Paying off a large debt like your rental property’s mortgage is unquestionably a great and liberating feat, but there are several circumstances where you might not want to do that.
Here are the other situations to consider that could make paying off a rental mortgage early a poor choice:
1) You lose your mortgage interest deduction. The mortgage interest is treated like a business expense for rental property. This deduction is most important in high tax brackets.
2) You lose a low borrowing cost. In the age of low mortgage rates, it makes sense to hold onto a low fixed mortgage rate for as long as possible. On the other hand, if you borrowed at a high rate either pay it down or shop around and refinance.
3) You tie up capital in an illiquid asset. Unless you have a very diversified net worth, having a lot of capital tied up in a property can be risky.
4) You decrease your financial returns. If you put 20% down, a 4% appreciation on the property means a 20% cash on cash return thanks to leverage e.g. $100,000 down payment on a $500,000 house that appreciates by $20,000 = $120,000 equity, a 20% increase. If you’ve paid off the other $400,000 in mortgage early, the return falls all the way down to 4%.
5) You miss out on opportunities to invest more efficiently. Instead of tying up all of your capital in one property, you can invest surgically in multiple properties through methods such as “real estate crowdsourcing” in locations where valuations are much cheaper
If you no longer need motivation to achieve financial freedom, pay off your mortgage. Not having the tax deduction isn’t the end of the world because you still have the ability to deduct “depreciation” on your taxes.
Your goal should be to become debt free when you absolutely have no desire or ability to work a day job or maintain a rental property. You’ll find that the older you get, the less you want to deal with tenants.
It feels great to not only to have no mortgage on a rental property, but it sometimes feels even better re-investing the proceeds of a sale in passive income investments that require no work.
Source: Financial Samurai