Pay Down Rental Property Mtge for Guaranteed "Tax Free"Return

[Huston55]

I have a rental property that is close to break even and on which I have a mortgage of ~$170k at 5%. I'm considering paying down the mortgage to get the equivalent of a guaranteed 5% return on the pay-down $$$. I would pay down the mortgage to the point that expenses and depreciation canceled out positive cash flow, to avoid taxes.

Is there a down side to this? Other thoughts?

 

[jimnjana]

I guess I'm always in favor of paying down, provided you have ample cash reserves/emergency fund.

 

[arebelspy]

Is there a down side to this?

I can think of a few.

1) If you "pay down the mortgage to the point that expenses and depreciation canceled out positive cash flow, to avoid taxes" then future mortgage payments will tip the balance on that (going more towards principal than interest) meaning less interest paid = less tax shelter = you will start to pay taxes on that cash flow. By not paying it down, you won't hit that point until later in the future.

2) You will pay off the mortgage sooner, meaning that rental income isn't tax sheltered for as long.

(Though yes, for both 1 and 2 depreciation is likely the majority of the shelter, but interest paid will be a deduction affected by paying it down.)

And then there's obviously the standard "can you earn more with it elsewhere" objection. And the standard liquidity objection.

That's not to say you shouldn't do it, just answering your question of some potential down sides.

 

[Meadbh]

I am putting spare cash against the principal of my mortgages on my 3 rental properties. My goal is to have at least 2 of them paid off before I RE. Three would be even better. Sure, I could use the money elsewhere now, but the payoff is a retirement income stream that kicks in earlier.

 

[haha]

I have a rental property that is close to break even and on which I have a mortgage of ~$170k at 5%. I'm considering paying down the mortgage to get the equivalent of a guaranteed 5% return on the pay-down $$$. I would pay down the mortgage to the point that expenses and depreciation canceled out positive cash flow, to avoid taxes.

Is there a down side to this? Other thoughts?

Mortgage interest on a rental is fully deductible. 5% on a rental loan sounds pretty good. I'd keep the money. Interest rates will not be so ridiculously low forever, no matter what the Fed thinks or does.

Ha

 

[Huston55]

I am putting spare cash against the principal of my mortgages on my 3 rental properties. My goal is to have at least 2 of them paid off before I RE. Three would be even better. Sure, I could use the money elsewhere now, but the payoff is a retirement income stream that kicks in earlier.

This is part of my thinking, to generate steady retirement income.

What do you use as your threshold return on investment on the rentals to determine whether to pay them off or invest elsewhere?

 

[Parr0thead98]

I have a rental property that is close to break even

Huston: this means you own a money-losing investment the way it's currently structured, esp when you factor in maintenance costs and future vacancies. I'm only a real estate novice, so factor in the source of these thoughts, but I'd re-structure/pay down the mortgage to turn it to at least break even, but preferably a positive monthly cash flow. There are plenty of money-losing investments, but a positive cash flow investment is a thing of beauty! Even if you pay taxes on your positive cash flow after depreciation...you're still left with cash in your pocket vs cash out of your pocket every month.

Again, your situation is unique to you. And someone made a good point about not leaving yourself without any cash reserves.

Just one point of view based off info you posted.

 

[teejayevans]

You're also losing some protection in case of a lawsuit, right now you have a partner (bank).
TJ

 

[SJ1_]

I have a rental property that is close to break even and on which I have a mortgage of ~$170k at 5%. I'm considering paying down the mortgage to get the equivalent of a guaranteed 5% return on the pay-down $$$. I would pay down the mortgage to the point that expenses and depreciation canceled out positive cash flow, to avoid taxes.

Is there a down side to this? Other thoughts?

