Mortgage Refinancing And Real Estate Investing

thumb

In this  Ask the M-Network article, PJ shared information about his home and his desire to buy a house that just came on the market. Should he refinance is current home, or sell it to buy the new one? Should he buy the new home and rent out the old one? Here’s the question from PJ:

Greetings M-Network! I’m a regular reader of most of the M-network sites, and I’d love to hear you guys tackle a PF/real estate combo question. Here it is:

My wife and I moved into our townhouse in 2006. It is about 1075 sq ft. We LOVE our neighborhood- we can walk to everything one could need, a rarity in our part of the country. (walkscore.com = 82!)

However…we hope to expand our family in the next year or two, and will need more space. A 3 BR/2.5 BA place just came on the market, in the same neighborhood, at 1600 sq ft. This is a rather rare opportunity in our neighborhood, where most home are older, smaller, more historic, and more expensive.

Until this place came on the market, we had been planning to refinance our townhome this summer to lower our monthly payment, saving up for a year or two, with the longer view of moving to a bigger place and renting the current one out. Suddenly, we have a chance we did not expect to see for some time.

Our ideal outcome would be to buy the new place and rent the old. Here is my current strategy:

  1. Refinance to lower payments on current home, and rent it out.
  2. Buy the new home for a price below $255k using home equity in the current townhome to cover some or most of the down payment. Without tapping home equity, we do not have the cash for a down payment above 2-3%. (most of our net worth is tied up in 401k plans/IRAs) We’d rather put down 5-10%.
  3. Avoid paying PMI on either property, or paying as little PMI as possible.
  4. Keep closing costs down as much as possible.

IS THERE A BETTER WAY TO DO THIS?

Other info that may help:

  • Based on Zillow’s estimate, we have 16.5 % equity in our current townhome, but we could get it to 20% if needed.
  • We make about $70,000/year combined, and both have very stable employment that is not threatened by the current economic climate.
  • Our credit score is above 800.
  • Current house: $120K mortgage owed; value roughly $145k.
  • Mortgage is 6.875%; 30-yr fixed; currently no PMI due to good credit and being 1st-time homebuyer.
  • Proposed house: my guess of market value is about $230k, though seller is asking for more than $255k.
  • Only debts are student loan of $156/month, and $76/month loan from Prosper, which I re-loaned and generates more in payments each month than the $76.

Thanks for any ideas you have! Let me know if you need more information.

Cheers,

PJ

Here’s the response from Patrick at Cash Money Life

It sounds like the two of you are doing fairly well right now — homeowners, saving for retirement, excellent credit scores, low debt, etc. Good job! Your plan to refinance your current home is a great idea. You should be able to beat 6.875%, which will save you a lot of money every month.

As you already plan on doing the home refinance, the question now is — should you buy the second home this summer or not? You’ve already stated some of the reasons to go ahead and do it — fewer homes of that size in that neighborhood, perfect for your future plans, etc. But have you considered the reasons not to do it?

What if you can’t rent out your current home? How long can you maintain two mortgage payments? Does your wife plan on working after you have children? If so, will the cost of child care considerably reduce your take home pay? Do you have a fallback plan if someone else buys your dream home? Is there anything else that could derail your plans?

As long as you take those factors into consideration, I don’t see why you can’t do it. Just be careful that you don’t over extend yourself. (and I don’t know how to avoid PMI on the second home).

Here’s the response from Plonkee at Plonkee Money

I’m not sure that you can avoid PMI as your total equity will be less than 20% of the value of both houses. I think you need to do the sums very carefully to be sure that you can release enough equity from your townhouse for the down payment and at the same time lower your monthly payments.

When you’re considering renting out, don’t forget to allow for vacancy periods in your calculations. (probably about 10%?) and of course there are likely to be tax issues at some point — you may end up not paying more tax but filling in your return is likely to be more complicated.

Overall, I’d say that this is a reasonable strategy to pursue, it’s essentially the one pursued by most buy-to-let landlords in the UK although that’s not necessarily a great advert. The biggest risk is that you will end up carrying both mortgages for an extended period of time. I’d personally feel more secure if this was possible (if unpleasant) on earned income alone.

Here’s my response

PJ, thank you for reading our blogs and sending in your question.

Here’s the short version of my answer: I would either refinance the current house and stay in it, or buy the new house and sell the old one.

Now for the long answer. I was in a similar situation as you about two years ago. My wife and I wanted a bigger house and went through a house hunting process. As part of that, we discussed what we wanted to do with the “current” house, and of course, the idea of renting it out came up as well. Anyway, we are still in our original house and didn’t go through with the upgrade, but if we did, we would have sold our current house.  Here’s why.

  1. We would have to pay Private Mortgage Insurance on both houses. I think you’ll run into the same issue with PMI. You’re not at 20% on your current house, and I simply cannot see how you would get away with not paying PMI on both houses — especially, in this tougher credit period and with you no longer qualified for first time homeowner incentives.
  2. While the idea of earning rental income is appealing, we didn’t want to deal with these potential issues:
    • Vacancies and finding the “right” tenant.
    • Violations and citations — This problem is common with rental properties that are not well maintained.
    • Maintenance and potential midnight calls to fix things.
    • Pro-tenant law in our locality — check you local law about rental property!
    • Lawsuits and liability issues.
  3. The rental property will make our taxes more complicated.
  4. There is a better way to earn rental income without all the hassle of being a landlord — i.e., you can invest in Equity REIT.
  5. I would rather spend my time doing other things, as opposed to dealing with rental property issues and management.

