Refinance or Pay Off Mortgage?
Hi all,
Need some advice. I moved into one of my rentals full time. It was purchased on a 5/1 ARM at 3.875% about 5 years ago and started out as an accidental house hack due to a temporary out of state work assignment. Our initial plan was to live here for 5 years and then move to a nicer primary residence. But, plans changed and I've decided to stay here. I achieved financial freedom about 4 years ago but still work a W2 that I really like because...why not?
Loan is now due to adjust to 5.125% and my monthly payment would jump up around $100/mos if I stay with current mortgage provider (who I detest).
Details...
3/2.5 townhouse in trendy, walkable class A area
- Original purchase price: $142k
- Current value: ~$300k
- Balance owed/payoff amount: $112k
- Current monthly PITI: $820/mos @ 3.875%
- HOA: $390/mos (includes water, trash, sewer and all exterior maintenance + pool and clubhouse access)
Option 1: refinance with new lender
- 4.375%, APR 4.663% - 30 year fixed
- PITI: $840/mos
- HOA: $390/mos
- Closing costs: $4-6k (lender says these will be rolled into the loan/absorbed by appreciation so my out of pocket will be very little)
- I’d been moving ahead with this option but noticed that I’d be paying $30k in interest over the next 5 years and the total interest percentage over the 30 year loan would be 79.92% :(
Option 2: pay off loan balance of $112k
- Monthly payment: $390/mos HOA + insurance and utilities other than water, trash, sewer
- I’d still have six figures+ of cash reserves after paying off the loan
- Save $30k+ in interest plus $4-6k in closing costs
Option 3: allow loan to adjust to 5.125%
- PITI: $950/mos
- HOA: $390/mos
- No closing costs, still paying principal down at a good clip
- Downside here is that it can keep adjusting up every year and I detest my current loan provider, so I hate to keep giving them my business
I know many will recommend a cash out refi to buy more property or invest, but I already have ample cash from selling a property and my portfolio is in a good place where my rentals cover my monthly expenses if I were to quit my W2. I’m also self-managing 7 units (all but one owned outright). I have been looking to possibly add 1-2 more or a small multi but haven’t seen any deals worth moving on recently.
Any recommendations on the best course of action here? What would you do and why?
@Shaun Weekes I took your advice in the spirit that it was given (and I'm guessing that others read it that way too) and greatly appreciated your input. Always excited hearing about different investment vehicles and have been researching all of the tips suggested here.
If I was in your shoes, I would pay off the mortgage and get a 80% ltv heloc. It won’t cost you a penny in closing costs, and you get the lowest rate by staying 80% ltv. You have reserves and ample cash and you have a re portfolio so time to pay them off. if something comes up you have the heloc and you can always refinance the paid off property in the future if you need to or you find a deal to add to your portfolio.
Ericka Grant
The return from equity in a property is zero.
Allowing the bank to have more equity in a property that you 100% control is better than the other way around. Having 70% - 80% LTV is actually an asset protection strategy.
You might look at this combo of options:
1.) refinance into a 30-year fixed to reduce the monthly payment and allow for even more monthly cashflow to invest.
2.) invest the $112k you would have used to pay off the loan into AHP Servicing. AHP provides a 10% preferred annualized return and you can access your initial capital back in 30 - 60 days if needed. They offer monthly distributions or auto reinvestment. It’s a social investment that helps families stay in their homes instead of being foreclosed on by banks.
3.) take a HELOC out on the property to access the remaining equity that is getting you zero return. There are many lenders that pay the closing costs, so it’s only the time gathering and completing the paperwork for you. HELOCs are great for short-term deals and cash reserves on rentals or general emergency fund. Keep in mind the variable rate though.
@Craig Jeppesen this is really resonating with me...I'm leaning in this direction. Thanks for the input. I NEVER thought I'd be someone to pay off my mortgage early when loans were so cheap, but looking at the overall market situation, my personal situation, and the amount I'd save on interest, it seems like the best move right now. The last thing I need to figure out is if opening a HELOC will negatively impact my credit vs. keeping the mortgage.
@Eric Schultz I hear you. I've had folks on BP telling me that owning a property outright is silly for years, but, I personally like a mix of leverage and full ownership...I use leverage when it makes sense, but in this case, since I have ample cash reserves (so paying this off won't impact my ability to invest in other deals or have an emergency cushion), the $30k in interest and $6k in closing costs to refi makes leverage more of a liability than it seems to be worth. Also, due to rising rates, I'd be paying all this money to refi and then also have a slightly higher monthly payment :( For me, it comes back to the question - why pay interest on money I don't need to borrow? Why not flip things and be the one earning interest (I'll invest my monthly payment instead) now that interest rates are higher?
Allow loan to adjust to 5.125% ( for now ) ...payoff the loan as fast as you can...save the 6K in expenses ....
@Dave Skow this makes a lot of sense too...the rate might end up being a bit less than 5.125% since LIBOR has been going down lately. Called bank yesterday and they said the new rate will lock on the day my loan is actually due to adjust in May, or something like that. I'll see where the rate lands and make a final decision I guess.
Originally posted by @Dave Skow:
Allow loan to adjust to 5.125% ( for now ) ...payoff the loan as fast as you can...save the 6K in expenses ....
