Should I Pay Off My Mortgage?

"We have mortgages on 3 properties and live in a home with no mortgage. My husband is 64 and I am 55, we could pay off all 3 mortgages in 11 years, but would we be better off doing something else with that cash?"

I enjoy receiving real estate questions because frankly, I don’t get too many of them and I enjoy investing in real estate as well.  A lot of what you are asking depends on your situation and your ages.  I am going to remove your ages from the discussion 1) because majority of my readers are younger than you are and 2) because it doesn’t seem like you are relying on this for retirement income.  I assume you have your retirement fully funded and that you are looking to just make the best decision regarding these properties.  I am also going to assume these three properties are all rental properties.  There are two trains of thought on what may be best.

The first thought is that eliminating all debt is good.  This approach would recommend doing exactly what you are suggesting and paying off all three mortgages as quickly as you can.  If you choose this route then pay them off one by one instead of paying down all three at the same time.  This will increase your cash flow as each house is paid off and you will be able to pay down the remaining ones faster.   I would never disagree with the statement “eliminating debt is good.”  I may argue that it may not be the best way to maximize wealth.

The second thought is that some debt when used the right way can be good debt.  Now this may be an unpopular statement especially in this day and age, but I personally use this strategy in my own rental properties.  Hopefully you view your rental properties as a business but even if you don’t the IRS does.  For tax purposes, it makes a lot of sense to maintain your mortgages on these properties for as long as you have them.  Here is why.

First of all, you should have very low mortgages on these properties (<4.5%).   Secondly, because this is a business all of the interest paid on these mortgages is deductible right from the rent received.  In other words every dollar you pay in interest reduces your taxable income by one dollar.  This is not the case with your mortgage interest on your residence.  For that reason, it is good you paid your house off first.

To further emphasize my point. let’s say you are in a 33% tax bracket, then effectively, the out of pocket interest you are paying is <3.0% (this is right around the long term rate of inflation).  In a sense, you are borrowing money at the rate of inflation.  Put another way, you are basically borrowing for free.

So let’s take this one step further, instead of paying down these mortgages early, what if you invested this extra cash as you mention in your question.  Do you think you could do better than the rate of inflation?  I would argue that with the right investment plan and using historical performance, you should be able to beat inflation.  If not, we are all in a world of hurt for the future.

In summary, you really can’t go wrong either way, and you have a good problem to have.  The reality is paying off the mortgages is the safe bet.  As a financial planner, it is my responsibility to look at the alternatives and allow you to choose which is right for you.  I choose to maximize the potential in my real estate investments by reducing my taxable income.  This may or may not be the right thing for you but at least you know your options.