Tax Downsides to Paying Off a Mortgage

[Account Closed]

Hello everyone! My name is Jesse and I am a new investor. I am about to close on my first property on march 22nd (tuesday!). It is a $250000 2 bedroom condo in the NY metro area. I will be renting this apartment out after I purchase it. However, I am trying to weigh the pros and cons of aggressively paying off my mortgage.

I graduated school with 100,000 dollars worth of student loan debt in 2013. I started to pay the minimum at first. I asked around about the benefits and found out that I would get the interest back on my tax returns. So I sat around and thought about it. BAsically, I pay the interest to the government for my loan, and then they give it back to me. Sounded like a very silly game to me. So I decided to aggressively pay back my student loans. I finished paying it in 10 months.

Now I know when you buy a property, you get other tax benefits besides just the interest on your tax returns. My question is, is it a better approach to aggressively pay it off like i did with my student loans, or are there other tax benefits to slowly paying off the mortgage?

[Kevin Yoo]

Hmmmm. It seems as though either there is a failure to understand debt and leverage by the BP Community or some members of the Community simply are so debt aversive that they do not care about the different types of debt and the power of leverage. I am OK with the latter but I would be disturbed if the commenters to the original question simply failed to understand the former. This would mean that many in BP fail to understand the simple concepts of debt in real estate investing.

@Account Closed. THE ANSWER TO YOUR QUESTIONS IF THERE ARE OTHER TAX BENEFITS TO SLOWLY PAYING OFF THE MORTGAGE IS NO. However, I hope you read the rest of this and find it helpful. There is a big difference between your student loan debt and the debt on your investment property as mortgage. Kiyosaki called them bad debt and good debt. The student loan debt does not generate for you any wealth (except for tax deductions on interest paid out). This is bad debt akin to owning a yacht, big screen television, or carrying a balance on credit card.

The mortgage on your rental is good debt because it generates wealth for you. I hope I am insulting your intelligence when I say this because the reasons how it does this are really obvious.

1. Interest deductions: I know many have discounted this and yes, it is only a fraction of what you pay, but if you have 500 rental properties and are in the highest tax bracket possible, this will be very very valuable. If you plan to only own a few rentals, then I understand why you would want to own them free and clear and that is totally OK.
2. Depreciation: I know this has to be recaptured at time of sale and you have to pay taxes on that, but again if you own many many rentals, this is a tremendous deduction. Again, if you want to own a few rentals forever without ever selling, then paying off your mortgage quickly is a fine strategy.
3. Higher Return (IRR): If you have $100,000 into your rental because you paid off the mortgage as opposed to only $30,000 because you put a mortgage on the property, then the net income you get as a return of the cash you invested is higher with the second scenario even after taking into account the mortgage payments. If you have all paid all cash for a property, the returns are very typically in single digits. If you leverage with a mortgage, then the returns are typically in double digits many times in 20 or even 30%ile.
4. Leverage: If you spend all $100,000 to own a property, you have all that money tied down into that one property. If you have only $30,000 sunk into that one property, you can go and own  two more properties like this one with 30% down. Your returns on your money is again much much higher.

There is, no doubt, tremendous benefits to owning properties free and clear. I wish I had all my properties that way. There is no doubt there is great danger in having mortgages. I have learned that lesson the hard way. But I plan to own thousands of income generating properties. I cannot get there without using debt, at least not in my lifetime. Therefore, I spend a lot of time understanding debt and mastering the use of it, so that I accomplish my real estate investment goals.

The philosophical way to answer your question is for you to answer how big of a portfolio do you want. If you want to stop at a few properties, paying them off is safe and just fine. But if you want to own a large portfolio, be as aggressive at learning how to create good debt and use it as you were so aggressive in paying down your student loan. Just acquiring debt without understanding it, is in my opinion, as stupid as paying down your mortgage as fast as you can without really understanding how that is affecting all of your other finances. Lastly, don't ever worry about how much interest you are paying to the bank because it is definitely a lot and thinking about it will only drive you crazy. Just realize that this is part of doing business and instead realize that you are not paying the interest. Your tenants are.