The Early Payoff: Is It Wise To Settle Investment Property Loans Ahead Of Time?

Paying off an investment property mortgage early is a complicated question and the answer depends on a number of factors. For example, if you have a negative cash flow on the property, paying off the mortgage can turn the situation around. However, if you have a positive cash flow on the property, it may make more sense to let the tenants continue to pay down the mortgage for you.

There are both advantages and disadvantages to paying off an investment property mortgage early. One advantage is that you will save money on interest payments. On the other hand, a disadvantage is that you will lose out on mortgage interest deductions, which can be important for investors in high tax brackets. Ultimately, the decision of whether or not to pay off an investment property mortgage early depends on the individual's financial situation and goals.

Peace of mind: Being debt-free can ease your burden and reduce stress

Being debt-free can significantly impact your mental well-being and overall quality of life. Debt often brings stress and anxiety, especially when it accumulates and becomes difficult to manage. Here are some ways in which eliminating debt can bring peace of mind:

• Reduced Stress and Improved Mental Health: Debt can be a significant source of stress and anxiety. The constant worry about making payments, managing high-interest rates, and dealing with creditors can take a toll on your mental health. Eliminating debt removes this burden and provides a sense of relief and improved psychological well-being.
• Sense of Accomplishment: Paying off your investment property early gives you a sense of accomplishment and pride. It demonstrates your financial discipline and commitment to achieving your goals. This sense of achievement can boost your confidence and motivate you to make more financially responsible decisions.
• Financial Freedom: Clearing your debt gives you greater financial freedom. You no longer have to worry about making regular payments, allowing you to redirect your income towards other financial goals or personal aspirations. This freedom can reduce the pressure of financial constraints and provide a sense of control over your economic life.
• Improved Cash Flow: Paying off your investment property early improves your cash flow by reducing monthly mortgage payments. This extra money in your budget can be used for other purposes, such as building an emergency fund, investing in other opportunities, or simply enjoying a higher disposable income.
• Enhanced Stability: Being debt-free improves your financial stability. You no longer have to worry about the risk of defaulting on payments or the potential loss of your property due to unforeseen financial difficulties. This stability can provide a sense of security and reduce the fear of financial uncertainty.
• Opportunity for Diversification: Clearing your debt gives you the opportunity to diversify your investment portfolio. Instead of being tied down to a single property, you can explore other investment avenues, such as investing in multiple properties through real estate crowdfunding or exploring different asset classes altogether. Diversification can reduce risk and potentially increase your overall returns.

While paying off your investment property early has financial implications that should be carefully considered, the peace of mind that comes with being debt-free can be invaluable. It allows you to focus on other aspects of your life, reduce stress, and make more confident financial decisions.

Interest savings: You could save thousands in interest payments

Paying off your investment property mortgage early will save you a lot of money in interest payments. The longer you carry a mortgage, the higher your total interest amount will be. The higher the interest rate on the mortgage, the more beneficial it is to pay it off early.

For example, let's say you borrow $150,000 to buy a home at 6% interest with a 30-year term. By the time you pay off your loan, you will have paid a total of $173,757.28 in interest, in addition to the $150,000 you initially borrowed. Now, if you pay an extra $100 every month towards the loan, you will pay a total of $128,170.57 in interest, which is $45,586.71 less than you would have paid without the extra payments. You will also pay off your loan 81 months earlier.

The higher your mortgage rate, the more capital you should allocate to paying it down. If your mortgage rate is below the interest rates on safe investments, such as Treasury bills, high-yield savings accounts, and CDs, then you are better off investing your money there instead of paying off your mortgage early. However, if your mortgage rate is higher than these interest rates, then paying off your mortgage early could be a good option to save on interest payments.

Another factor to consider is the opportunity cost of your money. If you can invest your money in something that will earn a higher return than the interest rate on your mortgage, then it may be more beneficial to invest rather than pay off your mortgage early. However, if your mortgage rate is higher than the return on your investments, then paying off your mortgage early could be a better option.

It's important to weigh the benefits of paying off your mortgage early against the potential downsides, such as losing the mortgage interest deduction, reducing your financial returns, and tying up capital in an illiquid asset. Ultimately, the decision to pay off your investment property mortgage early depends on your individual financial situation and goals.

Loss of tax breaks: You may lose out on tax deductions for mortgage interest

Paying off an investment property early may result in the loss of tax breaks, specifically the ability to claim tax deductions for mortgage interest. This is because the interest portion of your mortgage payment decreases over time, so by the time your mortgage is almost paid off, your payments are mostly non-deductible principal.

