Pay off mortgage or purchase other assets?

Question

Hi there, I'm new to BiggerPockets but want to start leaning further into Real Estate to build assets. Currently I own 2 properties, a condo and home.

Regarding the condo, I've been debating whether or not I should pay off the mortgage entirely or use those liquid funds to invest into other assets (stocks, Index funds, IRAs, etc). If I pay off the mortgage, I would gain about 20% of it back annually from rent. There are so many different scenarios and investment strategies that run through my head so I thought I'd get opinions from others. Thanks!

Thomas S. · Answer

Paying off a mortgage will not generate any greater return than the interest rate on the mortgage. It does not increase cash flow on a property. If you can invest anywhere else for greater than the mortgage interest rate that would be an investment. Paying down a mortgage is not investing.

Based on the standard opportunity value of cash paying down a mortgage costs $2 for every $1 it saves. Definatly not a wise investment.

Michaela G. · Answer

Depends on what your end game is. Leverage allows you more properties.

For example: Let's say you have 100K in cash and you could buy:

a) (1) 100K house with cash - no mortgage - monthly rent of $ 1000

b) (3) 100K houses with 70K mortgages - monthly rental income $ 3000 - after mortgage payment net = $ 1000

Sounds like it's a wash, but you'd have more work with 3 houses.  But, let's say after 15 years you'll have your mortgage paid down to 50K each and appreciation of 100%

a) (1) house worth 200K - no mortgage - monthly rent of $ 2000 - 200K equity

b) (3) houses worth 200K each , mortgages paid to 45K each - rents after mortgage payment $ 4000 net, equity 465K

Yes, those are very simple numbers, just to make the concept easy to understand. Hope it gets the point across

Aaron K. · Answer

If you are that close to paying it off it probably doesn't make sense to refinance to get more cash flow unless you also take money out (which I personally dislike).  Paying it off early is going to be a fairly reliable return on your money and would most likely significantly increase your monthly cash flow.  Stocks, ETFs etc. are good assets but perform better over the long term and of course are not guaranteed.

Mark McCain · Answer

I think what @Thomas S means is that if you invest at greater than the mortgage rate you are deriving a net positive return. So the mortgage rate is 4%, you invest at 5% you are netting 1%.

Unfortunately, it’s not quite that simple. A pay down on mortgage is a tax free return of say 4% while a 5% return on stocks or another real-estate investment is generally taxable.

On the other hand, you are able to expense the interest on a mortgage which will help offset your taxable income so it is not a 4% expense every year like @joshua Smith suggests but actually a bit less.

There are also the intangibles of not paying down your mortgage. You get to have more liquid equity, which puts you in a better position if a good investment opportunity comes along or a large unforeseen expense.

You should pay down a mortgage only if you retain some equity to cover  unforeseen expense and you don’t have any other investment opportunities  that have a return greater than your mortgage rate + your effective tax  rate, adjusted for projected risk. This is still simplified but should get  you pretty close.

Jeffrey Boyce · Answer

Hi @Thomas S., what do you mean by "invest for greater than the mortgage interest rate?

Jeffrey Boyce · Answer

Thanks so much for your input everyone. A lot of varying strategies - I'll take these insights and make a decision based on my circumstances and how I plan to move forward. Appreciate it!

Joshua S. · Answer

See, I disagree with this thinking. People say that a 4% mortgage is cheap money, but the true percentage on a 4% / 30 year is usually 67% over that time, ie. on a $200,000 loan you pay about $150,000 in interest. You almost pay for two houses. So, when you prepay principal, say $1000/month / $12,000/year you save around $100,000 in interest and take 19-20 years off of your mortgage.

What other investment can you make where you pay $120,000 (that you were going to pay anyway) over ten years and have a return of $100,000 / 83%? Then in year 11 you take your whole mortgage payment and do whatever you want with it. I can never understand when people say prepaying principal is not a good investment. :)

Bjorn Ahlblad · Answer

Unless you have another RE deal where you can use the cash do what Aaron suggests above.

Pay off mortgage or purchase other assets?

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