest rate and we plan to stay here for at least another 20 years.

However, my wife is on track to leave her job to stay home around August of next year, when my oldest starts Kindergarten. Ahead of this, I completed the payoff on our SUV last month, and we will see a drop in daycare expenses once she stays home. Our daughter will only go once or twice a month (to maintain her spot for state funded pre-K), eliminating around $750/month after paying for those days.

To continue to improve the monthly cash flow, I'm considering a payoff on the rental by next August. I do believe this to be somewhat of a mental/emotional decision rather than a strictly financial one, but I'm curious what everyone else thinks.

For the record, the rental mortgage is currently $129K at 4.875%. The monthly payment is $900/month, $785 of which is P&I. The rental is cash flow positive, and the tenants are reliable and stable.

So, would you eliminate the $785/month or retain the cash and let it ride?

I have no intention of modifying any investments as a result of this decision, so it wouldn't be a sacrifice of current or future investment funds to complete this payoff.

Thanks in advance for your advice!

 

[JDARNELL]

I am in the pay off camp. Cashflow is king and the ability to have low out going cash commitments is huge in the event of a market downturn.

I have multiple rentals and I have always paid ahead and am in the middle of paying them off. I have a friend who has as many as I do but he has chosen not to pay his off. He regrets how he has set his up and is always telling me that I am able to enjoy my funds now. I just say yep. Well in 10 years he will have about 6K a month in income. He wishes he had it now like I do.

 

[DrRoy]

One way that I look at these situations is: would I buy a bond at the mortgage terms? In this case I think so.

 

[Senator]

I have 25 renters in 9 buildings. I only have two mortgages, as I paid off another one last week. I paid $160K over the past two years with current excess cash flow. My recent mortgage was at 5.375%.

Where else are you going to get 4.875% return, 100% guaranteed. The 4.875% is more guaranteed than a government T-bill.

 

[NgineER]

For the record, the rental mortgage is currently $129K at 4.875%. The monthly payment is $900/month, $785 of which is P&I. The rental is cash flow positive, and the tenants are reliable and stable.

My 2 cents... Your rate seems high, you could probably refi to a better rate and improve your cash flow without locking the money in the property. I am trying to keep my taxes while accumulating money low and when I FIRE I will have more room in my tax bracket to take the extra income that I would have when it is paid off.

 

[Standard Staples]

I have 25 renters in 9 buildings. I only have two mortgages, as I paid off another one last week. I paid $160K over the past two years with current excess cash flow. My recent mortgage was at 5.375%.

Where else are you going to get 4.875% return, 100% guaranteed. The 4.875% is more guaranteed than a government T-bill.

Great points. I am certainly leaning towards the payoff, and you're right about the guaranteed 4.875% return. If I didn't have any other investments, I'd be concerned about tying up too much cash in real estate, but I'm fairly well diversified.

 

[Standard Staples]

My 2 cents... Your rate seems high, you could probably refi to a better rate and improve your cash flow without locking the money in the property. I am trying to keep my taxes while accumulating money low and when I FIRE I will have more room in my tax bracket to take the extra income that I would have when it is paid off.

Unfortunately, that's really not the case. I've checked, and lenders "penalize" the rental property with a 0.5% upcharge from standard rates. The best I have found is about 4.5-4.6%, which wouldn't really move the needle, especially when adding in appraisal/closing costs.

I agree on the minimization of taxes, but I ran the numbers, and with her income going away completely, the tax bill doesn't really change if the rental adds more income as a result of the mortgage payoff.

 

[Luck_Club]

Cash flow Vs Reserves

So, here's my situation, and I'm curious about other opinions.

We have two mortgages (primary/rental) and no other debt. I have no intention of paying off the primary quickly, as it's a very low interest rate and we plan to stay here for at least another 20 years.

However, my wife is on track to leave her job to stay home around August of next year, when my oldest starts Kindergarten. Ahead of this, I completed the payoff on our SUV last month, and we will see a drop in daycare expenses once she stays home. Our daughter will only go once or twice a month (to maintain her spot for state funded pre-K), eliminating around $750/month after paying for those days.

For the record, the rental mortgage is currently $129K at 4.875%. The monthly payment is $900/month, $785 of which is P&I. The rental is cash flow positive, and the tenants are reliable and stable.

So, would you eliminate the $785/month or retain the cash and let it ride?

I'm not sure I would divert your $129K reserve to improve cash flow at your point in life. When your wife leaves the work force you will be very dependent upon your income, and a job hiccup could bring your world crashing down upon you. I experienced a life changing event at 45, which resulted in about a 65% drop in income.

