Author Topic: Pay Extra Principle on House or Rental Property?  (Read 4848 times)

CBHome2

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Pay Extra Principle on House or Rental Property?
« on: September 02, 2013, 10:49:09 AM »
Hi,

I would like to pay down my mortgages and I am not sure which one to pay down first. I have a 30 year fixed mortgage on my house at 3.5%, which I started paying last year and currently have about 14% equity. The mortgage on my rental property is also a 30 year fixed at 4.25%, which I refinanced about a year and a half ago and have about 20% equity.

It seems like paying down the rental property first would be better, because of the higher rate. Plus, there is the tax break on the interest paid on my house. Anyone disagree or need more information to decide? What else do I need to consider?

Thanks,
CBHome2

 

arebelspy

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Re: Pay Extra Principle on House or Rental Property?
« Reply #1 on: September 02, 2013, 10:55:34 AM »
Yes, the one with the higher rate is better.

You should be able to deduct interest from either, so that's a wash.

I wouldn't be paying down either at those rates, but would be investing the surplus, but if you're very risk averse then paying down the 4.25% loan is better.

(In the case of being sued, it's probably better to have equity in the primary residence instead of the rental, but assuming you are sufficiently insured and not worried about that remote possibility, I'd be paying down the rental.)

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CBHome2

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Re: Pay Extra Principle on House or Rental Property?
« Reply #2 on: September 02, 2013, 11:16:08 AM »
Thank you for the quick response. I am pretty risk adverse, but I am also maxing my 401k and making regular contributions to my Vanguard fund.

Thanks for the tip about being sued. That is not an angle I had considered. I do have the required insurance on the rental property, plus an umbrella policy that I hope I never have to use.

Blindsquirrel

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Re: Pay Extra Principle on House or Rental Property?
« Reply #3 on: September 02, 2013, 08:33:57 PM »
  It is entirely  up to your personal pref. The higher yield off a leveraged rental property can be stunning. If you take cash out of a rental and buy another rental until you have none of your cash in it and they both or all  still making money after expenses, your yield is incredible. This is how many real estate investors end up broke and suffer rotten financial setbacks that can be avoided. You can buy their formal rentals at a steep discount when the bank takes them back.   If you are risk adverse it is very hard to get hurt when you have paid off rentals and a paid off house.  Rental yields have been off the charts around here so I have bought rentals for cash rather than pay off a 2.75% 15 year fixed on my own house. (We are in a very strong position financially though.)  You have to look at your own comfort level.  Eventually rental yields will revert to the mean in the area where I live and my yields will drop. Either the values of the houses will go up or the rents will come down. Who cares in the grand scheme of things as they will still kick off a solid cash flow in the absence of debt.  No asset kicks off huge yields forever as the high yields will draw capital and thus yields will drop. Supply and demand never fails for long, it is not just a good idea, it is the Law! :) You have fixed rate financing that is at a very low rate historically and along the lines of the historical rate of housing appreciation. When capital investment yields in real dollars ( look at the 10 year average treasury for the last 50 years as a no risk bench mark) revert to historical averages you may well have fixed financing below the rate of inflation. AKA free money if your rents and income keep pace with inflation.   If you look at the P/E for rental real estate right now it is very low in many areas. I would rather buy a house I can manage myself in a market I know at a P/E of 5 than a share of the S&P 500 at a P/E of 14 ish. All of the math aside, if you are risk adverse, pay the 4.25% loan  down to zero and enjoy the nice free cash flow.(always pay the highest rate first unless you have variable financing in which case pay that off first unless you hold the cash to pay it off if/when rates go up). You are much less likely to get hurt financially with paid off rentals. It is really hard to get hurt with a lot of paid off rentals. We only have a loan on 1 rental out of 14 now which gives you an idea of how risk adverse I am. (Very risk adverse of late). The key is not to get crushed by 1 horrible tenant or even 2 or 3. It is a long  race my friend and not a sprint. Arebelspy knows his stuff for sure.

icefr

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Re: Pay Extra Principle on House or Rental Property?
« Reply #4 on: September 02, 2013, 11:26:39 PM »
Do you have PMI on your primary residence that you could remove at a certain equity %? If so, I would consider paying that one down first until you reach that % of equity to eliminate those extra payments, and then re-evaluate.

Hamster

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Re: Pay Extra Principle on House or Rental Property?
« Reply #5 on: September 03, 2013, 12:41:51 AM »
Another point to remember is that you only get a tax benefit for mortgage interest on your primary residence if your itemized deductions exceed the standard deduction. So, it may be more tax-beneficial to pay down your primary residence first. There are a lot of people out there who don't benefit at all from mortgage interest deductions on their primary residence, particularly if they don't have an expensive home, and don't have many other deductions.

Interest paid for a mortgage on a rental property is always tax deductible since it counts against income (unless your rental income is negative once you factor in depreciation, which gets more complicated).

Also, I echo icefr's comment about PMI. If you can pay down the balance to get rid of PMI, then do that. Otherwise, if property values are increasing in your area, you could also look into the bank's rules on getting it reappraised and seeing if you could get rid of PMI, even without paying down your mortgage further at some point.

CBHome2

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Re: Pay Extra Principle on House or Rental Property?
« Reply #6 on: September 03, 2013, 08:48:16 PM »
Thanks to all for the replies. No PMI and we do itemize.

I will throw all extra principle payments to the rental.

Blindsquirrel

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Re: Pay Extra Principle on House or Rental Property?
« Reply #7 on: September 04, 2013, 06:02:49 PM »
 Fine choice. Just remember, passive losses for RE investment phase out starting at 165k AGI or so.

tomsang

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Re: Pay Extra Principle on House or Rental Property?
« Reply #8 on: September 04, 2013, 07:37:15 PM »
Put the extra in a Vanguard whole world fund and keep the free cheap loans!  Now that I got that out of my system, I encourage you to read the pros and cons at:
http://www.mrmoneymustache.com/forum/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/

I truly do think that you will be much better off over the next 30 years by not paying down your 4.25% fixed rate mortgage if you actively invest the difference.  If people want to pay down their mortgage for emotional, financial or any other reason I am good with that if they have truly thought through the pros and cons and understand that there is a pretty good position on keeping fixed rate loans at 4.25% or less.  Especially since you are potentially getting tax incentives which reduce the true cost of the loans.

Debt is not evil, bad or anything else.  It is a financial instrument, that can help or hurt your financial well being.  If you are going to blow your money, then you should pay down the loans. If you are going to actively invest your money for long term success, then I believe that you will be better off not giving up the cheap/free money that they government provided you to stimulate the economy.   

Good Luck!

hybrid

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Re: Pay Extra Principle on House or Rental Property?
« Reply #9 on: September 10, 2013, 02:16:07 PM »
I'm in a similar housing situation though our financial situation is different from most.  Wife can likely retire in three years if we reduce enough expenses and have a rental free and clear supplementing our income, so we are working to pay off our rental completely in those three years and be down to one mortgage.  Yes, we could chase better returns in the market (just about the only place to get 4% or better these days) but we already have (more than) enough eggs in that basket already.  Not inclined to add any more.

I say pay down that rental....  If financial conditions change you can change too, but with CDs buried at 1-2%?  I'm not big on bonds either at the moment.  Go with the safe play, I doubt you'll regret it.