Author Topic: 40k in Investments or Real Estate  (Read 1156 times)

Invester17

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40k in Investments or Real Estate
« on: July 17, 2017, 09:05:30 AM »
Hi all,

I'd to invest 40k somewhere by the end of this year or early 2017. I already have a majority of my money in investments and also have a single rental property today.

I like the idea of real estate long term since I could eventually live in the property for early retirement and essentially use others people's money to grow wealth / pay it off. This might be slightly opinionated, but where would it best to invest?

Option A: Home purchase for $150,000 with 27% down (40k)

Expected Rent: $1,250
PM fee (10%): $125
Mortgage (including HOA, Insurance, Taxes): $1,085

Profit per month: $40
- Tax deduction / property depreciation
- Equity build up / long term rental & rent increase
- Good area that is expected to really grow over the next decade.

------

Option B: Invest 40k into S&P500 or other investment
Expected return: 5-8% ($3,200 per year)
- Will continue to grow over time, compounding
- Liquid and available
- No maintenance required
- No tax advantages

This might be a loaded question, but I just would like to get peoples take here what makes more sense. I kind of hate dealing with rental properties, but it sometimes seems like a more sound investment long term for passive income.

Thanks,
SL
« Last Edit: July 17, 2017, 09:12:53 AM by Element926 »

RWD

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Re: 40k in Investments or Real Estate
« Reply #1 on: July 17, 2017, 09:50:23 AM »
At 5% returns $40k will turn into $173k over 30 years. Or $403k at 8% returns. Or $541k at 9.07% returns (the CAGR of the S&P 500 from 1871 through 2016).

With the rental paid off after 30 years you will have $150k in equity plus appreciation plus rent net profit  (subtracting for vacancies, maintenance/repairs, etc). Assuming 7% vacancy, 2.69% inflation (for house value and rent increases), and 1% annual maintenance/repair my calculations come up with a final value of $437,570. This is a pretty simplistic calculation and ignores some variables.

If you have different assumptions you should adjust accordingly. No one can tell you which investment will be more profitable in the long run. I can say for sure that the S&P 500 is a lot less work.

Cwadda

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Re: 40k in Investments or Real Estate
« Reply #2 on: July 17, 2017, 10:37:29 AM »
Hi all,

I'd to invest 40k somewhere by the end of this year or early 2017. I already have a majority of my money in investments and also have a single rental property today.

I like the idea of real estate long term since I could eventually live in the property for early retirement and essentially use others people's money to grow wealth / pay it off. This might be slightly opinionated, but where would it best to invest?

Option A: Home purchase for $150,000 with 27% down (40k)

Expected Rent: $1,250
PM fee (10%): $125
Mortgage (including HOA, Insurance, Taxes): $1,085

Profit per month: $40
- Tax deduction / property depreciation
- Equity build up / long term rental & rent increase
- Good area that is expected to really grow over the next decade.

------

Option B: Invest 40k into S&P500 or other investment
Expected return: 5-8% ($3,200 per year)
- Will continue to grow over time, compounding
- Liquid and available
- No maintenance required
- No tax advantages

This might be a loaded question, but I just would like to get peoples take here what makes more sense. I kind of hate dealing with rental properties, but it sometimes seems like a more sound investment long term for passive income.

Thanks,
SL

If you go the real estate route I'd look for a property with better numbers.
You also need to take into account capital expenditures and monthly repair budgeting.

Invester17

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Re: 40k in Investments or Real Estate
« Reply #3 on: July 17, 2017, 12:00:28 PM »
RWD:

Nice calculations, super useful. I almost wonder based on this why real estate would ever make sense given it's clearly much less work and potentially better return. I suppose I'm looking at passive income from a rental wrong, I suppose a return on investment each year after 30 years would almost be the same as a rental property if you broke it down by month.

Given your example the 400k at 8% after 30 years would then continue to compound but at that rate would still be $32k a year (or almost $2.7k per month).

