Refinance 30yr to 15yr mortgage?

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GrumpyMonk
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Refinance 30yr to 15yr mortgage?

Post by GrumpyMonk »

Just finished the "Bogleheads Guide to Investing" book and was intrigued, so now I am new to these forums. I have so many questions...

I currently have a rental property in a good area, easy to rent, etc. It's a 30yr loan at 3.5%, original balance was $270k. Currently, the principal balance is at $237k. My wife started working so we've had extra cash and I've been pondering whether to pay down the current mortgage or try to refinance to a 15 yr mortgage at a lower rate. Currently, I just started adding a $500 principal payment each month, which will effectively reduce the term of the loan by about 10 years. Monthly mortgage payments are about $1500, I also pay $360 p/month in HOA fees.

We already fund both 401(k) retirement accounts, and will probably be doing the backdoor roth contributions as well. Everything else goes into the market.

I lack the mental fortitude to calculate what's the better way to move forward; on the one hand I HATE paying so much interest on the loan so refinancing to a 15 year mortgage appeals to me, assuming I can get a rate around 2.5%. But... would I be better off just continuing to add principal payments to my already low interest rate? Or should I just pay the minimum each month and not worry about any of this principal only payment/refinance stuff?

Thank you in advance for your help!
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jjg247
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Re: Refinance 30yr to 15yr mortgage?

Post by jjg247 »

You should research 15yr mortgage rates, I don’t think 2.5% is possible without paying for points. I use this webpage http://www.mortgagenewsdaily.com/mortga ... aily.aspx

In the last 52 weeks the lowest a 15yr FRM has been is 3.12%.
petulant
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Re: Refinance 30yr to 15yr mortgage?

Post by petulant »

15-year and 30-year mortgages on a rental property involve a risk-return trade-off. You get a lower rate for the 15-year, but your principal payments are larger, meaning you have less or negative cash flow which is a risk to your liquidity. You also have greater risk until your exit that a chain of 2-3 months of vacancies require even more cash. So if it looked like it would save you a lot of money, I would be asking you whether you could afford the extra mortgage payment on the 15-year out of your pocket in the event of a vacancy.

However, as jjg247 points out, 15-year mortgage interest rates are not low enough for you to seriously benefit from a refinance at this time.
stoptothink
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Re: Refinance 30yr to 15yr mortgage?

Post by stoptothink »

jjg247 wrote: Fri Nov 17, 2017 6:36 am You should research 15yr mortgage rates, I don’t think 2.5% is possible without paying for points. I use this webpage http://www.mortgagenewsdaily.com/mortga ... aily.aspx

In the last 52 weeks the lowest a 15yr FRM has been is 3.12%.
Yeah, I'd love to know where anybody is getting anything close to 2.5% on a 15yr.
cherijoh
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Re: Refinance 30yr to 15yr mortgage?

Post by cherijoh »

GrumpyMonk wrote: Fri Nov 17, 2017 1:37 am Just finished the "Bogleheads Guide to Investing" book and was intrigued, so now I am new to these forums. I have so many questions...

I currently have a rental property in a good area, easy to rent, etc. It's a 30yr loan at 3.5%, original balance was $270k. Currently, the principal balance is at $237k. My wife started working so we've had extra cash and I've been pondering whether to pay down the current mortgage or try to refinance to a 15 yr mortgage at a lower rate. Currently, I just started adding a $500 principal payment each month, which will effectively reduce the term of the loan by about 10 years. Monthly mortgage payments are about $1500, I also pay $360 p/month in HOA fees.

We already fund both 401(k) retirement accounts, and will probably be doing the backdoor roth contributions as well. Everything else goes into the market.

I lack the mental fortitude to calculate what's the better way to move forward; on the one hand I HATE paying so much interest on the loan so refinancing to a 15 year mortgage appeals to me, assuming I can get a rate around 2.5%. But... would I be better off just continuing to add principal payments to my already low interest rate? Or should I just pay the minimum each month and not worry about any of this principal only payment/refinance stuff?

Thank you in advance for your help!
Expect to pay a higher interest rate on a mortgage for a rental property vs. an owner-occupied property.

I refinaced my personal residence from a 30-yr to a 15-yr mortgage when interest rates had dropped by about 200 basis points. The reduction in interest rates offset a large portion of the increase in principal, plus I didn't want to extend the duration of having a mortgage beyond the point that I expected to be retired.

However, I don't think it makes sense to do so in your case - I doubt you would see much (if any) reduction in your interest rate, so your payments would go up quite a bit and you would lose a lot of flexibility. Right now you can make extra principal payments but suspend them if the rental property needed maintenance or if you have to evict a tenant. Or if you found yourself a victim of a layoff from work.
KlangFool
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Re: Refinance 30yr to 15yr mortgage?

Post by KlangFool »

OP,

Why would you prepay principal on a rental property?

A) If it is cash flow positive and you are making money out of it, why would you put more money into it?

