15 vs 30 year refinance vs cash out refinance

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

hello Bogleheads,

I have an odd dilemma. I just need to know what you would do in my shoes.

I plan on buying 5-6 rental properties over the next 12 months and I wanted to use the equity on my house. I currently have a 15 year loan at 3.5%, payment ~ 2230$ per month. My bank is offering me 3 financing options for my real estate investing: cash out refinance, plus a heloc, plus a line of credit.

Now assume that you're not your prototypical bogleheads :happy but a businessman, someone who takes a calculated risks on his home equity. To me, a home equity is imprisoned money. It is useless if it does not work for you. And I have about 200K equity imprisoned in my house.

Which of the following 3 options would you choose:

1. You cash out refinance the house for 30 years at 4.1%, monthly payment is ~2230$, the same as my current loan and you cash out ~140K for real estate investing. We bought our house cheap and did a lot of renovations so it acquired a lot of value.

2. You simply refinance your house for 30 years without cashing out. It would be 30years at 4%, monthly payment $ 1500 per month. The advantage of this is that I would lower my mortgage by $730 per month and invest the difference. But I don't like paying too much interest to the bank. We will be in that house for less than 5 years. I would then use a HELOC as real estate investment down payment.

3. You leave your mortgage alone and simply use a HELOC/LOC to invest in real estate.
Thanks for your consideration.
User avatar
Pajamas
Posts: 6015
Joined: Sun Jun 03, 2012 6:32 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Pajamas »

I think of the equity in my home as providing me a place to live and the lost opportunity cost as a substitute for rent. I wouldn't pull cash out of my home to invest in a real estate business (effectively to provide housing for other people) and would keep my personal and business finances distinctly separate. My home is not what I would choose to take calculated risks with because I need a place to live.
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

Pajamas wrote: Fri Sep 15, 2017 5:34 pm I think of the equity in my home as providing me a place to live and the lost opportunity cost as a substitute for rent. I wouldn't pull cash out of my home to invest in a real estate business (effectively to provide housing for other people) and would keep my personal and business finances distinctly separate. My home is not what I would choose to take calculated risks with because I need a place to live.
Thanks, so you would not choose any of the 3 options?
spammagnet
Posts: 2481
Joined: Wed Apr 27, 2016 9:42 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by spammagnet »

Pajamas wrote: Fri Sep 15, 2017 5:34 pmI think of the equity in my home as providing me a place to live and the lost opportunity cost as a substitute for rent. I wouldn't pull cash out of my home to invest in a real estate business (effectively to provide housing for other people) and would keep my personal and business finances distinctly separate. My home is not what I would choose to take calculated risks with because I need a place to live.
I'm not debt-averse as some Bogleheads are but agree completely with this advice. Keep your home separate from your business investments. Don't put yourself at risk of losing a place to live.
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: 15 vs 30 year refinance vs cash out refinance

Post by grabiner »

If you will be in your house for less than five years, you should have either a 15-year mortgage or a 5-year ARM on the home. You don't get the benefit of the longer term in a 30-year mortgage, since you can't lock in the right to borrow at that low rate for 30 years.

For similar reasons, the cash-out refinance isn't a good deal. You are borrowing money on a five-year loan but at long-term rates. If you have a better use for the cash and can do a cash-out refinance into a 5-year ARM, that may be a good deal.

You should not focus on how much interest you are paying to the bank, but on how your debt costs you (in interest) versus how much it benefits you (in the return). I could pay off my mortgage, but I get a benefit from keeping the mortgage because it allows me to invest more (and I don't take any more risks, as I count my mortgage as a negative bond in my asset allocation).
Wiki David Grabiner
User avatar
Pajamas
Posts: 6015
Joined: Sun Jun 03, 2012 6:32 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Pajamas »

Streptococcus wrote: Fri Sep 15, 2017 8:40 pm Thanks, so you would not choose any of the 3 options?
No, I wouldn't, but I don't really know what you should do since you think of it very differently, as having $200,000 in equity "imprisoned" in your house.

Seems like you should be renting instead of owning, or at least carrying the largest mortgage you can get, to rectify that.

But ten years ago, a lot of people who did what you are proposing to do ended up bankrupt and homeless when the financial crisis hit. Some people are still suffering for it.