If on the other hand you could weather a 12 month unemployment and a pay cut and still carry your family, then go for it.

 

[pb4uski]

The argument of a 4.875% guaranteed "return" is a fallacy unless you are using money currently invested in cash or bonds to pay the $129k mortgage and effectively changing your AA as a result of the decision.

If you have a target AA, use portfolio money to pay the $129k and then rebalance to the same target AA then you are losing the return for $129k for that AA and gaining 4.875% on $129k.

 

[Senator]

The argument of a 4.875% guaranteed "return" is a fallacy unless you are using money currently invested in cash or bonds to pay the $129k mortgage and effectively changing your AA as a result of the decision.

If you have a target AA, use portfolio money to pay the $129k and then rebalance to the same target AA then you are losing the return for $129k for that AA and gaining 4.875% on $129k.

Here is my logic...

If you have $1,000, you can invest it anywhere. Putting it on the mortgage save 4.875% on that $1,000 for the life of the loan. It become il-liquid, but earns 4.875%. Guaranteed. You are in effect buying a 4.875% mortgage bond. Your own.

Whatever you pay towards the mortgage saves 4.875% on the amount, 100% of the time. It does not count other competing investments, but is 100% guaranteed as that is the mortgage interest rate. If you do not pay the mortgage, the bank 100% takes the property away.

Stocks do not have a guaranteed return rate, nor do bonds have a 4.875% rate these days. I paid my mortgage off using current surplus cash.

 

[pb4uski]

If you only have $1,000 then you are't paying off the mortgage. The OP is asking about paying off the mortgage. Presumably that $129k is invested somewhere.

If he pays off the 4.875% loan from a savings account paying 1.15% and is ok with the change in his AA and doesn't rebalance, then I agree with you that he comes out ahead.

OTOH, if he uses some cash to pay off the mortgage and then rebalances to the AA that he had before paying off the mortgage, then the return for that AA is the relevant rate to compare to the 4.875%. If he has a 50/50 AA the average annual return from 1926 to 2016 is 8.3% while there is some risk that he will earn less than that, things would have to go sideways in a pretty big way for him to regret keeping the mortgage. Projected returns for domestic equities are 7% and for domestic bonds is 4.6% so a 50/50 portfolio would be expected earn 6.8%.... lower than the historical 8.3% but still quite a bit more than 4.875%.

 

[Senator]

The largest downside to paying only a portion of the mortgage is you have less disposable cash.

You lose the ability to use that money until the mortgage is paid off. Your cash flow doesn't get better until it is paid off.

I am 100% glad I paid off as many mortgages as I have. Having seven buildings paid off adds about $100K in annual disposable income for me.

 

[pb4uski]

....I am 100% glad I paid off as many mortgages as I have. Having seven buildings paid off adds about $100K in annual disposable income for me.

After considering lost investment income and appreciation?

 

[FlaGator]

The largest downside to paying only a portion of the mortgage is you have less disposable cash.

You lose the ability to use that money until the mortgage is paid off. Your cash flow doesn't get better until it is paid off.

I am 100% glad I paid off as many mortgages as I have. Having seven buildings paid off adds about $100K in annual disposable income for me.

+1

For me, being able to pay the entirety in one shot was the key. Picking at it with a few hundred extra/ month doesn’t really move the needle, and if that comes at the cost of having smaller reserves, I wouldn’t do it.

To the OP - Late DW was a SAHM and I made sure I had plenty of life insurance and about a year of expenses in the bank. If you’re comfortable you have the reserves and your widow won’t wish she had the cash instead of a paid off rental, wire the money and be done with it.

 

[pb4uski]

OP, what is the $129k that would be used to pay off the rental mortgage currently invested in? FDIC insured savings account? Equities? Something in between? How much has that money earned in the last 12 months?

 

[97guns]

Stand pat and keep the mortgage deduction, if you run the numbers I'm sure you'll see that your return on investment is better with the loan and less capital outlay. from the cash flow perspective of course pay it off and create more cash flow or you can create cash flow somewhere else with the same funds

 

[Aerides]

OP you don't mention your total non-taxable cash on hand (ie, non investment savings). Assuming the diversion of those funds leaves you still with adequate emergency coverage and worst-case-job-loss type coverage, for a good number of months, I'd probably pay it off too.

So, especially with two kids, if you have a good remaining reserve after the pay off, I would.

 

[Senator]

After considering lost investment income and appreciation?

Looking back, it would have been better to be in the market than pay down mortgages. Looking back, getting out of the market in 2008, and back in, in 2009, would have been best. If only we had foresight like we do hind sight.

