Author Topic: Should we pay this off or do something else with the money?  (Read 1440 times)

RPlinker

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Should we pay this off or do something else with the money?
« on: February 06, 2020, 06:01:19 PM »
My wife and I bought a rental in a LCOL area this past June. Property was purchased for $85k with a mortgage of $63.5k @ 4.625% on a 30 year fixed. After HOA($88), taxes, insurance and mortgage is paid we are ahead $290/month. We rent it for $875/month as of today. Goal by Dec 2020 is to have this one paid off then buy another and do the same thing.

I have been paying rental income towards the principal as well as an extra from our personal income each month since June. We now have a balance on the loan of 48k.

I get quarterly bonuses and we have been living off one income for a while now so we could do this no problem. We both currently max our 401ks at our employers and have a 6 month buffer in savings for emergencies. Pretax income of almost 200k last year. Zero debt besides our primary homes mortgage and the rental. East coast US as well... not sure if that changes anything.

My thought process is in the next few years we will have kids and having extra income towards the cost associated with them wouldnít hurt. My wife has no plans on staying home and I donít see that changing but you never know.

What would you do with this money we are throwing at this rental each month? We have both said for peace of mind it would be good to have the first paid in full. Thoughts? Much appreciated!



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« Last Edit: February 06, 2020, 06:18:59 PM by RPlinker »

waltworks

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Re: Should we pay this off or do something else with the money?
« Reply #1 on: February 06, 2020, 09:25:22 PM »
Dude, you're only making $300/mo without including anything for maintenance, vacancy, management, etc?

I would carefully reassess your plan to buy more of this type of rental. At the very low end (where you're at) the overhead can just kill you. One $10k new roof (which will definitely happen, they only last 20-25 years) will wipe out years of profits on a low end property. You'll need paint and carpet regularly, you'll need appliances, the sewer line will crack, etc, etc. None of that stuff costs much more on a $3k/month house than an $800/mo house, though.

Any freestanding SFH needs minimum $1500-2000 a year to maintain it, unless it's cinderblocks with a metal roof or something.

Assuming you want to keep doing this, you need to decide if you want to go the max leverage route (riskier, but more profitable most of the time) or pay off mortgages as you go. That's more of a philosophical decision than a financial one, though, honestly. You can lose all your properties with leverage - or get rich fast. If you pay cash, you're not getting foreclosed on but you're not leveraging that, erm, leverage and cheap gov't subsidized money.

-W

RPlinker

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Re: Should we pay this off or do something else with the money?
« Reply #2 on: February 07, 2020, 05:43:28 AM »
Dude, you're only making $300/mo without including anything for maintenance, vacancy, management, etc?

I would carefully reassess your plan to buy more of this type of rental. At the very low end (where you're at) the overhead can just kill you. One $10k new roof (which will definitely happen, they only last 20-25 years) will wipe out years of profits on a low end property. You'll need paint and carpet regularly, you'll need appliances, the sewer line will crack, etc, etc. None of that stuff costs much more on a $3k/month house than an $800/mo house, though.

Any freestanding SFH needs minimum $1500-2000 a year to maintain it, unless it's cinderblocks with a metal roof or something.

Assuming you want to keep doing this, you need to decide if you want to go the max leverage route (riskier, but more profitable most of the time) or pay off mortgages as you go. That's more of a philosophical decision than a financial one, though, honestly. You can lose all your properties with leverage - or get rich fast. If you pay cash, you're not getting foreclosed on but you're not leveraging that, erm, leverage and cheap gov't subsidized money.

-W

W, appreciate the reply. I forgot to mention this is a town house. HOA covers all exterior maintenance, pest control, landscaping etc for $88 per month. They property is fairly new so as far as dues increasing to cover big ticket items like roofs I see that maybe happening 10+ years down the road. I have kept an eye on the HOA financials for the past few years before buying one and it seems to be managed well with a solid cash reserve. We actually used to live here several years ago.

As far as management we handle that ourselves. Itís not far from us and I have the flexibility that if something breaks my work schedule can be shifted around to handle it. Iím very handy so can fix almost anything thatís not major myself. Paint carpet etc all have costs but again, material costs only no labor. I can do all of that. Havenít felt the need to hire someone else at this point.

I guess we do have some decisions to be made as far as how we want to approach this longer term. Thanks for the reply.



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waltworks

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Re: Should we pay this off or do something else with the money?
« Reply #3 on: February 07, 2020, 07:04:21 AM »
If you're managing yourself, that's a job, not an investment. Take off 10% of your gross for management no matter what.

LOL, $88 a month ain't gonna cover things for long. Good luck!

-W

Car Jack

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Re: Should we pay this off or do something else with the money?
« Reply #4 on: February 07, 2020, 08:41:57 AM »
What's your eventual goal?  If you want to someday own a 100 unit complex, I would think that instead of paying off the rental property, you'd be buying more already and leaving the mortgages in place, working on leverage.  I get that paying off debt is great and I'm in that camp, but it's sort of opposite world when you've got rentals.  You let the bank's money work for you.  Take the deductions on interest payments.