B) If it is not cash flow positive and you are not making money out of it, why would you keep the property?

If you have extra money, invest in a taxable account. Do not put more of your money into this rental property. That is putting more of your eggs into this basket. You can ignore this statement if your net worth is a few million. Or else, this is lousy diversification.

My advice has nothing to do with the return rate. It has to do with the diversification. How much of your net worth is tied up with real estate (your primary residence and the rental property)?

KlangFool
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Re: Refinance 30yr to 15yr mortgage?

Post by BogleBoogie »

KlangFool wrote: Fri Nov 17, 2017 8:41 am OP,

Why would you prepay principal on a rental property?

A) If it is cash flow positive and you are making money out of it, why would you put more money into it?

B) If it is not cash flow positive and you are not making money out of it, why would you keep the property?

If you have extra money, invest in a taxable account. Do not put more of your money into this rental property. That is putting more of your eggs into this basket. You can ignore this statement if your net worth is a few million. Or else, this is lousy diversification.

My advice has nothing to do with the return rate. It has to do with the diversification. How much of your net worth is tied up with real estate (your primary residence and the rental property)?

KlangFool
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GrumpyMonk
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Re: Refinance 30yr to 15yr mortgage?

Post by GrumpyMonk »

jjg247 wrote: Fri Nov 17, 2017 6:36 am You should research 15yr mortgage rates, I don’t think 2.5% is possible without paying for points. I use this webpage http://www.mortgagenewsdaily.com/mortga ... aily.aspx

In the last 52 weeks the lowest a 15yr FRM has been is 3.12%.
Thank you for that, I was operating off of old quotes given before, probably too good to be true it seems.
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GrumpyMonk
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Re: Refinance 30yr to 15yr mortgage?

Post by GrumpyMonk »

KlangFool wrote: Fri Nov 17, 2017 8:41 am OP,

Why would you prepay principal on a rental property?

A) If it is cash flow positive and you are making money out of it, why would you put more money into it?

B) If it is not cash flow positive and you are not making money out of it, why would you keep the property?

If you have extra money, invest in a taxable account. Do not put more of your money into this rental property. That is putting more of your eggs into this basket. You can ignore this statement if your net worth is a few million. Or else, this is lousy diversification.

My advice has nothing to do with the return rate. It has to do with the diversification. How much of your net worth is tied up with real estate (your primary residence and the rental property)?

KlangFool
Thanks everyone for their input!

To answer these questions, I'm not sure if it is cash flow positive.... My monthly obligations are about $1900 after mortgage, HOA fees, taxes. I get about $1500 from the renter, so there' s a deficit of $400 each month, but they are paying most of my mortgage and fees. To me that is cash flow positive, but I am not sure if that's truly the definition you're asking. Forgive my ignorance!

My wife and I are lucky enough to be in high paying fields in healthcare, but it required a large investment of time on the front end. So, I didn't start making money until my 30's really. What I've been doing is maxing my 401k and Roth (until recently where we can't without the backdoor option). The rest has gone into a taxable account, so that's where most of our money is tied up, tax deferred and taxable accounts. We lived in the rental property for 3 years as our primary house, and decided to keep it as an investment property when we finished training and had to move.

Our net worth is around 550k, but we are relatively new to the savings game and will have very solid income going forward. Such that we could fairly easily pay the mortgage out of pocket for years if we aren't able to rent it out.

To answer your original question, I really hate paying interest. It seems crazy to me to pay so much interest on the loan... but I guess with the market as it is I could make more money by just investing in the taxable account. I had always assumed I could get a lower rate by refinancing to a 15 yr mortgage, but I guess interest rates have gone up since last I looked.

Thanks again everyone for your thoughtful responses.
stoptothink
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Re: Refinance 30yr to 15yr mortgage?

Post by stoptothink »

GrumpyMonk wrote: Fri Nov 17, 2017 8:14 pm
To answer these questions, I'm not sure if it is cash flow positive.... My monthly obligations are about $1900 after mortgage, HOA fees, taxes. I get about $1500 from the renter, so there' s a deficit of $400 each month, but they are paying most of my mortgage and fees. To me that is cash flow positive, but I am not sure if that's truly the definition you're asking. Forgive my ignorance!
It is not cash flow positive
KlangFool
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Re: Refinance 30yr to 15yr mortgage?

Post by KlangFool »

GrumpyMonk wrote: Fri Nov 17, 2017 8:14 pm
KlangFool wrote: Fri Nov 17, 2017 8:41 am OP,

Why would you prepay principal on a rental property?

A) If it is cash flow positive and you are making money out of it, why would you put more money into it?

B) If it is not cash flow positive and you are not making money out of it, why would you keep the property?

If you have extra money, invest in a taxable account. Do not put more of your money into this rental property. That is putting more of your eggs into this basket. You can ignore this statement if your net worth is a few million. Or else, this is lousy diversification.

My advice has nothing to do with the return rate. It has to do with the diversification. How much of your net worth is tied up with real estate (your primary residence and the rental property)?

