Which loan do I pay off first? Input pls.

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Letsgo
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Which loan do I pay off first? Input pls.

Post by Letsgo »

My primary mortgage loan balance is about 2x the amount of my rental property loan. Both loans have rates < 2.5%. 10/6 ARM on primary and 7/6 ARM on the rental.

Liquidity isn’t a major concern. Total have around 30-35x expenses saved (~85/15 allocation) and portfolio size is about 4x+the combined loan balances.

I haven’t been paying the loans down because the rates are so low but am starting to think I should prioritize paydown soon.

In about 10 years, we might want to sell a home and move up. Not sure which one, but we would need proceeds to pay for the move-up home.

Is this decision purely about rates? Pay the rental loan first because it has a slightly higher rate by 0.25%? Also the rental loan is smaller so it could be paid off much faster. Both homes have about the same amount of equity tied up.

Should I view the two loans as fungible? It feels like paying off the rental loan reduces my investment property return profile, but if I view the loans as fungible it doesn’t matter.

Any good reason to pay both down together proportionally which is what I’d been planning even though it would prolong the ultimate final payoff? Thanks.
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Stinky
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Re: Which loan do I pay off first? Input pls.

Post by Stinky »

Letsgo wrote: Sat Jul 24, 2021 8:10 am
Is this decision purely about rates? Pay the rental loan first because it has a slightly higher rate by 0.25%? Also the rental loan is smaller so it could be paid off much faster. Both homes have about the same amount of equity tied up.
I think you’ve given two good reasons to pay off the rental loan first. That’s how I would proceed.
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neurosphere
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Re: Which loan do I pay off first? Input pls.

Post by neurosphere »

Is the interest on both loans equally deductible? On the rental property, the interest is typically deductible as an expense. On the personal home loan, the interest is only deductible if you itemize. In addition, when itemizing, not all of the interest is deductible in certain circumstances. For example, if the mortgage interest is necessary to push you past the standard deduction vs you would be taking the itemized deduction anyway even without the mortgage interest.
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galawdawg
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Re: Which loan do I pay off first? Input pls.

Post by galawdawg »

neurosphere wrote: Sat Jul 24, 2021 9:45 am Is the interest on both loans equally deductible? On the rental property, the interest is typically deductible as an expense. On the personal home loan, the interest is only deductible if you itemize. In addition, when itemizing, not all of the interest is deductible in certain circumstances. For example, if the mortgage interest is necessary to push you past the standard deduction vs you would be taking the itemized deduction anyway even without the mortgage interest.
+1.

One additional note. I am a fan of the sinking fund approach rather than paying down (vs. paying off) your mortgage by adding extra to your payments each month, year or periodically.

There are a couple of advantages of the sinking fund approach:

1. The funds you are setting aside to payoff your mortgage are liquid and more readily available in the event of an emergency or if financial flexibility is required.
2. If you are able to obtain an after-tax rate of return that is greater than the interest rate of your mortgage, the amount you need to contribute to payoff your mortgage would be less than adding an amount to each monthly payment.
3. If interest rates are significantly higher in the future, your priorities may change and you may prefer at that time to keep the low-interest rate mortgage in favor of investing the funds at a higher interest rate.

Here are a few potential disadvantages:

1. The increased "availability" of the funds may steer you away from your goal of paying off the mortgage and instead be diverted to other spending.
2. Depending on the investment vehicle you choose, your after-tax rate of return could end up lower than the interest rate on your mortgage. In that case, you would have to contribute more to the sinking fund to payoff the mortgage than you would have paid had you instead added to your monthly payment each month.
3. Capital gains tax rates in the future may increase which would require an even larger sinking fund balance. You may also find yourself reluctant to sell those funds to payoff the mortgage both because of the tax you would owe on any gains but also because you don't want to miss out on the compounding effect of a significant holding.

As long as your after-tax rate of return on the sinking fund will be greater than your mortgage interest rate and as long as you have the willpower and commitment to leave those funds alone until you have enough to payoff your mortgage and then do so, the sinking fund is a good approach. If those two things are uncertain, then the safer approach is to simply pay extra towards your principal each month.

Good luck in whatever you choose!
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Toons
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Re: Which loan do I pay off first? Input pls.

Post by Toons »

Take Your Pick
Pay Off One
Then The Other
Or
Pay them off at the same time


:happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
Raycpact
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Re: Which loan do I pay off first? Input pls.

