Alex asks: “I own an apartment that is rented out and almost debt-free, and a house that is still pretty high in debt. My plan is to sell the apartment, and use the money to pay off the major amount of debt on my house. What do you think?”
Question 20 – Should I Sell My Apartment To Pay Mortgage? – Shownotes
Today’s question comes from Alex:
I own an apartment that is rented out and almost debt-free, and a house that is still pretty high in debt. My plan is to sell the apartment, and use the money to pay off the major amount (about 70%) of debt on my house, leaving me with about 90k in debt which will be very easy/cheap for me to pay off.
• House debt: £290k @1.75% interest, house value £350k
• Apartment debt: zero, market value: £220k.
• Yearly net income from rent: £10k (after putting aside 10% for upkeep and repairs). 30% income tax on that, so make it £7k.
• Return on apartment value: 3% per year based on market value.
I am starting to think it would be a better idea to keep on paying the relatively low interest debt on the house, and take the income from the apartment as a return on investment, because let’s face it, where can I get that kind of return in the finance market right now, and with relatively low risk?
I think it’s mostly the subconscious desire of wanting to be free of debt in a certain timeframe, even though the interest is low and I will lose a steady income.
Thanks for your question Alex. I’m firstly going to answer it from a purely mathematical standpoint and then discuss other factors after.
Let’s look at your current situation as a whole.
How You Currently Stand…
- Total assets: £350k house, £220k apartment
- Invested: £280k
- Mortgage: £290k
- Annual apartment income after tax: £7,000
- Annual expense of own home mortgage: £5,075
- Annual return = £1,925 / Investment = £280,000 = ROI of 0.7%
- Capital growth of 5% pa = £28,500
- ROI with cap growth = 10.9% pa
…Or If You Were To Sell…
If you were to sell the apartment and pay down the house debt:
- Total assets: £350k house
- Invested: £280k
- Mortgage: £70k
- Annual expense of own home mortgage: £1,225
- Annual return: -0.4% pa
- Capital gains of 5% = £17,500
- ROI with cap growth = 5.8% pa
Therefore, your return is currently better, and hence we would recommend (mathematically) sticking with how you are.
Other factors to consider:
- Risk – Having a £290k mortgage is (theoretically) more risky that having a £70k mortgage. Therefore, you need to think about your monthly cash flow and whether you’d ever have an issue with servicing the £290k mortgage.
- Diversification – depending on your overall net worth, you may be overly invested in property compared to other asset classes (such as stocks and shares). Therefore, another option may be to sell the apartment and only repay some of the mortgage and invest the proceeds in long-term assets in a different asset class (returning better than the 3.2%).
- Opportunity cost – A cash-on-cash return from an investment property of 3.2% (£7,000 over the £220,000 value) isn’t great. If you do want to invest in property, there will be better returns available.
I, personally, due to my attitude to risk, would be trying to maximise my ROI. The mortgage is actually helping to do this (by leveraging good debt) but the investment property (unless the fundamentals are amazing and your annual cap growth is off the charts) isn’t the most effective way of currently doing this. As such, selling may be an option (consider all fees and costs), but not primarily to pay off the mortgage.
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