Should I pay off my $132,000 15 year mortgage currently at 5% fixed or
pay off loan? I receive $1750 month in rent and with taxes, upkeep etc
my expenses would leave me $1500 a month free. Which should I do?

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Clarification of Question by echopk-ga on 24 Jan 2005 20:03 PST

Okay, okay, so I wasn't clear. Let me try again, I do appreciate all the input.
1) Loan is 2 years of 15 year loan @5% on balance of $132,000
2) Valued at $450,000, equity $318k
3) Current monthly payment is $1100 
   (same tenants 2 years extended lease 2 more years-home is in good shape)
4) Current monthly rent is $1750 or $21,000/yr
5) Expenses for taxes,insurance, etc of $4,100/yr or $342 monthly.
6) Only property, just sold principal residence, enough to pay off current loan.
7) Age early 50's; debt free; don't rely on income; have 6 months cash reserve 
8) Have an appt with financial consultant in 2 weeks, but like to have
done my homework first.

Hi Echopk,

Play it again Sam! Rewrite your question. "Should I pay off .. or pay off" ????

How old is your loan? What's the value of your house? How much
borrowable equity? Other properties? Your borrowing power? Your income
source - passive or earnt? Your plans? Your age range (with respect)?
Your other commitments? Your attitude to investments -
Conservative/Short Term/Long Term/Gambler?

If you are talking about a rental, gear it to the hilt. Otherwise you
have what we call a lazy asset.

Your surplus suggests a positive cashflow. If so, the sky is the limit
with borrowings on those types of properties. Sounds more like a
single property with the capital owing reduced over a number of years.
All the more reason to borrow again depending on your lifestyle,
income stream and market predictions.

Do you rely on the surplus to support your lifestyle. If not, you are
on your way to making millions if you have not already been there.

Phil

First, I assume you have other income to pay your mortgage and that
the rent money is additional income.  That being the case the accepted
wisdom would be to keep that 5% mortgage.  It is an excellent rate and
leverages your money you have invested in the mortgage.  Then 1) Pay
off any credit card debt; 2) Accumulate a cash reserve for emergencies
in an insured account.  Six months income is the recommended amount;
3) Max out on any contribution to retirement accounts such as a 401K,
IRA, etc.; 4) I would keep the rental home in good shape for future
sale, so don't skip on maintenance there.  5) Review your insurance. 
Make sure you have sufficient life, disability, homeowners, rental,
automobile and liability insurance.  Consider long-term care insurance
if you are 50 or over.  6) With all that covered invest anything left
in an insured account or split between an insured account and mutual
funds, depending on your risk tolerance.  7) Consider a consultation
with a financial planner if you think this is too complicated.  8) Get
financial books by Ric Edelman and subscribe to Money magazine.

It is not clear what your situation really is.

Are you asking whether you should spend the $1500 rental 'surplus' on
paying off the mortgage - or should you invest it elsewhere ?

If that is the case, then the question is similar to:
  'Should I take out a mortgage to invest in an Indexed fund'

I have a friend who sort of has many properties something like yours.
Typically he sells the property with contract for deed. The "buyer"
messes up. Gets moved out. He sells it again with contract for deed.
An occassional person pays off the contract and gets a deed, but it
appears the average buyer lacks self disapline. He is a nice guy and
hates to do this to people, but other choices are unattractive, when
the "buyer" is several month's behind on the payments, and very
unlikely to ever catch up. The advantage over renting is the buyer
takes better care of the property than the average renter.
 No one commented on index fund. These are a bad investment if there
is a large up front charge and/or large charges that occur monthly,
quarterly or anually, so make sure you know what you are getting.
Sales persons can be very deceptive, so read the prospectus carefully
with help from an indepentent person.
 Perhaps you are thinking of buying the place with a 132,000 mortgage,
that will leave you $1500 monthly surplus. Most of this surplus may
disappear due to people stiffing you for the last three months rent
and leaving the unit in need of costly clean up and repair. $250 per
month does not seem like enough to cover such contingencies. Lots more
details will help.  Neil

Hey Echopk,

This is good stuff I'm sure you would agree. Everyone wants to see
others succeed as well as themselves. Everyone likes to help solve a
puzzle.

