Rental Houses Debt vs. Building the 529 plans

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bullspooker
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Rental Houses Debt vs. Building the 529 plans

Post by bullspooker » Fri Sep 20, 2013 3:05 pm

Leaving retirement out of it and just focusing on the college issue:

Child 1 starts college on 8/2023.
Child 2 starts college on 8/2026.


Rental House 1 pays off on 12/2026 (current value $130k, owe 68k on 4.25% 15 yr). Income is 800.
Rental House 2 pays off on 8/2027 (current value $150k, owe 98k on 3.25% 15 yr) Income is 1000.

$9000 in 529 plans now.

Withdraw 529 money ($8500 after fee and tax) and put toward Rental House 1.
Add 400/mo to rental house 1 so it pays off on 8/2019.
The total of rent income plus 400 = 1200/mo which is then applied to Rental House 2 and it pays off on 5/2022.

Then a year and 3 months later, we pay for college out of cashflow from houses with 30k saved from the 2500 (two rental incomes plus the 400 per month).

…otherwise we keep the 9000 in the 529 plan for college expenses and add the 400 per month to it. Using 5% return, it would come to 78k to pay for school when child 1 starts college.
That money should last until Rental House 1 gets paid off (3 years) then 1 more year and child 2 starts college. 1 year later, Rental House 2 is paid.

The rate of return in the 529 plan could be more or less affecting our results, but the loan repayment plan is guaranteed as the loan rates do not change.

The end result is:

Houses paid off and 30k in bank=more guaranteed with fixed mortgage rates.
OR
78k in bank when when Child 1 starts college, 3 years later Rental House 1 is paid and 1 year after that Rental House 2 is paid.

I am thinking I am an idiot to not pay down the houses. Does this seem logical?
Last edited by bullspooker on Mon Sep 23, 2013 8:47 am, edited 1 time in total.

bungalow10
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Re: Rental Houses Debt vs. Building the 529 plans

Post by bungalow10 » Fri Sep 20, 2013 4:01 pm

What is the P&I on each house payment? Is the income gross or net?
An elephant for a dime is only a good deal if you need an elephant and have a dime.

mamarachel
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Re: Rental Houses Debt vs. Building the 529 plans

Post by mamarachel » Fri Sep 20, 2013 4:04 pm

All of your income from the houses is taxable, the 529 gains are not. Add that to your thought process.

Also, you are in fixed rate low-interest loans, which (in general) only get cheaper and easier to pay down with inflation of rents and salary. Your gross rents will come up in addition. I think you can easily get them both paid off before DC1 enters college AND have the money in the 529.

bullspooker
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Re: Rental Houses Debt vs. Building the 529 plans

Post by bullspooker » Fri Sep 20, 2013 5:22 pm

I net about $150 a month after paying the mortgages. And, yes it will get easier to pay, but I also will have a ton of other expenses...cars for kids maybe, vacations, travel sports.....

DVMResident
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Re: Rental Houses Debt vs. Building the 529 plans

Post by DVMResident » Fri Sep 20, 2013 6:18 pm

My guess is $150/month net isn't quite right after considering taxes. The houses depreciate, which lower your tax liability, as do repairs and capital investments (e.g. carpets, frigs, etc.). Landlords often make a lot of their early income from tax write offs, which is slowly replaced with unearned income as inflation drives rental prices up and deductible depreciates wane.

What is the impact on your taxes? Include depreciation (a tax deduction) and rental (unearned) income costs (a tax liability, which increases under ACA). My guess is you're netting more than $150/month-it's just hidden in your tax return :o

This book helped me understand the ins and outs of being a landlord:
http://www.nolo.com/products/every-land ... -dell.html
If you not taking your full deductions, spends some time with this book or hire a tax professional for 1 year to deduct everything correctly. Missing these deductions can be huge.

House 1 is grossing 7.38% of purchase price.
House 2 is grossing 8.00% of purchase price.
Both are decent. So it's worth keeping the properties.

You're plan is fine, but if it was my money, I would fund the 529* over pre-pay the mortage. These mortgages rates are low and fixed incomes source (e.g. T-notes) may surpass them soon.

*If your state allows for 529 deductions, the 529 is a no-brainier.