KlangFool
Thanks everyone for their input!

To answer these questions, I'm not sure if it is cash flow positive.... My monthly obligations are about $1900 after mortgage, HOA fees, taxes. I get about $1500 from the renter, so there' s a deficit of $400 each month, but they are paying most of my mortgage and fees. To me that is cash flow positive, but I am not sure if that's truly the definition you're asking. Forgive my ignorance!

My wife and I are lucky enough to be in high paying fields in healthcare, but it required a large investment of time on the front end. So, I didn't start making money until my 30's really. What I've been doing is maxing my 401k and Roth (until recently where we can't without the backdoor option). The rest has gone into a taxable account, so that's where most of our money is tied up, tax deferred and taxable accounts. We lived in the rental property for 3 years as our primary house, and decided to keep it as an investment property when we finished training and had to move.

Our net worth is around 550k, but we are relatively new to the savings game and will have very solid income going forward. Such that we could fairly easily pay the mortgage out of pocket for years if we aren't able to rent it out.

To answer your original question, I really hate paying interest. It seems crazy to me to pay so much interest on the loan... but I guess with the market as it is I could make more money by just investing in the taxable account. I had always assumed I could get a lower rate by refinancing to a 15 yr mortgage, but I guess interest rates have gone up since last I looked.

Thanks again everyone for your thoughtful responses.
GrumpyMonk,

<< To answer these questions, I'm not sure if it is cash flow positive.... My monthly obligations are about $1900 after mortgage, HOA fees, taxes. I get about $1500 from the renter, so there' s a deficit of $400 each month, but they are paying most of my mortgage and fees. To me that is cash flow positive, but I am not sure if that's truly the definition you're asking. Forgive my ignorance! >>

It is cash flow negative even with a renter. You need to put money in every month. So, why are you keeping the property?

<< We lived in the rental property for 3 years as our primary house, and decided to keep it as an investment property when we finished training and had to move.>>

You are an accidental landlord. Instead of cutting your losses, you sink more money into this house.

<< Our net worth is around 550k, but we are relatively new to the savings game and will have very solid income going forward. Such that we could fairly easily pay the mortgage out of pocket for years if we aren't able to rent it out. >>

But, you will be putting more eggs into this money-losing basket.

<<To answer your original question, I really hate paying interest. It seems crazy to me to pay so much interest on the loan...>>

Then, sell this rental property. Putting more money into a money-losing house is not going to help you.

KlangFool
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UncleLongHair
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Re: Refinance 30yr to 15yr mortgage?

Post by UncleLongHair »

The 15 year mortgage obligates you to a higher payment every month, whereas you could keep the 30 year mortgage and just pay extra on it if you wanted. The only reason to get the 15 year is if you can get a substantially better interest rate, which I'm guessing you can't do these days. The rates for investment properties are generally higher than for residences. The best way to get a good rate on an investment property is to buy it as a residence first, then keep it and rent it. But if you refinance it'll be an investment property.

Prepaying a mortgage which is at 3% is basically a guaranteed 3% return on your money, which isn't really that good. If it were me I'd keep the cash and invest it elsewhere.
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Re: Refinance 30yr to 15yr mortgage?

Post by grabiner »

KlangFool wrote: Fri Nov 17, 2017 8:41 am OP,

Why would you prepay principal on a rental property?

A) If it is cash flow positive and you are making money out of it, why would you put more money into it?

B) If it is not cash flow positive and you are not making money out of it, why would you keep the property?

If you have extra money, invest in a taxable account. Do not put more of your money into this rental property. That is putting more of your eggs into this basket. You can ignore this statement if your net worth is a few million. Or else, this is lousy diversification.
There is no diversification issue. If you own a rental property worth $400K, and property values drop by 25%, your net worth will drop by $100K regardless of the size of the mortgage. If you have no mortgage, it drops from $400K to $300K; if you have a $300K mortgage, your equity drops from $100K to zero. And if you keep the $300K mortgage rather than paying it off, you must have done something else with that $300K; if you invested the $300K in municipal bonds which didn't lose money, the decline in housing prices drops you from $400K to $300K.

What there is is a liquidity issue. If you pay down your mortgage, you can't get that money back out of the property unless you take a new loan against it, or until you get the money back once the mortgage is gone. Essentially, you are buying a very-long-term bond with a taxable 3.5% yield (since your interest is deductible), and that isn't a particularly good idea.
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GrumpyMonk
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Re: Refinance 30yr to 15yr mortgage?

Post by GrumpyMonk »

Thanks again for the responses. Clearly I'm a novice, armed with just enough info to be very dangerous to my financial future. That being said, I don't quite understand the advice to sell the property...

From my perspective, I have someone else paying 80% of the mortgage and associated fees for this property. Even if I am still paying 20% of the fees out of pocket each month, I will presumably make this money up on the back end, when I sell the property or if we hold it long enough to pay off the mortgage. So if for the life of the mortgage or whatever equity I have at the point of selling, I've only put in 20% of the expenses, don't I stand to benefit from that on the back end when I take 100% of the profits from the sale?