I also think buying five or six rental properties over the next year is too aggressive unless being a landlord is going to be your full-time occupation. Seems like buying one and getting it stabilized with a good tenant and then looking for another one would be the way to go. I see a lot of people underestimating the work and risk involved in being a landlord.
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

grabiner wrote: Fri Sep 15, 2017 9:34 pm If you will be in your house for less than five years, you should have either a 15-year mortgage or a 5-year ARM on the home. You don't get the benefit of the longer term in a 30-year mortgage, since you can't lock in the right to borrow at that low rate for 30 years.

For similar reasons, the cash-out refinance isn't a good deal. You are borrowing money on a five-year loan but at long-term rates. If you have a better use for the cash and can do a cash-out refinance into a 5-year ARM, that may be a good deal.

You should not focus on how much interest you are paying to the bank, but on how your debt costs you (in interest) versus how much it benefits you (in the return). I could pay off my mortgage, but I get a benefit from keeping the mortgage because it allows me to invest more (and I don't take any more risks, as I count my mortgage as a negative bond in my asset allocation).
Thank you for your comments. I really appreciate them.
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

Pajamas wrote: Fri Sep 15, 2017 9:35 pm
Streptococcus wrote: Fri Sep 15, 2017 8:40 pm Thanks, so you would not choose any of the 3 options?
No, I wouldn't, but I don't really know what you should do since you think of it very differently, as having $200,000 in equity "imprisoned" in your house.

Seems like you should be renting instead of owning, or at least carrying the largest mortgage you can get, to rectify that.

But ten years ago, a lot of people who did what you are proposing to do ended up bankrupt and homeless when the financial crisis hit. Some people are still suffering for it.

I also think buying five or six rental properties over the next year is too aggressive unless being a landlord is going to be your full-time occupation. Seems like buying one and getting it stabilized with a good tenant and then looking for another one would be the way to go. I see a lot of people underestimating the work and risk involved in being a landlord.
Thank you Pajamas, for taking the time to reply.
Northern Flicker
Posts: 15363
Joined: Fri Apr 10, 2015 12:29 am

Re: 15 vs 30 year refinance vs cash out refinance

Post by Northern Flicker »

If you are sure you will be selling the house within 5 years, closing costs are an important consideration. A HELOC is likely preferred on that account, but it depends on interest rates and how long you stay in the house. Many HELOC's are variable rate, so he sure you will indeed sell within 5 years or less.

The plan can be a risky maneuver. Many people lost their home and rentals from doing this pre-2008.
fundseeker
Posts: 1076
Joined: Mon Dec 24, 2007 8:02 am

Re: 15 vs 30 year refinance vs cash out refinance

Post by fundseeker »

Here is the definition of dilemma:

"a situation in which a difficult choice has to be made between two or more alternatives, especially equally undesirable ones"

It sounds like your situation is totally optional :happy . And IMHO, all of your alternatives are very very risky! The only way I'd use our equity, and our house has been paid off for many years, would be if I could borrow the money at much less than I could get from an FDIC insured CD. But, I am pretty risk adverse.
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

jalbert wrote: Fri Sep 15, 2017 11:17 pm If you are sure you will be selling the house within 5 years, closing costs are an important consideration. A HELOC is likely preferred on that account, but it depends on interest rates and how long you stay in the house. Many HELOC's are variable rate, so he sure you will indeed sell within 5 years or less.

The plan can be a risky maneuver. Many people lost their home and rentals from doing this pre-2008.
fundseeker wrote: Sat Sep 16, 2017 5:51 am Here is the definition of dilemma: "a situation in which a difficult choice has to be made between two or more alternatives, especially equally undesirable ones"

It sounds like your situation is totally optional :happy . And IMHO, all of your alternatives are very very risky! The only way I'd use our equity, and our house has been paid off for many years, would be if I could borrow the money at much less than I could get from an FDIC insured CD. But, I am pretty risk adverse.
Thank you Jalbert and Fundseeker,
I will indeed sell the house within 5 years. I understand the risk. Real estate investing, just like stock market has a risk that depends on your ability, need and willingness to take it.

