Should I pay off Heloc if it's tax deductible?

[mcu]

Hi,

Last year I bought a rental property and I used 50k from my HELOC in order to give down as my down payment. Now I have been told the interest I pay (~$135/month) is tax deductible, but is it worth paying it off with cash I have or just keep it aside ofr a rainy day or to buy other properties. I know buying another property would be best, but I have been looking for past six months and no good deals yet.

Right now I make about $50 interest on the cash so this is why I was thinking of using it to offset the $135/month on the other. I need your opinions please

[Just a Guy]

Well, it would depend on your cash flow and tax situation.

I'd recommend that you do set up some principal pay down on the heloc, TD has an excellent option where you could lock in the heloc like a mortgage and do a principal + interest payment at mortgage rates, but your credit on the heloc grows as you pay down the loan. It's never good to just pay interest only.

If your cash flow is generating a lot of taxable income, it may be good to not pay it down...you can give it to the bank, or give it to the government...at least the bank is helping you make money.

Personally, it's good to have cash available to you as credit can always be withdrawn, if you get a tax benefit, why use your cash...keep it for other investments or emergencies...but do set up a slow repayment of the loan.

[Eclectic12]

+1 that it depends on cash flow and tax situation.

IMO, some other factors to consider include how stable the rental is or what happens if it takes a while to find another renter or if the HELOC rate rises.


Cheers

[crazyjackcsa]

How much do you like spending a dollar to get a quarter back?

[Eclectic12]

How much do you like spending a dollar to get a quarter back?

Maybe ... but then again maybe not, there is not enough information to tell. As mentioned up-thread it will depend on the individual's tax situation.

Someone with a high income plus the rental income may get a $0.40 refund (or reducing taxes owed) from that dollar in interest. Someone with only the rental income will be closer or maybe below the $0.25 mark.


Cheers

[doctrine]

Based on your interest payments, it sounds like you have about a 3.25% line of credit. If your marginal tax rate is 40% (if you make > $85-90k), your actual rate is closer to 2.3% after deduction. Thats inflation, so unless you have a better use for your money, I would keep the cash for an opportunity.

[andrewf]

Isn't this just a matter of spreads and liquidity premium?

You borrow at (say) 4% for the investment property mortgage, and hold deposits earning (say) 1%. That's a negative 3% spread. Normally this is a bad idea, except in the case where you put some value on liquidity. Ie, you don't have confidence that you could borrow the cash you current keep on deposit.

Tax rates, incidentally, are not that important, except that the after tax spread is pre-tax times (1-t) where t is your marginal tax rate.

[Eclectic12]

Isn't this just a matter of spreads and liquidity premium?

You borrow at (say) 4% for the investment property mortgage, and hold deposits earning (say) 1%. That's a negative 3% spread. Normally this is a bad idea, except in the case where you put some value on liquidity. Ie, you don't have confidence that you could borrow the cash you current keep on deposit.

Tax rates, incidentally, are not that important, except that the after tax spread is pre-tax times (1-t) where t is your marginal tax rate.

As the post said $135 per month on $50K, likely the HELOC borrowing rate is 3% or so, with a negative 2% spread. A HELOC borrowing rate is not locked-in like a mortgage so it may change.

Then too - if no money is borrowed, likely there is more income and associated taxes to pay.


So I'm not so sure it is only the spread and liquidity.


Cheers

[andrewf]

If you use deposits to repay investment loan, you see the following effects (based on my example):

income decreases by 1%*deposit (no interest earned on deposit)
income increases by 4%*deposit (no deduction of investment interest from income)

So, income increases by (4%-1%)*deposit, or 3% of the deposit (the spread).

Regardless of what income tax rate you pay, it is less than 100%, and you end up with 3%*deposit*(1-T) in your pocket, where T is the marginal tax rate. T<100%. So this difference is the income you are giving up to have the liquidity. Call it 'liquidity insurance', and the cost is the insurance premium.

$50,000*3%*(1-45%)=$825 after-tax cost of carrying that negative spread.

Just trying to clarify our thinking...

[Eclectic12]

If you use deposits to repay investment loan, you see the following effects (based on my example):

income decreases by 1%*deposit (no interest earned on deposit)
income increases by 4%*deposit (no deduction of investment interest from income)

So, income increases by (4%-1%)*deposit, or 3% of the deposit (the spread).

[ ... ]

$50,000*3%*(1-45%)=$825 after-tax cost of carrying that negative spread.

Just trying to clarify our thinking...

Hmmm ... so if the HELOC rate is 3% as previously posted (the OP can confirm for sure), does not the income increase by 3%*deposit?

The spread then becomes 2%, which means the after-tax cost is $550 at the moment, until something changes.


Otherwise, this is a good summary.


Cheers