Pay down Mortgage on investment properties bad idea?

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Pan
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Pay down Mortgage on investment properties bad idea?

Post by Pan »

We have a lot of cash (~400k) And two Investment properties
town house mortgage 100k@4% value 480k
condo Mortgage145k@4.125%. Value 250k

Almost paid off primary home, 30k left

Currently No rental income since rents break even with mortgage Interest and fee
If we pay down the mortgage, The lower mortgage interest will result in a positive rental income and we are in a relatively high tax bracket with high state and local taxes

Does it make sense to pay down these with the extra cash?
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grabiner
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Re: Pay down Mortgage on investment properties bad idea?

Post by grabiner »

Paying down the mortgages gives you a risk-free taxable return of 4% or 4.125%. You say that you are in a relatively high tax bracket. If your tax rate is 40%, the after-tax return on the 4.125% investment is 2.625%, or 2.805% if the rental income qualifies for the qualified business income deduction (so that it is only 80% taxable). In either case, that is still a very good risk-free, tax-free return; muni funds from your state, which have some risk, yield about 1.5%.

Therefore, as long as you don't need liquidity, paying down the mortgages makes sense. In addition, paying off all the mortgages (including your primary home) would improve your cash flow, as it would eliminate some large monthly payments; this would allow you to keep a smaller emergency fund.

An alternative use for the money would be to use some of it to buy more rental real estate. This would increase both your risk and return; you have to decide whether that is worthwhile.
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FiveK
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Re: Pay down Mortgage on investment properties bad idea?

Post by FiveK »

Depends on what you would do with the extra cash. If "invest in bonds" see grabiner's analysis.

If "invest in stocks", or "invest in more real estate," etc., then you could have higher expected, but not guaranteed, returns by using the money that way.

Do you have a desired asset allocation (stocks/bonds/real estate/cash)? If so, how does your current actual allocation compare with your desired allocation?
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Re: Pay down Mortgage on investment properties bad idea?

Post by abuss368 »

I would consider paying of your primary home mortgage. Let the renters pay the mortgage down on the investment properties. Invest in low cost total market index funds.
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Topic Author
Pan
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Re: Pay down Mortgage on investment properties bad idea?

Post by Pan »

abuss368 wrote: Sat Aug 15, 2020 6:43 pm I would consider paying of your primary home mortgage. Let the renters pay the mortgage down on the investment properties. Invest in low cost total market index funds.
True but I am Already down to 30k in my primary home, paid down from 100k in recent months
Topic Author
Pan
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Re: Pay down Mortgage on investment properties bad idea?

Post by Pan »

grabiner wrote: Sat Aug 15, 2020 4:42 pm Paying down the mortgages gives you a risk-free taxable return of 4% or 4.125%. You say that you are in a relatively high tax bracket. If your tax rate is 40%, the after-tax return on the 4.125% investment is 2.625%, or 2.805% if the rental income qualifies for the qualified business income deduction (so that it is only 80% taxable). In either case, that is still a very good risk-free, tax-free return; muni funds from your state, which have some risk, yield about 1.5%.

Therefore, as long as you don't need liquidity, paying down the mortgages makes sense. In addition, paying off all the mortgages (including your primary home) would improve your cash flow, as it would eliminate some large monthly payments; this would allow you to keep a smaller emergency fund.

An alternative use for the money would be to use some of it to buy more rental real estate. This would increase both your risk and return; you have to decide whether that is worthwhile.
That’s makes sense, I am not saving 4% but 2.6% is better than other alternatives

I am not sure I want more rental real estate, the return hasn’t been great around here, especially the condo..
Topic Author
Pan
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Re: Pay down Mortgage on investment properties bad idea?

Post by Pan »

FiveK wrote: Sat Aug 15, 2020 6:40 pm Depends on what you would do with the extra cash. If "invest in bonds" see grabiner's analysis.

