Author Topic: Case Study: Optimize Housing Situation to Achieve Goals - 15 yr, 30 yr, rent/stay??  (Read 4207 times)

Field123

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Mustachians! I need your help. I'm trying to assess my housing situation so that I can best achieve my 3-5 year goals. I'm usually pretty good at this but for some reason I'm running into a mental block on some of the math...

About me: 28 years old. Single, no dependents. I really got into MMM about a year ago, just after I closed on my condo in Chicago (face punch? We'll see...). Before MMM I was pretty interested in personal finance but would place myself in whatever the next category is after MMM (ERE, MMM, ... Me.) I thought I had it all figured out and would cruise along with my 30-40% savings rate and retire at 65 with millions in the bank. Well, I've since decided to go full bore Mustachian which will require a complete reevaluation of my money habits and, for me, housing is the big one.

About my Condo: Purchased in July 2014 for $267,500. I bought it with 10% down at 4.625%. The condo is perfect - located in the best location possible, allows for an expanded future family situation and should meet my needs for the next 7-15 years. I live there with a roommate who pays me a flat $600 per month. This condo would rent for $2100 per month. My thinking at the time of purchase was that it was a good buy because the monthly payment for owning is less than the cost of rent in this particular area. My mistake was probably limiting myself to this (expensive!) neighborhood where I wanted to live.

My current stats:

Net Monthly Income: $6,219
Cash pay - $4,600
*PAYE student loan - ($522)*
Rent Income - $600
Simple IRA - $1291 ($1,041 me, $250 employer)
HSA: $250
*This program has been debated in other threads. I'm a big believer in its value for FIRE, but regardless I'm too far in to change course now. For those unfamiliar with the program, my monthly payment will always be 1/12 of about 8% of the prior years AGI. As it is tied to income and will be 0 upon FIRE, I chose to account for this as a reduction of income, like a tax, rather than an expense.

Total Monthly Expenses: $3,800
 Condo: $1,865
 P&I: $1,211 (P=$324, I=887) Again, Mortgage was for $240,000 in July 2014 at 4.625%. Condo value: $275,000. Current loan balance: ~$237,000
 HOA: $194
 Escrow: $460 (Taxes=$266, Insurance=$27, PMI=$167)
 *Other life expenses: ~$1,900/month
*Major room for improvement here, obviously, but outside the scope of the present conversation.

Retirement Accounts: $30,000
Cash on hand: $0.00
Debt (other than mortgage and student loan): $0.00

Near term goals (not necessarily in order):

1) Refinance mortgage on condo to get a better rate and drop the PMI
2) Buy an income property (3 flat).

My plan is to rent my condo in May 2016 for $2,100.00 per month. Move to a rental property in a different neighborhood where I will rent and have a total cost of living of $2,000 per month ($800 rent, $1200 other), whereby I will save about $24,000 in cash that year.

After a year, I hope to buy a 3-unit property in the same neighborhood for $400,000.00. I would like to do the purchase with a 3.5% down FHA loan, live in one unit and rent the other two. This should result in a break even cash flow situation where both the cost of ownership and rent return from the other two units are about $3000 per month. My total monthly cash flow at this point should be about $2500-3000 + any cash flow from the condo rental. After two years of living in the income property, I would like to refinance to a conventional loan at 80/20% LTV, rent out the third unit where I had been living, and move back to the condo where I will stay into the foreseeable future.  Target move back to condo date: May 2019.

At this time the rental building should cost about $2500/month and generate rents of $4500/month.

Sorry for all the buildup, I provided a lot more commentary above than I had intended....

The question is, what do I do with the condo? I feel that I need to refinance because my interest rate of 4.62% is too high (last year my credit score was about 680, now about 730) and I need to get rid of the PMI. I'd also like to ReFi before interest rates increase, and I need to do it while I am still an owner occupant to qualify for the best rates.

Here are the options as I see them (no particular order):

1) Sell condo. Walk away with about $27,000 cash and start over (buy the 3 flat now?) Problem is, I LOVE my condo. I'd really like to live here as long as I can. I realize this is an emotional response and, unless it's very close, I will pick logic over emotion.

2) Refinance for a 30 year note at ~ 4.1%. In this scenario I would borrow the cash to get me to 20%LTV from family ($17,000-23,000 depending on appraisal). New cost of ownership would be $1,500 per month. I'd rent at $2100 per month and pay back the relative with the $600 monthly cash flow generated by the rental over the 36 months I'd be renting it.

