Cash Out Refi or Pay off Mortgage?

Question

So my first house is almost paid off, (I currently have 6 years left on a 20 yr mortgage). I have had the same renters in this house for 9 years. I have not really done any other investing in rentals. I had another house I bought, lived in and sold. I currently do not have a mortgage for a primary residence either. So, I currently have a lot of flexibility at this particular stage in my life. My question is, what should be thinking about doing? I have roughly $100,000 of equity in that rental. Should I do a cash-out refi and look for another rental property in a better area? Or pay the mortgage off and start banking the rent (although this will affect child support I am told). What should I be looking at?

(note: I am not interested at all in doing flips!)

Thomas S. · Answer

Look at it from the perspective of what dead equity is costing you. At a 10% return on investment (conservative) your present equity is generating $866/month of your properties cash flow.

Is the property itself after that deduction actually generating any of it's own positive cash flow monthly. If not then the property itself is a liability not a asset. You either need to sell the property and invest your money elsewhere or pull out the equity and invest it else where. If pulling equity still allows for positive cash flow the property is worth keeping otherwise selling now is your only option.

Dead equity cost money it does not make money when left in a rental investment property. Cash investors do not understand how equity diminishes their returns or how much they are losing they only see what they are making which is usually minimal ROI.

Kerry Baird · Answer

I suppose that, if you don't know where you are headed, any path will take you there.  You need to firm up your goals, so we can give guidance such that you meet them.  My own goal was to "go wide" by buying 10 houses and then "go deep" by paying them off.

--> Buying houses all cash gives you a great amount of cash flow, when compared with leverage.  However, you are not diversified, and your equity is "dead."

--> Buying with leverage allows you to spread out the risk across a number of properties.  Your cash flow is diminished at the start.  But the tenants continue to pay them all down via inflation-induced debt destruction while also working to raise the values over time.

At the end of the road, I intend to have mine all paid off.  Either path (save up for another all cash, or leverage to purchase a handful more) will get you there.

Which path resonates with you?