If "invest in stocks", or "invest in more real estate," etc., then you could have higher expected, but not guaranteed, returns by using the money that way.

Do you have a desired asset allocation (stocks/bonds/real estate/cash)? If so, how does your current actual allocation compare with your desired allocation?
That’s a great question, the real issue is we are trying to figure out what to do with the 400k cash and what the allocation should be, I think we have too much cash but my partner disagrees

Our other assets
401k $2.25 million (95% stock, 2.5% bonds)
Roth $100k
Non retirement $500k (all stocks/S&P funds )
529 $160k 2 kids (11 and 15)
Cash $400k

Primary home $750k 30k@3%mortgage
Not planning to acquire more rental properties
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grabiner
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Re: Pay down Mortgage on investment properties bad idea?

Post by grabiner »

Pan wrote: Sat Aug 15, 2020 9:36 pm
abuss368 wrote: Sat Aug 15, 2020 6:43 pm I would consider paying of your primary home mortgage. Let the renters pay the mortgage down on the investment properties. Invest in low cost total market index funds.
True but I am Already down to 30k in my primary home, paid down from 100k in recent months
The benefit from paying down a loan doesn't depend on how much is left on the loan, only on the amount you pay down and the interest rate. Since your home mortgage will be paid off soon anyway, paying it off now gives you a short-term return equal to the home mortgage rate. Once you have earned that return by eliminating future mortgage payments, you can use the money that would have gone to mortgage payments to pay down some other loan at its rate, or to invest.

The reason for paying down your home mortgage first is that the interest is probably not deductible (unless you donate a lot to charity), and thus the after-tax interest rate is higher even though the mortgage rate is probably lower.
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babystep
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Re: Pay down Mortgage on investment properties bad idea?

Post by babystep »

Pan wrote: Sat Aug 15, 2020 10:00 pm
FiveK wrote: Sat Aug 15, 2020 6:40 pm Depends on what you would do with the extra cash. If "invest in bonds" see grabiner's analysis.

If "invest in stocks", or "invest in more real estate," etc., then you could have higher expected, but not guaranteed, returns by using the money that way.

Do you have a desired asset allocation (stocks/bonds/real estate/cash)? If so, how does your current actual allocation compare with your desired allocation?
That’s a great question, the real issue is we are trying to figure out what to do with the 400k cash and what the allocation should be, I think we have too much cash but my partner disagrees

Our other assets
401k $2.25 million (95% stock, 2.5% bonds)
Roth $100k
Non retirement $500k (all stocks/S&P funds )
529 $160k 2 kids (11 and 15)
Cash $400k

Primary home $750k 30k@3%mortgage
Not planning to acquire more rental properties
I would probably not pay off the rentals which generate the income and causes the tax in the high brackets. I would rather put 400k into the S&P 500. It is more tax-efficient due to long-term capital gains. It will generate additional cash flow of 8k = 2% of 400k.

Your RMDs will be quite high and Roth needs to be increased.

I wouldn't do any more bonds since 750k paid-off home is kind of compensating for that. If still want to do it then I would buy bonds in 401k.
Topic Author
Pan
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Re: Pay down Mortgage on investment properties bad idea?

Post by Pan »

babystep wrote: Sun Aug 16, 2020 12:44 am I would probably not pay off the rentals which generate the income and causes the tax in the high brackets. I would rather put 400k into the S&P 500. It is more tax-efficient due to long-term capital gains. It will generate additional cash flow of 8k = 2% of 400k.

Your RMDs will be quite high and Roth needs to be increased.

I wouldn't do any more bonds since 750k paid-off home is kind of compensating for that. If still want to do it then I would buy bonds in 401k.
The Roth is the max I can do through back door, you mean i should opt for Roth 401k Instead of the regular pre-tax 401k?

I am clueless about bonds as you can see I own Close to none.
How is the paid off home compensating for bonds
Why is bonds better than S&P in 401k?
Wricha
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Re: Pay down Mortgage on investment properties bad idea?