3) Refinance for a 30 year note at ~ 4.1% without bringing cash to the table. This would make the monthly cost $1800, saving only about $65 per month and adding another year of payments. I'm assuming PMI remains at $167/month here. Probably the worst option on the table.

4) Refinance for a 15 year note at ~ 3.1% without bringing additional cash to the table. Monthly cost here would be $2302.00 (includes $167 PMI) until month 19, when PMI would automatically cancel as I'd hit 78%LTV, bringing monthly cost to $2135.00.

5) Option #4, but borrow the $17,000-23,000 extra to get to 80% and have payments be $1,966.00 from the onset. As rent is only $2100, I'd have to dip into my own cash flow to pay the relative back over the 36 months, which I fear could throw off my timeline on acquiring the rental property if unforeseen expenses occur.*

6) Don't refinance and rent condo. Here I would cash flow about $235/month from the condo. PMI would automatically drop early 2022.

7) The rental property plus constant moving is stupid. Instead just do any of the above options, reduce expenses and continue to live in the condo.

*I came up with the 15-year note idea after reading MMMs article http://www.mrmoneymustache.com/2011/05/24/mmm-challenge-get-yourself-a-lower-mortgage-rate/ on the subject where he enthusiastically recommended it. Personally I've always disagreed,  thinking that, considering today's interest rates, it is best to leverage as long as possible and invest the savings in the stock market. Here, the $466 monthly difference between the 15/30 years invested at 7% return results in $140,521 after 180 months. The balance on the 30 year note at that time is $138,800. So it seems the 30 year note is the better deal, but I think the element of "forced savings" through the 15 year probably outweighs that ~$2,000 benefit....

So there we have it. Any and all thoughts, comments, and discussion are appreciated!

I'm particularly interested in getting people's opinions on which ReFi/housing option best allows me to own the income property at 80% LTV in May 2019. I'm really struggling with the calculations on whether the 15 year or 30 year is better, as well whether the benefits of borrowing additional funds to get me to 20% is worth the trouble.

However, if you see holes in any part of my plan, have a better alternative, or really any other ideas, by all means please share!

Thanks in advance!!
« Last Edit: October 08, 2015, 12:19:03 PM by Field123 »

mozar

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I would go for option 7 personally, and not do 1-6. Can you get a second roommate for your fancy condo?

ColoradoEng

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It seems like you are giving your roommate a pretty great deal to split a condo you could rent out for $2100.  This person is paying for less than 1/3 of the cost of the condo for 1/2 the condo.  Could you up the rent on the roommate a little?

Another Reader

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It looks to me that you do not understand rental property, as you think your profit is the rent less the mortgage, taxes and insurance, and HOA.  You have not considered vacancy and collection loss nor repairs, maintenance, and capital improvements.  It might be helpful to read iamlindoro's pinned post and a few of the books on Arebelspy's list of real estate investing books.

Your idea is not without merit, a triplex might be a worthwhile investment, but you need realistic numbers to evaluate the options.

justajane

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It doesn't sound to me like you have enough in liquid assets to afford the new rental property. IMO you would be living too close to the edge if you needed to make major repairs or if you had vacancies.

I would work on building your stash more. How long do you have left on the PAYE student loan payment?

Field123

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Thanks for the replies! I was getting nervous that no mustachians would come to my aid on this one..

I would go for option 7 personally, and not do 1-6. Can you get a second roommate for your fancy condo?

No. Unfortunately the condo, while indeed fancy, is only a 2 bedroom. Even if you wouldn't rent/pursue obtaining an additional rental property, would you try to do one of the ReFi options I presented? It sure seems to me that a ReFi is an absolute must, and the question is more 15 or 30 year...

It seems like you are giving your roommate a pretty great deal to split a condo you could rent out for $2100.  This person is paying for less than 1/3 of the cost of the condo for 1/2 the condo.  Could you up the rent on the roommate a little?

This is certainly an idea. And his deal is even sweeter because I pay the utilities on top of it. The current deal was me making the best out of an unfortunate situation -- last year I was living with a SO who I expected to become spouse and start a family -- so the whole condo purchase decision was predicated on that situation. When it didn't work out I was left scrambling to find someone to share the cost and it had to be someone I actually wanted to live with. It's a win-win, but definitely in the roommates favor. I guess I rationalized that I get the equity and tax benefits while making a deal with someone I wanted to live with at a price he could afford. I might be able to get another $100 out of him but unfortunately he is very limited in what he can afford.