Leverage is a common and powerful practice in real estate investing and while I understand that it could seem risky to take the equity on your house let me show you scenario:

Imagine you have a 1M 3 fund portfolio AA 30/30/40, a stable job and a 50K efund.
You have a mortgage on your home with a balance of 200K and 100K equity on it.
You want to invest in real estate and you found a rental deal for 100K that will cash flow $400 a month. Better yet, being it a deal and you being a savvy investor, you buy the property below market price. you pay 100K but the market value is 130K. You already made money

To pay for the rental you need a 20% down payment (20K) and your bank offers you a mortgage at 5% fixed rate with a 30 year amortization.
So instead of using your cash for the down payment, you decide to use the equity in your house that is, as I said above, imprisoned and is not working for you.
you cash out refinance your house, get 40K cash out of your 100K equity. In my case, my mortgage would be pretty much identical if I refinance with the same 15 year fixed rate.

In the end, you have a rental property that you bought for below market value that is cashing out $4800 a year and you basically did not even use your own money. You can even appraise for it's true value, refinance it for 130K and use the 30K as a down payment for the next property. The trick here is to find undervalued or distressed properties and avoid being overleveraged.

Now what is the investment return of a similar deal? Is this a risk worth taking? Everyone will have different needs and risk tolerance.

But I really appreciate Grabiner's comments. Always spot on.
letsgobobby
Posts: 12073
Joined: Fri Sep 18, 2009 1:10 am

Re: 15 vs 30 year refinance vs cash out refinance

Post by letsgobobby »

Deleted
Last edited by letsgobobby on Thu Oct 03, 2019 1:28 am, edited 1 time in total.
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

letsgobobby wrote: Sat Sep 16, 2017 8:51 am tell me more about your decision to buy 5-6 rental properties in the next year.
I have not invested in REIT. I have a 3 fund portfolio and I add rentals as a diversifier. You can however say that I invested in REIT if I own the 3 fund portfolio. I could buy max 6 but if I can only find 3 or 4 deals that fit my criteria that'll be fine. I will close on the first deal in the next month (hopefully).
fundseeker
Posts: 1076
Joined: Mon Dec 24, 2007 8:02 am

Re: 15 vs 30 year refinance vs cash out refinance

Post by fundseeker »

In your scenario, it sounds like you plan for this to happen:

$300k debt on your $300k house
$30k debt on your first rental
$70k debt on your second rental ($100k purchase price)

That may not be "overleveraged," but it at least looks "highly" leveraged. Guess it could work, and you seem to have enough money to make all of those loan payments during the periods after your tenants disappear, you make the repairs, and then find new tenants :).

Not saying it's a bad idea, it's just too risky for me. Sounds sorta like marriage - Easy to get into, but very hard to get out of. I just prefer the liquidity of the stock market and the ability to change my risk exposure with the click of a mouse.
Last edited by fundseeker on Sat Sep 16, 2017 10:07 am, edited 1 time in total.
ThePrince
Posts: 451
Joined: Sun Aug 20, 2017 9:15 pm
Location: U.S.A.

Re: 15 vs 30 year refinance vs cash out refinance

Post by ThePrince »

Pajamas wrote: Fri Sep 15, 2017 9:35 pm
Streptococcus wrote: Fri Sep 15, 2017 8:40 pm Thanks, so you would not choose any of the 3 options?
No, I wouldn't, but I don't really know what you should do since you think of it very differently, as having $200,000 in equity "imprisoned" in your house.

Seems like you should be renting instead of owning, or at least carrying the largest mortgage you can get, to rectify that.

But ten years ago, a lot of people who did what you are proposing to do ended up bankrupt and homeless when the financial crisis hit. Some people are still suffering for it.

I also think buying five or six rental properties over the next year is too aggressive unless being a landlord is going to be your full-time occupation. Seems like buying one and getting it stabilized with a good tenant and then looking for another one would be the way to go. I see a lot of people underestimating the work and risk involved in being a landlord.
+1
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

fundseeker wrote: Sat Sep 16, 2017 9:49 am In your scenario, it sounds like you plan for this to happen:

$300k debt on your $300k house
$30k debt on your first rental
$70k debt on your second rental ($100k purchase price)

That may not be "overleveraged," but it at least looks "highly" leveraged. Guess it could work, and you seem to have enough money to make all of those loan payments during the periods after your tenants disappear, you make the repairs, and then find new tenants :).

