Should You Pay Off Your Rental Property Mortgage Early?

People are greatly divided on the topic of early mortgage pay off — some say it’s a good idea, others disagree. This topic is highly debatable because there are so many factors to consider, and even a slight change in one of these factors could swing the answer in one way or another. In any case, a reader by the name of p3keith left an interesting comment with a different twist on this topic — should you pay off mortgage early on a rental property?

Photo woodleywonderworks via Flickr

Here’s the question:

Not to take this rabbit down a different hole, but I have a similar question on mortgage prepayment that involves a rental property. A little background on my situation. I am 35 years old and six years away from my military retirement. I am looking for my rental property to generate some additional income when I retire (it is zero sum right now, breaking even between rent income and mortgage payment), so I am considering paying it off in the next six years. To do this, I will have to stop my IRA and other retirement contributions.

Is it worth it?

Once it is paid off, I could start with the retirement contributions again, but I am not thrilled with the idea I can’t touch my retirement investments until I am 59 1/2. A paid off rental property is in effect a retirement savings that I would immediately reap the benefits of once it was paid off. I know my ROI drops with every dollar I pay into the property, but I think I am more concerned with cash flow than ROI. The cash flow from the property couple with my retirement would make a decent living in the area I want to retire in.

And here’s the first answer from another reader, Gene:

I’m in a very similar situation as you. I have a rental property that is zero sum as well… breaking even between rental income and everything I owe on the house monthly. I’m considering paying off the property so I can pocket the income (minus taxes and homeowner fees).

Taking everything discussed here into account — if one can pay off the mortgage on a property that in turn generates income immediately, the decision is heavily weighted towards paying it off. For instance, I owe $100,000 left on the rent house — and I have about $110,000 in mutual funds that are liquid — if I pay off the rental house, it not only immediately saves me 5.8% in interest but generates a net profit of $1,000 a month — which is which is a 1% a month gain on the “investment” of paying off the mortgage (the rent is actually $1,400 but 400 is spoken for via taxes, homeowner fee, insurance).

Does anybody have any input for us when it comes to paying off a home that currently has renters? I can’t see any additional drawbacks, but I do see an extra 10% on an “investment” in my mortgage being paid off…(PS: I’m military also and have very secure employment – 10 years away from full retirement if I stay in…). I also have $50,000 in a Roth IRA and max the contributions every year, so that $110,000 in mutual funds isn’t my only retirement fundage.

Here’s my take on this:

I think the problem is quite intriguing. Without going into all the fuzzy math and simply compare the two possible scenarios:

  1. Own a positive cash flow rental property, no mortgage, and has less in retirement savings, or
  2. Own a zero cash flow rental property with a mortgage, and has more in retirement savings.

I think the answer is self-evident…I would choose #1 over #2 any day — even if it means I have less “wealth” in the end. Why? I think there is a lot of value in the peace of mind that comes with scenario #1.

If you’re in this situation, what would you do?

About the Author

By , on May 19, 2010
Pinyo
Pinyo is the owner of Moolanomy Personal Finance. He is a licensed Realtor specializing in residential homes in the Northern Virginia area. Over the past 20 years, Pinyo have enjoyed a diverse career as an investor, entrepreneur, business executive, educator, and financial literacy author.

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Leave Your Comment (66 Comments)

  1. ronnie enochs says:

    very happy i found this sight. im 23 own a home. my game plan is pay of this house in 5 years thin buy a 2 home and use the rent and all my money i can afford to pay off my 2nd home thin do the same on the 3rd home ext.. to 6 or 7 rentals and retire when im 40 in 17yrs. i just want to kick back and take care of my rentals. im det free other than my home i own now that i owe$103k on. i make ok money and im smart enough not to buy news cars and quads cause i know at the end i can buy what ever my young heart dezired.

  2. david archuleta says:

    I own 12 rentals. I took out a HELOC on my primary and used it to buy the 12. I paid off the lowest balance first even though it had a good interest rate. I took the positive cash flow and any other cash I could to pay that off and continued to do so. It is always cheaper to pay taxes than it is to pay interest. I am not worried about saving for retirement because the rental income will fund my retirement. Handful of the properties are paid and all have raised in value. the change in value doesn’t matter unless I sell. I wont sell because of the depreciation recapture and cap gains. I will leave them for my kids.

  3. Spencer says:

    I have really enjoyed reading along. This thread appears to be full of people in similar situations to myself.

    I go back and forth on paying extra into my properties. I have a paid for primary and a payed of single family home. I had no idea how to figure out the rent amount on the single family as the house as it is the house my wife brought to our marriage and we paid off completely after the sale of a couple Multi family units I owned. It turns out I am renting it below market, but I have great tenants for now that do not call and pester for little things. They may also buy the house in the future.

