Pay off Debt for higher DTI Ratio or Invest? HELP!
Investor · Reading, PA · Member since 2015 · 29 posts · 3 votes
Current Debt.
1 SFH: rented - $200 positive cash flow after paying off mortgage
2 Duplex: rent one and live in another: $200 positive cash flow afer paying off loan
3. SFH: *currently rehabbing* - free and clear - ARV 70K
4. Car Loan: 17k left - 60months - 3% interest
5. Home Improvement Loan: 30k left - 10yr loan - 8.75% interest
6. 20k credit card - maxed out - no interest for the next 12 months.
OPTIONS AFTER REHAB OF #3.
Option 1: Sell number 3 after rehab in a month, pay off 6 and 5, and 4 (no debt)
Option 2: Home Equity Loan at 80%, $200 cash flow in rent income, pay off 6 and 5.
Option 3: Home Equity Loan at 80%, $200 cash flow in rent income, pay off 6 and invest the rest in 1 duplex or 2 SFH
As a general rule, if your DTI is high enough to cause underwriting problems then I would address it. Otherwise, keep buying investment property. Reduce your DTI not by targeting the highest interest rate or the biggest balance, but buy targeting the highest monthly payment.
For instance, I have a HELOC with a payment of $700/month, a personal loan with a payment of $1000/month, and a student loan with a payment of $107/month. It will help my DTI more to pay off the personal loan first, no matter what the terms of each of the two loans are.
What I like to do is to make a spreadsheet and divide the monthly payment by the outstanding balance and sort by this ratio. The higher this ratio, the more benefit you will see in your DTI by paying it off early. When you consider this, I get more DTI reduction per dollar by paying off the student loan first (it only has a remaining balance of $1814).
Keep in mind that if you'll pay off any debt within a few months (I think the rule is 6) then it is not considered in the DTI anyway, so don't throw cash at paying off balances that will be gone in less than 6 months.
What I don't like in your description is your cash flow after paying off mortgage. I'm not sure if this means you consider your cash flow to be Rent - Mortgage = $200. If so, this isn't correct and you need to add factors into this for vacancy, maintenance and capex. If you mean that once you pay off the entire mortgage balance the property will cash flow $200/month, then I'm concerned that you purchased a properties that do not currently cashflow. Whichever is true needs to be addressed urgently and is much more important than DTI reduction.
I hope this helps.
As a general rule, if your DTI is high enough to cause underwriting problems then I would address it. Otherwise, keep buying investment property. Reduce your DTI not by targeting the highest interest rate or the biggest balance, but buy targeting the highest monthly payment.
For instance, I have a HELOC with a payment of $700/month, a personal loan with a payment of $1000/month, and a student loan with a payment of $107/month. It will help my DTI more to pay off the personal loan first, no matter what the terms of each of the two loans are.
What I like to do is to make a spreadsheet and divide the monthly payment by the outstanding balance and sort by this ratio. The higher this ratio, the more benefit you will see in your DTI by paying it off early. When you consider this, I get more DTI reduction per dollar by paying off the student loan first (it only has a remaining balance of $1814).
Keep in mind that if you'll pay off any debt within a few months (I think the rule is 6) then it is not considered in the DTI anyway, so don't throw cash at paying off balances that will be gone in less than 6 months.
What I don't like in your description is your cash flow after paying off mortgage. I'm not sure if this means you consider your cash flow to be Rent - Mortgage = $200. If so, this isn't correct and you need to add factors into this for vacancy, maintenance and capex. If you mean that once you pay off the entire mortgage balance the property will cash flow $200/month, then I'm concerned that you purchased a properties that do not currently cashflow. Whichever is true needs to be addressed urgently and is much more important than DTI reduction.
I hope this helps.
As a general rule, if your DTI is high enough to cause underwriting problems then I would address it. Otherwise, keep buying investment property. Reduce your DTI not by targeting the highest interest rate or the biggest balance, but buy targeting the highest monthly payment.
