# Pay down investment property mortgage or invest?



## orange (Oct 23, 2011)

That's basically the question I have been asking myself lately. 

I have a place that I am currently renting out, making a small profit on each month after expenses. I have a mortgage on the rental property @4.99%, with 24 months left on the term. (Before anyone mentions is, it does not make sense to refinance for a better rate as my penalty for breaking the mortgage exceeds the "savings".)

Currently, I save some of the profit money each month for taxes and future maintenance, and add the couple hundred left to my general savings/spending budget. I am currently only paying the regular payments, no additional mortgage payments, as interest is tax deductible. Lately, however, I have been wondering if I should add the extra profit to paying down the mortgage on the rental property, as interest is wasted money, even if it IS tax deductible. 

I have no intention of using the rental income to reduce my mortgage on my principal residence, as it's rate is currently 2.25% and my fiance is not comfortable with me putting more towards the mortgage than he does. As a result, the money will either go back into the rental property or my own investments.

I don't really know the tax implications - how it works out as the less interest I pay, the more taxable income I have...and it's taxed at a higher rate...but paying interest just seems like a waste of money to me, and 4.99% is after-tax money...so it's an even larger guaranteed return.

What does everyone think? Pay down the rental mortgage or invest?


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## GreenAvenue (Dec 28, 2011)

I have always considered our rental properties as investments as well. We paid down the mortgages on those as soon as we could. It's relatively low risk and the house it self will increase in value. As soon as you paid down the mortgage all the rental money can than be invested in something else. 
My 2 cents...


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## Eclectic12 (Oct 20, 2010)

orange said:


> That's basically the question I have been asking myself lately.
> 
> I have a place that I am currently renting out, making a small profit on each month after expenses. I have a mortgage on the rental property @4.99%, with 24 months left on the term.
> 
> ...


IMO, the first question to answer is do you have a suitable emergency fund? Don't forget that if you get sick to the point disability, your income would drop or worse, if you lose your job - in these cases you'd need to be sure to be able to cover both mortgages. Or if the tenant leaves, how easy will be to find another one?


If you are comfortable with the emergency fund, the next question is why you see tax deductible interest as a "waste". The mortgage interest is an expense written off against the rental income, so you are not paying taxes on it. So it is not "after tax" money for you. 

I'd think you are better to invest. 

If you buy a stock that does not pay dividends and sell four years later, that's three years with no tax. Paying off the rental mortgage is going to increase your taxes for all future years. Even if the stock pays dividends, the dividends will be a small amount and taxed at better rate than income.


Cheers


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## Eclectic12 (Oct 20, 2010)

GreenAvenue said:


> I have always considered our rental properties as investments as well. We paid down the mortgages on those as soon as we could. It's relatively low risk and the house it self will increase in value.
> 
> As soon as you paid down the mortgage all the rental money can than be invested in something else.
> My 2 cents...


Hmmm ... if all of the rental money is being invested, what is used to pay the income taxes? While the mortgage is being paid, the interest can be written off against the rental income, reducing the income taxes.


In any case ... let's compare paying off the rental mortgage versus investing.
Say the amount to pay off the mortgage is $1,000.

Using the mortgage rate, the $1000 will generate interest of roughly $50. 

If invested in a dividend paying stock at 5% with a $10 commission, that is $990 of stock, which generates dividends of roughly $50. 

I don't know the income level so I'm assuming a high income of $100,000, without any deductions. The taxes on an extra $50 of income is $21.71 while on an extra $50 of dividends is $11.02


I'd prefer less taxes.


Note that there could be capital gains (CG) tax on the stock when it is sold, but there are no taxes until the sale. Then too, if the $50 was a CG, the added tax would be $10.85.


Cheers


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## Jungle (Feb 17, 2010)

I like the above anaylsis. I would agree with that only if you believe you can invest to:

1. Beat your mortgage rate and
2. Do it tax free to ensure your gains (TFSA OR RSP)

Beating your mortgage rate is not easy. Not sure what your skill and experence is in investing.


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## orange (Oct 23, 2011)

Hi All,

Thanks for your input.

@GreenAvenue – nice to hear from someone that has experience with investment properties. I was hoping I’d get some first hand experience. 

@Eclectic – as for the emergency fund, I don’t have a giant wad of cash stashed, no. But we are able to live off the equivalent of my fiance’s income, so as long as the property is rented we are fine. If I become disabled I have disability insurance that I am happy with. My job is about as stable as they get so I won’t lose it. If I lose my tenant it should not be difficult to find another. Should I somehow not become disabled but lose my job and am unable to find another AND I lose my tenant and I can’t find another (oh my!!), I have no doubt that I can sell the property without much trouble. I am fortunate.