    I also have another multi family with 20 units. It turns out to be a cash cow. Plenty of cash flow and I constantly upgrade and up the rents when units turn over. The location is perfect in a college town, yet it is occupied with either young business professionals or graduate students. I receive calls every week of the year with people wanting to move in, in 4 years I can count on one hand the number of times I have had a unit sit empty for more than a week or two. I have a little over $400,000 in equity in it. In 2014 I will have owned it for 6 years and will need to refinance again. The current rate is only 4%. By then the remaining amount due will be around $614,000 so still too large for a traditional mortgage.

    I have been thinking about taking the income from the other rental and adding it into the pay off on the 20 plex. Hoping to bring down the mortgage to a point I can lock in a 10 year pay off. I just keep thinking these low rates cannot last for the next 15 years, which is what my pay off currently would be, if the rates stay low. I know this is a sweet position to be in since I have no other debt and plenty of income without taking anything out of the rent. I simply reinvest in property upkeep so that I can keep raising the rents.

    I currently have no desire to take on any more properties. I work full time and have 5 kids. And even though they all help me maintain the units (I pay them to paint, weed, etc.) we have a life with scouting and church and school, so no more properties are needed.

    Do I simply leave things the way they are and put extra money into the market, or simply pay this down and retire on the six figure income in 15 years? I am currently 44. Also, is there a different type of Jumbo loan that I could lock in and not worry about refinancing every 3-6 years? Just trying to make my money work as hard as I do. Thank you

  4. tom rahm says:

    i refi’d my primary residence from a 5.5% rate to a 30 yr fixed @ 3.875% in december of ’11.

    my monthly payment with escrow went from $715 per month to $550. that’s apprx a 30% reduction. this is in my opinion a very responsible use of leverage. the money i could use to pay a low rate off in full is put to better use, like buying more property for example.

    i bought a single family rental property in february ’12 with a 30 yr fixed @ 4%. the rental was 75k, i put 25% down. my monthly mortgage payment with escrow is $463. i get $950 per month from my tenant. the 20k i have in this deal earns apprx $5800 per year in positive cashflow, not including the increased equity on the property. this return on my intitial output is close to 30%. that’s an excellent return by anyone’s standards.

    the key to making this steady 25% plus cashflow is the low mortgage rate. it also hedges against inflation, because the bank is essentially stuck with a 4% rate even if inflation goes through the roof.

    i have enough liquidity in index funds to pay both mortgages off in full, but if i did i’d lose all the advantages of those funds – namely dividend income, and overall growth, which if kept in these equities through our economy’s normal growth/expansion cycles, will easily out perform the 4% rate on the leverage.

    i’d be much better off buying more property with these funds than paying off existing loans.

    besides that, investment/rental income is taxed at 15%, so the tax angle favors keeping the leverage working for me.

    it’s a knee-jerk reaction to avoid debt. we’ve all heard the “old timers” and conservatives denounce debt, but used properly and responsibly, leverage can be an invaluable tool to creating wealth. if the cashflow on the properties is sufficient, it’s really a no-brainer.

  5. richard w says:

    Getting ready to take early ss benefit at 62. Primary res paid for. Cannot decide on possible best route to take between a couple of options. Three rental properties, all with good equity but we just let the money stay in llc account for repairs as you all know as renters leave so does carpet or whatever. Possible options, sell gold coins pay off one property to have clear,borrow against primary to pay off two of the rentals.

    Problem I see with this is now I trade income for small deduction on primary, which we will be renting also as we are retiring in Mexico and mostly looking for scuba diving money
    I do believe it typically comes down to what people believe they are the most comfortable with. Myself it is having stuff paid for and as we got hammered last year when we sold a couple of the rentals and recapturing depreciation took the wind out of our sails. Problem with gold coins is you hold them to the bitter end. Ideas?

  6. Pinyo says:

    @Amy – If you’re comfortable being a landlord, I think you’re in a great position. My wife and I just bought our first rental home. It’s cash flow positive at a decent mortgage rate. Since it’s already cash flow positive, we are not planning to pay it down.

    Personally, I’d continue the way you have been doing and just pay down the HELOC as you go. The property should continue to generate cash flow long after you pay off your HELOC and it will have value real value that is a good hedge against inflation.

  7. Amy Osho says:

    I currently own a rental property that is rented out to a family member. The only debt towards the rental I have is a $27,000 HELOC used for upgrades and repairs. I rent for $1100 a month and after paying ins, taxes and water I am left with around $750/month which I usually put towards the HELOC.

    I also own another property and the mortgage is $300k.

    I am just wondering if I should keep the rental property or sell it and stock the money away in mutual funds or if the return I get on my rental is great enough to hang on to it.

    I have had so many mixed comments on my situation. So many people tell me to sell the thing and invest and many tell me I would be stupid to sell.

    I am new to being a landlord. I have my worries but know that it goes with the business. Main thing I have learned is to really do your background checks on new tenants.