I understand there is risk in this as there's no guarantee that it will retain its value relative to the initial mortgage paid. I just don't understand how getting a tenant to pay 80% of the fees/mortgage up front is a bad investment? Even though it's not cash flow positive, it's still worth keeping for the eventual pay out, right?

Help me understand how I'm wrong on this please!
petulant
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Re: Refinance 30yr to 15yr mortgage?

Post by petulant »

GrumpyMonk wrote: Sun Nov 19, 2017 3:07 am Thanks again for the responses. Clearly I'm a novice, armed with just enough info to be very dangerous to my financial future. That being said, I don't quite understand the advice to sell the property...

From my perspective, I have someone else paying 80% of the mortgage and associated fees for this property. Even if I am still paying 20% of the fees out of pocket each month, I will presumably make this money up on the back end, when I sell the property or if we hold it long enough to pay off the mortgage. So if for the life of the mortgage or whatever equity I have at the point of selling, I've only put in 20% of the expenses, don't I stand to benefit from that on the back end when I take 100% of the profits from the sale?

I understand there is risk in this as there's no guarantee that it will retain its value relative to the initial mortgage paid. I just don't understand how getting a tenant to pay 80% of the fees/mortgage up front is a bad investment? Even though it's not cash flow positive, it's still worth keeping for the eventual pay out, right?

Help me understand how I'm wrong on this please!
Well I see two criticisms of the property in the comments above. One is that it has poor economics if you're having to put additional cash into it regularly. That criticism may be right or wrong; in some markets, investors have made millions carrying properties that need monthly cash infusions, and in others, it's the way to the poor house. You can figure it out for yourself with some basic spreadsheet modeling. For each year that you own the property from now until it's paid off, estimate the net cash flow (i.e. all revenues and costs inflation adjusted, mortgage not) as well as the aftertax cash flow from selling the property at the end (after appreciating). Then discount each of those values to the present using either 1) a low-risk interest rate number like 2.5% and/or 2) an opportunity cost of stocks of 5-7%. Add up all the discounted numbers to get a NPV and divide that by what you could get selling the property today (house value - realtor costs - debt payoff). That will give you a better picture of the expected return of the property.

The second criticism is that the property is not diversified. Thing is, even if it's got good economics as described above, you may have a lot of your total net worth invested in one property in one market. If something happens to the neighborhood, or the town, or the city and property markets decline, your net worth will take a bigger hit. Compare that to a stock index fund, where if something happens to one whole company, your overall net worth will hardly be affected.

You can model the risk of diversification on economics partly by revisiting the spreadsheet I mentioned before. Try different assumptions, especially about the appreciation of the house or increase in rents. Keep them flat but let everything else inflate. See if you still make money.

Problem is, you're already in the house, which means you would bear a large cost selling it. If you're investing aggressively in 401(k) and other accounts and not making EXTRA principal payments on the rental property, you'll probably come out fine.
Admiral
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Re: Refinance 30yr to 15yr mortgage?

Post by Admiral »

GrumpyMonk wrote: Sun Nov 19, 2017 3:07 am Thanks again for the responses. Clearly I'm a novice, armed with just enough info to be very dangerous to my financial future. That being said, I don't quite understand the advice to sell the property...

From my perspective, I have someone else paying 80% of the mortgage and associated fees for this property. Even if I am still paying 20% of the fees out of pocket each month, I will presumably make this money up on the back end, when I sell the property or if we hold it long enough to pay off the mortgage. So if for the life of the mortgage or whatever equity I have at the point of selling, I've only put in 20% of the expenses, don't I stand to benefit from that on the back end when I take 100% of the profits from the sale?

I understand there is risk in this as there's no guarantee that it will retain its value relative to the initial mortgage paid. I just don't understand how getting a tenant to pay 80% of the fees/mortgage up front is a bad investment? Even though it's not cash flow positive, it's still worth keeping for the eventual pay out, right?

Help me understand how I'm wrong on this please!
Welcome the to forum. Your original question has now been addressed, so I will address what's above.

The problem with your logic here is that you're essentially losing money on this investment in two ways: first, via interest on the loan, and second, because the rent doesn't cover your costs. You are basically saying, ok, I'm going to pay all this extra money in the hope that the value of the property will increase over time, and then I will sell it. That may happen. Or, it may not. You don't note what the market value is versus what your loan amount is.

Even if the property value goes up substantially over time (which is in itself an assumption that may or may not hold true), you're also losing substantial money over time, and on a monthly basis: to interest, and to rent that is too low to cover your costs. If the rent that you're charging is all the market will bear, then the property was not a good investment (i.e. you overpaid) and should be sold.

