What to do with mortgages, etc.

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kiva22
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What to do with mortgages, etc.

Post by kiva22 »

Greetings

I am seeking feedback on what to do with our home loan and our rental property. If I need to split the questions into 2 postings, let me know and I will do so. Some things have changed since my first investor post which require looking at our cash flow and long-term situation more closely. The details:

Primary home:

Value: approx 350-375k
owed: 229k @ 4.375. Term remaining: 22yrs, 2months
current payment (PITI): 1629.32

Rental Property:

Value: approx 575-600k
owed: 363k @ 4.25, 29yrs remaining
current PITI: 2328.29
Total rents: $3125/mo (37,500/yr)
tax basis: $331k (I think, after deciphering my tax's guy's answer on how much tax i'd pay if i sold)

Other debt:

"family loan" (long story; related to the one from my first post, but not worth explaining; it's essentially a HELOC:
40k @ 3.125%
payment: we currently pay $1100-1300/mo

Student loan: 15k @ 3.125. 8.5 years left.
Payment: $177/mo

Other relevant information:
I am 46 years old. Spouse is 44
full financial / retirement info: viewtopic.php?f=1&t=211218&p=3241371#p3241371
We just put some $ into remodeling our home instead of moving and we're there for the long-haul (at least 15 years). Yes, anything can happen, but kids just finished Kindergarten.

The rental is in a prime location - one of the best in the city - but the way the previous owner remodeled it, it has a basement without windows and though I tell the people that rent it that they can't use it as livable space, it makes me nervous. The previous owner actually rented the basement as another room and charged another 15-20% in rent. I just can't do that and sleep at night. The house is also old: 1941 so can be subject to high maintenance costs. Will probably need a roof within 5-7 years

One question I have about the primary loan is that we've paid 8 years on an amortized loan. At what point does refinancing it actually make the money even more expensive since the interest is front loaded? Just a thought that requires more math skills than I have...

Options considered for primary residence:

(1) Refinance primary residence w/ cash out to pay off the 40k. 15yr loan (we'd own the house upon retirement) would put us at a payment of about $2200 rate quoted a month ago was 3.625%. Total change in cash flow would be about +600 which can be put toward student loan or towards IRA's.

(2) Refinance primary residence w/ cash out to pay off the 40k. 30yr loan. Payment would be about the same, 1600. Rate 4.375%. This changes cash flow to +1100/mo which can go to student loan, then IRA's. Maybe make an extra payment or 2 each year to shorten the loan a bit?

(3) Sit tight and keep paying the most possible to the debt.

Options considered for rental:

(1) sell outright. Tax guy freaked out when I even suggested it. His first response when I asked about the taxes I'd pay:
Based on a sales price of $550k - 600k, you would realize a capital gain of $269k - $319k. The taxes on this capital gain would be $83k - $101k.
I asked for further explanation and got this:
Your Federal capital gain rate is 20%. California has no capital gain rate so you will be taxed at a 9.3% rate. Since your adjusted gross income will be so high, you will lose a percentage of your itemized deductions. You will also be subject to the Obama care tax which is applied against high-end taxpayers. Finally, depending on your adjusted gross income, you might be subject to the federal Alt Min tax which starts at 26%. What I provided you was a combined Federal and California estimated tax liability based on the sales price estimates provided by you. These numbers are for your planning purpose only as the real tax liability will be determined with the real numbers used on your 2017 tax returns.
so, needless to say, he says bad idea.

(2) Exchange into another property. This is a more complex question. A friend who does commercial property investment sent me an office building listing where I would be able to exchange in and pay cash. If you want, I could post the full financials, but my quick math said about an 8.5% return. My amateur math says my current rental is only making about 4%. (?).

(3) Do nothing.

Anyway, open to any and all ideas. Thanks!

matt
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grabiner
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Re: What to do with mortgages, etc.

Post by grabiner »

kiva22 wrote:One question I have about the primary loan is that we've paid 8 years on an amortized loan. At what point does refinancing it actually make the money even more expensive since the interest is front loaded? Just a thought that requires more math skills than I have...
Refinancing never makes a loan more expensive, unless you refinance to a higher rate (including any closing costs).

A loan accrues interest at its interest rate; on your 4.375% loan, that is 0.36% of the current principal every month. You pay all the interest, and the payment schedule determines how much principal you pay. Thus the actual cost of that month of the loan is only the interest; the principal payment did not change your net worth because it reduced the amount you owe. If you refinance to a 3.625% loan, then you will pay 0.30% of the current principal each month as an interest payment.

I would suggest refinancing the primary home loan to save on interest. If you have extra cash, pay that against the highest-rate loan. Since interest on the rental and primary loan are both deductible, the highest rate is on the family loan (unless that is legally structured as a HELOC and thus deductible), and on the student loan if you make too much to deduct it.

The tax cost does make selling the rental unattractive, but you have to decide whether that is the primary issue. Do you want to continue to be a landlord? If not, then it makes sense to sell the rental and pay the taxes, just as it makes sense to sell a stock fund and pay the taxes if you have decided that the stock fund is no longer right for you.
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kiva22
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Re: What to do with mortgages, etc.

Post by kiva22 »

grabiner wrote:
kiva22 wrote:One question I have about the primary loan is that we've paid 8 years on an amortized loan. At what point does refinancing it actually make the money even more expensive since the interest is front loaded? Just a thought that requires more math skills than I have...
Refinancing never makes a loan more expensive, unless you refinance to a higher rate (including any closing costs).

A loan accrues interest at its interest rate; on your 4.375% loan, that is 0.36% of the current principal every month. You pay all the interest, and the payment schedule determines how much principal you pay. Thus the actual cost of that month of the loan is only the interest; the principal payment did not change your net worth because it reduced the amount you owe. If you refinance to a 3.625% loan, then you will pay 0.30% of the current principal each month as an interest payment.

I would suggest refinancing the primary home loan to save on interest. If you have extra cash, pay that against the highest-rate loan. Since interest on the rental and primary loan are both deductible, the highest rate is on the family loan (unless that is legally structured as a HELOC and thus deductible), and on the student loan if you make too much to deduct it.

The tax cost does make selling the rental unattractive, but you have to decide whether that is the primary issue. Do you want to continue to be a landlord? If not, then it makes sense to sell the rental and pay the taxes, just as it makes sense to sell a stock fund and pay the taxes if you have decided that the stock fund is no longer right for you.
we are able to deduct the student loan interest.

I don't mind being a landlord - the tenant and property management of it - and the tax benefits are tremendous. That particular property has it's pros and cons, that's for sure. I'm more curious as to whether there is a better investment, but perhaps that's a different thread..

The family loan is not currently deductible by us. Are you thinking to do the cash out 15yr or 30yr or do you think that's completely dependent on our cash flow / personal preference?
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grabiner
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Re: What to do with mortgages, etc.

Post by grabiner »

kiva22 wrote:The family loan is not currently deductible by us. Are you thinking to do the cash out 15yr or 30yr or do you think that's completely dependent on our cash flow / personal preference?
If a cash-out refinance doesn't increase your interest rate, then cashing it out to pay off the non-deductible loan is a good deal.

If a cash-out refinance has a higher rate than a straight-up refinance, then it's better to go straight-up and throw extra money at the family loan in preference to any of the other loans. The reason is that if you refinance to a higher rate, you pay that higher rate on the whole loan balance, not just on the cash you took out.
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kiva22
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Re: What to do with mortgages, etc.

Post by kiva22 »

the cash out adds .125, I believe. maybe even .25.
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Re: What to do with mortgages, etc.

Post by DVMResident »

kiva22 wrote:
Rental Property:

Value: approx 575-600k
owed: 363k @ 4.25, 29yrs remaining
tax basis: $331k (I think, after deciphering my tax's guy's answer on how much tax i'd pay if i sold)
^ I raised an eyebrow at these numbers. How did you depreciate >half of the building but still have 29 years on the mortgage? Depreciation should 3.x% per year of the building, not land. I can only figure either you you refi'ed or the market price jump up a crazy amount in one year of ownership...anyways...

Here's an option to avoid the capital gains issues: rent your primary house, live in the secondary/rental house for 2 years to establish primary residency, then sell the rental, and then move back the primary house. Is this possible? Other possibility is wait for an foreseeable unemployment (e.g. children) to be back in the low brackets.

If that is not possible to skip the capital gains, I would sell outright. The cash on sale is ~$200k after capital gain. Cash-flow plus principle pay down is $15k/yr ($9k cash-flow, $6k principle). ROI on cash-sale is $15k/$200k = 7.8% plus an uncertain appreciation minus vacancies and property management and taxes. Your estimated 4% is probably in the ballpark. IMO that ROI does not justify a concentrated asset and the money is better deployed as diversified equity investments.

The upside of the 1031 exchange is potentially a better ROI, but will be largely offset by the transactional costs of sells twice (6~8% per sale) and leave you with no better exit options. The double transactional costs will take years of good tenants to overcome. If you go this route, make sure you're in for the long haul.
Topic Author
kiva22
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Re: What to do with mortgages, etc.

