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Leverage is a key tool for every real estate investor. Yet are there times when a landlord should pay off the mortgage early? Here are the pros and cons.

One of the critical strategies involved in purchasing and owning rental properties is using leverage. In a perfect scenario, you will purchase a property primarily using borrowed money. Then, the rent income from the property will not only pay the mortgage, but it will also provide you with a small profit. Over many years, that profit will grow, and your mortgage will shrink. Eventually you will have a property that’s a virtual cash machine.

But there may be times between now and then when you will consider whether or not you should ever pay off the mortgage on your rental property early. It’s not an easy decision, and here are some of the considerations.

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Why You SHOULD Pay Off Your Rental Property’s Mortgage Early

There are times when paying off the mortgage on your rental property early will make abundant sense. Some of those situations include:

When you have a negative cash flow on the property

If the monthly mortgage payment is making you lose money on the property, you are effectively subsidizing your tenant’s residency. But if you can turn that into a positive cash flow by paying off the mortgage, the property will instantaneously become a successful investment, and more so as the future cash flow builds.

When you need an income more than a tax write-off

Many times, the reason for owning rental property is to generate tax write-offs. Those write-offs reduce your tax liability on other sources of income.

One of the reasons why rental property can be so effective in generating tax write-offs is that the taxable loss of the property is usually related to depreciation. That means that you have a “paper loss” on the property, rather than an actual loss.

For example, let’s say that you break even on the property, based on actual rent income and cash expenses. But because of depreciation, it generates a tax loss of $5,000 for the year. Even though it isn’t a real loss in terms of dollars, it can be used to reduce your tax liability on other income sources.

But if you need an actual income property, it may be better if you pay off the mortgage. For example, let’s say that you have a $100,000 mortgage on the rental property. By paying it off, you’ll have an actual cash income of $800 per month. That would be an excellent reason to pay off the mortgage on the rental property.

Related: Investing in commercial real estate with RealtyMogul is an exciting way to multiply your investment in ways that aren’t often possible with small-scale real estate.

When you want to retire

As a general rule, debts of all types should be paid off once you reach retirement. Just as is the case in the example above, by paying off the mortgage on the rental property, you will maximize the monthly income that it produces. In addition, if you decide to sell off the property at some point after you retire, you will receive more cash on the sale of the property if it has no mortgage on it.

When the return on the paid mortgage is higher than what else you can invest in

This is where you have to crunch some numbers. Let’s say that the mortgage on the rental property has an interest rate of 6%. You have also been averaging an annual rate of return of 4% on your investment portfolio over the past several years.

Since the interest rate on the mortgage is higher than the rate of return on your portfolio, you’ll come out ahead by paying off the mortgage. You may be exchanging money invested in your portfolio at 4% per year to pay off a 6% mortgage. That will represent a return on your money that is 2% higher than what you are currently getting.

Related Question: Should You Invest or Pay Off Debt?

That strategy might actually make sense in today’s super low interest rate environment. In truth, it’s much more valid to compare the rate of return on fixed rate investments with the interest rate you are paying on a mortgage. That’s because both rates are certain.

Returns on a stock portfolio may not be entirely valid because they fluctuate over time. There are years in which stocks will easily outperform the rate you’re paying on the mortgage. There are others when they will seriously underperform it.

In that regard, paying off the mortgage on your rental property may be an even better long-term bet. This is especially true if you believe that the stock market is heading down, or is entering what could prove to be a long-term bear market trend. Paying off a 6% mortgage on a rental property could prove to be a windfall when compared to a market in which you may lose 25% or more of your stock portfolio over the next three or four years.

Related: 8 Ways to Pay Off Your Mortgage Early

Why You Should NOT Pay Off The Mortgage Early

Just as there are times when paying off the mortgage on your rental property early makes perfect sense, there are also times and circumstances where you probably won’t want to do it.

Examples include:

When you need leverage to buy more rental properties

The most basic problem with paying off the mortgage on a rental property early is that it requires capital to do it. In fact, it usually requires a lot of it. Once you pay off the mortgage, you lose access to that cash. It represents capital that can be used to purchase other rental properties.

If you have one rental property that’s providing a comfortable return on the investment, you may want to purchase other rental properties in the future. Paying off your current rental property early will certainly improve the cash flow on that particular investment. However, it may deny you the ability to purchase similar investments in the future.

When you need a tax write-off

If you do need a tax write-off to reduce taxable income sources, you may not want to pay off the mortgage early. Of course, this usually only makes sense when the loss on the rental property is the type of paper loss that we discussed earlier. That’s the kind where you’re at least breaking even on the property on a cash basis, but depreciation expense is creating a taxable loss.