Not saying it's a bad idea, it's just too risky for me. Sounds sorta like marriage - Easy to get into, but very hard to get out of. I just prefer the liquidity of the stock market and the ability to change my risk exposure with the click of a mouse.
I agree with your point. Although, I don't view the stock market as that liquid. If the market tanks by 50% tomorrow, it will not be a good idea to sell and get out and you will be stuck and unable to use it as liquid. On the other hand, if the market tanks tomorrow, people will still need to live somewhere. there will always be someone needing to live in a 100K house as opposed to, say a 1M dollar house. So in that sense, Real Estate could be less risky than the stock market. I view it as a diversifier.

Owning stocks and rentals that cash flow is better than stocks alone.

Yes, I would go from 200K debt to 400K but I would have 2 new assets (260K value) plus $800 cash flow per month. I call that good business. Again, this is just a hypothetical scenario of a common REI strategy. The main issue here is having the ability to pay off the rental mortgages, less than $1500 a month in case of extended vacancies. That's were overleveraged people get in trouble. Plus, keep in mind that as my mortgage payment stays the same for 30 years, the rent and appreciation go up, increasing the return on the money.
runner540
Posts: 1763
Joined: Sun Feb 26, 2017 4:43 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by runner540 »

Posts like this make me very bearish on buying a home when I don't otherwise need to buy. I do not want to be buying in a market where someone thinks it's a good idea to take out all the equity and lever up 5-6 more properties, counting on the cash flow from renters to make it work. Very vintage 2005/2006/2007.
Here's a perspective on the housing market cycle in S. Cal from 2 cycles ago (1985-1997).
http://www.rntl.net/history_of_a_housing_bubble.htm
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

runner540 wrote: Sat Sep 16, 2017 12:14 pm Posts like this make me very bearish on buying a home when I don't otherwise need to buy. I do not want to be buying in a market where someone thinks it's a good idea to take out all the equity and lever up 5-6 more properties, counting on the cash flow from renters to make it work. Very vintage 2005/2006/2007.
Here's a perspective on the housing market cycle in S. Cal from 2 cycles ago (1985-1997).
http://www.rntl.net/history_of_a_housing_bubble.htm
I agree with you 100%. You should stay bearish on REI. I don't think you understand much of it.
fundseeker wrote: Sat Sep 16, 2017 9:49 am In your scenario, it sounds like you plan for this to happen:

$300k debt on your $300k house
$30k debt on your first rental
$70k debt on your second rental ($100k purchase price)
First off, the above calculation is wrong. The equity taken from the primary home would be 20K not 100K, a fifth of the home equity. When you buy a home, you can use your home equity to pay for your down payment (cash out refi) or use your own cash. Some people use their cash, I'd rather take the equity from my home and keep the cash. Then I can put that cash in a CD, muni, stocks or else. It makes my home equity more liquid and gives me more freedom. It's a pretty simple concept.
letsgobobby
Posts: 12073
Joined: Fri Sep 18, 2009 1:10 am

Re: 15 vs 30 year refinance vs cash out refinance

Post by letsgobobby »

Deleted
Last edited by letsgobobby on Thu Oct 03, 2019 1:28 am, edited 1 time in total.
User avatar
Pajamas
Posts: 6015
Joined: Sun Jun 03, 2012 6:32 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Pajamas »

Streptococcus wrote: Sat Sep 16, 2017 11:13 am Although, I don't view the stock market as that liquid. If the market tanks by 50% tomorrow, it will not be a good idea to sell and get out and you will be stuck and unable to use it as liquid. On the other hand, if the market tanks tomorrow, people will still need to live somewhere. there will always be someone needing to live in a 100K house as opposed to, say a 1M dollar house. So in that sense, Real Estate could be less risky than the stock market. I view it as a diversifier.

Owning stocks and rentals that cash flow is better than stocks alone.
With stocks you can sell them in less than thirty seconds, with just a few clicks. There is also significantly more pricing transparency (you can see what exactly what they are worth at any time) and the transaction costs are very low. It takes a significant amount of time to sell real estate, transaction costs are high, and you don't know for sure what it is worth until you actually sell it. There's really no debate about which is more liquid, you are just trying to justify your decision.