Post by kiva22 »

DVMResident wrote:
kiva22 wrote:
Rental Property:

Value: approx 575-600k
owed: 363k @ 4.25, 29yrs remaining
tax basis: $331k (I think, after deciphering my tax's guy's answer on how much tax i'd pay if i sold)
^ I raised an eyebrow at these numbers. How did you depreciate >half of the building but still have 29 years on the mortgage? Depreciation should 3.x% per year of the building, not land. I can only figure either you you refi'ed or the market price jump up a crazy amount in one year of ownership...anyways...

Here's an option to avoid the capital gains issues: rent your primary house, live in the secondary/rental house for 2 years to establish primary residency, then sell the rental, and then move back the primary house. Is this possible? Other possibility is wait for an foreseeable unemployment (e.g. children) to be back in the low brackets.

If that is not possible to skip the capital gains, I would sell outright. The cash on sale is ~$200k after capital gain. Cash-flow plus principle pay down is $15k/yr ($9k cash-flow, $6k principle). ROI on cash-sale is $15k/$200k = 7.8% plus an uncertain appreciation minus vacancies and property management and taxes. Your estimated 4% is probably in the ballpark. IMO that ROI does not justify a concentrated asset and the money is better deployed as diversified equity investments.

The upside of the 1031 exchange is potentially a better ROI, but will be largely offset by the transactional costs of sells twice (6~8% per sale) and leave you with no better exit options. The double transactional costs will take years of good tenants to overcome. If you go this route, make sure you're in for the long haul.
Thanks for your reply..

Ya, was in an ARM pre-crash, then refied under obama's program; then refied again to lower rate.

Wife nixed the move over there for 2 years idea a while back. Maybe if I couch it in the "we'll save $75k" manner, but unlikely. Too disruptive to the kids, moving stuff 2x, etc. Staying married is a better option, me thinks :P

Am I misunderstanding the CPA when he says i'll be paying like 50% in taxes on a sale? (as a side note, is it just me or is the tone of his email kinda curt and oddly impersonal for being written to a client of 15 years?)

Transactional costs to exchange will be like 35-40k, which is brutal. Makes me want to go get my own license and work under a broker friend of mine. Ugh.

If it matters, we don't pay any management fees (I do it) and the location means never vacancies (I have a waiting list every time it comes up for rent)

Speaking off...different friend sent me this and I'm bad at reading such things.

https://goo.gl/photos/CqzyHSfZnqAntSS36

Now, wouldn't that be a higher ROI, even after transactional costs, + more cash flow since I'd own it outright? Brutal HOA's though...
Last edited by kiva22 on Fri Jun 23, 2017 1:00 pm, edited 4 times in total.
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Re: What to do with mortgages, etc.

Post by jimb_fromATL »

DVMResident wrote: Here's an option to avoid the capital gains issues: rent your primary house, live in the secondary/rental house for 2 years to establish primary residency, then sell the rental, and then move back the primary house. Is this possible? Other possibility is wait for an foreseeable unemployment (e.g. children) to be back in the low brackets.
That loophole has been closed. You still have to pay regular income tax on all the depreciation allowance (whether you claimed it or not) plus any gain in value during the time it was in rental service. And as with any other residence, you do not get to claim a loss for any drop in value during the time you lived in it. It sounds like the home was put into rental service because it was upside down or would not bring nearly enough, so in addition to the depreciation recapture it appears that there may be a LOT of taxable gain during the rental period that won't be subject to the exemption.
If that is not possible to skip the capital gains, I would sell outright. The cash on sale is ~$200k after capital gain. Cash-flow plus principle pay down is $15k/yr ($9k cash-flow, $6k principle). ROI on cash-sale is $15k/$200k = 7.8% plus an uncertain appreciation minus vacancies and property management and taxes. Your estimated 4% is probably in the ballpark. IMO that ROI does not justify a concentrated asset and the money is better deployed as diversified equity investments.
I haven't had time to get down to the details, but I think we need a lot more information before suggesting to sell the property, and before estimating the ROI for the current rental home.

It appears to have a positive cash flow -- the equivalent of a dividend in another investment-- plus the gain in net worth from reducing the debt with the payments on the principal. Plus there's the advantage of leveraging because you're getting the appreciation on the full value of the property even though the net amount you have tied up in it is a considerably less.

The property is in a good part of town that sounds like it has recovered greatly from the market crash, and has good prospects to continue to do so ... and is not likely to be vacant very long at a time.

Plus, the OP is managing it himself. So -- depending on the cash flow, vacancies, and any operating expenses, plus the depreciation allowance -- he may have a loss (or very little taxable income) on paper, but actually have a far better return on the investment, and that's with taxes deferred.

I'll be back with more questions about the details ...

jimb
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kiva22
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Re: What to do with mortgages, etc.

Post by kiva22 »

it is correct that, on our taxes, we claim a small loss with the rental each year. When I bought the house in, i think, 2004, I was single and lived in the attached studio, renting out the rest. I then moved to my current home in 2006 or so (fabulous timing, I know) and turned it into a 100% rental. It never was completely upside down but values did drop down to where the equity was pretty low. Local market is pretty nuts right now with little inventory, bidding wars on houses, etc. Feels like 2007 again...
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Re: What to do with mortgages, etc.

Post by jimb_fromATL »

kiva22 wrote:it is correct that, on our taxes, we claim a small loss with the rental each year. When I bought the house in, i think, 2004, I was single and lived in the attached studio, renting out the rest. I then moved to my current home in 2006 or so (fabulous timing, I know) and turned it into a 100% rental. It never was completely upside down but values did drop down to where the equity was pretty low. Local market is pretty nuts right now with little inventory, bidding wars on houses, etc. Feels like 2007 again...
So you're getting the increase in net worth paid with OPM without paying any income tax on it for now.
Same for any month-to-month positive cash flow;
... and same for the leveraged appreciation.

How much did you pay for it, and approximately what month in 2004?
When in 2006 did you put it into rental service?
What was its market value when you put it into rental service?
What was its value when you refinanced it? ... and when was that?

jimb
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Re: What to do with mortgages, etc.

Post by kiva22 »

jimb_fromATL wrote:
kiva22 wrote:it is correct that, on our taxes, we claim a small loss with the rental each year. When I bought the house in, i think, 2004, I was single and lived in the attached studio, renting out the rest. I then moved to my current home in 2006 or so (fabulous timing, I know) and turned it into a 100% rental. It never was completely upside down but values did drop down to where the equity was pretty low. Local market is pretty nuts right now with little inventory, bidding wars on houses, etc. Feels like 2007 again...
So you're getting the increase in net worth paid with OPM without paying any income tax on it for now.
Same for any month-to-month positive cash flow;
... and same for the leveraged appreciation.

How much did you pay for it, and approximately what month in 2004?
When in 2006 did you put it into rental service?
What was its market value when you put it into rental service?
What was its value when you refinanced it? ... and when was that?

jimb
paid $444k in, I think, April, 2004.
Put into rental service right away, as I was only residing in a portion. The rest was rented out and taxed / depreciated, I think.
Moved to other house in April 2006 and was put into full rental mode.
Market value when put into full rental service would be approx 550-600k (height before crash).
Refinanced 1 year ago. Appraised for 425k. Agent says would sell 575-600k now. Market is nuts here. Doesn't mean it's worth that (I don't believe so, but people are out of their minds right now).
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Re: What to do with mortgages, etc.

Post by jimb_fromATL »

kiva22 wrote:
jimb_fromATL wrote:
kiva22 wrote:it is correct that, on our taxes, we claim a small loss with the rental each year. When I bought the house in, i think, 2004, I was single and lived in the attached studio, renting out the rest. I then moved to my current home in 2006 or so (fabulous timing, I know) and turned it into a 100% rental. It never was completely upside down but values did drop down to where the equity was pretty low. Local market is pretty nuts right now with little inventory, bidding wars on houses, etc. Feels like 2007 again...
So you're getting the increase in net worth paid with OPM without paying any income tax on it for now.
Same for any month-to-month positive cash flow;
... and same for the leveraged appreciation.

How much did you pay for it, and approximately what month in 2004?
When in 2006 did you put it into rental service?
What was its market value when you put it into rental service?
What was its value when you refinanced it? ... and when was that?

jimb
paid $444k in, I think, April, 2004.
Put into rental service right away, as I was only residing in a portion. The rest was rented out and taxed / depreciated, I think.
Moved to other house in April 2006 and was put into full rental mode.
Market value when put into full rental service would be approx 550-600k (height before crash).
Refinanced 1 year ago. Appraised for 425k. Agent says would sell 575-600k now. Market is nuts here. Doesn't mean it's worth that (I don't believe so, but people are out of their minds right now).
Is the portion you lived in part of the same structure, or is it a "garage" apartment separate from the main home ... which might be listed as a separate value in your county tax records?

What's the value of the land versus the structure(s) ?

Do you have records of the value or amount claimed for depreciation each year?

jimb
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kiva22
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Re: What to do with mortgages, etc.