    Any advice for me?

    My rental is valued at $160,000 and it is paid off. All I owe is the $27,000 @ 3% interest. Which I could very easily pay off in 3 years. I do not use the HELOC for any consumer debt. It is only used for household upgrades I did on the rental property.

  8. Pinyo says:

    @hoops – It really depends on who you ask. The more experienced landlords that I speak to mostly agree that you should have a cash flow positive rental after all expenses (including the principal pay down) and before factoring in tax deductions and depreciation. However, I also know landlords that are perfectly happy with negative cash flow, but with net positive value after factoring in principal pay down, tax savings, and depreciation. It looks like you’re in the latter category and if you’re okay with it, I don’t think there’s anything to worry about.

  9. Carl W says:

    Thanks Pinyo – Once again great topic and advice very helpful!

  10. hoops says:

    Pinyo..You really know what you are talking about and I appreciate your advice.Here is my situation and I am really torn.I own 2 houses in Az and I live in Ca. Bought both new. One is 9 years old in a very nice retirement community and I owe 165,000 k at 5.125.The other is 8 years old in a regular community and I just refin it at 5% no cost and I owe 169k.The ret community house is 2700 sq ft and worth about 325k or so and the other one is 2300 sq.ft and worth about what I owe. The combined rent for the 2 houses is 2850 and my combined mort pay is 2000, but mgt fees, prop tax and hoa and landscaping are about 900 plus the day to day issues that come up like a new whatever is needed. What I do not understand is how does one weigh in the tax deduction, depreciation and tenant paying down the principal when determining if these are good investments. Sorry for being so long.

  11. Pinyo says:

    @Carl – Tax deduction alone is usually not a good enough reason to keep a mortgage if you can pay it off. For example, if paying off a mortgage saves you $100,000 in interest, that’s a $100,000 savings vs. deducting $100,000 which only saves you about $25,000 (assuming average tax rate of 25%).

    On the other hand, it might not be a bad idea to keep around a mortgage if your rate is low. It’s a good inflation hedge (both the mortgage and the house are good hedges), and it gives you the flexibility to do something else with your money.

    @Hoops – It depends on what your mortgage rate is and if you have any other plan for the money. If you plan is to let it sits in a MM account earning sub-inflation rate, then yes, pay off the principal.

    Have you thought about buying a second rental property with the money you have?

    @Marshall – Thank you. Buying anything with cash is generally a good advice if you can afford to do it. Most people I know can’t afford to buy a house with cash.

    @Chris – I understand your point about 10-year vs 30-year. Personally, I would go for the 30-year to maximize cash flow and try to save up for a second property. Even if you can’t take advantage of a second property, you can lock in a low borrowing rate for 30 years, which will probably cost you almost nothing after factoring in inflation.

  12. Chris says:

    I have a variation on this thread that I hope someone in the group could help me with.

    I am considering the purchase of a small SFH in a depressed market. Asking price is $69K (originally sold for $200K in 2007) and rental comps are $1000-1050/mo…an 18% CAP! I’ve been running the numbers for estimated OE and debt service and it looks like I could maintain a small positive net cash flow carrying a 10 year note. A 30 year note throws off an appreciable amount of cash. I can see both sides to this but the math starts getting fuzzy when you start accounting for tax advantage, future appreciation, etc.

    Anyone want to take a crack at this?

  13. Marshall says:

    I have a home paid cash, a 3 flat paid cash with a positive cash flow of $5600.00 a month. If possible, I think the way to go is to pay cash, or borrow equity from a home that may have a mortgage and purchase property with cash, rehab and rent or flip. Hope that helps some.

  14. hoops says:

    I have 2 rental houses with mortgages.My question is I owe 166,000 on the original that I bought in 2003 for 250,000 with 20% down.Is it wise to pay down the princ 20,000 at this point to inrease the amount by about 100 bucks a month that the princ will be paid down going forward vs. letting the 20k sit in a money market???Thanks for any opinions.

  15. Carl W says:

    Great topic! This has been very helpful learning all he different options available. I also own three properties; one primary and two rentals. I logged onto to this site to see what people have been contemplating in similar situations. I am 43 years old and want to choose the best financial option. I am a government employee with a pension plan so paying off my rental income properties sounds good. My accountant says I should keep a mortgage on my primary and one of the rental properties for the tax benefits because my salary and rental income could push me into a higher income bracket. I was thinking about refinancing my primary from a 30 year to a 15 year mortgage so that I would not have a mortgage when I retire in 20 years or so. Is my accountant giving good advice or does anyone differ?

  16. Jonathan says:

    Unable to take out a mortgage on the property at this time because the propety is a camp with no septic and no indoor plumbing. It is my understanding that I would have to pay cash to get the property. Then after improving the lot ie septic etc then I could get a mortgage.

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