I'm 26 so I have time on my side I'm just trying to get these things started early to let time take care of the rest.

Cwadda,

Would you elaborate on the numbers,  what should I look for? The general idea here was that I only have 40k available to invest so that's why the property made sense. I was also considering a 15 year loan vs. 30 to build up equity faster.

Papa bear

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Re: 40k in Investments or Real Estate
« Reply #4 on: July 17, 2017, 12:05:20 PM »
RWD:

Nice calculations, super useful. I almost wonder based on this why real estate would ever make sense given it's clearly much less work and potentially better return. I suppose I'm looking at passive income from a rental wrong, I suppose a return on investment each year after 30 years would almost be the same as a rental property if you broke it down by month.

Given your example the 400k at 8% after 30 years would then continue to compound but at that rate would still be $32k a year (or almost $2.7k per month).

I'm 26 so I have time on my side I'm just trying to get these things started early to let time take care of the rest.

Cwadda,

Would you elaborate on the numbers,  what should I look for? The general idea here was that I only have 40k available to invest so that's why the property made sense. I was also considering a 15 year loan vs. 30 to build up equity faster.

With properties available at those numbers, id put my money in the market too, and I love rental real estate.

For a good real estate example, real numbers for one my brother just did:

2 unit purchase at 105

Update units at 20k each
Total cost 145

Rents for 2400/ month. 


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Invester17

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Re: 40k in Investments or Real Estate
« Reply #5 on: July 17, 2017, 12:26:44 PM »
Gotcha, I do see a single unit for 90k in the area that I could probably get for cheaper and better return. Do you prefer a 30 year and more profits per month or 15 year to build up equity faster?

Papa bear

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Re: 40k in Investments or Real Estate
« Reply #6 on: July 17, 2017, 01:00:01 PM »
For a rental I prefer 30 year fixed.  All expenses are tax deductible (not like your primary mortgage which is a deduction on schedule a and you have to cross over the standard deduction threshold before you see the savings).

Plus with rates so cheap, I want to keep those long term mortgages out as far as possible.  You can always pay more principal to your mortgage if you would like if you want to pay it down faster.


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Cwadda

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Re: 40k in Investments or Real Estate
« Reply #7 on: July 17, 2017, 01:06:41 PM »
Gotcha, I do see a single unit for 90k in the area that I could probably get for cheaper and better return. Do you prefer a 30 year and more profits per month or 15 year to build up equity faster?

Papabear had a good example. Remember, the deal is in the buy.

As for capital expenditures, this basically means you need to account for itemized things within the house that need to be maintained, fixed, and replaced. Example: A $700 refrigerator that is good for 10 years breaks down to $5.83 a month. Do this for everything: roof, water heater, appliances, furnaces, septic system, etc and factor it into your monthly numbers.

Invester17

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Re: 40k in Investments or Real Estate
« Reply #8 on: July 17, 2017, 01:37:14 PM »
Love it. Great information here guys, I appreciate it. Given those numbers if I went with a 30 year for that original house. After everything it would profit $238 per month (30 year mortgage, 40k down).

specialkayme

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Re: 40k in Investments or Real Estate
« Reply #9 on: July 17, 2017, 02:09:12 PM »

Would you elaborate on the numbers,  what should I look for?

Take a look at MMM's post on the 50%/2% rule:

http://www.mrmoneymustache.com/2011/10/10/lets-buy-a-foreclosure-episode-2-what-is-the-50-2-rule/

Love it. Great information here guys, I appreciate it. Given those numbers if I went with a 30 year for that original house. After everything it would profit $238 per month (30 year mortgage, 40k down).

I don't think you would profit $238 per month. You'd have $238 available after P&I, Taxes, Insurance, HOA and PM fees. Is $238 a month enough for maintenance and upkeep?

