Nearly paid off house; Should I sell, go back to renting and invest the equity?

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cookymonster
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Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by cookymonster » Sat Mar 11, 2017 7:28 pm

In late 2015, I bought a four-bedroom house that in hindsight that I realize was way too big for a single person. I was probably better off not buying at all and continuing to rent, but after I realized the mistake I decided to just pay the mortgage off quickly as a low-interest but low-risk investment with a plan to sell it shortly afterward.

I can probably pay the mortgage off as quickly as the end of 2017 with a plan to sell the house in early 2018 after doing some minor improvements and preparation. However, I am rethinking whether it makes financial sense to sell the house and go back to renting immediately, or if I should stay in the house for a while longer (and possibly pay it off less quickly). The purpose of this thread for me is to delineate the costs and benefits of renting vs. living in a paid off house after the spring of 2018, and my hope is that the wonderful BH community can add to and poke holes in my numbers.

Here are some facts and assumptions:
Home: current Zestimate: $358,000, will assume I can sell for ~$375,000
Property Tax: $2874
Annual Utilities: $3113
Home Repairs: $3750
Insurance: $725

Moving Cost: Not sure, but I would sell a ton of stuff and hire some college kids just for the big items and rent a truck. Maybe $1000?
Monthly Rent and Utilities: ~$1200. Annually that's $14,400.

I'm assuming that if I invested the proceeds in the market, it would grow at ~7.5%, but if I kept it in the home, it would grow at inflation (~2.5%). So the proceeds would earn about $18,750, which subject to the 18.8% LTCG is about $15,225 a year.

When I look at this, it seems that I could live in the paid off house for ~$10400 a year, but if I were to sell and go to renting, if the market has average returns, the returns slightly exceed the total cost of rent and utilities. If my math is right, the difference is about $11,000 a year.

WhyNotUs
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by WhyNotUs » Sat Mar 11, 2017 7:44 pm

Maybe, you might make 7.5% maybe not. Straight line compounding leads to funky results since life rarely works that way.

You seem to live alone, is that a permanent state? A four bedroom might be in your future.

Is the unit that you can rent for $1200 a month going to work for you?

If you took the extra money that you are using to rapidly pay off your mortgage and put it into retirement savings and taxable investments, how would that change your equation?

A paid for house and a rapidly growing retirement account seem like a pretty good place to be.

OTOH, if you think mobility is in your near term plans, then cash is king.
I own the next hot stock- VTSAX

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cookymonster
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by cookymonster » Sat Mar 11, 2017 7:55 pm

WhyNotUs wrote:Maybe, you might make 7.5% maybe not. Straight line compounding leads to funky results since life rarely works that way.

You seem to live alone, is that a permanent state? A four bedroom might be in your future.

Is the unit that you can rent for $1200 a month going to work for you?

If you took the extra money that you are using to rapidly pay off your mortgage and put it into retirement savings and taxable investments, how would that change your equation?

A paid for house and a rapidly growing retirement account seem like a pretty good place to be.

OTOH, if you think mobility is in your near term plans, then cash is king.
I bought the house while I was in a relationship, thinking that things would work out well for a single family home. But I put the cart before the horse. If I met someone who liked the house, I'd stick around and delay selling. On the other hand, if I remain single with no partner on the horizon, we might as well pick a new house together. This one has kind of a funky layout anyway.

I am already maxing out retirement accounts. I'm going to invest the rest of my leftover money in taxable. The question is, before I do that, should I continue to pay off the low-interest "negative bond?" If it helps me save $11,000 a year in living expenses starting next year I think it makes sense.

I think I can do pretty well for 1 BR and $1200 a month. COL here is pretty average.

As for long-term plans, I am locked into my job for three years and may move again after that. So there is an argument I guess to be made for saving the one time moving expense and delay selling until 2020.
Last edited by cookymonster on Sat Mar 11, 2017 7:56 pm, edited 1 time in total.

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celia
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by celia » Sat Mar 11, 2017 7:56 pm

You DO NOT need to pay off the mortgage early when you sell. The mortgage will be paid off by the buyer's mortgage or cash down payment. The rest of the equity will be returned to you after the sale.

A big cost of owning a house is usually the up-front "fees" (title insurance, points, etc) and the agents' commissions (when selling). The up-front costs are gone, like water under the bridge.