Post by Raycpact »

Refi residence to 2%. Pay down rental.
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Letsgo
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Re: Which loan do I pay off first? Input pls.

Post by Letsgo »

Thanks for all the great replies. Both loans are equally deductible. I itemize and the rental property runs at a marginal profit so the interest deduction lowers rental income.

I like the sinking fund approach except that I find it hard to want to buy more BND yielding 1.3% when I pay 2-2.25% in mortgage interest. Equities only in the sinking fund make sense over a 5-10 year horizon but my AA is already around the upper end of where I want to be in stocks (~85%).
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galawdawg
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Re: Which loan do I pay off first? Input pls.

Post by galawdawg »

Letsgo wrote: Sat Jul 24, 2021 10:36 am Thanks for all the great replies. Both loans are equally deductible. I itemize and the rental property runs at a marginal profit so the interest deduction lowers rental income.

I like the sinking fund approach except that I find it hard to want to buy more BND yielding 1.3% when I pay 2-2.25% in mortgage interest. Equities only in the sinking fund make sense over a 5-10 year horizon but my AA is already around the upper end of where I want to be in stocks (~85%).
Just do a mix of bonds and equities in sinking fund. Perhaps something like 30% VTI/70% BND.

Here's how $500/mo in that mix would have done the past ten (10) years: https://www.portfoliovisualizer.com/bac ... tion2_1=70

Then you either use the sinking fund to payoff one of the mortgages when the fund balance equals the payoff amount OR in ten years you use the sinking fund, along with the sale proceeds of whichever property you sell, for your new home. Again, gives you flexibility.
babystep
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Re: Which loan do I pay off first? Input pls.

Post by babystep »

Letsgo wrote: Sat Jul 24, 2021 8:10 am My primary mortgage loan balance is about 2x the amount of my rental property loan. Both loans have rates < 2.5%. 10/6 ARM on primary and 7/6 ARM on the rental.

Is this decision purely about rates? Pay the rental loan first because it has a slightly higher rate by 0.25%? Also the rental loan is smaller so it could be paid off much faster. Both homes have about the same amount of equity tied up.

Should I view the two loans as fungible? It feels like paying off the rental loan reduces my investment property return profile, but if I view the loans as fungible it doesn’t matter.

Any good reason to pay both down together proportionally which is what I’d been planning even though it would prolong the ultimate final payoff? Thanks.
Rental first because the interest rate is higher and fixed duration is shorter.
babystep
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Re: Which loan do I pay off first? Input pls.

Post by babystep »

Letsgo wrote: Sat Jul 24, 2021 10:36 am Thanks for all the great replies. Both loans are equally deductible. I itemize and the rental property runs at a marginal profit so the interest deduction lowers rental income.

I like the sinking fund approach except that I find it hard to want to buy more BND yielding 1.3% when I pay 2-2.25% in mortgage interest. Equities only in the sinking fund make sense over a 5-10 year horizon but my AA is already around the upper end of where I want to be in stocks (~85%).
Agree, why would you buy so low yielding bonds instead of paying off higher interest loan. Also, you don't need liquidity.
Letsgo wrote: Sat Jul 24, 2021 10:36 am Liquidity isn’t a major concern. Total have around 30-35x expenses saved (~85/15 allocation) and portfolio size is about 4x+the combined loan balances.
babystep
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Re: Which loan do I pay off first? Input pls.

Post by babystep »

babystep wrote: Sat Jul 24, 2021 9:59 pm
Letsgo wrote: Sat Jul 24, 2021 8:10 am My primary mortgage loan balance is about 2x the amount of my rental property loan. Both loans have rates < 2.5%. 10/6 ARM on primary and 7/6 ARM on the rental.

Is this decision purely about rates? Pay the rental loan first because it has a slightly higher rate by 0.25%? Also the rental loan is smaller so it could be paid off much faster. Both homes have about the same amount of equity tied up.

Should I view the two loans as fungible? It feels like paying off the rental loan reduces my investment property return profile, but if I view the loans as fungible it doesn’t matter.

Any good reason to pay both down together proportionally which is what I’d been planning even though it would prolong the ultimate final payoff? Thanks.
Rental first because the interest rate is higher and fixed duration is shorter.
You state that mortgage is deductible as well as rental interest. Rental is generally fully deductible but one could still get the standard deduction if you are not doing the itemized deduction so you might have to consider that as well and that might swing in the favor of mortgage.
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