People always need a place to live but they also need food, clothing, transportation, and all the other things that stocks represent. I'm not sure why you think that residential real estate is safer than a food company.

You should also do a little research into recent history. Rental vacancy rates rose significantly in the 21st century leading into the financial crisis as there was so much new construction and so many people were buying real estate. Many landlords or flippers with financing crashed and burned just like individual homeowners during the crisis. Many keys were handed back to the lenders. Many lenders also imploded.

https://www.zillow.com/research/rental- ... 016-14293/

The smart real estate investors bought after the crash, not going into the market highs. The publicly traded REITs that hold single-family rental real estate had their genesis in the ashes of the real estate implosion. That they have recently been going public or merging recently (i.e. the smart investors that were buying on the cheap after the crisis are unloading those purchases) should tell you something.

https://www.reit.com/news/reit-magazine ... al-segment
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

letsgobobby wrote: Sat Sep 16, 2017 1:31 pm
Streptococcus wrote: Sat Sep 16, 2017 8:58 am
letsgobobby wrote: Sat Sep 16, 2017 8:51 am tell me more about your decision to buy 5-6 rental properties in the next year.
I have not invested in REIT. I have a 3 fund portfolio and I add rentals as a diversifier. You can however say that I invested in REIT if I own the 3 fund portfolio. I could buy max 6 but if I can only find 3 or 4 deals that fit my criteria that'll be fine. I will close on the first deal in the next month (hopefully).
how many rentals do you own now?
3. I'll stop when I cash flow 4K per month. It'll be 10-15 rentals.
Pajamas wrote: Sat Sep 16, 2017 1:40 pm
Streptococcus wrote: Sat Sep 16, 2017 11:13 am Although, I don't view the stock market as that liquid. If the market tanks by 50% tomorrow, it will not be a good idea to sell and get out and you will be stuck and unable to use it as liquid. On the other hand, if the market tanks tomorrow, people will still need to live somewhere. there will always be someone needing to live in a 100K house as opposed to, say a 1M dollar house. So in that sense, Real Estate could be less risky than the stock market. I view it as a diversifier.

Owning stocks and rentals that cash flow is better than stocks alone.
With stocks you can sell them in less than thirty seconds, with just a few clicks. There is also significantly more pricing transparency (you can see what exactly what they are worth at any time) and the transaction costs are very low. It takes a significant amount of time to sell real estate, transaction costs are high, and you don't know for sure what it is worth until you actually sell it. There's really no debate about which is more liquid, you are just trying to justify your decision.

People always need a place to live but they also need food, clothing, transportation, and all the other things that stocks represent. I'm not sure why you think that residential real estate is safer than a food company.

You should also do a little research into recent history. Rental vacancy rates rose significantly in the 21st century leading into the financial crisis as there was so much new construction and so many people were buying real estate. Many landlords or flippers with financing crashed and burned just like individual homeowners during the crisis. Many keys were handed back to the lenders. Many lenders also imploded.

https://www.zillow.com/research/rental- ... 016-14293/

The smart real estate investors bought after the crash, not going into the market highs. The publicly traded REITs that hold single-family rental real estate had their genesis from the ashes of the real estate implosion. That they have recently been going public, i.e. the smart investors that were buying on the cheap after the crisis are unloading those purchases recently.

https://www.reit.com/news/reit-magazine ... al-segment
A stock is more liquid than a home. But a home that's cash flowing is a good diversifier during downturns, when you cannot or better, should not cash your stocks. That's the definition of diversification. I was specific in my statement. So I don't disagree with you. But you can't tell me that owing stocks exclusively is better than owing stocks and rentals that cash flow.
User avatar
Pajamas
Posts: 6015
Joined: Sun Jun 03, 2012 6:32 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Pajamas »