So my question to you is why do you want to keep your current house? Have you considered all the implications of owning two homes and being a rental property owner? Also, I’d like to second Patrick’s concern about your cash flow and what would happen when your wife gets pregnant. Would you be able to pay for both mortgages and the extra medical bills without her income? If she’s planning to go back to work, then consider the added expense of day care.

If you can answer all of these questions and have plan in place to deal with them, then go for it — buy the new house and rent out the old one. If not, I think you would be better off to either refinance the current house and stay in it, or buy the new house and sell the old one.

I hope you found our answers helpful.

Please remember that our answers are opinions and should not be considered professional advice and we assume no responsibility of any kind. Please consult a certified financial expert as needed.

Do you have a question you would like to have us try to answer? Send it in to Ask The M-Network!

Read more about

401(k) plans, Private Mortgage Insurance, Real Estate, rare opportunity, br 2

Recommended articles

Get free updates

  twitter  via Twitter
  twitter  via Facebook
  rss  via RSS or Email

Share this article

Pinyo
Pinyo is the brain behind Moolanomy personal finance blog and a few other web sites. If you like this article, please subscribe for free daily email updates.

All posts by Pinyo

6 Comments

  1. gravatar
    PJ
    March 10, 2009, 20:38

    Thanks for the reply! We’re taking a careful look at the numbers before acting. We could probably carry the two mortgage payments for almost a year, but this would wipe out all our other savings activities- right now we save for our emergency fund, car repairs, life insurance premium, vacation, and charitable giving.

    My wife’s income is about 20% of household income- she is a student right now.

    In the long term, I am interested in becoming a real estate investor. However, I increasingly think we will refi the current place and stay put, or if we could move up, sell the current place and look for real estate investment opportunities elsewhere.

    Any other comments are most welcome. Thanks for the 4 opinions!

  2. gravatar
    Pinyo
    March 11, 2009, 11:02

    I am glad you found the article helpful. I think you’re making the right choice not to have two mortgages right now.

  3. gravatar
    MITBeta
    March 14, 2009, 21:59

    You don’t say what the monthly payment on the current home would be after the refinance, nor what you could get for rent there. There are two very important data points here. You should make sure that the mortgage cost will be less than 65% of the rent you can get.

    Pinyo: You said: “Only one property would be considered primary residence and helps reduce our tax burden. The rental property will make our taxes more complicated.”

    This is not true. The rental property expenses would count as deductions on Schedule E — including mortgage interest. This is actually one of the best tax deductions available to “small time” landlords. You can deduct up to $25,000 in expenses for your rental properties.

  4. gravatar
    MITBeta
    March 14, 2009, 22:00

    Sorry — yes, it will make your taxes more complicated, but it will be well worth it.

  5. gravatar
    Pinyo
    March 14, 2009, 22:30

    @MITBeta – Thank you for the correction. Rental properties are considered business and mortgage interest would be part of the expenses, so yes, it’s deductible.

    http://www.investopedia.com/ar.....lowner.asp

  6. gravatar
    Joseph Aldeguer
    March 26, 2009, 0:13

    The best thing is, your mortgage lender or your legal housing/credit counselor can help you decide which option is best for you.

Please share your comment:


Please do not use the name of your site or keywords.


Email will not be published.

Comment Rules: Constructive criticism is welcomed. Please use your PERSONAL name or initials and not your business name or URL, as the latter comes off like spam and I'll most likely delete your comment. Have fun and thanks for adding to the conversation! Here's our comment policy and guidelines.

Refinance Rates
Purchase Rates
Refinance Rates,
   Product:                      Today        Last Week
Compare rates in your area:
Mortgage Rates
Refinance Rates
Purchase Rates
Purchase Rates,
   Product:                      Today        Last Week
Compare rates in your area:
Mortgage Rates

Your Credit Score

Featured Reviews

Featured Articles

Recent Articles

Affiliate Relationships

As required by FTC regulations, please note that we have a financial relationship with many of the companies mentioned on this site. We occasionally review products or services that we have been given access to for free. However, we do not accept compensation in any form in exchange for positive reviews and the reviews found on this site represent the opinions of the author.
 

Important Notice:

The information found on Moolanomy is provided and intended for informational and entertainment purposes only and does not constitute financial, legal, or other advice of any kind. The information contained on this site is aimed at a general audience, and does not attempt to offer specific advice to your specific circumstances. If you are looking for professional advice, you should consult with an independent financial adviser.

This site contains information about third party products and services, such as credit card offers, online banking, discount brokers, and credit score services. While we endeavor to ensure that the information presented on this site is accurate at the time of publication, any offers and rates shown on Moolanomy can and do change without notice. Visit the official site of the offer for up-to-date information.

For additional information, please review our Terms and Conditions.

Archives By Year

2007, 2008, and 2009

Additional Resources

  • CheapLoans.co.uk - A simple way to find cheap loans. For a hassle free quotation, apply now!
  • Mortgage Refinance - FHA lender offers fixed rate mortgage refinance loans for consolidating adjustable rate debt and loans, getting cash back and financing a new home remodel.