Pay large sum to mortgage/student loan or add 3rd unit and rent?

Multi-Family and Apartment Investing
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Pay large sum to mortgage/student loan or add 3rd unit and rent?

Shane Evans
VT · Member since 2013 · 6 posts · 0 votes

Hi everyone,

I've been following along on this forum for quite some time and this is my first post. Thank you for your time. 

I bought a 2 family home in November of 2015 and live in one unit. (First time home buyer) after months of settling in and updating the rental apt, we just put a tenant in the second unit this month. (10 months between purchase and rent income) we are getting $1300 per month for the 1 bedroom. We pay for heat and water. Our mortgage is $2300 per month. Utilities around $150. Mortgage is 219k@ 4% interest, we pay 120$ in PMI within the 2300.

Our student and car loans are around 100k@ an average of 5% interest, with a monthly payment of 1400. 

My question to you all is what would you do with the following situation. 

We have 35k in savings. (20k of which is from an estate) We were told, to our surprise, by the town housing department that we have a 3rd unit registered. The home has an large unfinished space that is set up to be the 3rd unit. 

Should we drop the 20k into the 3rd unit or should we put it toward the mortgage/loans? I'm guessing we can get about 1300$ or more for this space as well and we would only pay for water. 

Thanks for your time and input!

Shane

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Aaron HowellBusiness Member
Real Estate Agent · Crozet, VA · Member since 2014 · 436 posts · 223 votes
10y

This is a Dave Ramsey vs. Robert Kiyosaki answer !  

If you put the $ towards debt you'll still have debt left over but it will get paid off sooner but if you finish the 3rd unit you'll have $1300 extra per month to work with.  

I would go for the 3rd unit because you're going to be increasing your income and cashflow plus long term you'll have increased the value of the property by X amount of dollars which you could then apply to another property or toward those loans.

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  • Aaron HowellBusiness Member
    Real Estate Agent · Crozet, VA · Member since 2014 · 436 posts · 223 votes
    10y

    This is a Dave Ramsey vs. Robert Kiyosaki answer !  

    If you put the $ towards debt you'll still have debt left over but it will get paid off sooner but if you finish the 3rd unit you'll have $1300 extra per month to work with.  

    I would go for the 3rd unit because you're going to be increasing your income and cashflow plus long term you'll have increased the value of the property by X amount of dollars which you could then apply to another property or toward those loans.

    Story House Real Estate527 Reviews
    WebsiteView Page
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  • Jim Adrian
    Architect · Papillion, NE · Member since 2015 · 1k+ posts · 840 votes
    10y

    I would look at adding the 3rd unit and letting your money work for you.  Can you provide separate utility metering for the units?  Can you extend out your student loan payment to reduce monthly payment? Im guessing you are on a 10 yr repayment plan. 

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  • Stephen Seaberry
    Woodbridge, VA · Member since 2015 · 44 posts · 7 votes
    10y

    Taking a shot in the dark before I read any comments, to see where my own head is at regarding investor psychology.

    With the 1 unit already rented, it looks like your coming out of pocket $1,150/month.

    Plus $1,400 in SL and Car Note

    You have $20k in free cash that's not currently earning anything, but has the potential to earn $1,300/month or $15,600/year.

    That would mean your RR on the $20k would be 78% if you do the necessary upgrades to rent the 3rd unit.

    The $1,300/month also means you'd be living rent free with a cash flow of $150/month. Free cash of $1,300/month (the $1,150 you are currently paying in mortgage and utilities plus $150 cash) could then be used to pay towards principal on SL and car not, accelerating debt pay down.

    78% RR on 20k minus 5% avg SL and Car interest and 4% mortgage interest = IRR of 69%

    I think (assuming I'm looking at this the right way), using your 20K in cash soldiers to generate additional income is more advantageous than using it to pay down debt. Grant Cardone would tell you to only carry debt other people can pay for. This seems like a situation where that would apply.

    This isn't even accounting for the additional tax benefit you get from "making interest payments" on the mortgage.

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  • Andrew Mullen
    La Porte, IN · Member since 2014 · 5 posts · 6 votes
    10y

    I agree, let your assets pay your student loans.

    1Reply
  • Shane Evans
    OP
    VT · Member since 2013 · 6 posts · 0 votes
    10y
    Originally posted by @Jim Adrian:

    I would look at adding the 3rd unit and letting your money work for you.  Can you provide separate utility metering for the units?  Can you extend out your student loan payment to reduce monthly payment? Im guessing you are on a 10 yr repayment plan. 

     Jim yes I am looking into metering all three units. I can lower my student loan payment because I'm paid ahead quite a bit. 

    0Reply
  • Shane Evans
    OP
    VT · Member since 2013 · 6 posts · 0 votes
    10y
    Originally posted by @Stephen Seaberry:

    Taking a shot in the dark before I read any comments, to see where my own head is at regarding investor psychology.