If that tax loss is important to your income tax situation, you’ll almost certainly want to keep the mortgage outstanding.

You have a positive cash flow, even with the mortgage

If you have an actual positive cash flow on the property even with the mortgage – meaning that the rental income more than covers the mortgage payment, property taxes, insurance, maintenance and other expenses – you probably won’t want to pay off the mortgage.

Learn More: The 1% Rule: How to Determine If a Home Is a Good Real Estate Investment

The basic idea is that the rental income is both providing you with a monthly profit, while at the same time gradually paying down the mortgage until it is paid in full, when your cash flow will really take off. That’s a successful real estate investment. It’s also one that’s probably best left undisturbed by major strategies… like paying off the mortgage early.

You can earn a higher return on your capital than you’re paying in interest on the mortgage

Let’s say you’re earning 7% on your investment portfolio, and the property’s mortgage has a rate of 6%. By paying off the mortgage early – presumably by liquidating part of your investment portfolio – you will actually lose money on the exchange. That’s because the rate of return on your investment portfolio is higher than the interest rate on the rental property mortgage.

Just be careful that you’re comparing “apples-to-apples” when doing this. Meaning, be sure that the rate of return you will receive on your investment portfolio represents at least relatively stable income. That means primarily your interest or dividend income. Since higher-yielding investments, including interest and dividend yielding securities, tend to be riskier at higher returns, you also have to factor your current level of portfolio risk into the mix.

Related: How to Rebalance Your Portfolio

If you’re considering whether to pay off the mortgage on your rental property early, you’ve got some thinking to do. It will all depend upon your personal circumstances. You should take into account the rate you’re paying on the mortgage. And of course, ask the opportunity cost question of,”What else could I be doing with the money?” other than paying off the mortgage.

Author Bio

Total Articles: 131
Since 2009, Kevin Mercadante has been sharing his journey from a washed-up mortgage loan officer emerging from the Financial Meltdown as a contract/self-employed “slash worker” – accountant/blogger/freelance blog writer – on OutofYourRut.com. He offers career strategies, from dealing with under-employment to transitioning into self-employment, and provides “Alt-retirement strategies” for the vast majority who won’t retire to the beach as millionaires.

Article comments

Jeri Frank says:

Awesome article! This is a conversation we often engage in at our house. In the end, we have always chose not to pay-off because of the very reasons you mentioned. But, we the reasons you listed are entirely valid and reasons we have not yet encountered.

Beth says:

Doesn’t factor in the risk beta. Pay cash or pay them off as soon as possible.

funtymer says:

also worth it to consider that more mortgage interest is paid off with additional principal payments early in the life of the loan. so timing is a factor in deciding whether to pay it off or not

Lindel Turner says:

Also if your a small time operator I say 80 units or less, it’s easier to maintain 40 paid off than 80 with mortgages. It’s half te work load. I’ve been doing this since 1992. I struggle with this Eerytime I sell something

Phinney 1 says:

I think most people don’t take into consideration that the interest you pay on a mortgage adds to the cost of the property. Just like a car loan without the tax advantages. I say pay off everything as quickly as possible

Eric says:

Not paying off mortgage doesn’t mean your money sits in cash. If your interest rate is 4% and you can earn 7% on another investment, then those returns will cover the interest, in addition to providing you excess returns of 3% vs. paying off your mortgage.

E.g. If I pay an extra 10000$ per year on the mortgage, I save 400$ interest a year. If I put that 10000$ in another investment that returns 7%, then I gain 700$ a year. 400$ goes to what I would’ve saved by paying off mortgage and 300$ is additional profit. Additionally, there’s a tax write off on interest payments.

You have to do the math, and not just go with blanket statements such as “always pay down the debt”.

Oola says:

But how can you know that you will make 7% in a year on anything?

Brian says:

7% is very doable in fact i would say 10% is easy if someone puts a little bit of effort into it. I personally have been averaging 14% every year but i look at and move investments around all the time but the average person can get 7% easy with a set it and forget it retirement fund and about 10% with an index fund.

Dave says:

You are even further ahead if you take the cash from one house and buy another and leave it in, vs leaving the cash in the first house. Real estate is a leverage game which is the beauty of the asset! Investing based in emotions is the wrong reason anyway. Because it feels better doesnt make it the right decision. You can train yourself to feel any way you want.