Post by kiva22 »

jimb_fromATL wrote:
kiva22 wrote:
jimb_fromATL wrote:
kiva22 wrote:it is correct that, on our taxes, we claim a small loss with the rental each year. When I bought the house in, i think, 2004, I was single and lived in the attached studio, renting out the rest. I then moved to my current home in 2006 or so (fabulous timing, I know) and turned it into a 100% rental. It never was completely upside down but values did drop down to where the equity was pretty low. Local market is pretty nuts right now with little inventory, bidding wars on houses, etc. Feels like 2007 again...
So you're getting the increase in net worth paid with OPM without paying any income tax on it for now.
Same for any month-to-month positive cash flow;
... and same for the leveraged appreciation.

How much did you pay for it, and approximately what month in 2004?
When in 2006 did you put it into rental service?
What was its market value when you put it into rental service?
What was its value when you refinanced it? ... and when was that?

jimb
paid $444k in, I think, April, 2004.
Put into rental service right away, as I was only residing in a portion. The rest was rented out and taxed / depreciated, I think.
Moved to other house in April 2006 and was put into full rental mode.
Market value when put into full rental service would be approx 550-600k (height before crash).
Refinanced 1 year ago. Appraised for 425k. Agent says would sell 575-600k now. Market is nuts here. Doesn't mean it's worth that (I don't believe so, but people are out of their minds right now).
Is the portion you lived in part of the same structure, or is it a "garage" apartment separate from the main home ... which might be listed as a separate value in your county tax records?

What's the value of the land versus the structure(s) ?

Do you have records of the value or amount claimed for depreciation each year?

jimb
Part of the same structure. Only 1 county listing.
Value of land would be on the county tax form, right? County has 225k as current value for land. 325k for structure. I can get this from my tax return, if you like.
I can get those records. Tax guy says current basis is 281k, i believe. I can get the year by year depreciation figures, if you like.

Thanks again...
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Re: What to do with mortgages, etc.

Post by Carefreeap »

jimb_fromATL wrote:
DVMResident wrote: Here's an option to avoid the capital gains issues: rent your primary house, live in the secondary/rental house for 2 years to establish primary residency, then sell the rental, and then move back the primary house. Is this possible? Other possibility is wait for an foreseeable unemployment (e.g. children) to be back in the low brackets.
That loophole has been closed. You still have to pay regular income tax on all the depreciation allowance (whether you claimed it or not) plus any gain in value during the time it was in rental service. And as with any other residence, you do not get to claim a loss for any drop in value during the time you lived in it. It sounds like the home was put into rental service because it was upside down or would not bring nearly enough, so in addition to the depreciation recapture it appears that there may be a LOT of taxable gain during the rental period that won't be subject to the exemption.
This isn't quite true.

The law changed effective 1/1/2009. Therefore what one has to do is bifurcate the cap gain between date of purchase and 1/1/2009 until the property goes back into service as a primary. Maybe trifurcate is the real word because there would be 3 pieces to this equation, prior to 2009, the rental service up until the conversion to a primary and then again during the primary. Note that if a property is purchased as a primary and then converted subsequently to a rental and the 2 out of the 5 year rule applies, you still can partially exclude the gain. In both situations, however you will need to recapture the depreciation for the time the property is rented.

This is why the OP's tax situation looks so extreme; it's the adding back of the depreciation into the game that makes it so painful. One question for the OP is whether s/he has any carry-forwards?

We're in the process of selling a condo whereby I have a similar size cap gain. We are reducing (but not eliminating) our cap gain by taking back a seller carryback and spreading out the gain over a three year period of time. We (and the property) are both in CA. It's not a solution for everyone but I'm blessed with a buyer who has very strong financials and fantastic credit. I've known them for a long time and am delighted that this is going to work out for everyone.
Last edited by Carefreeap on Sun Jun 25, 2017 11:16 am, edited 1 time in total.
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Re: What to do with mortgages, etc.

Post by jimb_fromATL »

kiva22 wrote: Part of the same structure. Only 1 county listing.
Value of land would be on the county tax form, right? County has 225k as current value for land. 325k for structure. I can get this from my tax return, if you like.
I can get those records. Tax guy says current basis is 281k, i believe. I can get the year by year depreciation figures, if you like.

Thanks again...
Edited after some more number crunching:

No need to look up the depreciated amount. Some preliminary guesses I made came up with a total tax liability within the range your tax guy says, but it would be interesting to know how much was depreciated for the time you lived there and after it became fully rented out.

So it appears you'll pay a bunch of tax if you sell. Looking at what you'll clear after paying the tax and paying off the mortgage, I suspect we're going to find that your real rate of return for any positive cash flow, plus the increase in net worth from debt reduction an leverage appreciation is gong to be in the range of double ... and maybe more ... than you can count on earning in the stock market on the proceeds from the sale over a long time. At the very least, it is likely to be far more than the capitalization rate for the rent alone.

jimb
Last edited by jimb_fromATL on Fri Jun 23, 2017 11:16 pm, edited 1 time in total.
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Re: What to do with mortgages, etc.

Post by jimb_fromATL »

Carefreeap wrote:
jimb_fromATL wrote:
DVMResident wrote: Here's an option to avoid the capital gains issues: rent your primary house, live in the secondary/rental house for 2 years to establish primary residency, then sell the rental, and then move back the primary house. Is this possible? Other possibility is wait for an foreseeable unemployment (e.g. children) to be back in the low brackets.
That loophole has been closed. You still have to pay regular income tax on all the depreciation allowance (whether you claimed it or not) plus any gain in value during the time it was in rental service. ...
This isn't quite true.

The law changed effective 1/1/2009. Therefore what one has to do is bifurcate the cap gain between date of purchase and 1/1/2009 until the property goes back into service as a primary. Maybe trifurcate is the real word because there would be 3 pieces to this equation, prior to 2009, the rental service up until the conversion to a primary and then again during the primary. Note that if a property is purchased as a primary and then converted subsequently to a rental and the 2 out of the 5 year rule applies, you still can exclude. In both situations, however you will need to recapture the depreciation for the time the property is rented.
...


Since the loophole was closed, the prorated proportion of the total capital gain during the years it was a rental is not excludable. HERE. is one of many articles about it.
  • "...In addition to the limitation of Section 121 regarding depreciation recapture, as a part of the Housing Assistance Tax Act of 2008, Congress further limited the exclusion of capital gains for property that was converted from a rental to a primary residence. The new rules, enshrined in IRC Section 121(b)(4), stipulate that the capital gains exclusion is specifically available only for periods during which the property was actually used as a primary residence; any other time (since January 1st, 2009) that the property was not used as a primary residence is deemed “nonqualifying use”. Accordingly, to the extent gains are allocable to periods of nonqualifying use (gains are assumed to be pro-rata over the holding period), those gains are not eligible for the exclusion..."

See example 2B and 2C.


jimb
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kiva22
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Re: What to do with mortgages, etc.

Post by kiva22 »

Carefreeap wrote:. One question for the OP is whether s/he has any carry-forwards?

We're in the process of selling a condo whereby I have a similar size cap gain. We are reducing (but not eliminating) our cap gain by taking back a seller carryback and spreading out the gain over a three year period of time. We (and the property) are both in CA. It's not a solution for everyone but I'm blessed with a buyer who has very strong financials and fantastic credit. I've known them for a long time and am delighted that this is going to work out for everyone.
I don't know what a carry-forward is, so I'm thinking no...
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Re: What to do with mortgages, etc.

Post by Carefreeap »

kiva22 wrote:
Carefreeap wrote:. One question for the OP is whether s/he has any carry-forwards?

We're in the process of selling a condo whereby I have a similar size cap gain. We are reducing (but not eliminating) our cap gain by taking back a seller carryback and spreading out the gain over a three year period of time. We (and the property) are both in CA. It's not a solution for everyone but I'm blessed with a buyer who has very strong financials and fantastic credit. I've known them for a long time and am delighted that this is going to work out for everyone.
I don't know what a carry-forward is, so I'm thinking no...
Deductibility of real estate passive losses starts to phase out when your AGI exceeds $100k and is fully phased out at $150k. You don't lose this "benefit", you just "carry forward" the losses until your income drops or you have a capital gain that can be partially off-set by them. As an example my husband and I had over 10 years of these collective passive losses from the years he had a high income. Last year we were able to use them to off-set a $400k cap gain when we sold a property last year. We actually paid $0 fed taxes and about $3,500 CA state taxes.

You should be able to tell if you have any by looking through your tax return from last year. There's a worksheet for "allowable" vs "unallowable" passive activity losses.
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Re: What to do with mortgages, etc.

Post by Carefreeap »

jimb_fromATL wrote:
Carefreeap wrote:
jimb_fromATL wrote:
DVMResident wrote: Here's an option to avoid the capital gains issues: rent your primary house, live in the secondary/rental house for 2 years to establish primary residency, then sell the rental, and then move back the primary house. Is this possible? Other possibility is wait for an foreseeable unemployment (e.g. children) to be back in the low brackets.
That loophole has been closed. You still have to pay regular income tax on all the depreciation allowance (whether you claimed it or not) plus any gain in value during the time it was in rental service. ...
This isn't quite true.