The downsize of having a mortgage is greater than not having one esp. when
you are ready to retire.
Even though you will pay more taxes your cash flow will be better and
what you need to live on will be less.
Even though it is good debt it doesn't compare to no debt
and 5% is a lot of interest.
JMO

 

[l2ridehd]

I have two rentals, adding a third, and maybe a forth. I built a spread sheet to show cash flow, pay down, tax loss, depreciation, so that I could maximize positive taxes while I have W2 income, and then over time as I get to retirement, change them to income. What your planning is exactly the right thing to do, the science in the when to do it to minimize taxes when you need to and provide income when you need it.

 

[modhatter]

Duplicate post here. Goofed, so taking one out.

 

[modhatter]

Just so you know. Having rental properties for income when you retire, isn't true retirement. You will always have a job, and the older you get the less stamina you will have dealing with tenants, the clean ups and re-do's after each tenant leaves. I speak from experience here. I have had multiple properties all my life, but view it more now in retirement as a ball and chain around my neck. I would now take less income for less work. But I can not complain, as my rental properties took the place of a 401K, or Ira for me.

It provided a means of savings for my retirement, whether I chose to sell them or rent them now.

Without all the extra work in my youth having rentals, I would have nothing but social security now. I think saving for retirement when you are fortunate enough to have a good paying job, and a good 401 K is a much easier way of reaching the same end. I just didn't know enough about stocks, and there was the fear element. I was always self employed, so there was no employer matching my 401 K, and as I had employees, there were no options for me other than an Ira.

Real estate was all I knew, and I started pretty early in my life, so I have seen it all and learned a lot. I think it is more certain an investment avenue, but comes with a price.

 

[Letj]

Everything in life comes with a price. Someone who has worked a high stress job may not think it was the easiest way to earn a living.

 

[GrayHare]

If you forsee more central bank money printing, a mortgage is a great way to preserve your wealth: you pay back the mortgage later with the inflated currency.

 

[ziggy29]

It seems like everyone is in exactly one of two camps with respect to the future of interest rates and inflation: low interest rates for many, many years because of lack of demand for capital, or an eventual spike in rates caused by inflation and the "printing" of money out of thin air.

If you are in the first camp, a "sure thing" 5% equivalent is likely far superior than anything available with "safe" use of cash these days (and for the foreseeable future), assuming there will still be an acceptable level of liquidity and/or emergency savings afterward. If you're in the latter camp, it may feel better to use other people's money at 5% for many years.

Me? My crystal ball is busted....

 

[modhatter]

Everything in life comes with a price. Someone who has worked a high stress job may not think it was the easiest way to earn a living.

Yes that may be true. But working a high stress job AND managing rentals, can be a real ball buster sometimes. My point was-it is not a passive income investment, and when you get older and would like to take it easy and enjoy your remaining years, it may not be the best choice for some. I am not opposed to it during the accumulating phase of your life, but it is additional stress and work at any time.

 

[samclem]

Is there a down side to this? Other thoughts?

Do you think that a bank will ever again lend money this cheaply for the purchase of rental properties?

Do you think inflation is likely? To put it another way--the US government owes a lot of money to a lot of folks, there's no political stomach for raising taxes or cutting government spending, and what they have to pay others will skyrocket when interest rates rise. They are also free to print lots of money to pay off the debts they owe--is that a recipe for inflation? If inflation is likely, wouldn't it be great to have a fixed long term loan at an interest rate at/below inflation that you could pay off with money worth less and less each year?

Also, much depends on where you are going to get the money to pay off this loan--will the sale of appreciated assets generate taxes? Will you be selling presently owned assets at a loss?

Don't shortchange that liquidity argument. If you need money in the future, it can be a lot harder to get it back from the bank once you use it to pay off this loan. Particularly if your are retired (i.e. unemployed).

But, others certainly will disagree with these points, and that's what makes markets.

 

[Letj]

Yes that may be true. But working a high stress job AND managing rentals, can be a real ball buster sometimes. My point was-it is not a passive income investment, and when you get older and would like to take it easy and enjoy your remaining years, it may not be the best choice for some. I am not opposed to it during the accumulating phase of your life, but it is additional stress and work at any time.