I suggest you understand WHY you don't like owning this house. Is it just too big for you? Too expensive? Too much maintenance? Too far from work/ family/ shopping/ or ??? I don't think you should move until you understand the problem better or you might just move into another version of the same problem.

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cookymonster
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by cookymonster » Sat Mar 11, 2017 7:59 pm

I know I don't need to pay the mortgage off, I have just chosen to do it because it is a low risk investment. I don't like taking care of it and it is too big for me.

As I mentioned, I don't want to find another house or property to buy, I just want to go back to renting. I've learned from this experience that owning a single-family home (at least if I'm living alone) is not for me. Maybe at some point in the distant future I'll try a condo or a townhouse.

I am also tentatively planning to try selling without an agent (using threads from this forum as a guide) and will hopefully save $10,000+ that way.

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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by DVMResident » Sat Mar 11, 2017 8:15 pm

cookymonster wrote:I am locked into my job for three years and may move again after that.
I see no point in triggering an early move with such a short time horizon. Moving is expensive (and a pain).

OTOH, this makes a better case for an accelerated pay down of the mortgage. Low interest (3-4%?) on a 3 year time horizon is attractive. Similarity termed CD rates are going for 1.5-2%. These comments are made with the assumption you're already maxing out tax advantaged accounts, which will generally beat out mortgage pay downs.

Personally, with such a short/uncertain time horizon I would just sit tight unless you really hate owning a house.

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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by petulant » Sat Mar 11, 2017 8:25 pm

DVMResident wrote:
cookymonster wrote:I am locked into my job for three years and may move again after that.
I see no point in triggering an early move with such a short time horizon. Moving is expensive (and a pain).

OTOH, this makes a better case for an accelerated pay down of the mortgage. Low interest (3-4%?) on a 3 year time horizon is attractive. Similarity termed CD rates are going for 1.5-2%. These comments are made with the assumption you're already maxing out tax advantaged accounts, which will generally beat out mortgage pay downs.

Personally, with such a short/uncertain time horizon I would just sit tight unless you really hate owning a house.
+1.

If there's a possibility you're moving in the next three years, keep the house. Max out tax-advantaged space before making extra payments. Figure out what you want to do in 2020, then sell the house and do it.

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cookymonster
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by cookymonster » Sat Mar 11, 2017 8:33 pm

Thanks everyone.

My mortgage is only 3%. I am maxing out all tax-advantaged space at about ~$45k a year. My gut still tells me it is worth it to move twice in two years if it saves me an extra $11,000 a year though. I know that is contingent on a ton of assumptions about market returns, home sale, etc. I am only thinking I COULD move again in 2020. It would be preferable for my personal life not to relocate.

RoadHouseFan
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by RoadHouseFan » Sat Mar 11, 2017 8:41 pm

You are in a win win situation. Nothing wrong with renting. It can help to simplify home life as well as reduce spending.

randomguy
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by randomguy » Sat Mar 11, 2017 9:03 pm

cookymonster wrote:I know I don't need to pay the mortgage off, I have just chosen to do it because it is a low risk investment. I don't like taking care of it and it is too big for me.

As I mentioned, I don't want to find another house or property to buy, I just want to go back to renting. I've learned from this experience that owning a single-family home (at least if I'm living alone) is not for me. Maybe at some point in the distant future I'll try a condo or a townhouse.

I am also tentatively planning to try selling without an agent (using threads from this forum as a guide) and will hopefully save $10,000+ that way.
So why aren't you selling the house today? Why do you want to invest in something making 2.5% when you could be investing at 7.5% to use your assumptions? Moving if you are living in a 1 bedroom isn't a big deal. You just can't get enough stuff.

If you want to make money in this situation, get 2 room mates and charge them 700/month.

Nearly A Moose
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by Nearly A Moose » Sat Mar 11, 2017 9:04 pm

Don't forget, the gains from the sale are taxed if you don't buy a new primary residence within a certain period of time.

If there's a very real chance you might move in 3 years--whether because of job change, new spouse, getting sick of it--I would be reluctant to pay down the mortgage any more quickly than you need to. The interest over three years is a lot, but it stills pails in comparison to the interest over the total life of the loan. So you're not saving that much. And, since you are likely going to "forced" to sell at a fixed point, you run a very real risk of selling at a low, possibly locking in your loss. Yes, you still have to pay off the mortgage at sale even if the house has depreciated, but you'd have the option of using any funds available to you to do so. If you instead put your extra principal payment into the market, you'd have the option of keeping those shares to allow them to regain. (I'm sick in bed writing this, so someone please tell me if the fever is affecting my analysis).