For instance, I have a HELOC with a payment of $700/month, a personal loan with a payment of $1000/month, and a student loan with a payment of $107/month. It will help my DTI more to pay off the personal loan first, no matter what the terms of each of the two loans are.
What I like to do is to make a spreadsheet and divide the monthly payment by the outstanding balance and sort by this ratio. The higher this ratio, the more benefit you will see in your DTI by paying it off early. When you consider this, I get more DTI reduction per dollar by paying off the student loan first (it only has a remaining balance of $1814).
Keep in mind that if you'll pay off any debt within a few months (I think the rule is 6) then it is not considered in the DTI anyway, so don't throw cash at paying off balances that will be gone in less than 6 months.
What I don't like in your description is your cash flow after paying off mortgage. I'm not sure if this means you consider your cash flow to be Rent - Mortgage = $200. If so, this isn't correct and you need to add factors into this for vacancy, maintenance and capex. If you mean that once you pay off the entire mortgage balance the property will cash flow $200/month, then I'm concerned that you purchased a properties that do not currently cashflow. Whichever is true needs to be addressed urgently and is much more important than DTI reduction.
I hope this helps.
Thank you for your feedback.
Yes, Cash Flow of +200 is after paying off mortgage and factors such as vacancy, maintance, and repairs. I'm leaning towards aggressively paying credit card for next year before it starts encouring interest charges. and If I get a Home Equity Loan based on the equity of the new home, I can utilize it to re-invest in more properties and continue the cycle. (BRRR Strategy).
How do you factor in vacancy and maintenance? What %'s do you use?
@Jacob Sampson It's really best to base that on prior history in your specific area with your specific properties. If you're just getting started though I would use 10% for vacancy and 20% for maintenance/capex. I don't personally spend that much on maintenance but I do a full rehab before I rent them out.
Also, for me personally, I would be uncomfortable in your position. I think you have done some creative things to get yourself started in the business, and that is good, now it's time to protect the progress you have made.
Bare minimum, I pay off the CC and improvement loan before I do anything else. Your current situation should be as short term as possible.
But great job on getting started! You have bigger balls than I do.
I agree. I use 30% as my number as well. I was asking because I find that most people that are new to fairly new use much smaller numbers. I wanted to see if he actually had cash flow or not.
Also, for me personally, I would be uncomfortable in your position. I think you have done some creative things to get yourself started in the business, and that is good, now it's time to protect the progress you have made.
Bare minimum, I pay off the CC and improvement loan before I do anything else. Your current situation should be as short term as possible.
But great job on getting started! You have bigger balls than I do.
Yes, My plan is to agressively pay off the CC within the next 12 months (currently at 0% introductory offer) ... so thats definitely a requirement for me to tackle head on.
If I pay off the improvement loan now with a Home Equity loan, I feel I will limit greatly my spending power to continue investing. payment on home equity loan is about $370 monthly for the next 9 years. so there's no immediate hurry to pay off. Is great to be debt free, I know but even if I pay off everything now.. If you want to continue investing long term on rentals and rehabs, I will see myself in the same predicament in 2 years from now. Thats all Im debating now.. what choice to make.
@Fernando H. Talk to me about the numbers you have for your cash flow on your rentals when the loan is paid off. Are you saying after a mortgage is paid off, meaning you are free and clear on the property, you only cash flow $200 a month on the property? That is very alarming to me as I would guess with an 80/20 LTV on the property you would have negative cash flow on the property. Please show the numbers on your current rentals and I will provide my suggestion.
I'm not suggesting paying off improvement loan with HELOC. I'm suggesting paying of the improvement loan the old fashioned way, with cash. My vote is to spend a bit of time protecting the progress you have made. I know that's boring, but I'm a boring guy.
I am concerned, as well, that he may not have much actual long-term cash flow.
payment on home equity loan is about $370 monthly for the next 9 years. so there's no immediate hurry to pay off. Is great to be debt free, I know but even if I pay off everything now.. If you want to continue investing long term on rentals and rehabs, I will see myself in the same predicament in 2 years from now. Thats all Im debating now.. what choice to make.