The law changed effective 1/1/2009. Therefore what one has to do is bifurcate the cap gain between date of purchase and 1/1/2009 until the property goes back into service as a primary. Maybe trifurcate is the real word because there would be 3 pieces to this equation, prior to 2009, the rental service up until the conversion to a primary and then again during the primary. Note that if a property is purchased as a primary and then converted subsequently to a rental and the 2 out of the 5 year rule applies, you still can exclude. In both situations, however you will need to recapture the depreciation for the time the property is rented.
...


Since the loophole was closed, the prorated proportion of the total capital gain during the years it was a rental is not excludable. HERE. is one of many articles about it.
  • "...In addition to the limitation of Section 121 regarding depreciation recapture, as a part of the Housing Assistance Tax Act of 2008, Congress further limited the exclusion of capital gains for property that was converted from a rental to a primary residence. The new rules, enshrined in IRC Section 121(b)(4), stipulate that the capital gains exclusion is specifically available only for periods during which the property was actually used as a primary residence; any other time (since January 1st, 2009) that the property was not used as a primary residence is deemed “nonqualifying use”. Accordingly, to the extent gains are allocable to periods of nonqualifying use (gains are assumed to be pro-rata over the holding period), those gains are not eligible for the exclusion..."

See example 2B and 2C.


jimb
I appreciate the article but all of the references were about property that was originally purchased as a rental and then subsequently converted to a primary. I didn't see a reference to the situation where someone buys the property as a primary, then converts to a rental within the qualified period OR a situation where we might find ourselves; buy as primary, convert as rental and convert back to primary and sell within the qualified time.
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Re: What to do with mortgages, etc.

Post by jimb_fromATL »

Carefreeap wrote: I appreciate the article but all of the references were about property that was originally purchased as a rental and then subsequently converted to a primary. I didn't see a reference to the situation where someone buys the property as a primary, then converts to a rental within the qualified period OR a situation where we might find ourselves; buy as primary, convert as rental and convert back to primary and sell within the qualified time.
I don't think it matters whether it was initially purchased as a rental or residence.

The $250K or $500K exclusion was meant for personal residences, not investment property. It took the place of the previous requirement to buy another --and more expensive-- home in order to defer the cap gains tax from the sale of a home.

The old law grossly penalized people who were downsizing for retirement, or who were moving from a high-cost-of-housing area to a lower-cost area.

(In the 70s and 80s people who moved from high-cost-of-housing areas to lower cost areas were literally forced to buy mansions -- much larger homes -- in the low-cost areas, else pay the much higher cap gains tax rates (which were 28% to 33% back then) on the profit from the sale of their previous home. And people who needed to downsize because of retirement or even because of a job loss or cut in pay were forced to pay the high taxes if they sold their current home and did not replace it with one of equal or higher value.)

The new law had an unintended loophole that allowed people to rent out a property, then go back and live in it for two years and get to exclude the capital gain that occurred while it was an investment instead of their personal residence. That loophole was closed later by clarifying that the depreciation recapture was not exempt, and that the capital gain for personal use (qualified) is prorated with the investment use (unqualified) for the time the property was owned.

On the other hand, if you think there's still a loophole, go for it.

jimb
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Re: What to do with mortgages, etc.

Post by Carefreeap »

jimb_fromATL wrote:
Carefreeap wrote: I appreciate the article but all of the references were about property that was originally purchased as a rental and then subsequently converted to a primary. I didn't see a reference to the situation where someone buys the property as a primary, then converts to a rental within the qualified period OR a situation where we might find ourselves; buy as primary, convert as rental and convert back to primary and sell within the qualified time.
I don't think it matters whether it was initially purchased as a rental or residence.

The $250K or $500K exclusion was meant for personal residences, not investment property. It took the place of the previous requirement to buy another --and more expensive-- home in order to defer the cap gains tax from the sale of a home.

The old law grossly penalized people who were downsizing for retirement, or who were moving from a high-cost-of-housing area to a lower-cost area.

(In the 70s and 80s people who moved from high-cost-of-housing areas to lower cost areas were literally forced to buy mansions -- much larger homes -- in the low-cost areas, else pay the much higher cap gains tax rates (which were 28% to 33% back then) on the profit from the sale of their previous home. And people who needed to downsize because of retirement or even because of a job loss or cut in pay were forced to pay the high taxes if they sold their current home and did not replace it with one of equal or higher value.)

The new law had an unintended loophole that allowed people to rent out a property, then go back and live in it for two years and get to exclude the capital gain that occurred while it was an investment instead of their personal residence. That loophole was closed later by clarifying that the depreciation recapture was not exempt, and that the capital gain for personal use (qualified) is prorated with the investment use (unqualified) for the time the property was owned.

On the other hand, if you think there's still a loophole, go for it.

jimb
I believe there still is with property purchased as the primary. However I'll confirm on Tuesday when I meet my CPA for lunch.

As I understand it, the law was passed due to folks taking long held investment property, doing a 1031 exchange into a house, live in it for 2 years then sell it for a large profit close to tax free. Rinse and repeat. We wanted to do that when we did a 1031 exchange out of a strip retail shopping center and into a nice house midway between my parents' homes (they were divorced and lived in separate corners of San Diego County) in 2005. That scheme didn't work out the way we planned for a number of reasons but in the end we did o.k. when we sold it last year. We were able to use accumulated carry-forwards to completely off-set about a $400k gain and paid no Federal income taxes. I love my CPA! :beer
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Let's get back to the refi and mortgages

Post by jimb_fromATL »

kiva22 wrote:

Primary home:

Value: approx 350-375k
owed: 229k @ 4.375. Term remaining: 22yrs, 2months
current payment (PITI): 1629.32

,,,
Other debt:

"family loan" (long story; related to the one from my first post, but not worth explaining; it's essentially a HELOC:
40k @ 3.125%
payment: we currently pay $1100-1300/mo

One question I have about the primary loan is that we've paid 8 years on an amortized loan. At what point does refinancing it actually make the money even more expensive since the interest is front loaded? Just a thought that requires more math skills than I have...

Options considered for primary residence:

(1) Refinance primary residence w/ cash out to pay off the 40k. 15yr loan (we'd own the house upon retirement) would put us at a payment of about $2200 rate quoted a month ago was 3.625%. Total change in cash flow would be about +600 which can be put toward student loan or towards IRA's.

(2) Refinance primary residence w/ cash out to pay off the 40k. 30yr loan. Payment would be about the same, 1600. Rate 4.375%. This changes cash flow to +1100/mo which can go to student loan, then IRA's. Maybe make an extra payment or 2 each year to shorten the loan a bit?

(3) Sit tight and keep paying the most possible to the debt.
It can pay to refinance if for the same money out of pocket at closing and the same payment per month, the savings in interest will make up for the closing costs and save some more interest by the time you either sell the home or have it paid off ... at which times you will realize the benefit of the extra principal paid with less interest.

Bear in mind that Time is an exponential factor in compound interest on an investment or on a mortgage or other debt. (The borrower's debt is the lender's investment in an annuity that has a guaranteed rate and minimum monthly payout with interest compounded monthly on the unpaid balance.)

So -- just like you can potentially earn more total compound interest by starting to invest sooner, you can end up paying more compound interest by stretching out a loan for a substantially longer time -- even if the rate on the new longer loan is lower.

You can probably save some money by refinancing your primary home mortgage. But NOT by rolling the private debt into a new mortgage.

To illustrate the problem with the private loan:
  • Rounding to an integer number of months, the current HELOC-like debt of $40,000 at 3.125% with a payment of $1197.22 per month will be paid off in 35 months with $1903 interest.

    If you roll it into a new cash-our refi, the closing costs at typically 1.5% of the new balance will be $600. If you pay that amount on the current debt, then with the $1197 payment the remaining $39,400 will be paid off in 34.45 months. The total cost will be 600 + (34.45 x 1197 ) = $41,845 with $1845 interest.

    If you roll the $40,000 into a cash-out refinance at 3.625% for 15 years, it will only add $288.41 to the new mortgage payment. But the total cost will be 600 + (180 x 288.41 ) = $52,515 with $12,515 interest. That's $10,670 more than you would pay if you just keep the current loan.

    Even if you pay the same $1197.22 per month extra on the new mortgage, it will take 35.27 months and cost 600 +(35.27 x 1197.22 ) = $42,829 with $2,229 interest ... which is $984 more than the current debt.
I'll be back with some numbers for the main home mortgage later.

jimb
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More about prorating gain while the property wa rented out

Post by jimb_fromATL »

Carefreeap wrote: I appreciate the article but all of the references were about property that was originally purchased as a rental and then subsequently converted to a primary. I didn't see a reference to the situation where someone buys the property as a primary, then converts to a rental within the qualified period OR a situation where we might find ourselves; buy as primary, convert as rental and convert back to primary and sell within the qualified time.
You might want to take a look at the worksheet in publication 523. Even if you meet the two out of five year requirement and get to that worksheet, it appears to prorate and exclude the gain for all of the non-residence time, I.E. rental use. I didn't see anywhere it appears to matter whether it was bought as a residence or rental or in what order it was rented and lived in.

