Mortgage Refinancing And Real Estate Investing

By Pinyo, on March 9, 2009

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!

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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.

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