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Just a little financial puzzle.

Inputs:

  • An investment mortgage with 5.5% interest rate, 100K balance and 20 years left.
  • Saving account with 100K in the saving account at 0.5%
  • HELOC without any balance and 100K credit limit.
  • Let's say the rent is $700 and just covers the mortgage payment (ignore all the maintenance fees)

Question. Does it make sense to do any of the following?

  • Payoff the mortgage with savings. That means have no life savings, keep HELOC as a backup plan (but keep $700 a month to restore the savings)
  • Use HELOC to payoff the mortgage. The current rate would be 3.5% (prime + 0.25%) but it's not fixed and may go up.
  • Use some kind of combination of the 2 above

Keep in mind that this is an investment property and right now the mortgage interest is an expense for tax purposes. If the mortgage is paid off then "would be interest" becomes a taxable rental income.

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2 Answers 2

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I don't think it's all or none. First, 15 year mortgages are sub-3% right now, even for an investment property you'd get under 4%. shop around, do the math, a 1% drop is $1000 a year to start, nothing to sneeze at. Don't let the tax tail wag the decision dog. If you could invest the $100K at a taxable 5.5% in this economy, you would. In this case, that's your return on prepayments on this mortgage. Personally, I'd like to see a refinance and pay down of principal so the cash flow is at least positive. Beyond that, you need to decide how much cash you're comfortable having or not having in savings. I'd also consider when to start investing long term, in equities. (low cost ETFs is what I prefer).

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  • A refinance is not an option because of the location and type of the property. I already looked into that and I agree, it would be the most logical solution. That's why it's more a dilemma of all or none. That's exactly my thinking, why not invest myself and get 5.5% back.
    – Vitalik
    Nov 23, 2012 at 12:16
  • Understood. These decisions are about risk/reward. It's a compromise between the 5.5% and the lack of liquidity if you use the entire $100k. Don't know the rest of your situation, your investments, other goals, etc.
    – JTP - Apologise to Monica ♦
    Nov 23, 2012 at 15:19
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I would not recommend using your own money to pay off something that is not a strong asset. Use the savings where it will have the maximum return. Why not put (some of) the savings into another investment mortgage? Thanks to the leverage your return would be much higher than 5.5%, plus you would have more income.

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  • It's not easy to get a lot more than 5.5% return in real estate these days unless you plan to finance 80-90% which is a high risk. Any property that returns 7-8% on cash is sold in days.
    – Vitalik
    Jan 23, 2013 at 23:31
  • Why would you even consider such a high downpayment? The biggest advantage of real estate over the stock market is that you can buy real estate with the bank's money. Say you buy a rental property for $600K that yields $1600/month after all expenses (mortgage, tax, insurance, utilities, maintenance). That's a puny 3.2% a year. BUT, you didn't pay $600K for it; you only paid a 20% downpayment ($120K). In this case your cash-on-cash return is (1600 x 12) / 120000 = 16%. Plus, you're getting a few hundred $ in equity each month, not to mention appreciation.
    – alekop
    Jan 24, 2013 at 0:42
  • These are real numbers from a fourplex I own in Los Angeles. In a different market YMMV, but I am sure great deals can be found in every market. The key is leverage.
    – alekop
    Jan 24, 2013 at 0:45
  • I think this discussion is outside of the original question.
    – Vitalik
    Jan 24, 2013 at 15:33

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