If you're assuming 7.5% nominal in the market, I think you should model the scenario of staying put, paying your normal mortgage payment, and investing the rest. Btw, it's extremely unlikely that you will 7.5% returns in any given year. If you're looking only a NPV a few years out, you have an extreme amount of uncertainty in any of your calculations.

Also, as someone mentioned, there are all the transaction costs of buying a new house. If you think you and your next SO might actually want to live in a house like that, consider how long you'd have to rent to make up for the transaction costs of your next purchase.

And, if you want to make this house "yours" (plural), you can always draw up a Reno to fix that funky layout.
Pardon typos, I'm probably using my fat thumbs on a tiny phone.

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Watty
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by Watty » Sat Mar 11, 2017 9:11 pm

cookymonster wrote:As for long-term plans, I am locked into my job for three years and may move again after that. So there is an argument I guess to be made for saving the one time moving expense and delay selling until 2020.
A big problem is that in a bad housing market it can be nearly impossible to sell a house quickly and you may need to discount it greatly to sell it. There will always be people that have to sell a house because of things like a death, divorce, or financial problems. You do not want to have to discount your house that much to be able to sell it.

Several times I have seen job offers and promotions go to the person that could relocate the easiest.

During the last housing crunch a lot of people ended up keeping houses as rentals because they could not sell them and becoming an involuntary landlord which can be difficult especially if you are not living close by.

One option would be to put the house on the market but only sell it if you can get a really good price.
Don't forget, the gains from the sale are taxed if you don't buy a new primary residence within a certain period of time.
That rule changed a long time ago.

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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by jimb_fromATL » Sat Mar 11, 2017 9:53 pm

Maybe I missed it, but I don't see enough information for anybody to guess what might be best financially. It would require knowing how much you paid for the house; how much you paid down; the amount you financed; the current balance of the loan, the rate, the payment per month for P&I, and the property tax. Also very important is whether the home is appreciating in value and/or is likely to do so, and your income and top tax brackets for federal and state.

With substantial income and high tax brackets, a good mortgage rate, and a home that is appreciating in value, the actual cost out of pocket may not be nearly as much --on the average--- by the time you sell in a few years.

If you qualify, the tax deduction for mortgage interest and property taxes can substantially reduce the actual costs from year to year. Plus you're building net worth/equity/net worth in the form of reducing your debt (instead of building equity/reducing the debt for your landlord).

Plus, if the home is appreciating in value while you have a mortgage, you're getting leveraging on your "investment" by getting the appreciation on the full value of the home even though you don't have the full amount tied up in it.

So ... how much did you pay for it?
How much did you pay down?
How much did you finance?
What is the payment for PE&I on the mortgage?
How much is the property tax alone? (Insurance is not tax deductible.)
IS it appreciating in value?
... if so, how much?
... and is it in an area that is likely to appreciate in value ... or at least not drop in value?

How much more would you guess you will need to spend for maintenance and repairs if you keep it a few years?

Also ... what are your top tax brackets for federal and state?
Do you have enough state income tax and other itemized deductions to meet the standard deduction so that the mortgage interest and property taxes are all -- or mostly -- deductible?
I'm assuming that if I invested the proceeds in the market, it would grow at ~7.5%, but if I kept it in the home, it would grow at inflation (~2.5%). So the proceeds would earn about $18,750, which subject to the 18.8% LTCG is about $15,225 a year.
At that price, for that amount of time, and with normal appreciation in value, you probably won't pay any capital gains tax ... provided you don't sell it too soon.

The rule that someone else mentioned about having to buy another home to avoid cap gains tax went away years ago. Nowadays if you live in the home for two out of the last five years before you sell it, a single person gets to exempt the first $250K of profit from capital gains tax. (it's $500K for a couple).

That's for the profit. Not what you sell it for; and not what you clear after selling it. The potentially taxable capital gain is only the difference between your cost basis and the amount you realize after the expenses of the sale. You cost basis is the purchase price plus any improvements you may have made that qualify as capital improvements as defined by the IRS. The amount realized from the sale is the sale price minus any expenses of the sale. The profit/capital gain is not really related at all to the financing.