Look for the part that says:
    • Did you have non-residence gain? If there were times after 2008 when neither you nor your spouse (or a former spouse) used your home as a main residence, and didn’t meet the situations under the Second test, above, do the following calculation:
       
      (1) Enter the total number of days after 2008 when neither you nor your spouse (or former spouse) used the home as a main residence. This is the non-use days
      (2) Enter the total number of days you owned your home (counting all days, not just days after 2008). This is the days owned
      (3) Divide the non-use days by the days owned. Calculate to 3 decimal places. This is your non-residence factor
       Multiply line 3b by your non-residence factor. This is your non-residence gain
      For example, if you owned your home for 10 years (3,650 days), didn’t use it as your main residence for 500 days after 2008, and had a $20,000 gain, your calculation would look like this.
      Calculation of non-residence factor: 500 ÷ 3,650 = 0.137
      Calculation of non-residence gain: $20,000 × 0.137 = $2,740
      add your total depreciation (line 3a) to your non-residence gain (line 3c). You might have one but not the other. See also Recapturing Depreciation.
      this is your ineligible gain

      Determine gain eligible for exclusion.
      Enter your gain (from line 3b)
      Subtract your non-residence gain (line 3c)
      This is your gain eligible for exclusion
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Re: More about prorating gain while the property wa rented out

Post by Carefreeap »

jimb_fromATL wrote:
Carefreeap wrote: I appreciate the article but all of the references were about property that was originally purchased as a rental and then subsequently converted to a primary. I didn't see a reference to the situation where someone buys the property as a primary, then converts to a rental within the qualified period OR a situation where we might find ourselves; buy as primary, convert as rental and convert back to primary and sell within the qualified time.
You might want to take a look at the worksheet in publication 523. Even if you meet the two out of five year requirement and get to that worksheet, it appears to prorate and exclude the gain for all of the non-residence time, I.E. rental use. I didn't see anywhere it appears to matter whether it was bought as a residence or rental or in what order it was rented and lived in.

Look for the part that says:
    • Did you have non-residence gain? If there were times after 2008 when neither you nor your spouse (or a former spouse) used your home as a main residence, and didn’t meet the situations under the Second test, above, do the following calculation:
       
      (1) Enter the total number of days after 2008 when neither you nor your spouse (or former spouse) used the home as a main residence. This is the non-use days
      (2) Enter the total number of days you owned your home (counting all days, not just days after 2008). This is the days owned
      (3) Divide the non-use days by the days owned. Calculate to 3 decimal places. This is your non-residence factor
       Multiply line 3b by your non-residence factor. This is your non-residence gain
      For example, if you owned your home for 10 years (3,650 days), didn’t use it as your main residence for 500 days after 2008, and had a $20,000 gain, your calculation would look like this.
      Calculation of non-residence factor: 500 ÷ 3,650 = 0.137
      Calculation of non-residence gain: $20,000 × 0.137 = $2,740
      add your total depreciation (line 3a) to your non-residence gain (line 3c). You might have one but not the other. See also Recapturing Depreciation.
      this is your ineligible gain

      Determine gain eligible for exclusion.
      Enter your gain (from line 3b)
      Subtract your non-residence gain (line 3c)
      This is your gain eligible for exclusion
jimb
Thanks again for the link. I had to read the section before the section quoted 3 times before it made sense. :wink:

I'm sticking with an earlier post whereby I stated that the cap gains calculations are actually trifurcated because there's the rental use before 2009 for a primary residence, the rental use after 2009, and the 2 out of 5 year rule during prior to the sale. Had we sold our primary in 2014 or 2015 we might have had four pieces to the equation.

As I said, I'm going to double-check with my CPA on Tuesday. Clearly the exemption favors long-held properties which were primarily owner-occupied and were put into brief rental service after 1/1/2009. In our situation we bought in 1995, converted to rental in 2003, moved back in 2012. Therefore according to this section of the code over our 22 years of ownership our ineligible time is only going to be 3.5 years, from 1/1/2009 until 7/1/2012. The irony is that the property value actually fell during this time and didn't start recovering until we moved back in! At this point we plan on staying in this property for another 10-11 years when my husband turns 70 and we should re-evaluate the suitability of living in a two story house. At that point those 3.5 years will only be about 10% of the entire holding period.
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More about refinancing -- this about the primayr home

Post by jimb_fromATL »

I showed in a previous post that using cash-out to roll the private loan into a new mortgage at a higher rate would cost a lot more money if you stretched it out for a longer time, and that even with the same payment it will still cost more because of the higher rate and the closing costs of the new mortgage.

However, it will save some money to refinance the existing mortgage under the terms described.

Here's how it could work:
  • The current mortgage balance of $229,600 at 4.375% with 348 months (29 years) remaining has a payment of $1165.58 per month and will cost $405,623 with $176,023 interest.

    If you refinance it the closing costs at typically 1.5% of the balance will be $3444. If you just pay that amount on the current debt, then with the $1166 payment the remaining $226,156 will be paid off in 337.69 months. The total cost will be 3444 + (337.69 x 1166 ) = $397,052 with $167,452 interest.

    For the refi with closing costs paid up front, the new balance of $229,600 at 3.625% for 180 months (15 years will have a payment of $1655.500.40 per month. The total paid will be 3444 + (180 x 1655.5 ) = $301,434 with $68,390 interest.
    For an apples to apples comparison, if you use the closing costs to pay down the current mortgage plus make the higher payment of $1655.50 per month the loan will be paid off in 193.58 months (16.13 years). The total cost will be + (193.58 x 1655.50) = $323,920 with 90,876 Interest.

So ... for the same amount of money up front and per month, refinancing could save $22,486 and 13.6 months of payments.

One thing that needs to be addressed is your cash flow for now and anticipated in the future. It would not be worth refinancing and committing to the higher payment if there were any significant chance that you might have to reduce maximum contributions to any tax-deferred retirement plans ... like a 401(k) ... in order to be comfortable with the higher payment on the mortgage.

If there is no problem with the higher payment on the refi mortgage plus the current payment on the private HELOC, and if you really want to eliminate the HELOC -- because of personal feelings or family dynamics -- it is conceivable that the extra cost I showed for the cash-out could be worth it in the long run. The main thing is that you should not reduce the payment significantly because of the effect of time in compound interest if the payment is reduced by very much.

Speaking of cash flow ... IS there any problem with committing to the higher mortgage payment for refinancing the primary home mortgage plus continuing to pay the $1200 or more for the HELOC debt if it's rolled into the mortgage ... if it's not?

jimb
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Re: More about refinancing -- this about the primayr home

Post by kiva22 »

jimb_fromATL wrote:I showed in a previous post that using cash-out to roll the private loan into a new mortgage at a higher rate would cost a lot more money if you stretched it out for a longer time, and that even with the same payment it will still cost more because of the higher rate and the closing costs of the new mortgage.

However, it will save some money to refinance the existing mortgage under the terms described.

Here's how it could work:
  • The current mortgage balance of $229,600 at 4.375% with 348 months (29 years) remaining has a payment of $1165.58 per month and will cost $405,623 with $176,023 interest.

    If you refinance it the closing costs at typically 1.5% of the balance will be $3444. If you just pay that amount on the current debt, then with the $1166 payment the remaining $226,156 will be paid off in 337.69 months. The total cost will be 3444 + (337.69 x 1166 ) = $397,052 with $167,452 interest.

    For the refi with closing costs paid up front, the new balance of $229,600 at 3.625% for 180 months (15 years will have a payment of $1655.500.40 per month. The total paid will be 3444 + (180 x 1655.5 ) = $301,434 with $68,390 interest.
    For an apples to apples comparison, if you use the closing costs to pay down the current mortgage plus make the higher payment of $1655.50 per month the loan will be paid off in 193.58 months (16.13 years). The total cost will be + (193.58 x 1655.50) = $323,920 with 90,876 Interest.

So ... for the same amount of money up front and per month, refinancing could save $22,486 and 13.6 months of payments.

One thing that needs to be addressed is your cash flow for now and anticipated in the future. It would not be worth refinancing and committing to the higher payment if there were any significant chance that you might have to reduce maximum contributions to any tax-deferred retirement plans ... like a 401(k) ... in order to be comfortable with the higher payment on the mortgage.

If there is no problem with the higher payment on the refi mortgage plus the current payment on the private HELOC, and if you really want to eliminate the HELOC -- because of personal feelings or family dynamics -- it is conceivable that the extra cost I showed for the cash-out could be worth it in the long run. The main thing is that you should not reduce the payment significantly because of the effect of time in compound interest if the payment is reduced by very much.

Speaking of cash flow ... IS there any problem with committing to the higher mortgage payment for refinancing the primary home mortgage plus continuing to pay the $1200 or more for the HELOC debt if it's rolled into the mortgage ... if it's not?

jimb
Hi Jimb

Ok, first, the primary home has the 227k balance, but 22 years, 3 months left, not 29. Current principal + interest is 1339.63. Not sure if that makes a difference in the calculations.

