Advice on best approach to deleveraging...

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Archimedes
Posts: 123
Joined: Wed Feb 15, 2017 11:27 am

Advice on best approach to deleveraging...

Post by Archimedes » Tue Nov 28, 2017 7:37 pm

In my younger days I used a lot of leverage to build a substantial rental real estate portfolio. Most of my properties are paid off and mortgage free, generating rental income. As I approach retirement, I am interested in paying off my remaining debt over the next couple of years. I want to take tax benefits into account as I decide which debt to pay down first.

I could pay off all remaining debt immediately, but I would lose some liquidity so I don't want to do that. But I do want to pay down the debt relatively rapidly over the next couple of years while my earned income remains high. I am thinking about paying down around 600k over the next couple of months, and then paying down roughly 250k/year starting in 2018. Once these mortgage debts are paid off, my monthly rental cash flow will significantly increase and my monthly expenses will decrease, making my financial situation stronger and more comfortable for retirement.

Current loans outstanding:

Personal Residence:
2.45M market value
827k mortgage balance at 2.625%
1.48% effective rate after income tax deduction for mortgage interest (39.6% federal marginal, 6.85% state marginal)

Rental Property:
925k market value
627k mortgage balance at 3.25%
tax deductible, sort of (see below)

The mortgage interest on the rental property is a deductible rental property expense. The rental property generates positive cash flow, but after subtracting deductions and depreciation on all of my properties, I have remaining paper losses which get deferred to future years to use against future passive income. So while the mortgage interest expense is deductible, some of that deduction is deferred to future tax years.

My thought on this is I should pay off the rental property mortgage first and then work down the primary home mortgage balance to save the full 3.25% cost in the current tax year. Am I analyzing this situation correctly?

overthought
Posts: 201
Joined: Tue Oct 17, 2017 3:44 am

Re: Advice on best approach to deleveraging...

Post by overthought » Tue Nov 28, 2017 11:40 pm

The personal residence has better loan-to-value ratio (lower risk of going underwater in a recession), generates no income (so sinking money into it just ties up equity sooner), and has a lower interest rate. Plus, taxes avoided later are worth less than taxes avoided today. Everything seems to favor paying down the rental first.

CurlyDave
Posts: 685
Joined: Thu Jul 28, 2016 11:37 am

Re: Advice on best approach to deleveraging...

Post by CurlyDave » Wed Nov 29, 2017 2:52 am

I wouldn't pay off either mortgage.

I would put any available cash into equities where you can reasonably expect a CAGR in the 6-10% range and enjoy the fruits of taking the risk and reaping the "risk premium".

Sure, there are going to be years where the return is not as good, but if you have the financial strength to weather these periods, you can take advantage of the arbitrage.

I have been retired for years and have gained enormously in this manner.

Remember mortgages are not callable if you keep up the payments. Interest rates are rising and if your mortgages are fixed rate, in a couple of years you might be able to buy treasuries with more than a 2.625 or a 3.25% return. If you did nothing more clever than buying Treasuries you could enjoy free income.

Archimedes
Posts: 123
Joined: Wed Feb 15, 2017 11:27 am

Re: Advice on best approach to deleveraging...

Post by Archimedes » Wed Nov 29, 2017 4:02 am

CurlyDave wrote:
Wed Nov 29, 2017 2:52 am
I wouldn't pay off either mortgage.

I would put any available cash into equities where you can reasonably expect a CAGR in the 6-10% range and enjoy the fruits of taking the risk and reaping the "risk premium".

Sure, there are going to be years where the return is not as good, but if you have the financial strength to weather these periods, you can take advantage of the arbitrage.
I understand that being leveraged at these low interest rates is most typically quite beneficial over the long run. But at this point in life, we have more than enough. My predicted life expectancy is roughly another 30 years based on currently perfect health (who knows?), but one goal is to work towards simplifying our finances. If anything happens to me, my better half is not nearly as well equipped to manage the financial aspect of things. I would not want anyone to have to start learning about interest rate arbitrage.

The rental property mortgage has a fixed rate for 30 years. The primary home is fixed until 2023, then variable. Maybe I should pay down the remaining rental property mortgage over the next year to take advantage of using up some of the suspended depreciation losses and tax benefits. Then I can continue paying down the home mortgage with a plan to finish paying it off slowly by 2023 when the interest rate will go from fixed to variable.

Olemiss540
Posts: 551
Joined: Fri Aug 18, 2017 8:46 pm

Re: Advice on best approach to deleveraging...

Post by Olemiss540 » Wed Nov 29, 2017 8:23 am

Archimedes wrote:
Wed Nov 29, 2017 4:02 am
CurlyDave wrote:
Wed Nov 29, 2017 2:52 am
I wouldn't pay off either mortgage.

I would put any available cash into equities where you can reasonably expect a CAGR in the 6-10% range and enjoy the fruits of taking the risk and reaping the "risk premium".

Sure, there are going to be years where the return is not as good, but if you have the financial strength to weather these periods, you can take advantage of the arbitrage.
I understand that being leveraged at these low interest rates is most typically quite beneficial over the long run. But at this point in life, we have more than enough. My predicted life expectancy is roughly another 30 years based on currently perfect health (who knows?), but one goal is to work towards simplifying our finances. If anything happens to me, my better half is not nearly as well equipped to manage the financial aspect of things. I would not want anyone to have to start learning about interest rate arbitrage.

The rental property mortgage has a fixed rate for 30 years. The primary home is fixed until 2023, then variable. Maybe I should pay down the remaining rental property mortgage over the next year to take advantage of using up some of the suspended depreciation losses and tax benefits. Then I can continue paying down the home mortgage with a plan to finish paying it off slowly by 2023 when the interest rate will go from fixed to variable.
I think you have a great plan, that is the route I would go as well.
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.

overthought
Posts: 201
Joined: Tue Oct 17, 2017 3:44 am

Re: Advice on best approach to deleveraging...

Post by overthought » Wed Nov 29, 2017 11:44 am

Olemiss540 wrote:
Wed Nov 29, 2017 8:23 am
Archimedes wrote:
Wed Nov 29, 2017 4:02 am
The rental property mortgage has a fixed rate for 30 years. The primary home is fixed until 2023, then variable. Maybe I should pay down the remaining rental property mortgage over the next year to take advantage of using up some of the suspended depreciation losses and tax benefits. Then I can continue paying down the home mortgage with a plan to finish paying it off slowly by 2023 when the interest rate will go from fixed to variable.
I think you have a great plan, that is the route I would go as well.
+1

Carefreeap
Posts: 2385
Joined: Tue Jan 13, 2015 7:36 pm
Location: SF Bay Area

Re: Advice on best approach to deleveraging...

Post by Carefreeap » Wed Nov 29, 2017 3:34 pm

If your goal is to simplify, I'd probably pay off the house over time, say pre-pay until you retire and/or the re-set happens. If something happens to you it's probably much easier for your spouse to sell the rental house and get rid of its loan than to deal with trying to make payments or deal with a large balloon or re-set loan on the primary. FWIW I've seen widows do this; terrified they can't afford the payments on the house and sell before they have had a chance to think things through.

You could do something similar with rental. Once you're retired you can start using those passive losses to off-set the rental income. Or keep kicking them forward until you sell the rental and check into doing something like ROTH conversions from 401ks during the low income years.

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