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

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.

My Take

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.

Advantages of Early Pay Off

Here are some advantages that I can think of right away

  1. Better cash flow.
  2. No more interest payment (so the higher the interest rate on the mortgage the better it is to pay off early).
  3. 5% saving on mortgage interest is better than 5% gain on your investment because you don’t have to pay taxes for the former.
  4. It reduces your debt-to-income ratio and allow you to purchase more rental properties.

Disadvantages of Early Pay Off

On the flip side, here are some disadvantages

  1. You lose out on mortgage interest deduction so more of your rental income is taxable at your regular tax rate.
  2. You are less diversified (a big chunk of your money is in real estate instead of diversified investment).
  3. Your investment might grow faster.
  4. You are less liquid (easier, faster, and much cheaper to sell a stock or fund than it is to sell a house).
  5. You lose out on inflation. Basically, $1000 you pay on your mortgage today is going to be a progressively smaller payment each time after you factor in the effect of inflation on mortgage payment.

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

About the Author

By , on Dec 19, 2016
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 has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, and financial literacy author.

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Leave Your Comment (88 Comments)

  1. Marissa says:

    My rental is under $98k and I am eager to pay it off to and get the $1700 monthly ( excluding tax, etc.). Instead of liquidating the remainder from my stocks, I will make a 2-3 year plan make 3-4 smaller lump sum payments based on stock /dividend performance each quarter. That with the regular mortgage payments should allow me to reduce my portfolio by $70k or so. This depends of course if the market behaves and I must account for additional trading fees and capital gains tax (which would benefit spread over a couple years vs. all at once). The risk of staying in the mortgage or market really depends on the health of the economy, but no one said building wealth would be easy. Overall my instincts prefer my rental because it’s set in an established economic region that did well even during the recession.

  2. Patrick says:

    Hey guys, love this thread.
    I’m looking to retire from the Fire Dept in 6 years at the age of 54. At that time I’m thinking about paying off my 3 rentals using my 457k. I would need to draw 150,000 out of my 200,000 457k to do that.
    Any bought son weather I should touch my 457k to do that or not.
    Really struggling with this….

    • No Nonsense Landlord says:

      Do not take your tax deferred funds out. Make lifestyle changes and put the extra towards the mortgage.

      You can also use a HELOC to reduce the interest expense, if you have enough self control.

      I wrote about my payoff experiences on my own blog. I have paid off over $300K in the past 2.5 years.

  3. Charles says:

    Each decision will depend on what your plans for the future on investing will be. I like to keep investing in real estate to accumulate as many rentals and flips as i can. I try and buy at least 2 or 3 rentals a year. I pull out equity from my units after purchasing with cash so i can keep my money free to buy other homes. I only do that when there will be positive cash flow even with a mortgage. In my area homes are cheap and rentals are pennies on the dollar. Our rents received are less than most bigger cities but the out of pocket money and mortgages are cheaper as well. I buy rentals for 20 to 30k that rent out for an average $650 per mo. That is a huge return for a little investment. Subtract taxes and ins around=$125.00 then add $200 mortgage at 6% for 10 years totals $325. That’s still a $325.00 cash flow. No reason to pay off a mortgage as long as your using the equity for more profits.

  4. Ash says:

    Thank you for lot of feedback here. My case is slightly diff than the ones I could read.

    In 2012 I rented my first home after living there for 8 years. I’m planning to sell it this year. After taxes, there should be easily $100K. I have another condo rental on which I have around 97K mortgage with an interest rate 4.5%. Right now after all the expenses, condo sucks around $100 from my pocket. On my primary residence I have around 360K balance with an interest rate of 3.875. Questions (1) How is tax calculated upon the sale of my first home (2) What is a better investment of that 100K? Options I’m contemplating are (a) Payoff condo mortgage and then refinance my existing mortgage to 15 years at a lower interest rate and then use the condo income to offset the increase in the new 15 year mortgage loan. When I payoff this, won’t there be tax on the rental income? (b) put that 100K into my primary mortgage so that I can pay it off much faster.

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