When we rented our house out using a PM company, we were required to use their repair people. A total rip. That's where they really make their money. A small issue that would cost me $50 in parts and 30 min in labor results in a "bill" from their repair guy (invoiced through the PM company) at $500. Oh, and they take it direct from the rent, so just pay you the difference. I don't know what PM company you planned on using, but if they do things like this be prepared for an increase in maintenance expenses.

So, using your numbers, if the property generates rent at $1,250 per month, your expenses should be $625 per month (which would include maintenance, taxes, insurance, and HOA, but probably not PM fees). A $150,000 mortgage at 4% would be $716. So, your costs are $715 mortgage (P&I) at 100% financing, $125 PM fee, and $625 in expenses = $1,465. You're losing money.

Your expected rent is also below the 2% benchmark, although I've never known anyone locally to get close to that number. Industry standard around here, by guys that have been doing residential rentals for decades, is 1%+. At $150,000 if you can't get $1,500 a month in rent, I'd walk for certain.

Cwadda

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Re: 40k in Investments or Real Estate
« Reply #10 on: July 17, 2017, 03:14:29 PM »
Quote
Your expected rent is also below the 2% benchmark, although I've never known anyone locally to get close to that number. Industry standard around here, by guys that have been doing residential rentals for decades, is 1%+. At $150,000 if you can't get $1,500 a month in rent, I'd walk for certain.

2% is extremely rare in residential cases. Also, 2% deals tend to be in rough neighborhoods (i.e. drugs, evictions, crime), so be careful about buying properties on numbers alone. I purchased my property for $350k and it brings $4400 in rent. This is about 1.25%, no where near 2%.

Another consideration is that you can value add your way into the 1% or 2% rule. For example, rents are $1000 but you make repairs and renovations, allowing new rents to be $1200-$1300. Value add can take a sub-par deal and turn it into a great one.

Invester17

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Re: 40k in Investments or Real Estate
« Reply #11 on: July 17, 2017, 03:34:43 PM »
The area definitely won't pull more than $1,200 or $1,300 at this time. It's a good area that is up and coming with more developments (town center sort of area right behind it). I could see the price of the homes exploding with this development and therefore increased rent. You're right about expenses and such - I'm not sure what to expect.

Is there a general percentage after all expenses (PM fee, mortgage, maintenance) that I should be looking for in a rental to be profitable? What if your intentions are simply to break even and once it's paid off be a stream of passive income later in life.

tralfamadorian

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Re: 40k in Investments or Real Estate
« Reply #12 on: July 17, 2017, 04:48:35 PM »
Option A: Home purchase for $150,000 with 27% down (40k)

Expected Rent: $1,250
PM fee (10%): $125
Mortgage (including HOA, Insurance, Taxes): $1,085

Profit per month: $40
- Tax deduction / property depreciation
- Equity build up / long term rental & rent increase
- Good area that is expected to really grow over the next decade.

Additional expenses left out above:
Vacancy: $125
Maintenance: $125
CapEx: $125

Average real monthly cashflow: -$335

Your PITI&HOA number is very high for the purchase price.  I'm not sure where you are- in some areas, insurance is relatively high, in some, taxes.  I suspect the HOA is a big reason why this particular property does not work. 

Is there a general percentage after all expenses (PM fee, mortgage, maintenance) that I should be looking for in a rental to be profitable?

The percentage that works for you in your area is going to depend on the details.  Use a calculator like this:
http://www.calculator.net/rental-property-calculator.html

Find out what your typical landlord insurance is for your target properties in your target area.  Look up what your property tax rate is.  Assume your management, maintenance, capex and vacancy will each be 10% of the rent per month until you have hard data otherwise (ex: you take a local real estate investor with fifty properties out to lunch and get real numbers from him/her).  Find out what the HOA fees are, if any, in your target neighborhoods.

Then take all the data you gathered along with the calculator and start running the numbers on a ton of properties available for sale, or even better, the sold prices, for those neighborhoods.  Make a spreadsheet with a tab for each neighborhood you like.  Track what you could expect that your income per month/cap rate/IRR/your favorite measurement on those properties to be.  Then decide what your personal goals are for property profitability- $200/door?  10% cap rate?  12% 14%?  You'll probably prune out some neighborhoods during this process.