Now, there are some caveats. If you do some research and find that similar properties in the area are appreciating quickly on a year over year basis, such that your gains when selling may outweigh the costs, then it's possible that holding it might be smart. But this is nothing more than a bet on real estate values. Or maybe you plan to make this property your second or retirement home, in which case it might be worth it to you.

But overall, landlords don't keep properties with negative cashflow for very long. They raise the rent, or they sell.
madrad
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Re: Refinance 30yr to 15yr mortgage?

Post by madrad »

GrumpyMonk wrote: Sun Nov 19, 2017 3:07 am Thanks again for the responses. Clearly I'm a novice, armed with just enough info to be very dangerous to my financial future. That being said, I don't quite understand the advice to sell the property...

From my perspective, I have someone else paying 80% of the mortgage and associated fees for this property. Even if I am still paying 20% of the fees out of pocket each month, I will presumably make this money up on the back end, when I sell the property or if we hold it long enough to pay off the mortgage. So if for the life of the mortgage or whatever equity I have at the point of selling, I've only put in 20% of the expenses, don't I stand to benefit from that on the back end when I take 100% of the profits from the sale?

I understand there is risk in this as there's no guarantee that it will retain its value relative to the initial mortgage paid. I just don't understand how getting a tenant to pay 80% of the fees/mortgage up front is a bad investment? Even though it's not cash flow positive, it's still worth keeping for the eventual pay out, right?

Help me understand how I'm wrong on this please!
I can understand where you are coming from: even if the rent doesn’t cover the entire monthly payment, certainly it should cover the taxes and insurance with any excess being equity that the tenant is “buying” for you. Or from another perspective (with made up numbers), you only have to pay $500 per month for $1000 of equity. So essentially the benefit of doing this is you can continue to build equity in the house, but for cheaper, and in theory, generate more money at a future sale. So it becomes a comparison of:

1) the proceeds from selling the house now
versus
2) the net present value of negative cash flows for a certain number of years (up to ?27 years left on the mortgage) and then potentially a certain number of years of likely significantly positive cash flows if the mortgage is ever fully paid off, as well as the proceeds from the eventual sale (assuming it will be sold at some point) minus expenses

And that last part is crucial. The expenses would include the cost of finding tenants, the cost of the house going unrented when you don’t have tenants, and repairs/maintenance. There are additional costs which don’t necessarily have a dollar value - the cost of your time to deal with all of these things (or the standard 6% to pay someone else to deal with them) and the cost of putting substantial money into an illiquid asset (as well as the opportunity cost of not putting this money into other assets).

When you start at negative cash flow, the chance that this endeavor ends up being negative net worth in the long run increases substantially. But I don’t think being negative cash flow for a certain number of years automatically makes it a bad idea—isn’t putting money into something with the expectation of a greater future return what investing is? It all depends on the numbers and your own situation.

This being a good long term decision is predicated on the principle that this particular property will appreciate in value long term. Otherwise, the equity you are accumulating is worthless. So consider the future prospects of this particular property.

I think you actually need to look at the numbers. If I were you, I would make an Excel spreadsheet with the estimated cash flows over the next X number of years with very conservative estimates of the expenses and then calculate NPV of that (see http://www.tvmcalcs.com/calculators/exc ... ions_page3). Compare that to the proceeds of selling today. Your guess is as good as mine as far as the rate to use - maybe 5-7% would be reasonable.
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Re: Refinance 30yr to 15yr mortgage?

Post by Bacchus01 »

stoptothink wrote: Fri Nov 17, 2017 8:02 am
jjg247 wrote: Fri Nov 17, 2017 6:36 am You should research 15yr mortgage rates, I don’t think 2.5% is possible without paying for points. I use this webpage http://www.mortgagenewsdaily.com/mortga ... aily.aspx

In the last 52 weeks the lowest a 15yr FRM has been is 3.12%.
Yeah, I'd love to know where anybody is getting anything close to 2.5% on a 15yr.
Especially on a rental. I doubt very much you could get the current rate you have on a 15 for a rental and I doubt you’d get below 4% for 30 on a rental. Feel good about it. Pay down more if you want.
Admiral
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Re: Refinance 30yr to 15yr mortgage?

Post by Admiral »

Bacchus01 wrote: Sun Nov 19, 2017 8:11 am
stoptothink wrote: Fri Nov 17, 2017 8:02 am
jjg247 wrote: Fri Nov 17, 2017 6:36 am You should research 15yr mortgage rates, I don’t think 2.5% is possible without paying for points. I use this webpage http://www.mortgagenewsdaily.com/mortga ... aily.aspx

In the last 52 weeks the lowest a 15yr FRM has been is 3.12%.
Yeah, I'd love to know where anybody is getting anything close to 2.5% on a 15yr.
Especially on a rental. I doubt very much you could get the current rate you have on a 15 for a rental and I doubt you’d get below 4% for 30 on a rental. Feel good about it. Pay down more if you want.
I have a 15 YR FRM at 2.25% on my primary residence. Loan originated about 14 months ago and I have not seen an equivalent rate since. Investment mortgages are typically not as low as primary residence mortgages in any case.
lakja
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Re: Refinance 30yr to 15yr mortgage?

