Pay off mortgage on rental property? UPDATED

[kadams767]

In today's edition of Should I Pay Off My Rental Property:

DH and I own a duplex.  We lived there in one apartment and rented the other until we bought our current house and we have continued to own it as a rental property, renting out both apartments.  The property generates positive income. We typically save the monthly profit, though, and use it to cash flow larger renovations or repairs at the house, so there isn't a huge stockpile of cash from the property just sitting there.  We would be using our own savings from outside of this property to pay off the mortgage.  

Mortgage is 5.25%, no PMI left.  We owe about $65,000 at this point, with 13 years left on the mortgage.    

Income:  Rental income is $2,200/month.

Expenses:  Monthly mortgage payment (PITI) is just over $1,000.  Additional expenses/utilities that we cover average $200/month.  As I mentioned above, we usually funnel the rest into an account to cover maintenance and repairs (old house, always needs something). 

I'm starting to wonder if it makes sense to pay off the mortgage now and keep the additional profit above what we normally save and put back into the property.  This would net us an additional $600 or so each month, on what I would consider an upfront $65k investment.  But I'm not sure if there is anything I'm not thinking of correctly. 

What does MM think?    

 

  

[jwright]

Initial thoughts -

5.25% is pretty high, but on a rental property that mortgage interest deduction is not limited. To access the $65k to pay it off, would you have to sell stocks that just took a hit and will be at a low point for awhile?

Would it make sense to investigate refinancing into a 15 year or 10 year loan at a lower rate? Obviously if the fees are high the math wouldn't work, but it seems like that may be the best of both worlds to lower your payment, still get a deduction, and don't have to take $65k out of the market while its low.

[kadams767]

Aug 6, 2019 9:14:01 GMT -5 jwright said:

Initial thoughts -

5.25% is pretty high, but on a rental property that mortgage interest deduction is not limited. To access the $65k to pay it off, would you have to sell stocks that just took a hit and will be at a low point for awhile?

Would it make sense to investigate refinancing into a 15 year or 10 year loan at a lower rate? Obviously if the fees are high the math wouldn't work, but it seems like that may be the best of both worlds to lower your payment, still get a deduction, and don't have to take $65k out of the market while its low.

No, we have the money in cash savings to pay off the mortgage.  We wouldn't be selling anything.

There are only 13 years left on the mortgage, so I don't want to refinance to a 15 year term and add time to it for a slightly lower rate.  Rental property rates are typically higher than owner-occupied mortgage rates, so I am skeptical that a refinance could really be worth it once you add in the fees and hassle.  

[scout8]

Will losing the interest deduction affect the taxes you pay on the rental income?

[kadams767]

Aug 6, 2019 9:49:35 GMT -5 spearmintleaf said:

How much is your principal + interest, and how much is tax? How many months until you’d get your 65k back?

I’d definitely consider paying it off early, but I’d probably wait to close that gap a bit. I’d want my money back in 3-5 years.

Principal and interest are roughly evenly split at $300/each monthly.  Taxes and insurance are the balance, so about $425 monthly.  

It would be roughly 9 years to recoup the $65k using the additional profit it would generate, not counting any tax consequences of losing the interest deduction.  

[kadams767]

Aug 6, 2019 9:50:52 GMT -5 scout8 said:

Will losing the interest deduction affect the taxes you pay on the rental income?

Yes, but I think the net effect of that would be roughly $1,000, max.  We actually had a small paper loss on the property last year because of a few major expenses.  

[scout8]

Aug 6, 2019 10:12:01 GMT -5 kadams767 said:

Aug 6, 2019 9:50:52 GMT -5 scout8 said:

Will losing the interest deduction affect the taxes you pay on the rental income?

Yes, but I think the net effect of that would be roughly $1,000, max.  We actually had a small paper loss on the property last year because of a few major expenses.  

Given that you don't want to refinance and the interest rate is pretty high, I think it makes sense to pay it off then. 

[jwright]

Aug 6, 2019 10:17:57 GMT -5 scout8 said:

Aug 6, 2019 10:12:01 GMT -5 kadams767 said:

Yes, but I think the net effect of that would be roughly $1,000, max.  We actually had a small paper loss on the property last year because of a few major expenses.  

Given that you don't want to refinance and the interest rate is pretty high, I think it makes sense to pay it off then. 

Agree with this if refinancing math doesn't work.

[imojoebunny]

Rental income is taxed as regular income, so if you pay off the house, you will have more regular income, by the amount of the mortgage that is deducted currently against your rental income. You will pay whatever your highest tax rate is on that, say 25% Federal + 6% state, or whatever yours is. For that reason, unless you are pretty low income and don't pay Federal Taxes, I would keep the mortgage on the rental property, and invest the excess cash elsewhere, where you could very likely make >5.25% long term, offsetting what you are paying on the mortgage, without losing the tax benefit of having a mortgage on an investment property.

[kadams767]

Aug 7, 2019 9:27:44 GMT -5 imojoebunny said:

Rental income is taxed as regular income, so if you pay off the house, you will have more regular income, by the amount of the mortgage that is deducted currently against your rental income. You will pay whatever your highest tax rate is on that, say 25% Federal + 6% state, or whatever yours is. For that reason, unless you are pretty low income and don't pay Federal Taxes, I would keep the mortgage on the rental property, and invest the excess cash elsewhere, where you could very likely make >5.25% long term, offsetting what you are paying on the mortgage, without losing the tax benefit of having a mortgage on an investment property.

Your post is a little unclear if you are implying otherwise, but only the mortgage interest is deductible, not the principal.  So at absolute max, I'd be looking at $3k or so in additional income due to losing the ability to offset my rental income by the mortgage interest.  Even at a 30% tax rate, that is $900 give or take, which is, unfortunately, negligible compared to my overall tax liability.     

[kadams767]

Update: I paid off the mortgage this month!  Thanks for everyone's thoughts and opinions.