Now, you can run the numbers when every new property comes on your radar.  Take a few minutes and plug it into your spreadsheet.  Pretty soon you'll know as soon as you see the listing generally what the property will make. 

Yes, all this will take a little bit of time.  But it's a lot of money you're investing and personally, I think it's worth a little time to figure out what is best for you in your area.  Not someone with C- $15k houses in Ohio whose 2.5% rule or bust.  And not someone with A+ properties in Hawaii with no HOA and 0.25% property taxes where 0.7% will do the job.


tralfamadorian

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Re: 40k in Investments or Real Estate
« Reply #14 on: July 17, 2017, 05:52:16 PM »
Double check your recurring costs section.  The calculator wants annual.  I'm presuming that the HOA is 150/mo, not year.  Also, the maintenance and other (capex) is low balled, especially capex.  This is what I get by upping main/capex and presuming the HOA number is a typo:
http://alturl.com/3q77a

Invester17

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Re: 40k in Investments or Real Estate
« Reply #15 on: July 17, 2017, 08:37:40 PM »
Yes, good corrections and assumptions. Given my scenario (buy and hold) this seems like a pretty good return. I like the idea that people alway need a house to live in and that seems to edge out stock investments especially if I'm maxing other elements like my 401k, HSA, Roth, and vanguard index fund.

Radagast

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Re: 40k in Investments or Real Estate
« Reply #16 on: July 17, 2017, 11:07:52 PM »
Yes, good corrections and assumptions. Given my scenario (buy and hold) this seems like a pretty good return. I like the idea that people alway need a house to live in and that seems to edge out stock investments especially if I'm maxing other elements like my 401k, HSA, Roth, and vanguard index fund.
I think there is some confirmation bias here (hearing what you want to hear). This property looks very "ok". I'd guess you could get similar or better returns with less work and greater liquidity in Total World Stock Index. It fails my own real estate smell check by apparently not being cash flow positive. It also does not meet the 1% rule. If you are already maxing every tax advantaged account it is ok for the long term, but if you want your money before then you may not be able to get it because it is tied up in a marginal rental property. My suggestion is like others... wait and look for something with better numbers. Real estate can require a lot of work and unexpected capital. Speaking from experience ... :) my house has better numbers than yours and I now think I'd rather be a tenant than a landlord! At least tenants can move on a month's notice (or none) with no skin in the game. And I literally thought compound interest was just a theory when I bought mine... now that you know, you can do better I think.

Do you need to pay ongoing utilities? That could be a deal breaker, I must pay a flat $2000 per year for water and sewer.

specialkayme

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Re: 40k in Investments or Real Estate
« Reply #17 on: July 18, 2017, 05:03:51 AM »
http://alturl.com/3q77a

Given my scenario (buy and hold) this seems like a pretty good return.

Seriously? It loses money for 10 years straight! You don't start seeing a return until year 11, and it takes until year 19 for you to make back your losses from years 1 through 10. That's insane.

Plus, that's with you forcing cash flow by putting 27% down. If you 100% finance (which is really the number you should be looking at: http://www.calculator.net/rental-property-calculator.html?cprice=150000&cdownpayment=0&cinterest=4&cloanterm=30&cothercost=0&ctax=1500&ctaxincrease=3&cinsurance=800&cinsuranceincrease=3&choa=1800&choaincrease=3&cmaintenance=1440&cmaintenanceincrease=3&cother=1440&cotherincrease=3&crent=1200&crentincrease=3&cvacancy=10&cmanagement=10&cknowsellprice=no&cappreciation=3&csellprice=200000&cholding=30&csellcost=8&printit=0&ctype=&x=53&y=15) then it's negative cash flow for 21 straight years!

This seems like a really bad idea, both short and long term.