Currently, we are not maxing out our retirement contributions. Beside our pensions, we contribute the max each year to each of our Roth's. Right now, that is it; we max those and pay the rest to debt. Monthly cash flow is fine as is, but, of course, would like to get to upping our retirement contributions. We are likely to be making more money in 12-18mo but, of course, nothing is guaranteed. I don't think we could, today, increase our mortgage payment via refinancing, maintain the max IRA contributions, and maintain the current debt payment. 12-18 months from now, probably.

if it's rolled into the mortgage....does that make sense since we'll pay a bit more in interest for the primary mortgage refi since it's cash out?
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Re: More about refinancing -- this about the primayr home

Post by jimb_fromATL »

kiva22 wrote: Hi Jimb

Ok, first, the primary home has the 227k balance, but 22 years, 3 months left, not 29. Current principal + interest is 1339.63. Not sure if that makes a difference in the calculations.
Oops ! That makes a little difference with the current minimum payment. However, that still won't make any difference for the real apples to apples comparison of the same payment up front and per month on both mortgages.
  • The current mortgage balance $229,600 at 4.375% with 267 months (22.25 years) remaining has a payment of about $1346.77 per month and will cost $359,588 with $129,988 interest.

    If you refinance it the closing costs at typically 1.5% of the balance will be $3444. If you pay that amount on the current debt, then with the $1347 payment the remaining $226,156 will be paid off in 260.31 months. The total cost will be 3444 + (260.31 x 1347 ) = $354,025 with $124,425 interest.

    For the refi with closing costs paid up front, the new balance of $229,600 at 3.625% for 180 months (15 years will have a payment of $1655.500.40 per month. The total paid will be 3444 + (180 x 1655.5 ) = $301,434 with $68,390 interest.

    For an apples to apples comparison, if you use the closing costs to pay down the current mortgage plus make the higher payment of $1655.50 per month the loan will be paid off in 193.58 months (16.13 years). The total cost will be 3444 + (193.58 x 1655.50) = $323,920 with 90,876 Interest.

    So for the same amount of money up front and per month, refinancing will save $22,486 and 13.6 months of payments.
Currently, we are not maxing out our retirement contributions. Beside our pensions, we contribute the max each year to each of our Roth's. Right now, that is it; we max those and pay the rest to debt. Monthly cash flow is fine as is, but, of course, would like to get to upping our retirement contributions. We are likely to be making more money in 12-18mo but, of course, nothing is guaranteed. I don't think we could, today, increase our mortgage payment via refinancing, maintain the max IRA contributions, and maintain the current debt payment. 12-18 months from now, probably.

if it's rolled into the mortgage....does that make sense since we'll pay a bit more in interest for the primary mortgage refi since it's cash out?
It will take some more number crunching, but I strongly suspect that you will come out much better to keep the lower mortgage payment and contribute more to tax-advantaged retirement.

How important is it to pay off the family HELOC-like mortgage faster? Since it's a lower rate than your current or new mortgage, It would really be better for your finances NOT to hurry it up -- if the person you owe the money to is happy with earning that percentage on their money. They can't get that nearly much in a savings account or CD. So if they don't need the money, they actually may be benefitting if you don't pay it off too fast.

If you or they do feel a need to pay it off faster, I suspect the numbers will show that it would probably be better to pay a bit more interest on it over a longer time by rolling it into the new mortgage than to reduce or postpone contributions to tax-deferred retirement.

Refresh my memory about your top tax brackets for federal and state?

jimb
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Re: What to do with mortgages, etc.

Post by kiva22 »

we are currently 25% Federal, 8% State. Does "effective tax rate" come into play here? That is, our tax paid divided by our AGI after deductions? Or does one simply do it based on income level?

So, if i'm hearing you correctly, it may be beneficial to roll the heloc loan in and then take any extra and invest additional into tax-advantaged retirement. I have a 403b w/ Vanguard that we're not currently contributing to and a roth403b @ fidelity, also not currently contributing.

we could also take our own heloc out; we just didn't have it available when the debt was incurred.

also, if it matters, the 15yr non-cash refi rate i'm getting quoted right now is 3%.
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Re: What to do with mortgages, etc.

Post by jimb_fromATL »

kiva22 wrote:we are currently 25% Federal, 8% State. Does "effective tax rate" come into play here? That is, our tax paid divided by our AGI after deductions? Or does one simply do it based on income level?
Not really. Your top tax brackets for federal and state determine the percentage of tax that you defer and invest for yourself in a 401(k) or 403(b) type plan. They also determine the percentage of tax that you save for the amount by which your property taxes and mortgage interest cause you to exceed the standard deduction.

... and as your tax guy pointed out, you're in high enough tax brackets that you'll pay a lot of taxes if you sell the rental property.
So, if i'm hearing you correctly, it may be beneficial to roll the heloc loan in and then take any extra and invest additional into tax-advantaged retirement. I have a 403b w/ Vanguard that we're not currently contributing to and a roth403b @ fidelity, also not currently contributing.
In your tax brackets, it's a pretty sure thing that deferring taxes and investing the money in your 401k or 403b to earn compound interest for the rest of your life will be more beneficial than paying the tax now and letting the gubbament do whatever the heck they will do with it. The extra interest you pay (or don't save) on the relatively short-term debt will probably be very small in comparison to the extra compound interest you will earn by investing the tax money and extra after-tax money for yourself for the rest of your life.

(Incidentally, compound interest earnings don't stop just because you retire and stop contributing new money. In fact it's possible that you may earn nearly as much or even more on the large lump sum after retirement -- even while withdrawing some of it -- than you earned on the slowly increasing amount during your working years.

An exception might be if you expect to have huge increases in pay and huge pensions or other income that might cause you to have even more income after retirement than you expect to have while you're working ... and that after allowing for inflation. (The standard deduction, personal exemptions, and steps between lower tax brackets go up with inflation. So you'd need to have a lot more retirement income than you do now for your effective taxes to be a significantly higher percentage than you're paying -- or get to defer -- now.
we could also take our own heloc out; we just didn't have it available when the debt was incurred.
It's still a good rate for you, and a good rate for the (family? ) lender -- if they were otherwise going to put it into a savings account, CDs, etc ... instead of gambling with it in the stock market.

Is it desirable or urgent or even a little important to either parties to pay it off faster?

Whether you keep it or even roll it into another loan, I suspect you'll come out better by taking longer to pay it (or the new debt) longer IF that's necessary to allow you to contribute more to tax deferred retirement now.

More pondering, head-scratching, and number-crunching to come.

jimb
Topic Author
kiva22
Posts: 87
Joined: Sat Jul 30, 2016 2:56 am

Re: What to do with mortgages, etc.

Post by kiva22 »

jimb_fromATL wrote:
Is it desirable or urgent or even a little important to either parties to pay it off faster?

Whether you keep it or even roll it into another loan, I suspect you'll come out better by taking longer to pay it (or the new debt) longer IF that's necessary to allow you to contribute more to tax deferred retirement now.

More pondering, head-scratching, and number-crunching to come.

jimb
thank you for the explanations...your patience is appreciated.

The only rush to pay off the heloc is that it probably matures soon. They will probably just take another line. If we end up staying pat or just refinancing the primary, I could just take out the heloc myself and at least we'd get the interest deduction...

A lot of the rush on my end is probably just the "i hate debt" stuff in my head...

My wife has PERS and I have STRS. Both are meh as far as solvency, so who knows how they'll be when we retire. I'm 19 years into STRS and getting the itch to do something else; i'm just not sure I can put another 10-15 years into this system of care without doing damage to myself with the stress; an ongoing discussion in our house right now.

thanks for all the pondering....seriously, my kids are going to grow up learning about this stuff; we never spoke a word of any of it when I was growing up so feel always behind the 8-ball....
Topic Author
kiva22
Posts: 87
Joined: Sat Jul 30, 2016 2:56 am

Re: What to do with mortgages, etc.

Post by kiva22 »

Hi

Some new numbers on the refinance situation.

Current rate being offered on 15yr is 3.0%. Closing costs are 3200. If I roll the cash in, I will likely need to pay .625 of the loan amount as a fee. There is a chance BofA will match the credit union rate and pricing without that fee, but don't know that yet.

I also believe the goal here should be to maximize our retirement contributions, as we're only contributing about 9% of our gross income to retirement (not including pensions).

The 'family heloc' rate is now 5.09%. There is also the option of taking 2nd at about 4.375% fixed for 15 years which would give us the option of paying it off sooner, if we had the $. Thoughts on that vs. a roll in?

primary mortgage thoughts:

Refinancing the current into a 15 would increase the payment by $250/mo.

Refinancing into a 30yr @ 3.75% (dumb?) would decrease or mortgage payment $274/mo

Refinancing into a 20yr @ 3.75% would increase our payment about $20.

the 30yr would, of course, free up that $ to contribute to retirement, but, over 30 years, the $ gets expensive.

Thoughts? I'm leaning toward the 15 year @ 3.0% and rolling things in. Our new payment would be $526 more/mo. We would be able to take the extra $574 (1100-526) and put that into retirement accounts.

Best plan?
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Meg77
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Location: Dallas, TX

Re: What to do with mortgages, etc.

Post by Meg77 »

kiva22 wrote:Hi

Some new numbers on the refinance situation.