    With the 1 unit already rented, it looks like your coming out of pocket $1,150/month.

    Plus $1,400 in SL and Car Note

    You have $20k in free cash that's not currently earning anything, but has the potential to earn $1,300/month or $15,600/year.

    That would mean your RR on the $20k would be 78% if you do the necessary upgrades to rent the 3rd unit.

    The $1,300/month also means you'd be living rent free with a cash flow of $150/month. Free cash of $1,300/month (the $1,150 you are currently paying in mortgage and utilities plus $150 cash) could then be used to pay towards principal on SL and car not, accelerating debt pay down.

    78% RR on 20k minus 5% avg SL and Car interest and 4% mortgage interest = IRR of 69%

    I think (assuming I'm looking at this the right way), using your 20K in cash soldiers to generate additional income is more advantageous than using it to pay down debt. Grant Cardone would tell you to only carry debt other people can pay for. This seems like a situation where that would apply.

    This isn't even accounting for the additional tax benefit you get from "making interest payments" on the mortgage.

     Thank you for the detailed explain that you gave. So what I'm getting from this is that I may spend the 20k now but it will return 30k in 2 years. And that frees up more money to pay toward my other debt. 

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  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    10y

    the "unregistered unit" comment bothers me - - the City could be baiting you and then hit you with fees and non-compliance issues.  VERIFY what needs to be done to "rent out the 3rd unit" - - not just get it registered.

    1Reply
  • Stephen Seaberry
    Woodbridge, VA · Member since 2015 · 44 posts · 7 votes
    10y

    Absolutely...assuming you can achieve the rent you've presented. When NPV is factored in, it should be more than 30k. But bottom line dollar amount can be misleading. Look instead at the rates of return from the different options. Sure 30k may appear good, but if in that same period you're paying $35k in debt, you're not actually coming out on top. In this instance, assuming the numbers you presented are accurate, it seems like no brainer. Carry the debt, rent the 3rd unit, accererlate your debt pay down with the cash flow.

    I'm reading this book What Every Real Estate Investor Needs to Know About Cash Flow by Frank Gallinelli. Its brilliant at changing your perspective from looking at bottom line dollar amounts to looking at the trade offs in terms of rates of return. The author was also recently on the Passive Real State Investing podcast show 049. Good stuff.

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  • Stephen Seaberry
    Woodbridge, VA · Member since 2015 · 44 posts · 7 votes
    10y

    Wanted to correct my earlier post. The 69% IRR I stated isn't the IRR. I went back and revisited what IRR is and my answer is not how you arrive at IRR.

    0Reply
  • Shane Evans
    OP
    VT · Member since 2013 · 6 posts · 0 votes
    10y
    Originally posted by @Jeff B.:

    the "unregistered unit" comment bothers me - - the City could be baiting you and then hit you with fees and non-compliance issues.  VERIFY what needs to be done to "rent out the 3rd unit" - - not just get it registered.

     J Beard,

    Could you explain this to me a bit more? I'm not fully sure what concerns you have for this. 

    0Reply
  • Shane Evans
    OP
    VT · Member since 2013 · 6 posts · 0 votes
    10y
    Originally posted by @Stephen Seaberry:

    Absolutely...assuming you can achieve the rent you've presented. When NPV is factored in, it should be more than 30k. But bottom line dollar amount can be misleading. Look instead at the rates of return from the different options. Sure 30k may appear good, but if in that same period you're paying $35k in debt, you're not actually coming out on top. In this instance, assuming the numbers you presented are accurate, it seems like no brainer. Carry the debt, rent the 3rd unit, accererlate your debt pay down with the cash flow.

    I'm reading this book What Every Real Estate Investor Needs to Know About Cash Flow by Frank Gallinelli. Its brilliant at changing your perspective from looking at bottom line dollar amounts to looking at the trade offs in terms of rates of return. The author was also recently on the Passive Real State Investing podcast show 049. Good stuff.

     Thanks for the feedback. I'll have to look into that book. 

    0Reply
  • Shane Evans
    OP
    VT · Member since 2013 · 6 posts · 0 votes
    10y
    Originally posted by @Stephen Seaberry:

    Wanted to correct my earlier post. The 69% IRR I stated isn't the IRR. I went back and revisited what IRR is and my answer is not how you arrive at IRR.

     Thank you for clarifying!

    0Reply
  • Joshua D.
    Investor · Columbus, MT · Member since 2013 · 1k+ posts · 1k+ votes
    10y

    My Personal concern would be having ample cash reserves when you are done with the rehab.  2 units will eat cash on occasion, be ready.  

    With that said, I am a somewhat debt adverse guy  (although you could not tell from my balance sheet) , but I am still voting for you to rehab that unit.  Once you get them both rented you will be making more than the mortgage payment on the place! Having a payment covered is less risky that paying down a 100k debt by 20k.  

    You should also look into a REFI when the rehab is done and drop the PMI and possibly the an interest rate drop. might be worth looking into.

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