Paying off mortgage?

[Patrick E.]

I was wondering if anybody that buy and holds a house if they ever use the positive cash flow to pay off a house faster?? Is this a good startegy?

Lets say you pay it off faster then you get all the rent the tenants pay. Obviouslly you still have to pay insurance and maintenance still. But the money you would normaly use to pay off the loan would just go straight to your pocket.

[Jon Holdman]

OK, I just have to say that there are ZERO tax advantages to paying interest. Yes, you can deduct it. Yes, it reduces your tax bill. But, it reduces your tax bill by less than it costs you.

If you pay $100 in interest, and you're in the 28% tax bracket, that reduces your taxes by $28. So, you're out of pocket only $78 and not the full $100 you paid to the lender.

If you didn't pay $100 in interest, you'd be out, uhh, $0!

So, if the choice is to be out $72 or to be out nothing, I'll take nothing.

The advantage of leverage is just what is says. Most real estate, whether held for appreciation of for income, is not that great an investment. Look at the deals we talk about. You pay $25K for a property that generates $500/month in rent. That's would be a good deal based on Mike's 2% rule. You spend half of that in expenses, leaving $250 a month, $3000 a year in profit. You can shelter about $725 of that with the depreciation, so you'll only pay tax on $2275. Thats $637 at 28%. That leaves you $2363 after taxes. That's a pre-tax ROI of 12% and after taxes its 9.5%.

Maybe appreciation adds another 3% per year onto that. That's $750 per year.

If instead you use 20% down payments to get five such properties with that $25K investment, you would get annual before tax cash flow of $7,016 and $5,786 with the same tax assumptions. That's a more impressive 28% pre tax ROI and 23% post tax.

Details: $250 NOI less $133/month payment leaves you $116/month pre-tax cash flow. That's $1403/year. Depreciation is still $727/year, first year interest is $1394, leaving $879 in taxable income. Tax is $246, leaving $1,157 in after tax cash flow.

Note that the depreciation will be subject to depreciation recapture tax (currently 25%) when you sell.

Now, you also get all the appreciation even though you have only part of the money into each deal. You'll get $3,750 appreciation.

That's the power of leverage.

If prices fall, though, you get you hat handed to you. You take all the loss. That can easily each up all your "equity".

Costs cannot be neglected in a realistic analysis. You're going to pay $1000 for each house in buy closing costs, plus loan origination fees for the loans. You'll pay 8% each to sell them.