Which mortgage should I pay off first? Rental or my own

55 Replies

Ive often thought about this. There are pros and cons of both

1. Pay of rentals first: The reason is that it increases your cash flow but not your taxes by much due to depreciation (depending on your numbers of course). The primary home interest is also tax deductible against your regular income. Rental interest only against rental income and then sometimes you cannot even use the depreciation fully. So from a tax optimization pay the rentals first.

2. Pay Primary home first: This is best for peace of mind and ultimate security against down markets, lost jobs etc. You lose the tax deduction so thats the downside. But also you can more easily pull that money back out in the form of a HELOC much easier from a primary home compared to the rental.

So in the end do you want peace of mind or mathematical optimization (which some would argue is leverage even more!)

I've created the spreadsheet that Hal Davis mentioned above and I've done a few different scenarios.  If you're concern is interest expense, it's better to put extra dollars towards the property with the highest rate.  If you have equal or very similar interest rates with two different properties, then choose the property closest to being paid off.  Attack the rate.

I'm not sure if anybody else has mentioned this, but from an asset protection point of view, paid off properties are a target.  

It is all about what makes you feel comfortable, for most people that is paying off the primary home. 

 If you are asking a financial question, leverage as much as  you can and keep reserves to protect yourself.  It's impossible to plan for the catastrophic events, you can plan for the smaller issues, roof, A/C vacancy, etc.  In the event of the catastropic issue, you will have to hold a paid off property until the crisis has passed.  There is no exit strategy when the market dries up.  In a high leveraged scenario, you can do a strategic default and return the property to the bank and retain the money that would have been tied up in the property as equity.    

I find it interesting that people that are risk adverse always want to pay off their mortgages when in reality, paying off assets that are not liquid is much more risky. I have been working with my fiance on this concept as she is nervous that I want to do a cash out refinance on a house that we have 40% equity in. Here are two different balance sheets. One with the person that pays down their mortgage and one that puts all the extra money in cash reserves (or refinances)

Paydowner

Asset: Cash - 5,000                 

Asset: House - 200,000

Liability: Mortgage 95,000

Equity: 100,000

Reserver

Asset: Cash - 55,000

Asset: House - 200,000

Liability: Mortgage - 145,000

Equity: 100,000

Which "Company" or "Individual" is in a better finance position? Which one would do better during an economic downturn? The only factors to consider are interest rates (after tax advantage which is much lower than the stated APR) and fees (if you were to refinance).

Now with a certain amount of cash you have too much but that could be deployed into other investments (diversify) IRA, 401(k), taxable brokerage account, notes, other real estate. But the idea of paying off real estate (the most ill-liquid investment there is) is silly with today's low rates. You still have access to the cash to invest in paying down debt if you really needed to for some reason. Cash is King. The more cash you have the more conservative (or should I say safe) you are.

Paying down debt on real estate is risky from and investment and financial health perspective. If your debt is amortized, pay the minimum if you have a good rate. Let the standard amortization and the fact the the value of your debt will decrease with inflation work to your advantage. 

Another thing I find Funny are people that want to pay off their debt to increase cash flow. You are getting rid of cash to do this! You are paying cash today for cash later. Look at the Reserver...he doesn't need cash flow any time soon. He could breakeven. At $500 per month cash flow for Paydowner...how long until he has the cash of Reserver? 100 months or 8 years and 4 months. 

So my answer to your question is neither. If you already have so much cash that you just can't stand to have it sitting there losing to inflation...buy more real estate...sounds like you are doing this so if you don't need it for a down payment keep it for reserves. 

Originally posted by @Pat Coogan :

@Chris Mason What if you already have a lot of equity in your primary? Do you still recommend paying it off completely before doing a HELOC? Let's say one has 260K left on the primary but it's worth about 600K.

I'm in the same boat as you, Pat. Primary equity is solid, but still a substantial balance. I'm not doing a HELOC because I have a great fixed rate of 3.375 with only 9 yrs left. What's your rate and term?

Theoretically you could get a HELOC large enough to pay off your house I suppose, but then you'll have a variable rate credit line. Pluses and minuses to that. Access to cash would be nice but I don't like the variable rate or small print risk of the heloc.

In general, I like to have about 78% LTV on homes which keeps me below PMI, or none. With none I can put new debt on it or keep it paid off and put it into an entity. The middle ground 30-50% LTV stuff is tougher and becomes a personal decision how to deal with it, IMO. Cheers!

@Steve Vaughan 3.25, 15 yr fixed, 14 yrs left. Did this before I learned about BP and real estate investing. Like you, I don't want to lose the good rate on it now, but what to do with the equity is something I'm trying to figure out. 

As far as I can tell, you don't sound anywhere close to being over leveraged. With that being said, what do you even care about how long your tenants will have to keep improving your credit, your equity position, and your overall purchasing power. I agree with Chris Mason, although I personally hadn't heard of that particular HELOC strategy before, (to me) it makes a lot of since. If you were to use Chris's primary residence pay-off HELOC strategy accompanied with the mindset that I am suggesting you entertain in this post, I believe that you will be able to embrace and enjoy your OPM with a much needed POM (Peace Of Mind). Hope this helps. Much success!