It looks to me that you do not understand rental property, as you think your profit is the rent less the mortgage, taxes and insurance, and HOA.  You have not considered vacancy and collection loss nor repairs, maintenance, and capital improvements.  It might be helpful to read iamlindoro's pinned post and a few of the books on Arebelspy's list of real estate investing books.

Your idea is not without merit, a triplex might be a worthwhile investment, but you need realistic numbers to evaluate the options.

You're surely right that I am being very generous in some of my assumptions. I think my condo rent profit projections are 90%+ solid, but the Triplex is much less certain.

I'm not concerned about vacancy as I am certain of the high demand for the condo (I actually work as a realtor as a side-gig, so have access to the MLS etc). Having to go through collections would be unfortunate and I hope, especially at this price level and with said demand, to be able to screen for good tenants. But you're right, you never know. Your concern about repairs and maintenance is probably most valid. Everything in the condo is fairly new and I would only really have to worry about the appliances/plumbing (which are perfect right now) so I feel pretty good in the near term, but eventually something will come up and that will come out of the bottom line.

With the triplex you're absolutely right. My profit projections stated in the OP represent the absolute best case scenario that will absolutely not prove true over time. Ultimately if we can get the tri-plex to 80/20 LTV with a monthly PITI of about $2500 and a rental market supporting $4500, I am confident (hopeful :-/ ) that the investment will remain profitable even after accounting for the additional expenses you mention. But I will admit that while I feel knowledgable about the local real estate market I am inexperienced with actually managing a rental building...

It doesn't sound to me like you have enough in liquid assets to afford the new rental property. IMO you would be living too close to the edge if you needed to make major repairs or if you had vacancies.

I would work on building your stash more. How long do you have left on the PAYE student loan payment?

You're definitely right. If everything goes according to plan as outlined above, the rental property will allow for a much more rapid accumulation of cash, but if a major repair or other unforeseen expense occurred early on that would be a real problem.

With this thought in mind, if you were me, would you stay in the condo and try to build up cash here (with current expenses I should cash bank about $900/month... After I improve my spending I expect to be able bank closer to $1,500) or rent the condo and continue with Phase II of my plan whereby I downgrade my own housing and in turn bank a higher amount of cash?

I have 18 years remaining on the PAYE payment... I hope to FIRE in no more than 12 at which time the payments will drop to near 0. There is no scenario where paying off the student loan debt is economical at this point.

cchrissyy

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Whatever you do, don't sell a condo you love, in a neighborhood you want to be in long term, which is realistically able to bring in more rent than it costs to keep it.  Seriously, do anything BUT that.  The rent will rise with inflation. The mortgage is a fixed price. The principal is being paid down.


My options would probably be

 1) get a roommate who is able to pay $1000 a month and half the utilities.  Live in the condo, it's where you want to be.  Yes, refi it for better rates and to lose PMI. 

2) rent out the whole condo while you rent anywhere that costs less than $2100 a month.

justajane

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With this thought in mind, if you were me, would you stay in the condo and try to build up cash here (with current expenses I should cash bank about $900/month... After I improve my spending I expect to be able bank closer to $1,500) or rent the condo and continue with Phase II of my plan whereby I downgrade my own housing and in turn bank a higher amount of cash?

If I were you, I would stay in the condo and at least raise the rent on your roommate by $50-$100 and ask him to pay his portion of the utilities. Explain to him that this will still be well below market rate. I know it's worthwhile to have someone you like, but you are lengthening your time to FIRE. Is his company worth that?

I personally would build my stash not with rentals but with index funds, but I would say you need at least 20K liquid.  Perhaps those who have rentals can better advise you on the right number.

But, like others said, don't sell a condo you love living in and that you can afford.

Field123

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With this thought in mind, if you were me, would you stay in the condo and try to build up cash here (with current expenses I should cash bank about $900/month... After I improve my spending I expect to be able bank closer to $1,500) or rent the condo and continue with Phase II of my plan whereby I downgrade my own housing and in turn bank a higher amount of cash?

If I were you, I would stay in the condo and at least raise the rent on your roommate by $50-$100 and ask him to pay his portion of the utilities. Explain to him that this will still be well below market rate. I know it's worthwhile to have someone you like, but you are lengthening your time to FIRE. Is his company worth that?

I personally would build my stash not with rentals but with index funds, but I would say you need at least 20K liquid.  Perhaps those who have rentals can better advise you on the right number.

But, like others said, don't sell a condo you love living in and that you can afford.