Invester17

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Re: 40k in Investments or Real Estate
« Reply #18 on: July 18, 2017, 05:49:44 AM »
Trust me when I say I don't want a bad investment decision hence the post.

That being said - sounds like clearly this is not a good purchase. My question is now - how do you find a good property that is cash flow positive? Do I have to find something super cheap and fix it up? Foreclosure?

Maybe I'd be better off just throwing the 40k into the total stock market index fund.
« Last Edit: July 18, 2017, 06:31:59 AM by Element926 »

Papa bear

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Re: 40k in Investments or Real Estate
« Reply #19 on: July 18, 2017, 07:02:15 AM »
Trust me when I say I don't want a bad investment decision hence the post.

That being said - sounds like clearly this is not a good purchase. My question is now - how do you find a good property that is cash flow positive? Do I have to find something super cheap and fix it up? Foreclosure?

Maybe I'd be better off just throwing the 40k into the total stock market index fund.

Offer what you think the house is worth as investment.  Maybe that house for 150k, is only worth 120k to you as an investment (to meet your return requirements) Make the offer at 120.

I always joke, the worst they can say is yes! With a no, you're still where you started, you won't counter for more money because the house isn't worth that to you, you walk away. If they say yes... well congrats!  But I would be thinking to myself, could I have gone lower? What sort of work do I need to do now? Why did they accept so fast...


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Invester17

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Re: 40k in Investments or Real Estate
« Reply #20 on: July 18, 2017, 07:20:48 AM »
Good advice - makes sense. I think there is a pending offer on the house (unknown price).

Cwadda

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Re: 40k in Investments or Real Estate
« Reply #21 on: July 18, 2017, 07:42:10 AM »
Trust me when I say I don't want a bad investment decision hence the post.

That being said - sounds like clearly this is not a good purchase. My question is now - how do you find a good property that is cash flow positive? Do I have to find something super cheap and fix it up? Foreclosure?

Maybe I'd be better off just throwing the 40k into the total stock market index fund.

You could always look off the MLS. I find the MLS to be way too competitive for my area. Bunch of cash investors that snap up properties and my offer gets thrown out the window because there's a 30 day closing. I found my 4 family on Craigslist and represented myself. Or you could find an investor-friendly agent to source deals for you.

There's a method of investing when you buy a distressed property for cash, fix it up, rent it out, then cash out refinance, taking all your cash back out. But you need upfront capital to make this happen.

Invester17

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Re: 40k in Investments or Real Estate
« Reply #22 on: July 18, 2017, 09:38:36 AM »
Cool. My takeaway from this thread is I need to do more research to find a good home to be a rental and that alternatively it might make more sense to just continue to invest in the market.

Side question...I have a rental currently with a 30 year loan and it has $187 per month PMI. I could pay the principal down $17k to remove this. However, I'm not sure if it's worth it vs just making extra payments per month (currently I pay $3,200 a month so it will go away in 15 months).

RWD

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Re: 40k in Investments or Real Estate
« Reply #23 on: July 18, 2017, 09:44:11 AM »
Cool. My takeaway from this thread is I need to do more research to find a good home to be a rental and that alternatively it might make more sense to just continue to invest in the market.

Side question...I have a rental currently with a 30 year loan and it has $187 per month PMI. I could pay the principal down $17k to remove this. However, I'm not sure if it's worth it vs just making extra payments per month (currently I pay $3,200 a month so it will go away in 15 months).

Your PMI is effectively 13.2% interest if you can get rid of it with $17k. Definitely worth considering.

Cwadda

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Re: 40k in Investments or Real Estate
« Reply #24 on: July 18, 2017, 09:55:01 AM »
Cool. My takeaway from this thread is I need to do more research to find a good home to be a rental and that alternatively it might make more sense to just continue to invest in the market.

Side question...I have a rental currently with a 30 year loan and it has $187 per month PMI. I could pay the principal down $17k to remove this. However, I'm not sure if it's worth it vs just making extra payments per month (currently I pay $3,200 a month so it will go away in 15 months).