You are absolutely right, my mistake, the interest is not paid with after tax money, it’s paid by my rental income before taxes…but I still see any interest paid as a waste . As for why I see tax deductible interest as wasted money… well, for example, I paid about $3000 in interest on that mortgage in 2011. If I deduct it from my income, it just means I don’t pay tax on $3000 of income. My marginal rate is less than 40% (I WISH I made $100,000 ), but for ease..let’s use 40%. That means I save $3000 x 40% = $1200 in tax. So $3000 paid - $1200 back in tax savings = $1800 I gave to the bank for no reason. That’s $1800 of wasted money, as far as I can tell. Like I said, I don’t really know a lot about the tax implications, so if my assumptions are incorrect or I’m totally missing something please tell me! I’d really like to learn.

@Jungle - what if I plan on maxing out my RRSP and TFSA and any additional investment money from this rental income must be invested in a non-registered account? Does that no longer make investing the better option? or is it just less advantageous than it could have been?


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## jamesbe (May 8, 2010)

From the sounds of this, you are saying it is a small amount of money and you have no money squirreled away?

I'd keep that profit in a savings account for when your tenant moves out, any unforeseen repairs etc (dishwasher, stove fridge etc could go kaput forcing you to buy one or repair). IMO you should have at least 3 months of money to cover vacancy at a minimum. This is an investment you don't want to be taking money out of the personal budget to cover the unforeseen.


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## Chris L (Nov 16, 2011)

Over 4 years we piled onto our rental debt and now are closing down both mortgages. A guaranteed return of 5% right now is fabulous. 

***Just remember, that anytime you want, you can reborrow the money to invest and then continue to claim the interest.***

It's like a error-proof way to look at things.

If you're smart, you'll pay off your house first then your rental and then live happily financially free (sort of) ever after.

Many people told me that I was stupid to pay down my "good debt." When I catch up with them, I find they're still fully leveraged and making only a few hundred dollars a month on their "positive cash flow properties." Well, how do you like earning a few thousand dollars for each property? That's why paying down your rentals is a great idea. It's just another way to achieve independence. Once you get on a fast track, you can calculate down to the minute to your independence.

I converted to a HELOC and put in all my available money religiously. I would have changed nothing. Now the extra money is to live off and invest in whatever I want.

If you can, aggressively try to convert to a HELOC (talk the banks ear off). Then you can reborrow at anytime if you need extra funds.


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## Jungle (Feb 17, 2010)

I think the only time it's bad to pay good debt first is when you have bad debt to pay off. In other words, non tax deductible debt should be paid first.


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## Chris L (Nov 16, 2011)

Jungle said:


> I think the only time it's bad to pay good debt first is when you have bad debt to pay off. In other words, non tax deductible debt should be paid first.


Agreed, and also pay the highest interest rate first.

You should really pay off your home debt first, then focus on your deductible debt. What's getting lost in the era of debt, is that all debt charges are bad (unless you're holding the debt asset).


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## marina628 (Dec 14, 2010)

I have my principle residence and five rentals,Currently we are focusing on maxing the prepayment on the rental with highest interest and also maxing our RRSP.In 2015 two of the five rentals will be paid off so we will have to spend some money then to offset revenue.When your expenses are lower than the rent you can do upgrades which will increase your property value and help with the taxes on revenue.
So for me paying off the debt and investing is equally important so split the excess budget .


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## Eclectic12 (Oct 20, 2010)

orange said:


> Hi All,
> 
> Thanks for your input.
> 
> ...



No reason? Usually I pay someone interest for using their money ... *grin*


My understanding of the tax implications is that today, for $1 of principle, $0.05 of interest is being charged, where the interest is paid with pre-tax income from the rental. To avoid paying this, the suggestion is to use the rental income. To make easier to compare, I'll use pre-tax terms for all amounts. This means paying $1.40 where the $0.05 will be taxable at 40%, going forward.

Another idea is to invest the $1.40 in a Canadian dividend paying stock that will would earn say $0.04 in dividends which is also taxable but at a lower rate. It may also have a capital gain tax when sold but is also likely at a better tax rate. The advantage here is lower taxes and a second income producing asset that has a better tax rate. 

Then too, if the dividends are then used to pay down the rental mortgage, then approximately $1.20 pre-tax instead of the $1.40 is applied to the mortgage.


A third option is to put the rental income into a TFSA and buy the same stock. In this case, both the dividends and CG are tax free. Plus the TFSA allows withdrawals so the dividends can be pulled out yearly (or whenever the mortgage privileges allow) to pay down the mortgage, without any taxes. The RRSP will tax any withdrawals so it is better suited when leaving the money there until retirement. The advantage here is that for every $1 withdrawn from the TFSA, every $1 pays down the mortgage and is available the following year for re-contribution to the TFSA.


