Should you pay off your mortgage or invest in rental property? This is a common question among real estate investors that relates to personal debt. As a real estate investor, this is a question I wrestled with myself. In normal times, my answer is always to “Pay off your personal mortgage.” However, we are not in normal times. We are far from it.
For the sake of simplicity, let’s define our debate in this story to assuming one has a single personal mortgage on the home in which they live. Let’s also assume that the question is whether to pay off your mortgage or invest in real estate.
If you are considering buying a second rental property, the analysis is similar. Use the same arguments below to determine if you should pay off your rental property mortgage. Just be sure there are no penalties for paying off your rental property mortgage early.
Like any debate on financial moves, only you can answer what’s best for you. Let us offer some insight. In this story, we will make a case that in 2020, the answer to the question “Should you pay off your mortgage or invest in rental property,” is very likely, “Buy the rental property.”
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Mortgage Interest vs. an Inflation Hedge
Nobody likes to look at their monthly mortgage statement and see that they are primarily paying interest. For the first five to ten years of a 30-year mortgage, the amount of money that you pay each month to principal is minimal. You are, in effect, paying the bank to let you live in a house that the bank owns.
In normal times, your interest on that mortgage seems a bit more tolerable because you can “deduct it from your taxes.” That’s exactly what the mortgage lenders want you to think. You’re their slave, and they want you to have a reason to be happy about it. So the mortgage interest deduction on your personal income taxes is a salve to the wound.
In 2020, a mortgage may well have an unusual benefit. American fiscal policy shifted a decade or two back to keep inflation around 2% annually. That pushed mortgage interest rates to historic lows. With inflation so low, if you have a mortgage, you effectively are paying one or two percent on the money you borrowed from the bank that lets you live in its house.
However, if the inflation rate goes up to five or ten percent, and your mortgage is under 5 percent, you are now paying back that loan with money worth less than you borrowed. Suddenly, you are benefitting from having a mortgage. When inflation is higher than your effective interest rate after the deduction is factored in, you are actually earning money on a mortgage. The mortgage acts as an inflation hedge in your favor.
Argument One for Buying a Rental Property Now – Cash Flow
The main reason to not pay off your mortgage and to instead invest in rental property is cash flow. The idea is that if you buy a rental property, the cash you would have used to pay off your mortgage will make you money. It does this by generating cash flow from the rental property. But is it really better for you to invest in rental property?
The answer comes from doing a cash flow analysis. Mashvisor has a cash flow calculator to help you determine if a property you are considering will yield positive cash flow. A rental property calculator will factor in your costs of debt (assuming you finance the rental and don’t pay it in full). It will also factor in all the costs of owning a rental property. These include property taxes, utilities, repairs and maintenance, and other costs.
If you can generate positive cash flow from the rental income after all of the real-world expenses are added into the tool, then you have a strong case that you should be investing in rental property. To make the argument stronger, compare the cash flow to the money you won’t be paying in your monthly mortgage payments. Or at a minimum, the interest you pay on that mortgage.
2020 Will Be a Year for Rental Property Deals
Every indication is that this year will be a repeat of 2008 and 2009 when distressed properties flooded the market. With so many people out of work, condos and multi-family homes may become available at reduced prices. This is the time to strike if you want to break into real estate investing.
Furthermore, with rent strikes and renters unable to pay, other real estate investors may sell some properties. If you can obtain these properties at a discount and ride out the tough months ahead, they may be valuable holdings for you in years to come. Years like 2020 happen very infrequently.
Real-World Benefits to Paying Off Your Mortgage Early
A financial guru this author follows is Dave Ramsey. Mr. Ramsey offers advice to homeowners on how best to save for retirement and build wealth. One of his most frequent topics is “should you pay off your mortgage or invest in rental property?” His answer is always, “Pay off the mortgage first.”
His opinion is based on risk and the cost of a mortgage. As we have shown above, the risk landscape in 2020 is unusual. There is a new risk of high inflation about to become a reality. Three trillion in imaginary money was just printed by the Federal Government. That means the dollar’s value will be reduced. Perhaps it will be reduced dramatically.
The second risk is that you may end up unable to pay your bills and mortgage. Thus, your personal solvency is at risk. Only you can assess if this is a real risk for you. Do you have six months of living expenses including mortgage payments in a safety savings account? Do you possess an essential marketable skill? If so, your risk is low. If you answered “no”, your risk is high.
Finding Cash Flow Properties with Mashvisor
Due to social distancing mandates, the market is odd right now. Sellers who list properties may be highly motivated to sell. How do you find good cash flow properties? Mashvisor has all of the tools you need. There are heat maps to help you visualize where the best properties are located. There are calculators to help you quickly evaluate those listings for cash flow.
The important thing to remember is that you don’t need to reinvent the wheel. Mashvisor has already created the tools you need to evaluate properties quickly. Click here to get started today with Mashvisor.