Current rate being offered on 15yr is 3.0%. Closing costs are 3200. If I roll the cash in, I will likely need to pay .625 of the loan amount as a fee. There is a chance BofA will match the credit union rate and pricing without that fee, but don't know that yet.

I also believe the goal here should be to maximize our retirement contributions, as we're only contributing about 9% of our gross income to retirement (not including pensions). If the goal is to maximize retirement contributions, then you should go with the 30 year loan option to minimize monthly payments. It's still a great rate, especially after factoring in tax deductions and inflation.

The 'family heloc' rate is now 5.09%. There is also the option of taking 2nd at about 4.375% fixed for 15 years which would give us the option of paying it off sooner, if we had the $. Thoughts on that vs. a roll in? It makes more sense to roll it in to the mortgage and get a lower interest rate. You can always pay off the mortgage faster than the term you take out, so don't get confused by looking at how much interest you'll pay over the life of the loan. The key is what interest RATE you have. Mortgages are not front loaded the way people think; interest each month is calculated by multiplying the interest rate times the previous month's balance; then principal is added until your total payment equalis the fixed payment you agreed to. So if you pay extra on a mortgage, you aren't prepaying interest. You're jumping ahead on the amortization schedule (and therefore getting on track to pay it off early).

primary mortgage thoughts:

Refinancing the current into a 15 would increase the payment by $250/mo. Not bad, awesome rate.

Refinancing into a 30yr @ 3.75% (dumb?) would decrease or mortgage payment $274/mo Not dumb, but not a bad difference between this and the 15 year rate, plus would enable you do put $500 more a month (by comparison) into retirement, which a) would probably grow at a higher rate than this and b) would also give you a tax break. So probably the best bet mathematically (but not necessarily psychologically depending on your values).

Refinancing into a 20yr @ 3.75% would increase our payment about $20. Middle ground option - possibly ideal for you.

the 30yr would, of course, free up that $ to contribute to retirement, but, over 30 years, the $ gets expensive. Again, don't look at it over 30 years. 95% of 30 year mortgages don't make it to year 30. You'll likely pay it off early, refi, or sell before then.

Thoughts? I'm leaning toward the 15 year @ 3.0% and rolling things in. Our new payment would be $526 more/mo. We would be able to take the extra $574 (1100-526) and put that into retirement accounts. That's a fine choice, but you need to prioritize your goals. Paying off the mortgage early - which in this case also could mean refinancing to shorten the term - is not usually priority 1 for most people. Here are my priorities:

1. Get 401k matches.
2. Max Roth IRAs.
3. Max HSA
4. Pay off high interest rate debt (over 7%)
5. Have emergency fund of 3 months expenses.
6. Max 401ks
7. Pay off cheap consumer debt (under 7%)
8. Fully fund kids' 529 plans (I don't have kids, but here is where I'd place that)
9. Pay off mortgages early and/or invest in taxable accounts - depending on current interest rates and market cycle (if stocks tank I'd probably use extra cash to buy stocks; if stocks are at all time highs like now, I'd probably use extra cash to pay down higher rate mortgages).

10. Quit saving, start spending. (aka - Retire!)

Best plan?
"An investment in knowledge pays the best interest." - Benjamin Franklin
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Meg77
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Location: Dallas, TX

Re: What to do with mortgages, etc.

Post by Meg77 »

kiva22 wrote: Rental Property:

Value: approx 575-600k
owed: 363k @ 4.25, 29yrs remaining
current PITI: 2328.29
Total rents: $3125/mo (37,500/yr)
tax basis: $331k (I think, after deciphering my tax's guy's answer on how much tax i'd pay if i sold)

The rental is in a prime location - one of the best in the city - but the way the previous owner remodeled it, it has a basement without windows and though I tell the people that rent it that they can't use it as livable space, it makes me nervous. The previous owner actually rented the basement as another room and charged another 15-20% in rent. I just can't do that and sleep at night. The house is also old: 1941 so can be subject to high maintenance costs. Will probably need a roof within 5-7 years

Why on earth are you worried about the basement? This makes no sense to me...millions of homes in this country have finished basements with no windows that are used as living space. Am I missing something?? You may not be able to legally market it as a bedroom if it doesn't have windows, but there is nothing inherently unsafe about a basement without windows.

One question I have about the primary loan is that we've paid 8 years on an amortized loan. At what point does refinancing it actually make the money even more expensive since the interest is front loaded? Just a thought that requires more math skills than I have...

This is a common misperception, but mortgage interest is not front-loaded. The interest charged each month equals exactly the interest rate multiplied by the previous month's balance. The difference goes to principal. So it ALWAYS makes sense to refinance to get a lower rate, unless the closing costs are higher than the interest savings over the period you plan to keep the loan.

Options considered for rental:

(1) sell outright. Tax guy freaked out when I even suggested it.
(2) Exchange into another property. This is a more complex question. A friend who does commercial property investment sent me an office building listing where I would be able to exchange in and pay cash. If you want, I could post the full financials, but my quick math said about an 8.5% return. My amateur math says my current rental is only making about 4%. (?).

(3) Do nothing.

Anyway, open to any and all ideas. Thanks!
What is your goal? Why would you sell? It looks like it's cash flowing or at least breaking even (depending on vacancies and maintenance); you say it's not a hassle that is bugging you; the location is one of the best in the city; and you say your current personal cash flow is OK. So there appears to be no compelling reason to sell. The only reason I'd sell that property if none of those things change is if you have a need or better investment opportunity for the equity you'd net after sale. You're using cheap long term leverage to own an appreciating asset without coming out of pocket each month, while saving on taxes. Don't mess with success. True you could probably find better rentals, but the transaction costs of selling or exchanging are crazy, and it's probably not worth the hassle.
matt
"An investment in knowledge pays the best interest." - Benjamin Franklin
Topic Author
kiva22
Posts: 87
Joined: Sat Jul 30, 2016 2:56 am

Re: What to do with mortgages, etc.

Post by kiva22 »

thank you for your detailed feedback....
Meg77 wrote:
kiva22 wrote:Hi

Some new numbers on the refinance situation.

Current rate being offered on 15yr is 3.0%. Closing costs are 3200. If I roll the cash in, I will likely need to pay .625 of the loan amount as a fee. There is a chance BofA will match the credit union rate and pricing without that fee, but don't know that yet.

I also believe the goal here should be to maximize our retirement contributions, as we're only contributing about 9% of our gross income to retirement (not including pensions). If the goal is to maximize retirement contributions, then you should go with the 30 year loan option to minimize monthly payments. It's still a great rate, especially after factoring in tax deductions and inflation.

The 'family heloc' rate is now 5.09%. There is also the option of taking 2nd at about 4.375% fixed for 15 years which would give us the option of paying it off sooner, if we had the $. Thoughts on that vs. a roll in? It makes more sense to roll it in to the mortgage and get a lower interest rate. You can always pay off the mortgage faster than the term you take out, so don't get confused by looking at how much interest you'll pay over the life of the loan. The key is what interest RATE you have. Mortgages are not front loaded the way people think; interest each month is calculated by multiplying the interest rate times the previous month's balance; then principal is added until your total payment equalis the fixed payment you agreed to. So if you pay extra on a mortgage, you aren't prepaying interest. You're jumping ahead on the amortization schedule (and therefore getting on track to pay it off early).

Our current rate, 22+ years left, is 4.375%. Thank you for the clarification on front loading / extra principal

primary mortgage thoughts:

Refinancing the current into a 15 would increase the payment by $250/mo. Not bad, awesome rate.

Refinancing into a 30yr @ 3.75% (dumb?) would decrease our mortgage payment $274/mo Not dumb, but not a bad difference between this and the 15 year rate, plus would enable you do put $500 more a month (by comparison) into retirement, which a) would probably grow at a higher rate than this and b) would also give you a tax break. So probably the best bet mathematically (but not necessarily psychologically depending on your values).

I think you've hit on my internal debate. Brief history: family never really educated about money. Wife and I finally pulled out heads out and got into real budgeting (YNAB) a couple of years ago and are finally spending and saving somewhat efficiently. Psychologically, I don't mind having a mortgage, but those YNAB and Mrmoneymoustache people feel so anti-debt, it rubs off on me. I'm 47 and think of having the house paid off around retirement as a good idea, but, really, who knows. It seems a better idea to have more retirement savings since we're behind in that area.

Refinancing into a 20yr @ 3.75% would increase our payment about $20. Middle ground option - possibly ideal for you.

Given that the rate is the same as the 30yr, wouldn't it make sense to just do the 30yr and make, say an extra payment a year or something? Maybe start doing that 5 years from now?

the 30yr would, of course, free up that $ to contribute to retirement, but, over 30 years, the $ gets expensive. Again, don't look at it over 30 years. 95% of 30 year mortgages don't make it to year 30. You'll likely pay it off early, refi, or sell before then.