Cheers


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## Chris L (Nov 16, 2011)

Eclectic12 said:


> No reason? Usually I pay someone interest for using their money ... *grin*
> 
> 
> My understanding of the tax implications is that today, for $1 of principle, $0.05 of interest is being charged, where the interest is paid with pre-tax income from the rental. To avoid paying this, the suggestion is to use the rental income. To make easier to compare, I'll use pre-tax terms for all amounts. This means paying $1.40 where the $0.05 will be taxable at 40%, going forward.
> ...



I wouldn't double check what you did, but to me who is a real estate investor, would say that this is far too complicated! But I'm just another opinion here. If you plan to use money derived from your investment property than focusing hard to pay the debt down is a great way toward passive income. Far too many people are going the 25-35 year distance on these loans when they can do it in 15 years or less even by tossing in their own money. To keep it simple, whatever interest you're paying down is your return. But that's just how I looked at it. Many RE investors who payed down 5-6 buildings laugh well into their golden years with huge month to month cashflows. Many RE investors aren't that skilled at other investments, etc. Just saying...


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## orange (Oct 23, 2011)

Really appreciate everyone's input! Good points all around...which...I guess doesn't help! hahaha, no I'm kidding...it has given me lots to think about, and I guess the conclusion for me is...it's a good choice either way - since I'm not blowing the money on random stuff  Whether I pay down debt or invest, it's smart...I like what marina says too - split it! 

@ jamesbe - I don't want you to worry...I DO have a cushion! lol It's a small amount of money each month, yes...about $200, but that's AFTER I squirrel away money for vacancy, unexpected repairs, long-term maintenance, etc. I count those as expenses (though I don't claim them, obviously) even though I haven't incurred them...just to be on the safe side.

@Chris L - you've mentioned something really important...yes, I'd like to one day use the cash flow from the rental to replace some of my earnings - cut down my hours at work and make up the difference with passive income from the rental and investments. This is the major reason I am drawn to paying down the mortgage, to increase that cash flow.

@Jungle - I think I am better at general personal finance than actual investing, but I think with some experience I can do a decent job. I've had good returns so far on my own, but that's short term and mostly due to the general upswing in the market. I would not assume that I could beat the market...so paying my mortgage is a guaranteed return. Also, I would not have TFSA/RRSP room for this money, it would be invested in a non-registered account.

@Eclectic12 - I'm not caffeinated today and in my shiftwork day/night flip...I can't do math  I'll trust whatever you say....and agree with Chris L - too complicated! 

@marina - I love the idea of prioritizing both the debt reduction AND investing. The monthly amount I am talking about is quite small ~ $200, so not much to split, however I will be maxing out both RRSP and TFSA anyway, so perhaps using this money to pay down the rental mortgage is the best idea, as it is, when taking the big picture into account, essentially splitting my extra cash between investments and debt reduction.

Once again, thanks everybody! This forum has been most helpful!


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## jamesbe (May 8, 2010)

Lol wow.

I pay the same % and make $200 a month as well. Nearly identical situation.

Is your tenant constantly late on rent? Mine is ugh


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## orange (Oct 23, 2011)

hahaha no...I'm really lucky, I have what seems to be the perfect tenant. She gives me post-dated cheques that always clear (she makes way more money than I do, has great credit, secure job), never calls for things but lets me know as soon as there are any issues and what steps she's taken to try to resolve them first (or sometimes how she hasn't tried anything because she doesn't want to break anything!), the place looks amazing everytime I'm there for routine maintenance/inspection...yeah, I don't want her to ever leave! Sadly she will when her own condo is ready for occupancy 

I hope your tenant learns how to read a calendar soon! Hopefully they at least pay you in full when they get around to it, and that's your only issue with them.


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## jamesbe (May 8, 2010)

Nice! Yeah I always get paid, just 2 weeks late....


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## Eclectic12 (Oct 20, 2010)

orange said:


> Really appreciate everyone's input! Good points all around...which...I guess doesn't help! hahaha, no I'm kidding...it has given me lots to think about, and I guess the conclusion for me is...it's a good choice either way - since I'm not blowing the money on random stuff  Whether I pay down debt or invest, it's smart...I like what marina says too - split it!
> 
> [ ... ]
> 
> ...


If you have any doubts, use your favorite tax software or download a tax spreadsheet like the one at this url to run through the scenarios.
http://www.peeltech.ca/mytax.shtml


As for the "it's complicated" part, it sounds like you and Chris L. are getting lost in the tax implications explanation.