Can't disagree. We have 24 SF rentals and my husband works non stop. Luckily, because we bought most of them during the housing collapse, it makes the effort worthwhile. We were able to refinance and pull out all the money we put into the properties so our returns are truly gravy even after factoring all my husbands efforts. I don't think he would want to switch for a steady 9-5. For one thing, it would not give him flexibility he has right now and the pay would not be as good as what we can make in rentals. With that said, rentals are not for everyone. It requires a certain personality type - lots of patience, nerves of steel and willingness to work hard and not complain.

 

[Meadbh]

This is part of my thinking, to generate steady retirement income.

What do you use as your threshold return on investment on the rentals to determine whether to pay them off or invest elsewhere?

If, by paying down principal, I can change a 25 year mortgage into a 5 year mortgage, the payback will be 20 years of rental income during ER, when income taxes will be low. You can do the present value calculation of what that's worth....accounting for taxes, of course. With volatile markets and very low interest rates, I'm not seeing any short term return to speak of on other investments, therefore the opportunity cost of paying down principal versus investing elsewhere is negligible at this time.

 

[arebelspy]

If, by paying down principal, I can change a 25 year mortgage into a 5 year mortgage, the payback will be 20 years of rental income during ER, when income taxes will be low.

Well, no, because you get the rental income anyways, minus the mortgage payment. More clearly, the payback will be 20 years of that mortgage payment as cash flow. Think of it that way, you are trading that chunk of cash for years of payments to your pocket instead of the bank, similar to an annuity.

If you can pay off 10k of the principal to save off five year's worth of payments, for example, you're trading 10k now for the income stream of cash that would go towards the mortgage payment 20 years or whatever from now.

 

[gerntz]

I'm guessing you have a 30 yr loan. Why not refinanace to today's rates of around 4% instead?

 

[Huston55]

I'm guessing you have a 30 yr loan. Why not refinanace to today's rates of around 4% instead?

Correct, it's a 30yr fixed loan.

So,you're suggesting pay down the existing loan AND refi the remainder at a lower rate? If I could do that for ~0 refi costs, that might be worth the effort.

 

[Finance Dave]

I'm confused. You got a fixed rate 30 year loan on a rental?

I own two rentals and have never heard of such an option. Rather my options have been a 5-7 year balloon amortized over 30 years. As such, your rate will reset in 5-7 years...so don't bank on that rate being available for the life of your mortgage.

For the above reason (unless you have some really different borrowing arrangement), I'd pay down the loan if you have sufficient cash flow.

Someone else mentioned the liquidity downside, which is a real concern for many. An additional issue is that if you plan on buying more properties, it adversely affects your ability to fund the purchases of additional properties.

As for how I do it, you don't want to know...very complex but it works for me.

 

[arebelspy]

I'm confused. You got a fixed rate 30 year loan on a rental?

I own two rentals and have never heard of such an option. Rather my options have been a 5-7 year balloon amortized over 30 years. As such, your rate will reset in 5-7 years...so don't bank on that rate being available for the life of your mortgage.

Yikes, get a new mortgage broker. 30 year fixed, conventional loans are definitely available for investment properties.

 

[Huston55]

I'm confused. You got a fixed rate 30 year loan on a rental?

I own two rentals and have never heard of such an option. Rather my options have been a 5-7 year balloon amortized over 30 years. As such, your rate will reset in 5-7 years...so don't bank on that rate being available for the life of your mortgage.

For the above reason (unless you have some really different borrowing arrangement), I'd pay down the loan if you have sufficient cash flow.

Someone else mentioned the liquidity downside, which is a real concern for many. An additional issue is that if you plan on buying more properties, it adversely affects your ability to fund the purchases of additional properties.

As for how I do it, you don't want to know...very complex but it works for me.

I owned for the first 2yrs and kept the financing (with Mtge company's knowledge).