Yes I'd definitely consider putting that $17k down to achieve the appropriate LTV.

Then you could sock away the rest in the market, especially if you haven't already maxed your tax-sheltered accounts.

Invester17

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Re: 40k in Investments or Real Estate
« Reply #25 on: July 18, 2017, 10:11:53 AM »
RWD, how did you calculate that percentage?

Since the current mortgage is currently $2,684 (with the $187 PMI) and I currently pay $3,200. After I pay the $17k would you recommend to stop paying the additional principal ($17k is equal to about $516 for 32 months). My thoughts are that I would get an immediate return for the following reasons:

- No more PMI / $187 a month / reduced risk per month / better cash flow
- Additional equity in house
- Less interest paid / quicker loan payoff date
- I'd go back to $2500 required mortgage for 32 months (to recoup the money paid upfront)
- Continue back in 32 months at $3,000 a month (I'm attempting to payoff the house in 17 years on a 30 year note).

Thoughts?

RWD

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Re: 40k in Investments or Real Estate
« Reply #26 on: July 18, 2017, 10:34:23 AM »
RWD, how did you calculate that percentage?

($187 * 12) / $17,000. You have a $2,244 annual expense that could be removed by investing $17k.

Invester17

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Re: 40k in Investments or Real Estate
« Reply #27 on: July 18, 2017, 10:52:23 AM »
Ah yes. The only thing to note is based on the $1200 prinpal paydown per month it will be gone in 14 months. Do I pay 17k now or just keep going and it's gone in 14 months?

RWD

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Re: 40k in Investments or Real Estate
« Reply #28 on: July 18, 2017, 11:10:44 AM »
Ah yes. The only thing to note is based on the $1200 prinpal paydown per month it will be gone in 14 months. Do I pay 17k now or just keep going and it's gone in 14 months?

14 * $187 = $2,618. Is your $17k going to make you more than that over the next 14 months?

Papa bear

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Re: 40k in Investments or Real Estate
« Reply #29 on: July 18, 2017, 11:29:29 AM »
Ah yes. The only thing to note is based on the $1200 prinpal paydown per month it will be gone in 14 months. Do I pay 17k now or just keep going and it's gone in 14 months?

What about a refi?  See if the property appraisers higher so that you have more equity, thus getting rid of pmi.  Worth a call to a loan officer.


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Invester17

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Re: 40k in Investments or Real Estate
« Reply #30 on: July 18, 2017, 11:36:20 AM »
Papabear, just performed a new appraisal and it went from $440,500 to $459,000 (since March of 2015). That's gotten me in a reasonable range (17k) away from getting to 80% LTV.  Do I think I can make more than $2,618 with 17k in 14 months ~ unlikely but possible. This would be a guaranteed return though which is intriguing. Again, couple that with the fact that I could then only pay the required mortgage of $2,500 for over 2 years - that's the big incentive without throwing off my early pay off date at $3200 a month thus far.
« Last Edit: July 18, 2017, 11:57:36 AM by Element926 »

specialkayme

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Re: 40k in Investments or Real Estate
« Reply #31 on: July 18, 2017, 01:56:38 PM »
Last I checked, to get rid of PMI you need to have at least 20% equity AND 60 months of payments on the loan.

In order to avoid PMI on a refi, you just need 20% equity.

Unless the rules changed . . . .

$17k out of pocket is 17k out of pocket, but if you bought the home in 2015 it'll only be possible through refi.

Invester17

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Re: 40k in Investments or Real Estate
« Reply #32 on: July 18, 2017, 01:59:40 PM »
I have a inquiry with my bank for that now. We will see, if that's true then I guess it won't matter and I'll save the money. So far I've read the 60 months required to be true only when it's a FHA loan (this with a 5% down conventional loan for 30 years).
« Last Edit: July 18, 2017, 02:01:18 PM by Element926 »