Post by Wricha »

I’d probably pay off all the real estate $275k and add the remainder $125k to your stock allocation. That way your investing your cash across two different asset classes. Nothing wrong with creating an alternative revenue stream even if you have to pay taxes on it. Someday you may want to buy or 1031 exchange your real estate into something bigger/better. Real has been very good to me so I am blinded by its success.
babystep
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Re: Pay down Mortgage on investment properties bad idea?

Post by babystep »

Pan wrote: Sun Aug 16, 2020 10:35 am
babystep wrote: Sun Aug 16, 2020 12:44 am I would probably not pay off the rentals which generate the income and causes the tax in the high brackets. I would rather put 400k into the S&P 500. It is more tax-efficient due to long-term capital gains. It will generate additional cash flow of 8k = 2% of 400k.

Your RMDs will be quite high and Roth needs to be increased.

I wouldn't do any more bonds since 750k paid-off home is kind of compensating for that. If still want to do it then I would buy bonds in 401k.
The Roth is the max I can do through back door, you mean i should opt for Roth 401k Instead of the regular pre-tax 401k?

I am clueless about bonds as you can see I own Close to none.
How is the paid off home compensating for bonds
Why is bonds better than S&P in 401k?
No, I wouldn't do the Roth-401k due to high tax rates. I was referring backdoor Roth of 12k per year for MFJ.
Bonds are better in 401k vs taxable because there is no tax drag in 401k.
An example would be easy. One has a mortgage loan of 500k and paying 4% interest on it for 30 years. They make a big payment for 500k and now they no longer need to pay the interest on $500k, it is kind of buying a bond.
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capitalG
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Re: Pay down Mortgage on investment properties bad idea?

Post by capitalG »

Pan wrote: Sat Aug 15, 2020 2:43 pm We have a lot of cash (~400k) And two Investment properties
town house mortgage 100k@4% value 480k
condo Mortgage145k@4.125%. Value 250k

Almost paid off primary home, 30k left

Currently No rental income since rents break even with mortgage Interest and fee
If we pay down the mortgage, The lower mortgage interest will result in a positive rental income and we are in a relatively high tax bracket with high state and local taxes

Does it make sense to pay down these with the extra cash?
I’d pay both the mortgages off and take the guaranteed gain. I’m in a similar situation, we are fortunate to have significant cash reserve after maxing out our tax advantaged accounts and making a regular contribution to non-retirement accounts - we don’t feel comfortable making a lump sum investment (I know, stay the course with your AA, but still...). We have enough to either pay off our rental condo or make a significant dent in and recast our primary home mortgage - our goal here is to lock in a risk-free gain and free up cash flow and we will likely just pay off the condo to achieve this. Hope that helps

CapG
BestCoast123
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Re: Pay down Mortgage on investment properties bad idea?

Post by BestCoast123 »

grabiner wrote: Sat Aug 15, 2020 11:52 pm The reason for paying down your home mortgage first is that the interest is probably not deductible (unless you donate a lot to charity), and thus the after-tax interest rate is higher even though the mortgage rate is probably lower.
This.

Are your rental properties throwing off "Passive Income"? If so, consider investing $50k in a syndicated multi-family real estate investment to generate some passive losses to shelter the income from your other rentals. Once you start going down the Real Estate rabbit hole, you likely need to (eventually) keep investing in real estate so you keep deferring your taxes (by always having a Passive Loss balance).

If through earlier depreciation / deductions you have a bunch of built-up losses, then don't worry about it and you could consider paying down the mortgages... but your combined LTV's are very low - so I wouldn't unless your alternative investment options are bonds.
JBEB
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Re: Pay down Mortgage on investment properties bad idea?

Post by JBEB »

Good problem to have.

Food for thought-I never understood the idea of paying down...either pay it off or make the min payment.

The money sitting in equity is lost, but if you can clear off the loan, you free up your monthly payment.
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