Which mortgage should I pay off first? Rental or my own

[Shal Patel]

I own three homes with three different mortgages. Now I feel like I start paying off one property so I won't find myself in any future financial issues. What should I pay off first. Here is the details 1 my home - $200k left to pay 2 rental - $100k left 3 rental own by my dad. - $350k I need best advice from saving tax and interest perspective. Thanks in advance.

[Chris Mason]

Hi @Shal Patel,

I'm going to respond without reading the thread, so my answer isn't colored by the other responses. :)

Conventional 'debt payoff' wisdom falls into two categories.

- Pay off the highest rate first.

- Pay off the lowest balance first.

I can see the pros and cons of each.

Specific to real estate, however, I disagree with them both!

Pay off your primary residence first, all day every day, then open a HELOC for as much as you can get (not pitching HELOCs, I very rarely do them, and mostly refer them out to other lenders in the Bay Area that do them). Keep the balance at zero dollars, pay the $75/year maintenance fee (or whatever the nominal fee is).

Reasons:

- First and foremost, now that you owe $0 on your primary residence, you can paint the door red in accordance with the ancient Scottish tradition (and BP members everywhere will know you as a heretic for not being mortgaged up to your neck).

- You also have liquidity that is the envy of REI everywhere. Examples...

- Great deal comes up, you need $200k? Great, click your mouse button twice, dump it onto your checking account, and use it for a down payment. 

- Fellow real estate investor is in a bind, needs $50k in 7 days? Awesome, dump it into your checking account with two mouse clicks, and charge that fellow 10% interest (secure it by real estate... obviously) for saving the day. Borrowing at 4.5% and lending at 10% is a great example of arbitrage, and basically the same as when you put $50k into a bank CD at 2%, that the bank then turns around and lends to someone else as mortgage money at 4%. Grats, now you're a banker. 

- Ah, crap, one of your rentals has a major emergency that must be fixed now, your operating capital is tied up in escrow on some other deal, and it'll take 4-6 weeks for the insurance payout to arrive? Boom, you get the idea.

- Family emergency? Etc etc.

There are HELOCs on investment properties, but as many a REI HELOC seeker will attest, they are far far more conservative, lower LTVs, higher rates, etc.

There would hypothetically be savings in interest from paying off the higher interest rate rental properties first, granted, but I think for most people in the RE game that high level of liquidity will end up more advantageous. You putting that $200k (or whatever) to work on that great deal or two (and who knows what those deals will be, but you're ready for them!) over the course of five years should earn you more than paying that extra fraction of one percent in additional rental property interest rate difference over that same five years.