Pay down new mortgage or invest?

[Rollin]

I debated putting this question in Real Estate and Landlording, but thought this would be the best place for my question because it relates well to Investing.  Also, I know there are many posts/threads on this topic and I will continue to study them.  However, I'd like to give my current situation and ask what you all might suggest my plan of attack be.  It is always better for me to take action if I know my specific situation has been laid out properly (I am always cautious).

BTW - this is my 3rd post.  Not sure why I point that out except to say that I'm new here so be nice - or give me a punch in the face if you think that is what I need!

I own three homes as follows:
**Home 1 - paid for, in my pocket sale value $125,000, 2-bedroom, 2-car garage, 2 bath, has renter (a relative) until April.  Clean and good condition, new air conditioner, nice safe neighborhood close to schools, 1 mile from our downtown, and not far from area beaches/water.  Monthly cost to own (taxes and insurance $300).
**Home 2 - paid for, in my pocket sale value $150,000, 3 bedroom, 2 car garage, 2 bath, just moved out/vacant.  Clean, solar hot water, will need $4K of new AC unit in next 5 years.  Right next door to the house one so same location items.  Monthly cost to own (taxes and insurance $400).
**Home 3 - $206,000 mortgage and will be what I live in.  Just moved in and plan to stay.

I have no other debt.  I have a good retirement building (457K, employer provided, SS, and a life insurance annuity) and won't work more than 10 years more.  Have about the equivalent of 2 months of pay saved and will have 6 months worth by mid-summer.  If you need more information, let me know.

My question is when I sell these two should I place $206,000 of the $275,000 on the current new home to get rid of the 2.85% 15 year loan?  Or, should I invest that while continuing my approximately $1,900/month payments (that includes principal, interest, taxes, and insurance)? Or something of a hybrid between the two.  Likely, if I invest it will need to be safe and secure - but that can change!

Note:  I've considered renting both; or selling house 2 and continuing to rent house 1, but I am just not comfortable continuing to be a landlord.

Thanks all!

[lauren_knows]

If I were in your shoes, and you were definitely selling the rentals, and you planned on staying in your primary residence for more than 5 years, I'd absolutely pay off the mortgage.  It's not the mathematically correct thing to do, if you have any faith in the stock market, but it's a major psychological win. You reduce your expenses long-term, and open up cash flow for other investments.

FWIW, I think there is a difference between having a lump sum amount able to pay off a mortgage and trying to decide whether or not to focus on mortgage paydown with cashflow.  I've decided that we're not going to focus on mortgage paydown, and rather focus on the market.  But, if I had a lump sum, I'd kill my mortgage in a heartbeat.

[tooqk4u22]

Invest.

If you don't sell, then place some modest debt on the rentals and invest the funds.

My personal view is that if you had choice - it should be your primary house that is paid off and not the rentals.

[Spork]

If I were in your shoes, and you were definitely selling the rentals, and you planned on staying in your primary residence for more than 5 years, I'd absolutely pay off the mortgage....

I'm with bo_knows.  There is a huge psychological gain here.  Lots 'o folks can argue (with probably good reasons) why it's better to invest in a better return....  But *MY* retirement plan includes a paid off house.  And there is something immensely freeing of having enough FU money that you can walk out at any time and still meet monthly needs for a significantly long period of time.

You might also take that $1900 a month and invest THAT.  Keep making the payments, but pay yourself instead.

[Rollin]

Yes, it is odd that I have a mortgage on the one new one and none of the other two, but I got there by living in house 1 and paying it off, moving to house 2 and paying it off, and now living in house 3.....and paying it off.  I guess I see a pattern here.

If I paid off the $206,000 I'd certainly invest the remaing sale $$, as well as the $1,900/month that is going towards the mortgage.

I forgot to mention that I did a comparison of renting both vs. paying off the $206,000 and after five years there was not a significant difference in financial gain between the two.  Of course, after 5 years rentals would pay more.

I do plan on staying in thenew home for more than 5 years.  I am "investing" in energy saving measures in the new house by replacing the single-speed pool pump with a variable speed pump (should pay for itself through lower enegry bills in a few years), just "foamed" the attic (should double the life of my HVAC system, reduce cooling bills by 50% and heating by 30%, and lower my insurance - wind load credit), all lighting going to LED lighting, replace older windows (I get wholesale and install myself), etc.  We have a 17% utility and franchise fee added to our electric bill in our area, so not only does every dollar reduced add up to a dollar (go figure), but also saves us 17%.

Thanks for such quick replies.  I am not dismissing anything each of you post and will keep watching for your responses.

[Another Reader]

I have a lot of rentals, so my first question would be why are you selling these free and clear rentals?  If you don't like being a landlord, turn them over to a property manager and let them produce income with some tax shelter for you.  As long as they are not in a bad area and produce a reasonable rate of return, in your shoes I would keep them and use the income to pay off the mortgage on the principal residence.

[Rollin]

...not in a bad area and produce a reasonable rate of return, in your shoes I would keep them and use the income to pay off the mortgage on the principal residence.

This is my situation above.  I should be able to get $1200-1300 for the 3 bedroom and $1000 for the 2.  Total of say $2200, with the $700 taxes and insurance (deductible) subtracted that is $1500/month.  What do typical costs go for property managers?  I mainly do not want to spend a lot of time over there dealing with the property - I want to spend my spare-time time with my family.  I am also fearful of getting bad renters - have you ever seen the movie Pacific Heights!?  I guess I shouldn't watch movies like that...