Once you have kids, sure, more income is great.  More time is greater.  There's a clash there.

RPlinker

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Should we pay this off or do something else with the money?
« Reply #5 on: February 07, 2020, 09:46:34 AM »
What's your eventual goal?  If you want to someday own a 100 unit complex, I would think that instead of paying off the rental property, you'd be buying more already and leaving the mortgages in place, working on leverage.  I get that paying off debt is great and I'm in that camp, but it's sort of opposite world when you've got rentals.  You let the bank's money work for you.  Take the deductions on interest payments.

Once you have kids, sure, more income is great.  More time is greater.  There's a clash there.

Great question. Long term goal would be to own 5 of them. I could manage that and still do my day job. 2.5 of them if paid off will pay our home mortgage. (Modest balance 3% 15 year loan).

IF my wife stopped working then having the cash flow would help out and reduce financial stress on me. I guess we are trying to diversify so if we want to retire earlier we have income coming in. A large portion of our retirement is in investments that cannot be pulled out prior to 59.5 without penalties.

Iím trying to give myself options in case of job loss, my wife did change her mind on working and possibly retire before we are as old as dirt.

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RPlinker

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Re: Should we pay this off or do something else with the money?
« Reply #6 on: February 07, 2020, 09:50:51 AM »
If you're managing yourself, that's a job, not an investment. Take off 10% of your gross for management no matter what.

LOL, $88 a month ain't gonna cover things for long. Good luck!

-W


Iím sure it is a job, as of now with one unit and a good tenant it hasnít been time consuming at all. Iím sure that could change tomorrow. Good point about the 10%, thank you.

Yes $88 isnít much but theyíve kept it at that for the past 7 years and have over 400k in reserves. They are doing something right. Time will tell how they plan to handle roof and siding replacement.

We donít have a pool or any of that nonsense so with just exterior maintenance, pest control and basic cable it has been kept very affordable.


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Paper Chaser

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Re: Should we pay this off or do something else with the money?
« Reply #7 on: February 07, 2020, 10:56:33 AM »
What's your eventual goal?  If you want to someday own a 100 unit complex, I would think that instead of paying off the rental property, you'd be buying more already and leaving the mortgages in place, working on leverage.  I get that paying off debt is great and I'm in that camp, but it's sort of opposite world when you've got rentals.  You let the bank's money work for you.  Take the deductions on interest payments.

Once you have kids, sure, more income is great.  More time is greater.  There's a clash there.

Great question. Long term goal would be to own 5 of them. I could manage that and still do my day job. 2.5 of them if paid off will pay our home mortgage. (Modest balance 3% 15 year loan).

IF my wife stopped working then having the cash flow would help out and reduce financial stress on me. I guess we are trying to diversify so if we want to retire earlier we have income coming in. A large portion of our retirement is in investments that cannot be pulled out prior to 59.5 without penalties.

Iím trying to give myself options in case of job loss, my wife did change her mind on working and possibly retire before we are as old as dirt.

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You can access retirement funds before age 59.5 without penalty through something like a Roth IRA ladder. It's covered in great length here:

https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Establishing new revenue streams is good, but it's not as important as maximizing the return on your invested money. Historically, the stock market has returned 7-8% over pretty much any 30 year period. Investing in a low fee funds that tracks the general market is simple, easy, and uncomplicated. It can be bought/sold much faster and cheaper than RE. It gives you a piece of the entire market, so generally it's very diverse. It's The Easy Button for a reason.

On the other hand, A house puts all of your invested money into that single asset, which is more risk from the investor. That asset requires work from you, or it requires you to pay somebody else to maintain it. It complicates your taxes. It can be difficult and time consuming to buy/sell, and it's expensive to do so. Why deal with all of the additional hassle and risk that comes with RE, if you're not out performing the stock market by a decent amount?
« Last Edit: February 07, 2020, 11:05:54 AM by Paper Chaser »

Jon Bon

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Re: Should we pay this off or do something else with the money?
« Reply #8 on: February 07, 2020, 11:31:52 AM »
Two Words

Special Assessment

Your margins right now are not good, all it takes is the HOA to double or triple the fees along with a special assessment to cover a faulty roof to wipe you out for years. I generally dont touch anything with rents that low. A roof/furnace/windows on a 400k house renting for $4000 generally cost the same as they do on a 100k house renting for 1000.

You say exterior maintenance is included. However that cost is 100% passed onto you. If your HOA is under-allocating expenses for future exterior repairs who do you think is going to end up paying for that in the end?

This one feels like it is on a knifes edge with any small thing ruining your returns for years. Please dont buy more of these.