Post by lakja »

GrumpyMonk wrote: Sun Nov 19, 2017 3:07 am I understand there is risk in this as there's no guarantee that it will retain its value relative to the initial mortgage paid. I just don't understand how getting a tenant to pay 80% of the fees/mortgage up front is a bad investment? Even though it's not cash flow positive, it's still worth keeping for the eventual pay out, right?

Help me understand how I'm wrong on this please!
What’s the opportunity cost of tying that 20% expenses in the house? Also, if you don’t have tenets, you’re paying all expenses, plus the turnover cost to get the rental in condition to rent to the next renters. It’s likely you will get a better gain of the 20% with much less downside in other investments with more liquidity.

Also, if you’re set on keeping the property, why not raise the rent?
Last edited by lakja on Sun Nov 19, 2017 12:02 pm, edited 1 time in total.
DrGoogle2017
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Re: Refinance 30yr to 15yr mortgage?

Post by DrGoogle2017 »

You should run the mortgage calculator for the same duration and different rate, you will see that you save very little in interest. Not worth the hassle to get a 15 year mortgage. Plus you have higher payment. If for some reasons you don’t have income, you will be hurting. That’s why cash flow positive is important.
chevca
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Re: Refinance 30yr to 15yr mortgage?

Post by chevca »

GrumpyMonk wrote: Sun Nov 19, 2017 3:07 am Thanks again for the responses. Clearly I'm a novice, armed with just enough info to be very dangerous to my financial future. That being said, I don't quite understand the advice to sell the property...

From my perspective, I have someone else paying 80% of the mortgage and associated fees for this property. Even if I am still paying 20% of the fees out of pocket each month, I will presumably make this money up on the back end, when I sell the property or if we hold it long enough to pay off the mortgage. So if for the life of the mortgage or whatever equity I have at the point of selling, I've only put in 20% of the expenses, don't I stand to benefit from that on the back end when I take 100% of the profits from the sale?

I understand there is risk in this as there's no guarantee that it will retain its value relative to the initial mortgage paid. I just don't understand how getting a tenant to pay 80% of the fees/mortgage up front is a bad investment? Even though it's not cash flow positive, it's still worth keeping for the eventual pay out, right?

Help me understand how I'm wrong on this please!
Having this rental, you are a business owner. This business is losing money. Does owning this rental make you want to go out and buy more rentals where the rent would only cover 80% of the mortgage and costs?

You basically have the tenant paying the P/I of the mortgage, and you're covering the HOA fee, insurance, and taxes out of the goodness of your heart. And, you're throwing an extra $500/month at it. The only eventual payout you would see is the principal that has been paid down by the tenant(s). That is money that someone else paid to knock down the mortgage balance for you. Your own $500/month saves you the 3.5% in interest you never pay on that money again. But when you sell, it just comes back to you. You just traded where you kept that money basically.

Meanwhile you have been losing money on HOA, taxes, and insurance that you will never get back. That's gone. Don't forget that roofs, HVAC, and spendy things need to get replaced from time to time.

Keeping this rental for some possible eventual payout is not a wise move. When you moved out couldn't get enough in rent to cover the mortgage, HOA, taxes, and insurance, you should not have kept it as a rental. But, that's already been done. Drop this anchor and sell the rental, IMO. Sounds like you have high enough income(s) that you can recover from this easily and make better use of your money going forward.
Bacchus01
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Re: Refinance 30yr to 15yr mortgage?

Post by Bacchus01 »

While it may not cash flow, it’s not clear that he’s not making money. Those are two different things.
aristotelian
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Re: Refinance 30yr to 15yr mortgage?

Post by aristotelian »

GrumpyMonk wrote: Sun Nov 19, 2017 3:07 am Thanks again for the responses. Clearly I'm a novice, armed with just enough info to be very dangerous to my financial future. That being said, I don't quite understand the advice to sell the property...

From my perspective, I have someone else paying 80% of the mortgage and associated fees for this property. Even if I am still paying 20% of the fees out of pocket each month, I will presumably make this money up on the back end, when I sell the property or if we hold it long enough to pay off the mortgage. So if for the life of the mortgage or whatever equity I have at the point of selling, I've only put in 20% of the expenses, don't I stand to benefit from that on the back end when I take 100% of the profits from the sale?

I understand there is risk in this as there's no guarantee that it will retain its value relative to the initial mortgage paid. I just don't understand how getting a tenant to pay 80% of the fees/mortgage up front is a bad investment? Even though it's not cash flow positive, it's still worth keeping for the eventual pay out, right?

Help me understand how I'm wrong on this please!
The "back end" is 30 years away if you only pay the required payments. Since you are negative by about $5k per year (not including maintenance), that means it will probably take another 5 or more years after the mortgage expires for you to finally be breaking even on this property. Do you expect to even be alive in 30 years? I would think that is a 50/50 proposition at best.