[Another Reader]

Property management should be 8 to 10 percent of the gross.  You will have to shop to get a good one.  If I owned these two properties, I would probably hold them.  There might be better cash flow elsewhere, but the transaction costs would be high to sell and buy.  Take a close look at your tax return to measure the benefits of the depreciation and the amount of this income that is sheltered.  Let the tenants in these houses pay off the mortgage on your principal residence and enjoy some tax sheltered income.

[JamesL]

I would recommend keeping them and getting a property manager. You have to consider the money you gain in rental income as well as the equity of the homes going up. I think homes raise about the same as inflation, so 3-4% a year (correct me if I'm wrong), so you're making great returns on them. A property manager will filter clients and it sounds like you're in a great place, and should get 2 nice families in there. If you take care of your homes your tenants are much more likely to take care of the home, because they will see it as a "home" for themselves.

My dad just rented out his rental with a 2 year lease. He goes through a property manager (charges 8%) and as we were finishing remodeling the condo the renter showed up, chatted with us and asked us to mark the paint cans so he can do touch ups when he needs to. That tells us right away that he cares about the place, and wants to make sure the home he's living in is as nice as possible.

Honestly I'd kill to be in your position, of owning 2 homes outright like that. That's essentially my goal, to get a place, pay it off,  rent, etc. Exactly like you did.

Good luck :). I look forward to seeing what you decide to do.

[Rollin]

Wow, these responses are opening my eyes to some ideas that I hadn't thought of and causing me to maybe appreciate what I have a little more.

I should talk with someone about the tax implications and advantages as opposed to guessing.  There is a lot of little costs that I need to provide for in selling or renting, but that add up to fairly significant costs.  It sure would be nice to "deduct" those.

Also, I had a friend recommend a property manager and I can approach her with the thought of cutting me a deal for the two properties (to manage them) since they are right next door to each other.  I'd think that was worth something.  My realtor is great and offered to screen renters for us for $50, so that is an advantage and would help get me along with that part of the process.

[tooqk4u22]

...not in a bad area and produce a reasonable rate of return, in your shoes I would keep them and use the income to pay off the mortgage on the principal residence.

This is my situation above.  I should be able to get $1200-1300 for the 3 bedroom and $1000 for the 2.  Total of say $2200, with the $700 taxes and insurance (deductible) subtracted that is $1500/month.  What do typical costs go for property managers?  I mainly do not want to spend a lot of time over there dealing with the property - I want to spend my spare-time time with my family.  I am also fearful of getting bad renters - have you ever seen the movie Pacific Heights!?  I guess I shouldn't watch movies like that...

Understand though that your $1500 doesn't include amounts for expected vacancy, repairs, maintenance, replacement reserves, etc.

[Rollin]

Understand though that your $1500 doesn't include amounts for expected vacancy, repairs, maintenance, replacement reserves, etc.
[/quote]

The sound of a balloon popping!  Just kidding, but that does come into play and is factored into a spreadsheet I developed that again showed that after five years (renting vs. selling/playing off my mortgage) it was slightly in favor profit wise to go with rental.  I did factor in the purchase of a new AC unit in that timeframe, and about $100 per month in maintenance (total for both homes).  After five years it was more in favor of renting.

I'd like to retire in 10 or less if that factors in.

[Mr Mark]

I also hate the idea of selling those rentals, esp. If in a good area, are in relatively good condition, etc. The tax advantages are great. Think about protecting yourself with a limited company structure perhaps.

I'd have a 30 year fixed mortgage on the house you live in, enough equity to just avoid PMI, and indeed then maximise long term investments in the market, using your monthly savings and rental income. The equity you hold in the rentals offsets the mortgage, you gain tax advantages on both rental income, depreciation and interest payments, and if you wanted to consolidate into 1 fully owned house later no problem.

The rentals and rents are inflation proof income and assets. The home you live in is an expense.

Negotiate a slight discount due to the adjacent rentals and pay the management fee. A good manager is money well spent. I'd rather pay a good one 15% than a bad one 5%!

[Rollin]

I have an update that I'd like to share with all that posted.  I was panning on selling one house (putting the proceeds on my current mortgage) and renting the smaller/less valued house.

My current renter (a relative) was to be out by April 1, so I decided to show the place last weekend.  Had a great couple come over to look at it and while on their way over I had another talk with the relative.  Well, I guess due to personal reasons she will need to stay awhile longer!  I still showed the couple the house and told them it might not be available when they wanted it (they knew it was iffy coming in that it might be another month, or so).  I happened to be working on the house I planned to sell (right next door) and thought to myself, "hey they seem like a nice couple, why don't I show them the larger house?  Maybe I will reconsider sellling it."

Long story short they want the larger house for what I was happy with rent wise.  I need to have it ready by April 1 so lots of cleanup (paint, etc.), but it works out better in the long run.  I can always sell it at some later date and still get my equity out of it.  At least in this mean-time I can have a pretty good income on a paid-for house.

I appreciate the input from all.  Any further input?

[Another Reader]

Based on what you have said about the properties, that's what I would have done.  Just be sure to do a full vetting of the proposed tenants before signing a lease.

[Rollin]

Based on what you have said about the properties, that's what I would have done.  Just be sure to do a full vetting of the proposed tenants before signing a lease.

Thanks - I'm starting the background check now.

Mr. Mark - Do you know what type of professional I'd check for this - "limited company structure?" Tax accountant, insurance agent, attorney?

[Mr Mark]

All of the above. If you don't know people like this already, think about hanging around a Lions or Kiwanis club. Or a good bar. Or church I guess. I get this sort of advise for free through awesomely talented friends.