The mortgage interest deduction is a tax incentive that allows homeowners to subtract mortgage interest from their taxable income, thereby lowering the amount of tax owed. This deduction is particularly beneficial if you have a high mortgage interest rate. However, it's important to note that the Tax Cuts and Jobs Act (TCJA) of 2017 lowered the mortgage deduction limit to loans up to $750,000, or $375,000 for married couples filing separately.

Additionally, the benefit of the mortgage interest deduction may be outweighed by the standard deduction. For the 2023 tax year, the standard deduction is $14,600 for single filers, $29,200 for married couples filing jointly, $14,600 for married couples filing separately, and $21,900 for heads of households. If the standard deduction is higher than the amount you would save through the mortgage interest deduction, it may not be worth claiming.

Furthermore, if you choose to pay down your mortgage instead of contributing to tax-advantaged retirement accounts, you may also be giving up tax savings. Therefore, it's important to carefully consider the potential loss of tax breaks when deciding whether to pay off an investment property early.

Wealth is tied up: Property is an illiquid asset, meaning it can't be converted to cash quickly

Property is an illiquid asset, meaning it can't be converted to cash quickly. This is due to the nature of the real estate market, which requires time-consuming procedures such as inspections and appraisals before a property can be sold. Additionally, real estate purchases are often financed, which takes time for the buyer to secure. As a result, even if a buyer is willing to pay the asking price, finalising the sale and transferring the proceeds to the seller takes a significant amount of time.

The illiquid nature of property means that wealth is tied up in this asset. This can be a risky proposition, especially if the majority of an individual's or entity's wealth is tied up in property. In the event of a financial emergency or unexpected expenses, it may be challenging to access the cash needed. Selling a property can be a lengthy process, and if a quick sale is required, it may result in a significant loss in value.

The lack of liquidity in property investments can also impact an individual's ability to invest in other opportunities. With their capital tied up in property, they may miss out on more efficient investments or be unable to diversify their portfolio. This lack of diversification can increase risk, especially if the property market experiences a downturn.

Furthermore, the illiquid nature of property can affect an individual's financial flexibility. For example, if they wish to borrow money, having their wealth tied up in property may limit their options. Lenders may view property as a less liquid asset and, therefore, may be less willing to accept it as collateral or may offer less favourable terms.

In summary, the illiquidity of property means that wealth is tied up and may be challenging to access quickly. This can impact an individual's ability to invest elsewhere, diversify their portfolio, and maintain financial flexibility. While property can be a valuable investment, it is essential to consider the potential drawbacks of having wealth tied up in this illiquid asset.

Opportunity cost: Money spent on paying down your mortgage is money you aren't able to invest elsewhere

Paying off an investment property mortgage early can be a complicated decision. One of the main drawbacks is the opportunity cost of the money spent on paying down the mortgage. Here are some reasons why paying off an investment property mortgage early may not be the best use of your money:

Opportunity Cost

Money spent on paying down your mortgage early is money that you are not able to invest elsewhere. By paying off your mortgage early, you are essentially giving up the opportunity to invest that money in other assets that could provide higher returns. For example, you could invest in stocks, bonds, or other investment properties that may offer higher potential returns than the interest savings on your mortgage.

Loss of Liquidity

Paying off your mortgage early ties up your wealth in an illiquid asset. Property is not easily converted into cash, so if you need money in an emergency or want to seize an investment opportunity, you would need to sell your house, which can be a time-consuming process.

Reduced Tax Benefits

Mortgage interest is tax-deductible, so by paying off your mortgage early, you lose out on this tax benefit. This is especially important for investors in high tax brackets, as it can result in a higher taxable income.

Impact on Investment Portfolio

Paying off your mortgage early may lead to an unbalanced investment portfolio. By using cash to pay off your mortgage, you are effectively increasing your exposure to the real estate market. If the property values decrease or the market declines, your net worth could be negatively affected due to a lack of diversification.

Alternative Options

Instead of paying off your investment property mortgage early, you could consider the following options:

• Invest in a diversified portfolio of stocks, bonds, or other investment properties.
• Contribute to a retirement account, especially if your employer offers a match.
• Pay down high-interest debt, such as credit cards or personal loans.
• Build an emergency fund to cover unexpected expenses.

Frequently asked questions