If you aggressively pay the principal so that it becomes cash flow positive quicker, then you are using money that could be invested in the market. Any return you get then has to be discounted by your expected return from investing in stocks over 30 years.
Tal-
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Re: Refinance 30yr to 15yr mortgage?

Post by Tal- »

I'd probably sell. The house is clearly losing cash in an ideal month, and will continue to do so for a long time. Once vacancy and capital expenses are factored in, I'd wager that the total return for the next 10 years will be around 0. Time to sell.

If you want to keep it, I won't object too much. You're in good shape financially and can probably afford a non-performing investment.

But, do not refinance, and do not put extra money towards principle. This is simply putting good money after bad. Or rather, it's throwing good money at a not-so good investment to try and make that investment decent. It also breaks virtually every real estate investing guideline out there.

Congrats on being in great shape. You really are doing well, and are set up for long-term success. I just think that cutting ties with this property now will make things a bit more simple and a bit more profitable.

Happy hunting.
Debt is to personal finance as a knife is to cooking.
Admiral
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Re: Refinance 30yr to 15yr mortgage?

Post by Admiral »

Bacchus01 wrote: Mon Nov 20, 2017 7:42 am While it may not cash flow, it’s not clear that he’s not making money. Those are two different things.
How is he making money? He's losing money every month (negative cash flow), not making money every month. The only way for him to make money is to hope the property appreciates and then sell it, or raise the rent. Seems like if the market would have supported a higher rent, he would have raised it already. Seems pretty simple to me :confused

Again, the OP has not posted the market value of the prop vs. what he owes, so we have no way of knowing if he's taking a monthly loss with the expectation that he will ultimately get a large one-time gain on the sale. That would be the only reason to keep it, IMO.
Bacchus01
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Re: Refinance 30yr to 15yr mortgage?

Post by Bacchus01 »

Admiral wrote: Mon Nov 20, 2017 8:24 am
Bacchus01 wrote: Mon Nov 20, 2017 7:42 am While it may not cash flow, it’s not clear that he’s not making money. Those are two different things.
How is he making money? He's losing money every month (negative cash flow), not making money every month. The only way for him to make money is to hope the property appreciates and then sell it, or raise the rent. Seems like if the market would have supported a higher rent, he would have raised it already. Seems pretty simple to me :confused

Again, the OP has not posted the market value of the prop vs. what he owes, so we have no way of knowing if he's taking a monthly loss with the expectation that he will ultimately get a large one-time gain on the sale. That would be the only reason to keep it, IMO.
"Losing money" is a profit and loss statement. That's not the same as negative cash flow. He has depreciation, tax benefits, as well as his asset base is growing in the principle. He may very well be making money while being negative cash flow. Businesses do this all the time.

I agree. We don't know. But he may be.
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goingup
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Re: Refinance 30yr to 15yr mortgage?

Post by goingup »

We've been "accidental" landlords with 2 homes due to company relocations. The rent has always covered PITI with more to spare which is good because a home requires upkeep and needs repairs.

In your position I'd sell the house, probably next Spring. You have a losing proposition, and costs and repairs will increase over time. Can you raise the rent accordingly? Another consideration is that in order to not pay capital gains taxes on your home sale, you need to have lived in the home for 2 of the last 5 years. The exemption is $250K single/$500K married.

It sounds as though you're not quite sure what to do with a surplus of income after maxing out retirement savings so you are throwing it into the rental. I'd suggest instead you open a brokerage account and start saving in a taxable account with tax-efficient index funds.

I'm not a real estate mogul, but I think a property should be cash-flow positive within a reasonable time-frame. It doesn't seem like you're anywhere near to that.
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GrumpyMonk
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Re: Refinance 30yr to 15yr mortgage?

Post by GrumpyMonk »

goingup wrote: Mon Nov 20, 2017 8:36 am We've been "accidental" landlords with 2 homes due to company relocations. The rent has always covered PITI with more to spare which is good because a home requires upkeep and needs repairs.

In your position I'd sell the house, probably next Spring. You have a losing proposition, and costs and repairs will increase over time. Can you raise the rent accordingly? Another consideration is that in order to not pay capital gains taxes on your home sale, you need to have lived in the home for 2 of the last 5 years. The exemption is $250K single/$500K married.

It sounds as though you're not quite sure what to do with a surplus of income after maxing out retirement savings so you are throwing it into the rental. I'd suggest instead you open a brokerage account and start saving in a taxable account with tax-efficient index funds.

I'm not a real estate mogul, but I think a property should be cash-flow positive within a reasonable time-frame. It doesn't seem like you're anywhere near to that.
Thanks for the reply! Yea, I guess we are accidental landlords, and maybe should've sold when we left. The market will not support raising the rent at this time, there's currently a renter in there that has a 2 year lease. As far as capital gains tax if we sell, we are military, is there an exemption to the 2/5 year rules for capital gains exemption for military sellers?