Dave Skow beat me to it. Why not a "hybrid" option of 2 and 3? It doesn't have to be all or nothing. If you have the money to pay the whole 112k balance, but are still unsure whether or not to go for it, why not just put an extra $3000/month toward principal? You'll save interest by paying it off in ~3 years, still have the option to pay off the rest at any time, you have the option to STOP paying the extra principal at any time if you've found a better use for the money....and with the equity you'll add (and already have) you can still get a HELOC any time you want. It doesn't need to be paid off to obtain a HELOC.
One thing is for sure - I definitely would NOT recommend paying $4-6k in closing costs with all the other options you have, and especially not for $112k.
@Jim D. Thanks for the input - agree that a hybrid approach might make sense since the rate is still pretty low for the next year...that said, even if I were to keep the mortgage just one more year at 5.125%, I'd be paying close to $6k in interest in the first year.
If I pay the mortgage off and put that same monthly payment into an investment account - i'll essentially make whatever interest the market yields PLUS the 5.125% I would have been paying on that money if it stayed in the mortgage. Maybe I'm looking at it wrong, but it seems like as long as I do better than negative 5.125% in the market I'd come out ahead by getting rid of the mortgage interest payment (on cash I no longer need to borrow)? The more I think about this, the more I wonder why anyone would keep a mortgage on their primary a second longer than needed.
For investment properties, the tenants are paying the mortgage and interest, so it makes sense to use leverage responsibly there...but for the primary, the argument seems a bit less clear.
@Eric Schultz
I have enjoyed this conversation and it seems like people are willing to comment so I guess I can jump right in and ask for some opinions
I have have several rentals right now but my focus right now is concentrating on my primary in which I owe less than 70 wich is less than what I owe on any of my properties. My interest rate is 3.2 on a fixed 10 year loan. I have been on the fence about moving or staying and remodeling. The house is worth over 300k. Any inputs or thoughts.
@Lee Perry are you asking if you should pay off your primary? Can you clarify the question?
At first glance, 3.2% for 10 years sounds like a cheap loan, so I’d keep that one until it adjusts
I would run the numbers for each scenario. There is no right or wrong answer, if you are comfortable refi and paying more to save some $ on interest rates, or if you want to have leverage and refi longer term to pay less if you eventually move out and have a tenant paying your costs plus good cash flow.
Lee Perry
What year will the 10-year loan adjust?
As Ericka Grant said, that’s a really good rate. Inflation is basically creating a net neutral situation for you. Every dollar in interest that you pay the lender as the years go by is worth less, and hopefully you are experiencing a little bump each year on property appreciation to hedge inflation on the other end.
If you move, would you be remodeling to sell at a higher price to retail buyer or holding this property as a rental?
@Ericka G. I would also encourage the HELOC route. That is what I did with my primary residence. Although, there can be closing costs with a HELOC even though others have said there are not.
Also, there are still plenty of deals. You may need to change your strategy though. I personally like to invest in C class properties. I think those returns are better than other Classes.
Have you considered the lease option strategy? Here is an example:
1. Buy a property under market value around 60% of the ARV.
2. Fix up the property but don’t fix up everything, but make sure the major things such as the plumbing, electrical, AC unit, water heater, and roof are in good working order and will last at least 5-7 years.
3. Market the property as a lease with an option to buy for the ARV amount or a little bit higher (we usually mark it up 5-7% above current ARV to take into consideration appreciation). Have the new tenant themselves paint the property and do any upgrades they want.
4. Get a new loan on the property for 75% of the ARV. With this loan amount and the $3900 option fee, you should be very little out of pocket on the property.
5. The property is really easy to manage because the tenant buyer takes care of it because they have pride in their future ownership of the property and you have set up expectations as such.
With $100k - $200k you should be able to do this strategy all day long without leaving a lot of your own money into the property for very long. This strategy works best on properties where your all in is less than 140k and you can lease the property for at least .9% of your all in. These numbers are estimates and you would of course want to run your own numbers on the specific property.
@Shiloh Lundahl very interesting! I like that strategy. I considered setting one of my units up as a lease option but ended up renting it out the traditional way. The prices increased a ton in that market (suburban Detroit) so I’m actually glad I didn’t do the option on that one as it is worth way more now than the price I’d been considering for the option.
What % of yours actually take the option and go through with the purchase? I think prices will start to plateau soon so this is a good time to consider about this approach for my next deal. Thanks for the reco.
@Ericka Grant
This loan is fixed
@Eric Schultz
This a fixed loan that. The payment is 1028 a month and 839 I believe is principle. I just write a check for the taxes near the end of the year as well as my insurance for the year. We were considering both remodeling or moving but the main goal was to get at all that equity to continue my properties.
@Eric Schultz
My plan is to hold it then remodel at some point before selling. Since I would own it outright I would look into using HELOC to purchase more properties
Lee Perry
Rates are fairly low right now with the Fed only planning on one rate hike later in 2019 as of a couple weeks ago.
You might run the numbers on a cash out refinance (fixed rate) and compare to the HELOC (variable rate). With a credit score of 760+ you can get a cash out refinance rate on an investment property around 4.75% and lower than that for a primary residence (3/2019). Closing costs + 3rd party service fees on a cash out refinance may run about $2,500 - $3,200 depending on the lender you go with.
@Eric Schultz
Thanks for the thoughts.