Should I refinance a 15-year mortgage on a rental property to a 30-year term to create monthly income and a tax break at the end of the year?
I rent my home for $1,100 per month, and my mortgage is $1,035. I have 11 years remaining on my 15-year mortgage with a 3.5% interest rate. I currently owe $90,000. Does it make sense to refinance a 30-year mortgage to create monthly income, and a tax break at the end of the year from the interest I pay? I know I will pay more over time, but the income I would earn and the tax break I would receive at the end of the year would be beneficial in the short-term.
I love the question and you are absolutely thinking about an investment property in the right way. The answer does, of course, depend on your objective and tolerance for risk, but my short answer is you are spot on with your thinking.
First of all, the value of the property you own is not dependent on the mortgage balance against it. Meaning, if you have a $200,000 home value, it will increase or decrease, regardless of the mortgage balance against it. If your goal is to own the property over time and you resasonably believe in 10 years it could be worth $250k or $300k, this part of your investment moves independelty from how you structure your financing.
Second, are you in a more financially stable position with additional cash flow. I would say, probably yes. By paying more on the mortgage currently, you are increasing your equity in the home faster, essentially investing in the physical asset of your house but it in no way increases or decreases the appreciation of the atual investment (the hosue.) The additional equity is less liquid than another alternative investment or keeping the money in cash in case you need to access it. Having a higher payment is actually more of a risk to you in the ownership of the home until your mortgage is completley paid off - in any sort of a financial hardship, saving money outside of equity in an emergency fund or other type of inevstment and having a lower payment would be a stronger payment option.
Third, you would actually pay more interest over time, but that also creates more of a tax deduction over time (check with CPA for new tax laws though). People often say on a 15 year vs. 30 year mortgage that on the longer mortgage you will pay more money (i.e. more interest.) However, this looks at the transaction on a nominal dollars basis. Given inflation, a dollar you spend on interest 10 or 15 years from now is worth significantly less than it is worth today, so the interest you pay far off in the future is less costly than money spent today. Of course, you have to be smart and utilize the additional cash flow wisely, but I personally would say if you are a savvy and discipined business person and investor (which your questions indicates you are) the opportuniy cost of the lower cash flow today (not to mention debt-to-income ratios for loan qulaifiations) is greater than accelerating your mortgage - especially when your after tax borrowing cost is so low.
The concept is called "mortgage leveraging" and is nothing more than corproate finance 101 on a smaller or personal investor level. But, you have to execute it properly and make smart business decisions.
On another side note: don't listen to any of the people who tell you to invest the equity or cash flow in any sort of insurance product - that would be dumb. Just improve your cash flow position, invest in other great assets that can provide better liquidity. (Dang it - I thought this would be a short answer but I guess I was more opinionated on the matter than I thought.)
I would not recommend refinancing your mortgage. First, you have a great mortgage, both in term and in interest rate. I'd expect your refinanced 30-year loan would be at a higher interest rate, too. I understand your desire for a larger tax benefit; we'd all like to save on taxes. However, think of it this way: You're spending an extra $1 in mortgage interest to save $0.XX (you fill in your marginal tax rate - $0.25, $0.35, etc) in tax. Personally, I'd rather have the $1 even if I have to give $0.35 to the government! I don't know your expected ownership time-frame, but in 11 years your current mortgage is done! Talk about a great increase in monthly cash flow!
The property has a slight positive cash flow right now (as long as it stays rented). I'd recommend building equity quicker - and pay much less interest over time - by keeping your current mortgage.
To a large extent that depends on opportunity cost analysis ie what would you do with the extra money you would have by going into a 30-year loan which would have a lower monthly payment than a 15-year loan.
The rate on your mortgage seems pretty good . Rates have shot up a bit recently and it is very likely that you would have to pay a higher rate today. In addition, a 30-year loan will have a higher interest rate than a 15 year loan, and over time you will be paying more in interest on a 30 year loan than a 15 year loan. However, the monthly payment would be lower on a 30-year loan and you must figure out what explicit and implicit return you will earn with the extra cash.
As for the tax break: If I understand correctly, you are referring to the fact that the interest rate deduction would be higher on a 30-year loan than a 15 year loan. Well, that is because you are paying more interest on a 30-year loan than a 15 year loan (Higher rate on a 30 year loan and also interest is front end loaded in mortgages).
I don't know the details of your income, filing status etc. but, the recently passed tax bill doubles the standard deduction and limits state and property tax deductions. So, you may want to run the numbers again to see if you really are getting any benefit of deducting your interest payments.
PS: I am not a tax accountant and I don't give tax advice.
The first question to ask is how old are you and when are you planning to retire? I would stay away from refinancing if you are planning on retiring any time in the next 11 years. You also have an excellent interest rate that would likely be unattainable at this point in our rising interest rate environment. Why would you want to add 19 more years of interest payments? Rising interest rates means rising inflation, which means in the next few years you could charge more for rent on your home and 11 years from now, you'll own it free and clear which will mean substantially more positive cash flow for a potentially much longer period of time in your lifetime, and something you can pass off free and clear to any heirs. Certainly, it'd help to see the bigger picture of your current financial situation, but from what you've mentioned, the short-term benefits likely do not outweigh the long-term benefits and you should just stick with what you've been doing, knowing your income is only going to grow over time from this property.