 

Papa bear

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Re: Should we pay this off or do something else with the money?
« Reply #9 on: February 07, 2020, 02:28:49 PM »
What are market rents on these places? Do you have any room for growth here?  If not, start looking for better properties in your area. Any 2 unit places for 120k that can rent for 1600-1800?

This one is doesnít leave any wiggle room.  I really donít think youíll end up more than breaking even or keeping up with inflation in this one.

And managing 5 units while keeping a job?  And you donít have kids yet?  Wait until you have to spend your weekends turning a place, or spending your nights away from your kids because you have to go fix a toilet.  Managing 5 places, a full time job, and kids leaves no leisure time.  Your time on the rentals takes away from kids/family time.   


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bearman

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Re: Should we pay this off or do something else with the money?
« Reply #10 on: February 07, 2020, 09:13:26 PM »
I agree these aren't the type of numbers you want to replicate in 5 properties, but I don't think you need to rush out and sell it either. It sounds like a good and safe one to learn on. If your goal is 5 (or more than 1 really), I'd suggest not paying anything extra on the mortgage, and just save it. When you have enough for the next property's down payment, do some math and decide whether you want #2 and a mortgage, or #1 paid off. When it comes to math, you should master "cash on cash return" metrics, and be honest about all the numbers. It's the only way to be rational about selling a property or deciding on a worthwhile new one.

Dicey

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Re: Should we pay this off or do something else with the money?
« Reply #11 on: February 10, 2020, 07:07:07 AM »
If you want to keep this, you need to look at your current loan first. The interest rate is too damn high! Refinance into a new 30-year fixed loan and let it run. This will dramatically increase your margins. Start saving that for reserves and for a DP on the next one. Paying them off on an accelerated basis is seldom the best financial option, it's just the one that requires the least understanding of how things work.

Everything else I have to say on the topic has been covered by Walt and Joe. Thanks, guys.

tips^up

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Re: Should we pay this off or do something else with the money?
« Reply #12 on: February 10, 2020, 11:09:21 AM »
I agree with Dicey, 4.625% is pretty high for a residential property.  You said it used to be your primary?  Rates should be at least 1% lower.  I refi'ed last fall for 3.375%.  It's a little harder to get low rates if its not your primary residence, as investment or commercial are higher rates.

If the plan is to pay it off or sell it in the next few years, do a 5- or 7-year ARM for most favorable financing.  Adjustable rate mortgage would be higher risk and not recommended if you plan to hold long-term.

Jon Bon

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Re: Should we pay this off or do something else with the money?
« Reply #13 on: February 10, 2020, 12:08:29 PM »
I agree with Dicey, 4.625% is pretty high for a residential property.  You said it used to be your primary?  Rates should be at least 1% lower.  I refi'ed last fall for 3.375%.  It's a little harder to get low rates if its not your primary residence, as investment or commercial are higher rates.

If the plan is to pay it off or sell it in the next few years, do a 5- or 7-year ARM for most favorable financing.  Adjustable rate mortgage would be higher risk and not recommended if you plan to hold long-term.

Not his primary anymore though.

Gonna pay at least .5-.75% higher rates for an investment property.


Dicey

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Re: Should we pay this off or do something else with the money?
« Reply #14 on: February 11, 2020, 09:00:25 AM »
I agree with Dicey, 4.625% is pretty high for a residential property.  You said it used to be your primary?  Rates should be at least 1% lower.  I refi'ed last fall for 3.375%.  It's a little harder to get low rates if its not your primary residence, as investment or commercial are higher rates.

If the plan is to pay it off or sell it in the next few years, do a 5- or 7-year ARM for most favorable financing.  Adjustable rate mortgage would be higher risk and not recommended if you plan to hold long-term.

Not his primary anymore though.

Gonna pay at least .5-.75% higher rates for an investment property.
For our investment properties, we use a local lender who doesn't resell the mortgages and we pay exactly half a percent more. They, along with most other lenders, also require 25% down.

theoverlook

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Re: Should we pay this off or do something else with the money?
« Reply #15 on: February 11, 2020, 11:41:27 AM »
On the actual payoff question here, my opinion is that by making substantial regular additional monthly payments you're concentrating risk. The least risky way to do it is to take the $300/mo and put it in an interest bearing account or investment then pay the house off all at once after the balance on that account is high enough to do so. You have some additional carrying costs that way but you're pretty solidly insulated from problems that way. If you're making the regular monthly payments and funds become tight (for any reason) you have nothing to fall back on but the monthly bills on the rental keep coming. If you've held onto them you can use them to pay the monthly rental bills until things stabilize. If nothing happens and your account gets to the payoff figure you've had some cheap insurance against financial problems.

Your timeline is aggressive enough that it might not be an issue, but you're not paying off $45,000 by making $300/mo in additional payments for 10 months. So you're running pretty thin, cash-wise, is my guess.