*Correction*
$370 monthly payment for the next 9 years (8.75% interest) is for the "Home Installment loan"
I'm a fan of leverage against your properties, but not personal debt. I would take option #2. You then have the free $20k on the credit card, if you need it to fund part or all of another flip/acquisition. The DTI is one factor, but seeing that maxed out credit card will impact your credit score, which means you will pay more for any money you are able to get underwritten, regardless of your DTI.
This isn't a one dimensional equation. You have to approach it more like a Rubik's cube and understand that many factors impact where you get the most benefit. '
Again, I am a fan of leverage. Read Ben Leybovich's blogs for exactly why. But, ongoing credit card debt at the level you indicate is never good. And personal debt against anything that is depreciable (i.e. a vehicle) should be dealt with, if possible. However, you can do another flip to deal with the auto loan. With the interest rate as low as it is, it isn't killing you. The interest rate is why I would tackle the Home Improvement loan now.
I am concerned, as well, that he may not have much actual long-term cash flow.
Help me understand as I'm not understanding the long-term cash flow mentality..
What is the ratio of cash flow that I should be reaching for on a month to month for my rental?
I have cash reserves (for emergency, vacancy, maintenance) for 6 months for each property.
After I pay off mortgage every single month I am left with the following:
SFH: I am left with $200, free and clear x 12= 2,400
Duplex: where I occupy one of the apt rent free, I make $200, free and clear x12 = 2,400
3rd property: current not making anything, is being rehab as we speak - to be ready for rent in 5 weeks.
Completely agree with paying off the credit card first and foremost. While it's at 0% now, it won't be soon. Get that taken care of.
I would then tackle the Home Improvement loan next because of the interest rate you're paying. My reasoning behind this is evaluating your situation as if it's a business and you have an overall cost of capital. You need to make sure that your investment returns are far outpacing your incremental cost of capital. I would argue that #2 is certainly doing that for you (if you factored in that you would pay rent to yourself/have someone else in there) but #1 may not be.
You should know that I'm very risk averse when it comes to debt accumulation. Leverage is excellent if you do it the right way, but IMO you should always be looking for ways to become your own bank and own property outright.
I'm a fan of leverage against your properties, but not personal debt. I would take option #2. You then have the free $20k on the credit card, if you need it to fund part or all of another flip/acquisition. The DTI is one factor, but seeing that maxed out credit card will impact your credit score, which means you will pay more for any money you are able to get underwritten, regardless of your DTI.
This isn't a one dimensional equation. You have to approach it more like a Rubik's cube and understand that many factors impact where you get the most benefit. '
Again, I am a fan of leverage. Read Ben Leybovich's blogs for exactly why. But, ongoing credit card debt at the level you indicate is never good. And personal debt against anything that is depreciable (i.e. a vehicle) should be dealt with, if possible. However, you can do another flip to deal with the auto loan. With the interest rate as low as it is, it isn't killing you. The interest rate is why I would tackle the Home Improvement loan now.
Yes, I agree with all your points. and I appreciate your feedback.
I will definitely pay my credit card in the next year before I incur any interest payments on it but if I pay off my both credit card and improvement loans (50K). I dont believe I would have much buying or credit power to pursue more investments because I need at least 2 years reported rental income to be considered and this is year 1 of reporting for me.
If I go option 2, (2 home equity loans, 1 mortgage and a car loan.. will be too much of a hit on my DTI. and might not pass overwritting).
Completely agree with paying off the credit card first and foremost. While it's at 0% now, it won't be soon. Get that taken care of.
I would then tackle the Home Improvement loan next because of the interest rate you're paying. My reasoning behind this is evaluating your situation as if it's a business and you have an overall cost of capital. You need to make sure that your investment returns are far outpacing your incremental cost of capital. I would argue that #2 is certainly doing that for you (if you factored in that you would pay rent to yourself/have someone else in there) but #1 may not be.
You should know that I'm very risk averse when it comes to debt accumulation. Leverage is excellent if you do it the right way, but IMO you should always be looking for ways to become your own bank and own property outright.