I definitely think a rent increase is in order if I stay. Unfortunately, with this particular roommate, I'm probably limited to $100-200 increase. His company is absolutely NOT worth delaying FIRE as it relates to me moving. It probably is, as it relates to replacing him with a stranger from craigslist who is willing to pay market rate rent.

So it seems that the early consensus is to remain in the condo? I'm surprised. I definitely agree that selling is not the best option as it is a price controlled asset, but I actually expected a bunch of face punches telling me to take the rent and move to a cheaper place immediately.
« Last Edit: October 09, 2015, 03:53:10 PM by Field123 »

Field123

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Whatever you do, don't sell a condo you love, in a neighborhood you want to be in long term, which is realistically able to bring in more rent than it costs to keep it.  Seriously, do anything BUT that.  The rent will rise with inflation. The mortgage is a fixed price. The principal is being paid down.


My options would probably be

 1) get a roommate who is able to pay $1000 a month and half the utilities.  Live in the condo, it's where you want to be.  Yes, refi it for better rates and to lose PMI. 

2) rent out the whole condo while you rent anywhere that costs less than $2100 a month.

Thoughts on 15 year vs. 30 year? And thoughts on borrowing cash to get to 80%LTV and paying that back over say 36 months vs. either ReFing without the cash, or waiting until I save it on my own (maybe 12 months) while risking changes in interest rates etc

cchrissyy

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I am partial to a 30 year fixed rate, paid down early.  The price of a 15 or 30 year loan are close enough (usually I think less differnce than the 1% you are quoting), and you have the flexibility to pay just the 30 year payment when times are tight.

But it sounded to me like you fit in with the folks who say get 30 year and don't pay it down, rather, invest the difference. That's cool too.

As far as your LTV choices, well, none of them suck, I'd be inclined to lock in today's interest rates in whatever way avoids PMI the best, even if that means bring $ to closing through a family loan, and slightly delaying your plans to buy something else in the next couple years. Depending on the appraisal, this might not be very much of a delay.

For what it's worth, I'm a person who moved out of my primary (only!) house because I can rent it to others for a lot while I live in someone else's rental for less. I move a lot. I pay it down early even though my rate is low. It has been a Very Good Thing for me.
Like you, I bought with 10% down and got rid of PMI by refinancing, but did not have to bring $ to the table due to a higher appraised value.

justajane

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You'll find that MMMers differ on whether to do a 15 or 30 year. I personally like the lower payment security of a 30 yr, in the event of job loss, especially if you can get a good rate. You can always overpay and essentially turn it into a 15 year. Or you can take the difference between the two and invest it in the market and likely come out ahead.

People who aren't great investors or savers should probably do the 15 yr, especially if they can easily afford the payment of the 15 year and have relative job security. I don't know how to factor in your desire to purchase more properties. Others would be better at advising you on what is better for that scenario.
 

cchrissyy

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Quote
I don't know how to factor in your desire to purchase more properties.

If you need to save for your next down payment, you can

1- get the 30 year, don't pay it down, invest somewhere for the downpayment

2- get the 15 or 30 year, pay it on schedule or faster, and obtain a HELOC with so that your principal paydown on the condo can serve as the downpayment.

mozar

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I don't think a refi to 4.1% is worth it.So you are saying that going to 3.1% you would only save 2k? No I don't think that's worth it.  Can you pay down the ltv to git rid of pmi using your own cash?  I don't think borrowing more is the answer here.
If your condo allows it, I would get a second roommate, and sleep on the dang couch! I can't do that in my co-op.
And sorry to hear about the ex. The same exact thing happened to me 2 years ago.

Field123

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You'll find that MMMers differ on whether to do a 15 or 30 year. I personally like the lower payment security of a 30 yr, in the event of job loss, especially if you can get a good rate. You can always overpay and essentially turn it into a 15 year. Or you can take the difference between the two and invest it in the market and likely come out ahead.

People who aren't great investors or savers should probably do the 15 yr, especially if they can easily afford the payment of the 15 year and have relative job security. I don't know how to factor in your desire to purchase more properties. Others would be better at advising you on what is better for that scenario.

Is there a really good thread where the 15 yr vs. 30 yr is debated? I did a search but can't find a really deep thread on the issue

mozar

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No not really. I would say from what I've heard here is that the absolutely most optimum choice would be a 30 year with a rate under 5%. Because it's a hedge against inflation.  But it depends on your psychology. I decided to go from 5.1% 30 year to 3.5% 15 year. With the difference being $130 a month. Adding up everything, I come out ahead by $4k.
Just stick around, it comes up a lot.