Which mortgage to pay off

Question

I have three 30 year mortgages:

My home: 4.125% with 450k owed

Investment Prop #1: 4.675% with 325k owed

Investment Prop #2: 5.25% with 309k owed

I can start paying down principal but should I pay off my home or investment property 2 first? The interest rate on number 2 is higher, but it’s also tax deductible. Advice?

James Orr · Answer

@Eric D. I hope you don't mind, but I made some significant assumptions about your situation and put it into my real estate portfolio analysis software to see what it looks like with you for 3 scenarios:

1. Don't pay off any mortgages

2. Pay off highest interest rates first (investment properties then primary)

3. Pay off lowest interest rates first (primary then investment properties)

In all cases above, I made a bunch of assumptions:

• You had about $1,000 per month to put toward paying off loan balances (and that went up by about 3% per year)
• If you did pay off a property, you had that extra amount to apply toward paying off the next property.
• For the net wort calculations, I assumed property values and rents were going up at 3% per year

Based on my calculator and my assumptions, if you don't pay off the mortgages, over 40 years your net worth from these 3 properties and the cash in your bank would be about $7.58 million.

If you pay off the lowest interest rates first, you'll have $8.02 million. If you pay off the highest interest rates first, you'll have $8.06 million.

One could argue that you should take the $1,000 per month that we're applying toward mortgages and invest it in something else (maybe the stock market) to do a more fair comparison for the for the "Do Not Pay Off Mortgages" scenario. If your stock market number exceeds the interest rate numbers that will probably do the best.

Probably the most interesting chart is the True Cash Flow(TM) chart for the three scenarios. I've shown that below.

In the case where you do not pay off mortgages faster than normal, I assumed ALL three of your properties started their mortgages this month so they all paid off in the same month. I suspect this is NOT the case.

Here is a chart showing your "bank account" balance for the three scenarios. In the ones you're paying off the mortgages the balances hover at zero until you've paid off all three houses because I assume you take all your extra cash and pay off loans. With the other scenario, you're putting aside the $1,000 extra from your income and any additional cash flow from the rentals as cash flows improve over time.

I did not model the impact of tax deductions from the mortgage expenses.

Does that help at all?

Chris Mason · Answer

Investment Prop 2 has the lowest balance and the highest rate. Usually it's a debate between the lowest rate and lowest payment. In this case, one property wins both.

Once IP2 has a P&I payment of $0.00, use that additional cashflow to nuke the remaining two. At that point it'll be time to revisit the balance v rate debate.

Thomas S. · Answer

If you have money you do not want to invest in additional properties you could pay down your home mortgage and then set up a HELOC to access the cash.

There is no reason to pay down a income property mortgage.  Al that will do is save you at most 5.25%. If you do not want to invest in more properties put the money in a REIT, income fund or something similar and you should easily achieve 10% returns.

Paying down a income property mortgage amounts to hoarding of worthless cash.

Eric D. · Answer

Would you invest in more property instead? Thing is, I live in North Jersey where good deals are hard to come by

Brent Coombs · Answer

@Eric D., if both your investment properties cash flow positively, what's the hurry? (And if they don't, why did you buy them?) I can see both of the Chris's points of view, and Sam has added another layer of complexity as to which side might be "mathematically right". At this time, I tend to fall on the side of paying down your non-income-producing primary. My guess is: that's the one that will get the highest HELOC approved once it's closer to being paid off, right?

[And, I take it that you're not done with investing, any time soon?]

Anyway, great that you have plenty of dollars to play with. Kudos on your progress to date...

Sam Shueh · Answer

The standard deduction amounts will increase to $12,000 for individuals, $18,000 for heads of household, and $24,000 for married couples filing jointly and surviving spouses

Ideally if taking standard deduction you will be debt free sooner.

Which mortgage to pay off

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