I agree with your point and I appreciate your feedback.
Seems option #2 is the popular one. might have to reconsider. Thanks.
You have a home improvement loan...if that were paid off, could you not turn that into a HELOC, which would give you a line of credit and should come with a lower interest rate? With it being an LOC, you're only paying interest, when you have money borrowed against it.
You have a home improvement loan...if that were paid off, could you not turn that into a HELOC, which would give you a line of credit and should come with a lower interest rate? With it being an LOC, you're only paying interest, when you have money borrowed against it.
Unfortunately the home improvement loan is unsecured and is not lien against the property so is not an option. so that is why interest rate is 8.75% instead of what a HELOC will be at 3%-4%
@Fernando H. The numbers I would be looking for to evaluate your properties are as follows.
Property Value
Total Monthly Rent (per unit in the case of the dueplex)
Breakdown of Monthly Expenditures
Current financing if any
The reason I ask is because if you only make $200 a month after being free and clear on a SFR then depending on the value of the home I may suggest selling that to reinvest in other properties that provide a higher return for you. But unless I know those few things I cant make a suggestion. I would never want to own a SFR if I only made $200 a month on it while being free and clear. If you made that while being leveraged then that could be ok depending on the overall value.
Whether the home improvement loan is secured or not has nothing to do with it, unless you're also saying you don't have enough equity in that property to get a HELOC.
In my experience, the following numbers provide me with a pretty good idea of what my actual long-term cash flow will be on a property. By long-term we mean there will be months with 0 expense and months with tons but averaged out over the long term what sort of cash flow do you actually get.
rent - 30%(vacancy and maint) - PITI = long-term cash flow. If that cash flow is slim vs the rent then I am still concerned. if rent is $10k/month and I am getting $100/month cash flow, there are going to be rough times ahead.
I calculate PITI on 15 years notes, also. But I understand peoples argument against that.
Whether the home improvement loan is secured or not has nothing to do with it, unless you're also saying you don't have enough equity in that property to get a HELOC.
for SFH, I already have HELOC of 10K but I have 0 balance on it.
for Duplex, Home Equity is maxed out at 80%
for current property being rehabbed now. Is free and clear, no mortage. ARV is 70K.
Mind you I live in Reading, PA where alot of decent homes, even rehabbed sell for 50k - 100k and rent doesn't really exceed 1,000/monthly unless you go out of the city, is typically for a decent neighborbood is 600-850 a month.
I would get rid of that car payment altogether. The car depreciates over time.
I'm a fan owning a used vehicle purchased straight out so there are no car payments. Make sure it is a good brand that will be cheap to repair (Ford, Honda, Toyota) and take really good care of it!
I don't do any sort of credit cards whatsoever. Got rid of them when I got my first mortgage and only used it like a debit card before that (to establish credit and would pay off full balance every month). However, I have heard of people doing balance transfers to new cards to keep the interest at 0.
I would get rid of that car payment altogether. The car depreciates over time.
This is a logical fallacy. He already owns the car and the loan. The car will/has depreciated regardless of whether or not he pays the loan. There's no reason he should pay off a 3% loan when he has better alternatives.
To the OP, you and everyone else agree that the credit card has to go. What is your expected return on equity on your other properties and do you have cash reserves for an emergency? If your ROI is greater than 8.75% and you have cash reserves to offset the decrease in liquidity, go aggressive and keep expanding (if allowed by the bank). If not, pay off the Improvement Loan.
I agree on the car loan. You can't get money that cheap very often.
I have no issue with cc debt as long as I am using the money or other money to offset it. Let's say you have 20k in cc debt and 20k in the bank. Logic says to get rid of the cc debt but if you had a secure place to invest it and make a much larger return that what you are paying on your cc while still allowing you to slowly pay it down. This makes much more sense to me assuming it doesnt put a strain somewhere else.
Now the DTI issue arises and also you want to make sure you are not maxing your cc out because that will affect your credit score greatly. I recommend 50% of the max or less.