Streptococcus wrote: Sat Sep 16, 2017 1:46 pm A stock is more liquid than a home. But a home that's cash flowing is a good diversifier during downturns, when you cannot or better, should not cash your stocks. That's the definition of diversification. I was specific in my statement. So I don't disagree with you. But you can't tell me that owing stocks exclusively is better than owing stocks and rentals that cash flow.
Yes, for me it is much better. I wouldn't want to concentrate so much capital in a physical asset or just a few physical assets and be so undiversified in that manner. (There are various forms of diversification.) I own REITs to take advantage of real estate's benefits, including cash flow in the form of dividends, with no more effort than it takes to own other stocks.
JGoneRiding
Posts: 1973
Joined: Tue Jul 15, 2014 3:26 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by JGoneRiding »

So i am a LL. it wasn't very long after the crisis that I started so equity in my house was zero. I actually took a personal loan to buy the first. To buy the second i took out loans on my vehicles, which worked great and at 2.3% definitely lowest capital. I also bought it with owner financing from the previous LL and only 10% down. We were both happy with the loan and I refied 2 years latter and cashed out, on the rental. I used that money to buy my new primary and turn my old primary into a rental.

Moral--I would go slow!! I have 3 properties (5 doors) but I did it over 6 years not one. and I basically used one to help buy the next. So I might take a Heloc on my primary for say 20k and buy one property to get started, then use that property equity in a couple of years to buy the next. fyi it is basically impossible now to get a heloc on rental property now a days :? (but post crash I don't blame them). Getting into rental property to far and to fast is what caused Dave Ramsey to go bankrupt fyi
emoore
Posts: 676
Joined: Mon Mar 04, 2013 7:16 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by emoore »

It sounds risky to be taking your primary home equity to buy rentals. If it were a rental you were taking equity that would be different. I'm actually considering add a rental or two with the equity from my one rental. Maybe start with one rental for a couple of years and see how that goes?
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

emoore wrote: Sat Sep 16, 2017 3:11 pm It sounds risky to be taking your primary home equity to buy rentals. If it were a rental you were taking equity that would be different. I'm actually considering add a rental or two with the equity from my one rental. Maybe start with one rental for a couple of years and see how that goes?
JGoneRiding wrote: Sat Sep 16, 2017 3:03 pm So i am a LL. it wasn't very long after the crisis that I started so equity in my house was zero. I actually took a personal loan to buy the first. To buy the second i took out loans on my vehicles, which worked great and at 2.3% definitely lowest capital. I also bought it with owner financing from the previous LL and only 10% down. We were both happy with the loan and I refied 2 years latter and cashed out, on the rental. I used that money to buy my new primary and turn my old primary into a rental.

Moral--I would go slow!! I have 3 properties (5 doors) but I did it over 6 years not one. and I basically used one to help buy the next. So I might take a Heloc on my primary for say 20k and buy one property to get started, then use that property equity in a couple of years to buy the next. fyi it is basically impossible now to get a heloc on rental property now a days :? (but post crash I don't blame them). Getting into rental property to far and to fast is what caused Dave Ramsey to go bankrupt fyi
This thread was not about the risks of REI. I presented 3 options and asked to please weigh in. Interestingly, people who have a record of being thoughful and knowledgeable, like Grabiner, read the thread before commenting. Others just comment without even knowing what we're talking about.

I think I've already figured what I was looking for. Thanks Y'all.
ryman554
Posts: 1635
Joined: Sun Jan 12, 2014 8:44 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by ryman554 »

grabiner wrote: Fri Sep 15, 2017 9:34 pm You should not focus on how much interest you are paying to the bank, but on how your debt costs you (in interest) versus how much it benefits you (in the return). I could pay off my mortgage, but I get a benefit from keeping the mortgage because it allows me to invest more (and I don't take any more risks, as I count my mortgage as a negative bond in my asset allocation).
I respect you a lot, you've given me lots of good advice here even if you don't recall, but *if* treating your house as a negative bond, how does it allow you to invest more?

Assume 1.25M in assets and 500k home with a mortgage of 250k.

AA = 80/20 and pay off the mortgage. You have 800k in stocks and 200k in bonds.
AA = 80/20 and don't pay off the mortgage. You need to have 250 locked up in bonds to account for the -250k in mortgage "negative bonds". That leaves you with 1M left to invest, 800k in stocks and an additional in bonds. So, to keep your AA the same, you need 800k in stocks and 450k in bonds.