Thoughts? I'm leaning toward the 15 year @ 3.0% and rolling things in. Our new payment would be $526 more/mo. We would be able to take the extra $574 (1100-526) and put that into retirement accounts. That's a fine choice, but you need to prioritize your goals. Paying off the mortgage early - which in this case also could mean refinancing to shorten the term - is not usually priority 1 for most people. Here are my priorities:

1. Get 401k matches.
2. Max Roth IRAs.
3. Max HSA
4. Pay off high interest rate debt (over 7%)
5. Have emergency fund of 3 months expenses.
6. Max 401ks
7. Pay off cheap consumer debt (under 7%)
8. Fully fund kids' 529 plans (I don't have kids, but here is where I'd place that)
9. Pay off mortgages early and/or invest in taxable accounts - depending on current interest rates and market cycle (if stocks tank I'd probably use extra cash to buy stocks; if stocks are at all time highs like now, I'd probably use extra cash to pay down higher rate mortgages).

10. Quit saving, start spending. (aka - Retire!)

Best plan?
Given the above list...we have no 401k match possibility, we are close to matching Roth's, we have no high interest debt, we have our emergency fund intact. That leaves max HSA (not sure why you have that one in there; my wife has killer health care benefits, if that matters);
which leaves us to the max 401k/403b. Given that, it sounds like it would be best to refi into another 30-year (?) and take the savings and put it in to retirement? That sounds so crazy, but I see what you're saying.


again, thanks for your time.
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Meg77
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Joined: Fri May 22, 2009 1:09 pm
Location: Dallas, TX

Re: What to do with mortgages, etc.

Post by Meg77 »

kiva22 wrote:thank you for your detailed feedback....
Meg77 wrote:
kiva22 wrote:Hi

Some new numbers on the refinance situation.

Current rate being offered on 15yr is 3.0%. Closing costs are 3200. If I roll the cash in, I will likely need to pay .625 of the loan amount as a fee. There is a chance BofA will match the credit union rate and pricing without that fee, but don't know that yet.

I also believe the goal here should be to maximize our retirement contributions, as we're only contributing about 9% of our gross income to retirement (not including pensions). If the goal is to maximize retirement contributions, then you should go with the 30 year loan option to minimize monthly payments. It's still a great rate, especially after factoring in tax deductions and inflation.

The 'family heloc' rate is now 5.09%. There is also the option of taking 2nd at about 4.375% fixed for 15 years which would give us the option of paying it off sooner, if we had the $. Thoughts on that vs. a roll in? It makes more sense to roll it in to the mortgage and get a lower interest rate. You can always pay off the mortgage faster than the term you take out, so don't get confused by looking at how much interest you'll pay over the life of the loan. The key is what interest RATE you have. Mortgages are not front loaded the way people think; interest each month is calculated by multiplying the interest rate times the previous month's balance; then principal is added until your total payment equalis the fixed payment you agreed to. So if you pay extra on a mortgage, you aren't prepaying interest. You're jumping ahead on the amortization schedule (and therefore getting on track to pay it off early).

Our current rate, 22+ years left, is 4.375%. Thank you for the clarification on front loading / extra principal

primary mortgage thoughts:

Refinancing the current into a 15 would increase the payment by $250/mo. Not bad, awesome rate.

Refinancing into a 30yr @ 3.75% (dumb?) would decrease our mortgage payment $274/mo Not dumb, but not a bad difference between this and the 15 year rate, plus would enable you do put $500 more a month (by comparison) into retirement, which a) would probably grow at a higher rate than this and b) would also give you a tax break. So probably the best bet mathematically (but not necessarily psychologically depending on your values).

I think you've hit on my internal debate. Brief history: family never really educated about money. Wife and I finally pulled out heads out and got into real budgeting (YNAB) a couple of years ago and are finally spending and saving somewhat efficiently. Psychologically, I don't mind having a mortgage, but those YNAB and Mrmoneymoustache people feel so anti-debt, it rubs off on me. I'm 47 and think of having the house paid off around retirement as a good idea, but, really, who knows. It seems a better idea to have more retirement savings since we're behind in that area.

Refinancing into a 20yr @ 3.75% would increase our payment about $20. Middle ground option - possibly ideal for you.

Given that the rate is the same as the 30yr, wouldn't it make sense to just do the 30yr and make, say an extra payment a year or something? Maybe start doing that 5 years from now?

the 30yr would, of course, free up that $ to contribute to retirement, but, over 30 years, the $ gets expensive. Again, don't look at it over 30 years. 95% of 30 year mortgages don't make it to year 30. You'll likely pay it off early, refi, or sell before then.

Thoughts? I'm leaning toward the 15 year @ 3.0% and rolling things in. Our new payment would be $526 more/mo. We would be able to take the extra $574 (1100-526) and put that into retirement accounts. That's a fine choice, but you need to prioritize your goals. Paying off the mortgage early - which in this case also could mean refinancing to shorten the term - is not usually priority 1 for most people. Here are my priorities:

1. Get 401k matches.
2. Max Roth IRAs.
3. Max HSA
4. Pay off high interest rate debt (over 7%)
5. Have emergency fund of 3 months expenses.
6. Max 401ks
7. Pay off cheap consumer debt (under 7%)
8. Fully fund kids' 529 plans (I don't have kids, but here is where I'd place that)
9. Pay off mortgages early and/or invest in taxable accounts - depending on current interest rates and market cycle (if stocks tank I'd probably use extra cash to buy stocks; if stocks are at all time highs like now, I'd probably use extra cash to pay down higher rate mortgages).

10. Quit saving, start spending. (aka - Retire!)

Best plan?
Given the above list...we have no 401k match possibility, we are close to matching Roth's, we have no high interest debt, we have our emergency fund intact. That leaves max HSA (not sure why you have that one in there; my wife has killer health care benefits, if that matters);
which leaves us to the max 401k/403b. Given that, it sounds like it would be best to refi into another 30-year (?) and take the savings and put it in to retirement? That sounds so crazy, but I see what you're saying.


again, thanks for your time.
First of all, I have the HSA in there because that account combines the best parts of the Roth IRA and the Traditional retirement account. You get a tax deduction for contributing AND you get to take money out tax free - if funds are used for medical expenses (which are fairly broadly defined). What you don't use each year rolls over, and at retirement age you can tap the account just like any 401k or Traditional IRA (those distributions will be taxed though if not used for medical expenses). The account structure is so great for tax purposes that many people actually pay medical expenses out of pocket while letting their HSA funds compound so that they'll have a bigger tax free bucket in retirement (when health expenses are likely to make up a bigger percentage of the budget anyway).

As far as the refinance goes, I think we've established that 1) you should refinance to lower your rate, and 2) you should roll in your fairly expensive family loan to the refinance. Beyond that, the choice is between a 3.75% 30 year loan (so you can contribute more to retirement accounts) and a 3.0% 15 year loan (so you can have the house paid off by the time you retire).

Honestly, neither option is dumb. You're doing well, and you're likely going to have a great retirement one way or another. If refinancing into another 30 year loan sounds crazy to you, just don't do it! A 3% rate is amazing, and having your home paid off by retirement age will feel amazing. My husband and I refinanced into a 15 year mortgage a year or so ago, and now I'm so glad we did. Our incomes have gone up a bit, so now we're saving more than we used to anyway; and what I at first considered a stretch (the higher payment) is now just a no-big-deal part of our budget. *Technically* maxing out retirement accounts *probably* is a better option mathematically, but finance is personal - which is why these debates will never be settled. Personally I'd rather have the psychological boost of being mortgage free in retirement, as opposed to having an extra $100K or so in retirement accounts in 15 years - and it sounds like you would too. Besides, not having a mortgage reduces your monthly expenses dramatically, which reduces the amount you *need* invested in order to retire.

You're doing really well, and none of these are bad ideas of course! :sharebeer
"An investment in knowledge pays the best interest." - Benjamin Franklin
Topic Author
kiva22
Posts: 87
Joined: Sat Jul 30, 2016 2:56 am

Re: What to do with mortgages, etc.

Post by kiva22 »

I really appreciate your feedback.

As a last "tip the scales" moment, i have an "uncle" who is very wealthy and was a real estate developer in the bay area (not a blood relative; my (now deceased) father's lifelong best friend). I've always gone to him for financial advice and he guided me through stretching to get my first house, then into another, turning that to a rental, etc. He is very big on maximizing the tax deferred contributions toward retirement and I could have sworn he'd say do the 30yr and max out the 403b. After taking all the info and pausing for a bit, he said, "As you approach 60, there is a great practical and psychological benefit to being as debt free as possible. Do the 15yr."

I agree that our incomes should go up in the next 5-7 years. I'm going to make the slow move to private practice and, if more profitable, stay there. My wife will also start seeing private clients and that will bring in more $. The payment we're making to the family loan also needs to be factored in as that will no longer be going out (part of the mtg payment). I think we can swing it and, psychologically, owning the house when I retire and, btw, when our kids enter college, sounds like a good idea. The reality is that it is unlikely I'd completely retire anyway...

Again, thank you so much for your time. Right now, I'm negotiating with BofA (holder of our current loan) and a credit union for the best deal. The credit union guy is a total a-hole so i'm playing him vs. BofA as the latter says they'll match any offer. Should know soon if I saved about $2k in doing that. Feels cutthroat, but, business is business...

matt
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