There's more about capital improvements along with links to some IRS documents that may be helpful in my post in THIS THREAD

jimb

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cookymonster
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by cookymonster » Sat Mar 11, 2017 10:56 pm

jimb_fromATL wrote:Maybe I missed it, but I don't see enough information for anybody to guess what might be best financially. It would require knowing how much you paid for the house; how much you paid down; the amount you financed; the current balance of the loan, the rate, the payment per month for P&I, and the property tax. Also very important is whether the home is appreciating in value and/or is likely to do so, and your income and top tax brackets for federal and state.

With substantial income and high tax brackets, a good mortgage rate, and a home that is appreciating in value, the actual cost out of pocket may not be nearly as much --on the average--- by the time you sell in a few years.

If you qualify, the tax deduction for mortgage interest and property taxes can substantially reduce the actual costs from year to year. Plus you're building net worth/equity/net worth in the form of reducing your debt (instead of building equity/reducing the debt for your landlord).

Plus, if the home is appreciating in value while you have a mortgage, you're getting leveraging on your "investment" by getting the appreciation on the full value of the home even though you don't have the full amount tied up in it.

So ... how much did you pay for it?
How much did you pay down?
How much did you finance?
What is the payment for PE&I on the mortgage?
How much is the property tax alone? (Insurance is not tax deductible.)
IS it appreciating in value?
... if so, how much?
... and is it in an area that is likely to appreciate in value ... or at least not drop in value?

How much more would you guess you will need to spend for maintenance and repairs if you keep it a few years?

Also ... what are your top tax brackets for federal and state?
Do you have enough state income tax and other itemized deductions to meet the standard deduction so that the mortgage interest and property taxes are all -- or mostly -- deductible?
I'm assuming that if I invested the proceeds in the market, it would grow at ~7.5%, but if I kept it in the home, it would grow at inflation (~2.5%). So the proceeds would earn about $18,750, which subject to the 18.8% LTCG is about $15,225 a year.
At that price, for that amount of time, and with normal appreciation in value, you probably won't pay any capital gains tax ... provided you don't sell it too soon.

The rule that someone else mentioned about having to buy another home to avoid cap gains tax went away years ago. Nowadays if you live in the home for two out of the last five years before you sell it, a single person gets to exempt the first $250K of profit from capital gains tax. (it's $500K for a couple).

That's for the profit. Not what you sell it for; and not what you clear after selling it. The potentially taxable capital gain is only the difference between your cost basis and the amount you realize after the expenses of the sale. You cost basis is the purchase price plus any improvements you may have made that qualify as capital improvements as defined by the IRS. The amount realized from the sale is the sale price minus any expenses of the sale. The profit/capital gain is not really related at all to the financing.

There's more about capital improvements along with links to some IRS documents that may be helpful in my post in THIS THREAD

jimb
The home sold for $325k in 2015. I put 20% down, or about 65k
I make about $300k a year.
I think the home is appreciating in value (at least if you look at Zillow). It's in a good part of town. In general the housing market here (SLC, UT) has been pretty hot the last three years.
Tax brackets are 33% federal, 5% state. So I mostly deduct income and property taxes but have still been getting hammered with AMT the last two years and had itemized deductions limited.

avalpert
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Re: Nearly paid off house; Should I sell, go back to renting and invest the equity?

Post by avalpert » Sat Mar 11, 2017 11:40 pm

jimb_fromATL wrote:Maybe I missed it, but I don't see enough information for anybody to guess what might be best financially. It would require knowing how much you paid for the house; how much you paid down; the amount you financed;
None of that is relevant to what would be best financially going forward. All that information is good for is playing to anchoring bias and sunk cost fallacies.

OP - it sounds like you would be better off renting a smaller place and thus dramatically lower your housing expenses. Really, the rest is a distraction - you either are spending $1,200 to rent a place or forgoing the imputed rent on your current house (which presumably is much more than $1,200 and staying there. If you don't value the additional consumption of a 4br SFH over a 1br you are just overspending at the moment for no benefit.

The more challenging decision may be whether it makes sense to hold the house and rent it out or selling it and investing the proceeds in something else. Personally, I prefer diversified allocations to my chosen asset classes, so even if I wanted to increase my exposure to residential housing I would choose to do so through a broader fund - but arguments can be made in either direction.

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