My property has appreciated by double, so whether the market was better or property investing, maybe a wash. I scored a lot of great deals, even as late as 2015. If I was looking further, there are still deals to be had.

Many here jump on 1% CDs, and long term bonds at 3%. Putting money at 4.875 is a lot better.

I get huge tax write-offs, the most recent a 2017 Ford F350 Platinum for my rental business. Depreciation, office expenses, some travel, etc. Any business owner knows about the tax advantages of owning a business.

I paid most of my mortgages with lump sums. On my most recent I allocated $6K a month for two years to pay it off out of current revenues. I still have a healthy sum in the market and continue to invest even after paying $6K. And I am not working...

 

[FlaGator]

A little more for the OP, not germane to the specific question

I encourage you to take a hard look at a few scenarios, call them low probability/high impact, as you evaluate parting with 100K+ to pay off the rental:

1. What if you die before the kids are are their own?
2. What if DW dies and you have to raise the kids? Does your job require travel that would make a nanny a good choice? Do you have trustworthy family nearby to help manage the kids?
3. What if you both of you clock out at or about the same time?

In any of the above, making sure you have sufficient reserves/resources or insurance will make dealing with those situations less complicated.

I would put assurance for those scenarios above the rental payoff decision.

 

[Standard Staples]

OP, what is the $129k that would be used to pay off the rental mortgage currently invested in? FDIC insured savings account? Equities? Something in between? How much has that money earned in the last 12 months?

Good question and probably one I should have mentioned on the front end. Generally speaking, I'm the type to maintain $15-20K in cash, while investing the rest.

However, we recently decided to add on to our home, and with our equity, we performed a cash-out refinance on our primary at 3.865%. Originally, I had only planned to extract about the amount we needed to complete our addition. But when I thought more on it, I thought that since we're already paying the ~$1,900 to close, it may be wise to take out as much cheap money as we could, while maintaining a sub-75% LTV. This resulted in a new equity position of $138K, with a cashout of $140K.

This is where my dilemma has come in. The cash is currently sitting in a 1.2% yielding money market account, and I want to move it somewhere else. Originally, I had thought of doing what several have pointed to here and simply investing the money, with a goal of beating the 4.875% (maybe 4% after tax breaks). I am absolutely in the camp of recognizing the market *should* beat that number. This is why each year we put $18K and $5.5K each in our 401k and Roth IRA accounts, respectively. But the emotional value of improving the monthly cash flow has really tugged at me. I'm almost playing a game with myself of net zero, wherein my wife leaves her job and we don't "see" any monthly financial impact on the spreadsheet.

It may also be worth noting our overall financial picture:

Real Estate Equity: ~$154K

• Primary: Owe $342K, worth ~$480K

• Rental: Owe $129K, worth ~$145K

Investments: ~$500K

• 401k: $240K

• Roth IRA: $105K

• Rollover IRA: $50K

• College Account: $23K

• Taxable Brokerage: $82K

Cash/HSA: $138K

If things really hit the skids, we could unload the SUV for around $30K.

 

[Standard Staples]

A little more for the OP, not germane to the specific question

I encourage you to take a hard look at a few scenarios, call them low probability/high impact, as you evaluate parting with 100K+ to pay off the rental:

1. What if you die before the kids are are their own?
2. What if DW dies and you have to raise the kids? Does your job require travel that would make a nanny a good choice? Do you have trustworthy family nearby to help manage the kids?
3. What if you both of you clock out at or about the same time?

In any of the above, making sure you have sufficient reserves/resources or insurance will make dealing with those situations less complicated.

I would put assurance for those scenarios above the rental payoff decision.

Good questions. Answers as follows:

1. I have life insurance in the amount of $500K, plus approximately $300K as a work benefit. I would anticipate my wife to quit her job, at least for a while, to live off the insurance money. She could also collect on the rental, sell the house (if she chose to, she's unsure if she would do that) and move closer to her family.
2. She has life insurance in the amount of $500K, plus approximately $150K as a work benefit. My job requires travel, but if God forbid that were to happen, I would take a very extended absence and likely find local employment when the time was right. My parents would also be extremely available to help, as needed, although I would not want to lean on them as a full-time nanny.
3. If we both go, the $1M total would pay out, and our kids would be adopted by our close friends, as per our will (yes, we have had the discussion and agreement with them). A portion of the money would be earmarked for their care, a portion would be dedicated to paying for college and the remainder would be a trust available after a certain age.

 

[ERD50]

I am 100% glad I paid off as many mortgages as I have. Having seven buildings paid off adds about $100K in annual disposable income for me.

After considering lost investment income and appreciation?

