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



## mcu (Dec 6, 2009)

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


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## Just a Guy (Mar 27, 2012)

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Personally, it's good to have cash available to you as credit can always be withdrawn, if you get a tax benefit, why use your cash...keep it for other investments or emergencies...but do set up a slow repayment of the loan.


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## Eclectic12 (Oct 20, 2010)

+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


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## crazyjackcsa (Aug 8, 2010)

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


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## Eclectic12 (Oct 20, 2010)

crazyjackcsa said:


> 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


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## doctrine (Sep 30, 2011)

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.


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## andrewf (Mar 1, 2010)

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.


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## Eclectic12 (Oct 20, 2010)

andrewf said:


> 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


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## andrewf (Mar 1, 2010)

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...


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## Eclectic12 (Oct 20, 2010)

andrewf said:


> 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)
> ...


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


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## Cal (Jun 17, 2009)

I am surprised the OP has not mentioned how cash flow positive the property is to offset the payments. As if it isn't generating at least 5-10% I would have to wonder why they bought a property in the first place. As opposed to simply buying dividend paying equities or preferred shares that get tax preferential treatement.

Having said that, I agree with andrew, why earn 1% and pay 3%. Personally, assuming it is cash flow positive. I would probably continue to pay the 3%, and take the tax deduction, but invest the other money to make more than the 1%. Much more.


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## colossk (May 11, 2011)

Cal said:


> I am surprised the OP has not mentioned how cash flow positive the property is to offset the payments. As if it isn't generating at least 5-10% I would have to wonder why they bought a property in the first place. As opposed to simply buying dividend paying equities or preferred shares that get tax preferential treatement.
> 
> Having said that, I agree with andrew, why earn 1% and pay 3%. Personally, assuming it is cash flow positive. I would probably continue to pay the 3%, and take the tax deduction, but invest the other money to make more than the 1%. Much more.


It doesn't have to generate 5-10% when he's building up equity in the 8-10% range each year plus whatever points he is doing in positive cash flow to be better than dividend paying equities


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## mcu (Dec 6, 2009)

Thanks for the reply guys. The Heloc is at prime, so yes 3%. The building is cashflow positive (have to calculate what % that comes out to, but at least 10%). I don't want to invest in the market. Not enough experience....I have tried myself and with an advisor and both times came out with losses, so I will stick to real estate for now. I am looking to buy other property, but the problem is that the market has gone haywire and will not pay for an amount for a property that I don't think is worth that.


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## Chris L (Nov 16, 2011)

Wow, this got complicated for no reason!

Pay down the HELOC, then reborrow it. Borrowed money is still tax deductible if used for investing. If you plan to buy a toy then keep the cash.


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## LondonHomes (Dec 29, 2010)

This is the sort of thinking that got the American real estate market in serious trouble since nobody was paying off their mortgage because it was tax deductible.

This HELOC should probably be the last thing that you pay off, but you should pay it off when you can. If you want to buy another property you can just pull the equity back out when you need it.


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## Cal (Jun 17, 2009)

colossk said:


> It doesn't have to generate 5-10% when he's building up equity in the 8-10% range each year plus whatever points he is doing in positive cash flow to be better than dividend paying equities


Umm...the dividend paying equities should increase in share value also. But as mentioned they have preferential tax treatment over RE income.

But back to the OP....if all you know if RE...then by all means stick with what you know. It sounds like you are a disciplined investor in that you set your price target for a property, and if you don't get it for that, you don't make an unwise decision.


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