Author Topic: Yay low interest rates... now what to do?  (Read 2069 times)

Spondulix

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Yay low interest rates... now what to do?
« on: July 06, 2016, 08:17:15 PM »
I'm looking into a couple refinance options. We're in Southern California and our plan at this point is to buy a second home (in 5-10 years - probably out of SoCal) and turn this house into a rental.

Current loan:
approx $275k
30 year 3.875%
4 years into the loan
Monthly payment $1,446

Refinance option 1:
30 year 3.5%
Monthly payment $1,235
We'll probably make extra principal payments while we live in the house

Refinance option 2:
20 year 3.25%
Monthly payment $1,573

Right now our house would rent for over $3k/month. I'm leaning towards the 30 year loan since that would net more profit renting. Over ten years, the difference in interest between 3.25 and 3.5 percent is $10k, but an extra $300/month in rental income would be $36k. Or, does it make sense to do a 20 and refinance again down the road when it's time to rent?

Another Reader

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Re: Yay low interest rates... now what to do?
« Reply #1 on: July 06, 2016, 09:10:43 PM »
If you are in Southern California, rentals often do not make sense from the perspective of cash flow.  The second option will make you cash flow neutral to slightly negative over a long holding period, based on the 50 percent rule and your estimate of current market rent.  If rents double, the cash flow might be decent, but your ROI might not be so good.

You might want to think about what the house is worth vs the market rent.  It's not unusual to see the rent per month be 0.5 percent of market value per month.  Using the 50 percent rule, you would net 0.25 percent per month or 3 percent per year.  Not a great return on a risky asset that requires management.  Any interest rate over 3 percent in this scenario means your leverage is negative, and your return on equity will be less than 3 percent.

Each time I refinance a property, I assume it's the last time and the numbers have to make sense.  If the interest rates go down, I am pleasantly surprised.  They can go up, and have in the past.

talltexan

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Re: Yay low interest rates... now what to do?
« Reply #2 on: July 06, 2016, 09:22:02 PM »
Conventional wisdom says to ignore the Arm, but you should consider the value of the lower interest rate possible now. If you make what would be the highest payments you list, but against the low interest rate of the ARM, you will really see that principal decrease rapidly, leaving you less exposed to possible rate increases that may come in 5-7 years.


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Spondulix

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Re: Yay low interest rates... now what to do?
« Reply #3 on: July 06, 2016, 09:48:21 PM »
For reference: the house cost $410k (worth approx $580 now). With 2% rule on purchase price that'd be $8200... ouch. I see why having a rental here may not make sense.

Two follow-up questions:

Another Reader- how are you calculating the percentage of return on equity? Say rent goes up another $1k (conservatively) so $4k/month. With 50% rule and $1500/month mortgage (3.25%) I'd be netting $500/month. I'm guessing it's still under 5% but not sure how to calculate

My husband just asked, "If we've already put a lot of money into maintenance (and the cost of selling will be expensive), why not make what money we can keeping it as a rental?" We'll be losing over $30k to the agent cost alone. If we sell and invest in somewhere with better ROI for rental properties, won't it still take a fair amount of time to make up for those losses?

zephyr911

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Re: Yay low interest rates... now what to do?
« Reply #4 on: July 07, 2016, 07:25:40 AM »
My $.02: make the decision about the rental when it's time to move. Minimize your cost of credit right now with the shorter 20yr loan and you'll have way more equity in a few years. THEN, look at real estate values and decide if it makes sense to rent out or liquidate.

Another Reader

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Re: Yay low interest rates... now what to do?
« Reply #5 on: July 07, 2016, 08:17:13 AM »
The rule on single family is a minimum of 1 percent per month.  If the rent goes up $500, if the rent as a percentage of market value in your area does not change, the value of the house went up $100,000.  The amount of still negative leverage went down, so maybe your cash flow return improves slightly. However, you have a lot of low yielding capital tied up in this property.

I suggest you read some of the books in the list pinned to the top of this forum category to learn about real estate investing. In particular, Sword Guy's recommendation of Gallinelli's book will help you.  If you do not understand the concepts in that book, don't invest until you do.

Lmoot

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Re: Yay low interest rates... now what to do?
« Reply #6 on: July 07, 2016, 09:27:18 AM »
Take the higher payment and lower interest rate. This will reduce the principal the most by the time you're ready to buy that second property (as well as saving you more interest). Then, before you buy the 2nd property, refi again for 30 years, or whatever gets you the lowest payment.

Because:

Even if you get a renter for your house, many lenders will not count rental income towards your qualification for a second mortgage until after 1-2 years of rental income. Unless you make enough money to pay both mortgages and still meet the min DTI ration the lender requires for a second property, you will need to focus on keeping your debt payments (which includes mortgages of 1st and 2nd property, and often times also includes taxes and insurance....PITI), as low as possible.

You ran keep DTI lower  by putting a high DP on 2nd property, or paying down principle on 1st property. Or having a high enough income. But I would not count on being able to add a new lease agreement to your income on a loan for a second mortgage. Now CA is it's own country, so I don't know how things operate there; but it's worth checking out.

Spondulix

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Re: Yay low interest rates... now what to do?
« Reply #7 on: July 10, 2016, 12:36:41 AM »
Great advice everyone... this is exactly what I needed to know. Thank you!