Yes, it's always amazing/baffling to me that so many pro-pay-off posters justify the decision by looking at only half the equation. Heck, I can make just about anything sound good if I ignore the important stuff.

Looking back, it would have been better to be in the market than pay down mortgages. Looking back, getting out of the market in 2008, and back in, in 2009, would have been best. If only we had foresight like we do hind sight.. ...

But it isn't a matter of foresight or market timing, those are straw-man arguments. It's more like choosing to ignore the past. Historically, equities do well over longer periods. If you have a long time frame the odds are with you. While the future might not pan out as well as the past (we keep hearing that, and yet....), there is quite a bit of buffer in the numbers for equities over long time frames. They can perform worse than in the past, and still beat a 4.x% loan payoff.

... But the emotional value of improving the monthly cash flow has really tugged at me. I'm almost playing a game with myself of net zero, wherein my wife leaves her job and we don't "see" any monthly financial impact on the spreadsheet. ...

Why don't you "see" the $129K gone from your accounts? This is what I mean, so many times people totally ignore the cash that was used for the pay off, as if it didn't exist. I don't get this. It's like they have made up their mind and do not want to be confused by the facts?

I've also seen people claim their taxes will be lower, since they don't need as much cash flow (pulling from retirement accounts) to pay the mortgage. But they ignore that they had to pay taxes on the money they used to pay off the mortgage. Or, if there was no tax hit on that amount, there would be no tax hit on using it to pay the monthly bill either.

Personally, I'd rather have the money in liquid investments, and I include broad-based equity index funds in that. On the off chance that I need money if I lost my job, just sell some each month to get by. You can do that for a long time if the money isn't tied up in the house. You can't eat your house.

-ERD50

 

[Luck_Club]

Good question and probably one I should have mentioned on the front end. Generally speaking, I'm the type to maintain $15-20K in cash, while investing the rest.

However, we recently decided to add on to our home, and with our equity, we performed a cash-out refinance on our primary at 3.865%. Originally, I had only planned to extract about the amount we needed to complete our addition. But when I thought more on it, I thought that since we're already paying the ~$1,900 to close, it may be wise to take out as much cheap money as we could, while maintaining a sub-75% LTV. This resulted in a new equity position of $138K, with a cashout of $140K.

With this additional information that you are already paying interest on the money in your primary mortgage and have other reserves, so you might as well retire the debt.

It sounds like it was your intent to swap debt in the first place when you took out the extra money. Which if you are seeking validation for your decision may have come quicker had you asked something like this:

I'm taking out a loan on my house to build an addition, and have extra equity I could use to pay off a higher interest rate loan on a rental thus improving my cash flow by nearly $1000 a month (though I think it is closer to $140 not the $9XX you mentioned). Should I borrow the extra lower cost money or leave things as they are?

KISS Principle retire highest interest debt first.

 

[Senator]

But it isn't a matter of foresight or market timing, those are straw-man arguments. It's more like choosing to ignore the past. Historically, equities do well over longer periods. If you have a long time frame the odds are with you. While the future might not pan out as well as the past (we keep hearing that, and yet....), there is quite a bit of buffer in the numbers for equities over long time frames. They can perform worse than in the past, and still beat a 4.x% loan payoff.

Very true, but I am 100% guaranteed to be $960.35 a month better off starting the day I pay off the mortgage. And any money I put towards it, assuming i have an excess cash flow situation, I pay less interest immediately

Going by historical returns, no one would ever get anything less than an interest rate only mortgage, for 30+ years. As soon as they had equity in their home, they would either refinance, or get a Equity line, and immediately dump that into equities. And they would never be less than ~80% for AA in equities.

Taking some risk off the table makes sense to me now that I am not working. I can invest in my own mortgage bonds, and not some mismanaged municipality that may go bankrupt.

Has anyone ever calculated that if you have lower monthly expenses, i.e. no mortgage, you can have a higher equity allocation?

 

[pb4uski]

While you may be 100% guaranteed to avoid a $960.35 per month mortgage payment, you are also 100% guaranteed to have less money because of the big check that you wrote to pay off the mortgage and a 100% guaranteed to NOT get the investment earnings on that money.

On the second part, you are right. My dad was very successful financially and once told me that the one thing that he wished that he had done differently was to take better advantage of leverage... using other people's money... that has always stuck with me. While I wouldn't necessarily go out and mortgage up a property owned free and clear to invest the proceeds, at the same time I would not go out of my way to accelerate payment of a low interest mortgage... IMO the risk/reward proposition makes paying the low interest mortgage in accordance with its contractual terms the smarter play.

In fact, I refinanced just before retiring in 2012 and have made out like a bandit.