Daniel, Frde and Neil are obviously here to help. Me too. As Neil
says, lots more detail will help. No need to spill your guts about all
of your personal affairs. But we will need more info to try to help
you. Just bear in mind that laws differ from one country to another.
In fact some differ from state to state.

Neil .. by the way are you describing "Wraps", as in vendor financed
loans with part of the rent attributed to equity? Sounds like it. It
has some merit, but in my opinion Wraps are designed to fail. That's
how the vendor/landlord profits from another's loss. I attribute to
the school of win-win. Wraps are good in theory, but I am yet to hear
of a successful "Wrapee".

Phil

Ahaa .. Frde has asked a good question. Is the $1500 pm surplus AFTER
paying out the mortgage? I was thinking along the lines that you may
be closing in on the end of your mortage taken out near 15 years ago.
Either way, as it's positively geared, you will have a tax obligation
on the surplus. Again, all the more reason to gear that profit toward
multiplying your assets. And again, depending on your circumstance and
other commitments. If you have depreciated shares, you may be able to
write off a loss against a rental profit if you plan your timing
correctly.

C'mon Echopk .. you gotta help us out here, so that we can help you.
Daniel has even written a plan for you. Don't ya just hate these
organised types?  :)

We're waiting for your return .. just say that you've been fishing or something.

There are too many "ifs" until we hear from you again.

Phil

Here's the scoop:

You're paying 5% interest.  
In a respectable index fund you can expect atleast 10% interest per
your average year in the long run (finding a decade where the stock
market was below 10% average is less common than not... check the
great depression though).  10% is far greater than 5%, so the choice
isn't too hard here.

If you're not currently maxing out an IRA every year then you should
start by doing that.  Invest as much as they will allow you in the IRA
(currently $4,500 yearly since you're over 50... $4,000 for anyone +
$500 "catchup" for being over 50).  You can deduct that full $4,500
from your taxes and save yourself a considerable amount of money with
your tax return every year.  This money will then grow tax free in the
investment of your choice (the index fund) until you take it out after
retiring.  Just be prepared to change your investment strategy if Bush
succeeds in overhauling our skrewy tax system.

That is a sizable investment, however if you still have more money to
play with then paying off your mortgage isn't a bad idea.  Money that
you put in a non-IRA investment will be taxed, so you don't have as
big an incintive to invest elsewhere.

One more thing I'll mention is... You just sold your residence which
means you're missing a huge tax break associated with your personal
residence.  All interest you pay on your own house is tax deductible,
whereas any rent you are paying now is still fully taxed.  It might
not be possible to take advantage of this right now since you just
sold your house, but it's something to think about.

Echopk,

I didn't mean to hound you as such, just keen to see another success story.

As I mentioned, laws vary greatly from one country to another. I can't
comment on Indexed Funds, but Jack has done a good job there.

As for your LAZY ASSET, you have a gross return of around 16% against
the mortgage. Fantastic, hence the positive cash flow. But, against
the value of the property your return is 4.6% before outgoings. All
the more reason to refinance (assuming you have other regular income)
by using the untapped equity for further investment deposits. If you
can arrange even an 80% Line of Credit (LOC), you will become your own
bank with $228K to confidentally play with. $450K X 80% = $360K, ~
$360K - $132K = $228K. The advantage of the LOC is that you only pay
interest on what you use. Like a large credit card limit, it's there
when you need it.

To get out of a fixed loan you will most likely have break costs.
Should only be a few grand though.

Ask your Financial Advisor about Family Trusts. Income earnt by the
Trust can be directed to any nominated beneficiary within that Trust.
That way profits can be directed to the beneficiary on the lowest tax
rate to maximise the return to the Trust.

You are still young enough to accumulate further equity through
property growth if property is your cup of tea. Your borrowings can be
used for other investments of course. Shares, derivatives, contracts
for difference (CFDs), whatever. CFDs, similar to margin lending
afford you the leverage of realising a full gain while parting only
with a 5% deposit plus a small interest only on the balance "borrowed"
funds.

As you have sold your principal place of residence, you still need
somewhere to sleep. You could take the short cut to retirement, boot
the tenant out, pay out the loan and move in yourself.

As always, just thoughts in discussion, not advice.

Good luck with your goals, Phil