Oh also, I am putting a substantial amount of our extra cash into a brokerage account, as you stated. Good advice!

thanks!
Last edited by GrumpyMonk on Tue Nov 21, 2017 4:23 pm, edited 1 time in total.
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GrumpyMonk
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Re: Refinance 30yr to 15yr mortgage?

Post by GrumpyMonk »

Bacchus01 wrote: Mon Nov 20, 2017 8:27 am
Admiral wrote: Mon Nov 20, 2017 8:24 am
Bacchus01 wrote: Mon Nov 20, 2017 7:42 am While it may not cash flow, it’s not clear that he’s not making money. Those are two different things.
How is he making money? He's losing money every month (negative cash flow), not making money every month. The only way for him to make money is to hope the property appreciates and then sell it, or raise the rent. Seems like if the market would have supported a higher rent, he would have raised it already. Seems pretty simple to me :confused

Again, the OP has not posted the market value of the prop vs. what he owes, so we have no way of knowing if he's taking a monthly loss with the expectation that he will ultimately get a large one-time gain on the sale. That would be the only reason to keep it, IMO.
"Losing money" is a profit and loss statement. That's not the same as negative cash flow. He has depreciation, tax benefits, as well as his asset base is growing in the principle. He may very well be making money while being negative cash flow. Businesses do this all the time.

I agree. We don't know. But he may be.
Yes, I was banking on taking the short term loss to sell the property for profit later. Maybe a losing proposition. To answer some of your questions, the property is valued at about $280k now; there's $237k left on the mortgage (original loan amount of $269k, no money down). Purchased in May 2012. It's at 3.5% APR, I pay:

$1,508 monthly for principal, interest, taxes and insurance as one payment to the mortgage company. On top of that, I pay $360 p/month to the condo association and then 10% of the rent to a property manager (I am military, stationed overseas so I can't really manage the property from where I'm at). Rent is currently $1700 p/month on a recently signed 2 year lease. So, I get $1530 from the rent every month, after paying the manager. So, I basically cover the mortgage, insurance and taxes + property manager with the renter. Any other fees including HOA, come out of my pocket.

The property is in a very nice downtown area, it's a condo, not in a flood zone, newer building with an aggressive HOA so my risk of catastrophic damage or high expenses is low, as the HOA absorbs most of that. It's close to a major training hospital so it's fairly easy to rent to medical trainees, who are usually pretty reliable renters.

So yes, my thought was to raise the rent every year slowly climbing to cover most of my expenses, though I don't think I'll ever be able to bridge the gap to become cash flow positive with rent alone, unless I move back there and manage the property myself. However, my original thinking was to get someone to pay most of my mortgage/expenses, hold onto a nice condo in a nice location with an easy high end renter pool, then sell later after it appreciates (hopefully).

Any other info you guys want? Thank you all for the discussion! I'm sorry for the late responses, my time zone is very different than the states and I work very long shifts, several in a row which limits my ability to reply thoughtfully. Thanks again for taking the time to analyze my situation, all of your thoughts and advice are much appreciated!
chevca
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Re: Refinance 30yr to 15yr mortgage?

Post by chevca »

GrumpyMonk wrote: Tue Nov 21, 2017 4:05 pmAs far as capital gains tax if we sell, we are military, is there an exemption to the 2/5 year rules for capital gains exemption for military sellers?
Nope, sorry. It doesn't sound like there much to worry about there anyway. How much has it appreciated since you put it into service as a rental? Probably not a lot, so not like it's a huge tax hit if you sell.

The fact that a tenant just signed a two year lease throws a bit of a wrench in selling ASAP or not. You could offer a month or two of free rent because you want to sell in Feb. or Mar., for example. I did that when I sold an accidental landlord rental a couple years ago. The tenant was willing, luckily. If not though, they did sign a contract and could dig their feet in. Or, finish out the two year lease, let them know you're selling when the lease is up, and hope it appreciates more in the two years.

Or, hang on to it as you planned.
Tammy88
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Re: Refinance 30yr to 15yr mortgage?

Post by Tammy88 »

I think bank charges higher rate for rental properties so definitely watch out for that. You will need to compare what portion goes to principal with 30 years vs 15 years, depending on how many years you have paid for your current loan. I am personally a fan with 15 years as you pay mostly interest for 30 years' loan for the initial years.
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quantAndHold
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Re: Refinance 30yr to 15yr mortgage?

Post by quantAndHold »

You’ve owned the place for 5 years and it’s worth barely more than you paid for it, and it’s going to be a number of years before you’ll be able to get enough rent to be cash flow positive. If ever. So, the place isn’t exactly in a hot market.

I would offer to buy out the tenant to get them out, and sell it. I don’t see an upside here.
Bacchus01
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Re: Refinance 30yr to 15yr mortgage?

Post by Bacchus01 »

In 5 years you have $11k in possible appreciation? Less transaction costs so basically no gain? And you are cash flow negative?

Oh man, get out fast.
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