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grabiner
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Re: Rental Houses Debt vs. Building the 529 plans

Post by grabiner » Fri Sep 20, 2013 10:11 pm

Those mortgage rates are low, and also tax-deductible. If you are in a 28% tax bracket, paying down the 4.25% loan gives you a guaranteed return of 3.06% after tax. Also, it's a long-term return; you are considering paying off the loan in six years rather than thirteen, which gives an effective duration of nine years. You can earn 2.73% risk-free by investing in 10-year Treasury bonds in a tax-deferred account; an equivalent Vanguard fund would yield 2.53%. (You could also take a bit of risk by holding corporate bonds instead, and you could also choose to invest in something else, but nine-year bonds make a fair comparison.) By keeping the loan, you also keep more liquid cash, and retain the right to refinance your loans later if appropriate.

Thus, I would recommend funding the 529 for more tax-free growth, and likewise your IRA and 401(k), before paying down the mortgages.
Wiki David Grabiner

bullspooker
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Re: Rental Houses Debt vs. Building the 529 plans

Post by bullspooker » Sat Sep 21, 2013 4:26 pm

grabiner wrote:Those mortgage rates are low, and also tax-deductible. If you are in a 28% tax bracket, paying down the 4.25% loan gives you a guaranteed return of 3.06% after tax. Also, it's a long-term return; you are considering paying off the loan in six years rather than thirteen, which gives an effective duration of nine years. You can earn 2.73% risk-free by investing in 10-year Treasury bonds in a tax-deferred account; an equivalent Vanguard fund would yield 2.53%. (You could also take a bit of risk by holding corporate bonds instead, and you could also choose to invest in something else, but nine-year bonds make a fair comparison.) By keeping the loan, you also keep more liquid cash, and retain the right to refinance your loans later if appropriate.

Thus, I would recommend funding the 529 for more tax-free growth, and likewise your IRA and 401(k), before paying down the mortgages.
It is a question of returns, but also a question of cashflow. You do put it in perspective as a low rate of return. hmmmmmm

Rebecca_S
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Re: Rental Houses Debt vs. Building the 529 plans

Post by Rebecca_S » Sun Sep 22, 2013 9:50 am

I wouldn't withdraw any money from the current 529, the taxes and fees wouldn't be worth it. You didn't consider the situation where you leave the 529 balance alone but direct the $400/month to the rentals. That should get at least the one, possibly both, paid off before the older child graduates HS. Your rental income should rise with time but the mortgage payment will stay about the same.
How confident are you that both your kids will go to college in 10 and 13 years? Trade school, military etc. might be options or if one took a gap year it alters the timing.
Is the mortgage interest actually tax deductable on a rental? I was under the impression that only the interest paid on owner-occupied properties was tax deductable.

bullspooker
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Re: Rental Houses Debt vs. Building the 529 plans

Post by bullspooker » Sun Sep 22, 2013 3:25 pm

Rebecca_S wrote:I wouldn't withdraw any money from the current 529, the taxes and fees wouldn't be worth it. You didn't consider the situation where you leave the 529 balance alone but direct the $400/month to the rentals. That should get at least the one, possibly both, paid off before the older child graduates HS. Your rental income should rise with time but the mortgage payment will stay about the same.
How confident are you that both your kids will go to college in 10 and 13 years? Trade school, military etc. might be options or if one took a gap year it alters the timing.
Is the mortgage interest actually tax deductable on a rental? I was under the impression that only the interest paid on owner-occupied properties was tax deductable.
The interest is deductible but I have always thought people overestimate the power of deductions. I would think that to be a secondary consideration.

Pulling the money out will cost about 500 bucks but will take 1 or 2 years off the 1st rental mortgage and accelerate the benefit of the other payments so I was thinking it was worth it.

I guess in 5-7 years it may not seem like a good plan to pay them off because then rates will be higher (probably) and the money would be better saved or in bonds/CDs.

Seems like the decision is not real clear cut. For my fickle self, sinking the money into the mortgages is maybe a good way of staying the course.

travellight
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Re: Rental Houses Debt vs. Building the 529 plans

Post by travellight » Sun Sep 22, 2013 4:01 pm

My gut reaction agrees with Rebecca; I would not pull out any from 529s and pay any fees. I would pick a middle ground where you fund the 529s less perhaps and allocate a bit more to one mortgage so it is paid off. That being said, I personally chose to not fund any 529 plans and have aggressive mortgage pay down so that his college cost will be my new mortgage (and hoping rental income will cover it). I would defer to grabiner and DVMinvestor though who seem very knowledgeable on this subject.

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