Q: We own two rental properties. One has a 6.87 percent 30-year fixed rate mortgage with a loan balance of $170,000 left. The property is currently worth about $220,000. We have a long-term renter who pays us $1,500/month to live in the house.
Our second investment property has a 5.75 percent 30-year fixed with $35,000 left to pay off. We have a long-term renter who pays $1,275/month. Our primary residence has a 15-year fixed rate mortgage at 5 percent with $240,000 left on the loan.
We’re contemplating paying off the $35,000 on the second rental. Our combined income is $200,000. We fully fund our 401(k) plans, plus put $1,000/month in our 15-month-old son’s 529 plan. Basically, we live off one paycheck and bank the other.
The reason we want to pay off the $35,000 on the second rental is to have some peace of mind. If one property goes vacant, we could still be able to meet the mortgage on the other without a disruption to our cash flow from our jobs. We’re not too comfortable putting more money into this market and don’t have the time to manage another rental property. What do you think?
A: I think it’s fine to pay off the second rental property. Once you pay off the property, you can always start saving the rental payments to build up your cash reserves.
Just remember that in this economic environment, cash is king. It’s extremely difficult to get financing at the moment for investment properties so if you decide to make another investment, you may not be able to find the financing without a significant cash down payment. On the other hand, if you have a $35,000 cash stash, you have a lot of options.
Even if you lose a tenant, you’ll still have this pot of cash to keep making the payments for some time to come. Or, you could opt to pay off the mortgage at that time. If I were you, I’d keep building up your cash pile.
One final issue: You currently pay at least a little bit of interest on the second property and that interest payment offsets some of the income you receive from the tenant. You should talk to your accountant or review what will change on your income tax form if you no longer pay the interest on that loan. It’s possible you will pay more in income tax if you pay off the loan against the second property.
Jan. 19, 2009.