To be clear, the process is:

1) Take the "excess" rental income and buy a investment that pays income in a tax advantaged rate compared to the 40%. 
2) Use the investment income to pay rental mortgage principle.
3) Repeat at your convenience (ex. yearly, semi-annually, monthly, whatever).

Ideally, this would be done using a TFSA account as that would make the investment plus it's income tax free and adds only two additions steps. Namely - adding the money or stock to the TFSA and withdrawing the tax free income.


Based on yesterday's, if one bought TransAlta at the high of $20.62, the $1.16 dividends a year represents a 5.6% return that will be taxed at a much better rate than 40%.


Cheers


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## Eclectic12 (Oct 20, 2010)

Chris L said:


> I wouldn't double check what you did, but to me who is a real estate investor, would say that this is far too complicated! But I'm just another opinion here.
> 
> If you plan to use money derived from your investment property than focusing hard to pay the debt down is a great way toward passive income. Far too many people are going the 25-35 year distance on these loans when they can do it in 15 years or less even by tossing in their own money. To keep it simple, whatever interest you're paying down is your return. But that's just how I looked at it.
> 
> ...


And I'm of the opposite opinion - finding properties/tenants, dealing with maintenance/taxes and all that other stuff that comes with being a landlord is too complicated for me, with the full time job I have. *grin*

To each their own.


As for paying down the mortgage, I'd hope there isn't a 35 year mortgage on the rental property but I don't know.

As I say, the only issue I have with paying down the mortgage is that the proposal is to use heavily taxed income when there can be other income sources that are either taxed at a cheaper rate or tax free.


As for RE investors not being skilled at investing, I'm hoping this means that such people have a financial adviser. If they stick to RE because they "know" - they have all of their eggs in one basket.


Cheers


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## orange (Oct 23, 2011)

Thanks for the explanation, Eclectic12. I did get a little caught up in the tax implications...I was just thinking that if you take the rental profits and invest, you are investing after-tax income to generate income that will be taxed again (albeit at a more favourable rate), to then pay down the mortgage. This obviously leads to a mush smaller amount being applied to the mortgage, which led me to the "too complicated, not worth it" conclusion!  And I can't invest it in a TFSA or RRSP...no room. 

I wouldn't call myself a real estate investor at all...I fell into it as the rental property was my home originally, but then I bought a place jointly with my fiance...and chose to keep the original property to rent out. It was a 25 year mortgage - now has about 14 years left on it as I tried to pay down as much of the mortgage as I could when I was living there. 

Perhaps I need an advisor, but I'm _trying_ to be a DIY investor and am satisfied so far...I'll let you know how it turns out


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## Eclectic12 (Oct 20, 2010)

orange said:


> Thanks for the explanation, Eclectic12.
> 
> I did get a little caught up in the tax implications...I was just thinking that if you take the rental profits and invest, you are investing after-tax income to generate income that will be taxed again (albeit at a more favourable rate), to then pay down the mortgage. This obviously leads to a mush smaller amount being applied to the mortgage, which led me to the "too complicated, not worth it" conclusion!  And I can't invest it in a TFSA or RRSP...no room.
> 
> ...


*grin* - I think you mean *much* smaller amount ... the consistency of the money won't change ... ;-)

As for the "not worth it" - bear in mind that for the investments, there is the potential of a capital gain and the potential that the dividends can increase. Even an increase does not happen, each round of rental money being invested is going to increase the dividend income available to pay down the mortgage. 

This is at the same time that likely the mortgage principle is going down anyway, using pre-tax dollars. So a delay in paying down the rental mortgage does not have a huge impact.

Then too - paying the rental mortgage puts the income back into the same asset class. Investing the rental income allows the option to diversify the assets.

It's up to you to decide what makes the most sense, though some sort of split like the 50/50 mentioned earlier would let you see how each option works.


As for investing skills (RE or otherwise), my point is that there are many different ways to have access to the skills required - so don't let fear stop what could be a good move.


Cheers


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## mikep (Mar 13, 2017)

i see this is a very old post but i'm new to the forum.. 
I have a primary residence and a few rentals. 
I am refinancing one rental to clear the mortgage on my primary residence next year. 

I like the idea of refinancing and taking that money and investing into dividend paying stocks.. make money here and also have higher mortgage interest to deduct from rental income.. sounds like the right thing to do.. 

but what if the stock market crashes and now you lose half of that money.. no one seemed to mention that..
and now interest rates are higher and you are paying down your mortgages at a higher rate next renewal.. 

so maybe just paying down the rental properties might not be a bad idea and using your cash flow to invest once they are paid.

just sayin' lol


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