Q: I have a loan on property in Oregon and the interest rate is 7.75 percent. It is on a manufactured home on 110 acres. I have looked into refinancing and nobody will give a better rate on the place. It is a second home that we rent out, so the lenders are telling me it is an investment property.
We have very good credit and enough money to pay off the loan, which is around $60,000. We are only getting 3.5 percent interest on the money in a certificate of deposit (CD). The value of property is about $250,000. Should we pay off this loan?
A: Great question. At this point in time, cash is king. So, if you have plenty of cash (or at least enough to pay off this mortgage plus an emergency reserve), then consider paying off the loan.
But if you’re earning income from the property, then having a loan helps offset the income you’re receiving. The tax advantage could be worth more than the 3 to 4 percent you’re “losing” by having the cash in a CD.
Let me explain. At this point in time, federal income taxes top out at 35 percent. Income generated from a rental property is paid at the highest marginal tax bracket. So if you can lower your income by offsetting it with expenses, you’re saving quite a bit on your tax bill. If you treat the property as an investment property and take depreciation on your tax return for the property, the tax depreciation also will lower the federal income taxes you pay on the rental income from the property.
I think you’ll have to take out a pencil and pad of paper and do the calculations to see whether having the loan would help your bottom line more than not having the loan, particularly when you take into account your other expenses associated with the ownership of this investment property.
If you do your own taxes, you can run any number of scenarios through your tax software. Otherwise, you may want to have a quick conversation with your tax preparer or accountant. rong>