I fight the urge to pay my primary mortgage off, but it is a 15yr fixed at 3% and 10 yrs left. Dumb financial decision but it would sure feel good. It is the last personal debt we have.

aaron says:

also worth considering, with amortization, the tax rate you are paying over the first half of the mortgage is higher. By the time you pull the funds together to pay off the mortgage you have paid the lion’s share of interest already. The earlier you can pay your mortgage off the better. If you reach the halfway point…you might as well just finish it off.

Sonny says:

Just my two cents–but I think there is also a psychological factor that should be considered as well. Owing money (and in this case substantial amounts of money) takes it’s toll over time, whether it’s paid off or not. Personally, it drives me nuts knowing that I’m indebted to a person, business or financial institute regardless of whether it’s the right move to pay it off or not. That’s sort of a bottom line for me and I’m just a happier person knowing I don’t owe anyone anything. Having that burden on your mind for 30+ years can be detrimental to your mental health if it bothers you a lot.

Acer says:

Good call!

Wendell Marasigan says:

I have 10 properties. What if I paid off half of them or at least 4? We manage ourselves and buying more would mean more to manage. Paying half off would mean I can semi retire with the rental income and spend more time with family. Thoughts? Thanks in advance!

Kenneth F LaVoie says:

this is exactly our ploy. We sold a couple of buildings, reduced our 51 units to 34, retired 2 extra mortgages. This increased our cash flow relatively speaking, for the remaining term of the mortgages (11 years), which is when we need the extra income the most. We ended up with the same income, even slightly more stable, and fewer units to manage.

chris says:

Get a property manager and pay the 10 percent, you are not in the tenant business, you are in the investment business. Yes, pay off enough of them to allow you to be semi retired, also make sure you have enough cash on hand for a good life and emergencies. Time is more valuable then money…..Family and health is more important than anything…..

Bill Acevedo says:

The liability aspects should also be considered. Equity in a property could be a target for theft through a tenant lawsuit or an aggressive lawyer. By having low or no equity there is little to be gained if you were to be sued. A mortgage may actually prevent a suit form being filed in the first place.

J L says:

How does a renter find that out? Is it public information?

Eric says:

Learned that one in rich dad poor dad real estate tax loopholes. One of my favorite lessons

John Lawrence says:

This is an older article, so my comment probably won’t be seen. I think you completely missed a big area of discussion for whether to pay off an investment property early or not, and that is the tax write-off for the interest paid on the loan. You mentioned depreciation, but that will continue to be a write-off whether you have a loan or not, so that wasn’t really a major factor in whether it’s valuable to keep the loan or clear it. I’d be interested to hear your thoughts on how that could add to both the pro and con of the argument. Thanks!

Richard Andrade says:

Exactly. The article states “For example, let’s say that you break even on the property, based on actual rent income and cash expenses. But because of depreciation, it generates a tax loss of $5,000 for the year. Even though it isn’t a real loss in terms of dollars, it can be used to reduce your tax liability on other income sources.” but this ignores the fact that depreciation continues even if you pay off your mortgage, so you’ll continue to get that benefit, regardless.

Pat says:

Shouldn’t rent money that goes toward the principal, count as part of the investment also? If rent is $1,000, and covers everything, and $250.00 of it goes to the principle, than that’s a big return % to consider, isn’t it?

No Nonsense Landlord says:

I I have paid off most of my mortgages, on 10 properties. Only 2 small mortgages left.

Cash flow is nice to have.

Ron says:

Good informative article. With the escalating trade war with China I’m looking for less market exposure. I have one rental unit that used to be my primary residence. Did a 15 year finance in 2009. Great tenants for two years now but I am negative cash-flowing to the tune of $115 a month. If I cash out my taxable account and use most of my emergency funds I can pay off the mortgage and turn it cash flow positive to the tune of $600\month after expenses. I’m nervous about using emergency funds but excited to turn the rental in a nice little cashflow positive investment plus I would think with the lower debt\income ratio is should help set me up for getting a mortgage on rental # 2.

Russ says:

‘With the escalating trade war with China I’m looking for less market exposure.’ With respect, that make ZERO sense. How have you rationalized that a well-diversified market portfolio of the greatest companies on earth (and have ever existed) puts you more at risk than eliminating your emergency funds.

Elvis Diaz says:

Im a newbie, i have 1 unit where i owe 150k with 8years left on mortgage. Im thinking about refinancing to a 30 year because i currently am negative cash flow. Mortgage is 2250 on a 3.3 15 year. My renters pay 2000 and i take 1850 after management fees. So im negative $400 month when I can be positive 600 by switching to a 30.

I struggle with it because i can pay off the house in 8 years but would loose 400 month each month for those 8.