Unless your bonds are earning more tax-adjusted than your mortgage, or I did my math incorrectly, I don't see how having the additional money to invest is a benefit.
User avatar
Meg77
Posts: 2835
Joined: Fri May 22, 2009 1:09 pm
Location: Dallas, TX

Re: 15 vs 30 year refinance vs cash out refinance

Post by Meg77 »

This is an interesting choice. I am a banker and also have 7 rental units (I used to have 10 but sold 3 in the last year). I work with lots of RE investors and totally understand where you're coming from, so I'm not going to weigh in on whether I think you should buy rentals or cash out your home equity to do so. There are plenty of threads on that if you're interested.

To your question - here are the pros and cons of each choice as I see it.
Streptococcus wrote: Fri Sep 15, 2017 5:27 pm I currently have a 15 year loan at 3.5%, payment ~ 2230$ per month...And I have about 200K equity imprisoned in my house.
First - this is a good place to be in of course. Good mortgage rate (great after tax rate assuming you itemize), conservative amortization schedule, good equity. I am in a similar boat with a 2.75% mortgage on a 15 year fixed homestead with $150k in equity I could borrow while still staying under the banks' 80% LTV limits. I get where you're coming from by thinking you could be putting that equity to better use.
Streptococcus wrote: Fri Sep 15, 2017 5:27 pm 1. You cash out refinance the house for 30 years at 4.1%, monthly payment is ~2230$, the same as my current loan and you cash out ~140K for real estate investing. We bought our house cheap and did a lot of renovations so it acquired a lot of value.
This makes a lot of sense. You keep your payment the same but access the $140k for other purposes. You fix your rate and payment, reducing risk and payment uncertainty.

The downside of course is that you jack up your interest rate by 17% and more than double the amount of time it'll take you to pay off your home (which will be a great ease to your cash flow ultimately, enabling you to save a lot more each month and simultaneously requiring you to have much less saved in order to retire). And you're paying more interest on the whole loan - not just the additional portion you cash out. And you may not even need the cashed out portion all at once - having all that cash burning a hole in savings might push you to buy a rental that doesn't actually look that good. Otherwise you're paying interest on a loan to have extra cash in the bank though.

Another consideration: do you itemize your deductions to file taxes, and if so does your new projected mortgage interest payment exceed the standard deduction? Would it still if a new tax plan dramatically increases the standard deduction as has been proposed? If not, you're not getting any tax advantages on your home mortgage. It could be better to establish a new loan for rental investing that you could fully deduct as rental mortgage interest on schedule E regardless of whether you itemize individually.
Streptococcus wrote: Fri Sep 15, 2017 5:27 pm 2. You simply refinance your house for 30 years without cashing out. It would be 30years at 4%, monthly payment $ 1500 per month. The advantage of this is that I would lower my mortgage by $730 per month and invest the difference. But I don't like paying too much interest to the bank. We will be in that house for less than 5 years. I would then use a HELOC as real estate investment down payment.
I veto this choice. There's no reason to pay closing costs to refinance a mortgage on your home AND get a heloc - especially if you're not going to be there that long. Cutting your mortgage payment doesn't get you very far toward your actual goal - which is to come up with a lump sum to put down on investment property. This sounds like a mortgage banker trying to sell you on two loans, one of which you don't need.
Streptococcus wrote: Fri Sep 15, 2017 5:27 pm 3. You leave your mortgage alone and simply use a HELOC/LOC to invest in real estate.
My husband and I have talked about getting a home equity line of credit to invest in some RE investments going forward when/if we don't have the cash. However we would then pay the line down within a year rather than adding money to taxable investments. This is really the best/responsible way to use a line of credit. They are designed to revolve - to be drawn up and down as needed. Interest and payments are usually variable as a result. If you plan to draw the whole thing up and leave it outstanding for years then you don't need and shouldn't get a line of credit - you want a home equity term loan that will have a fixed interest rate and payment schedule. Source of funds (type of loan) should match use of funds. You don't buy a house on a credit card, and buying a rental with a HELOC is effectively the same thing.

So the answer to this one depends on your personal cash flow. If you get a $140k HELOC and draw it up over 12 months to put down payments on several properties, how long would it take you to pay down that line? Could you do so from your own income within a year or two even assuming all the properties break even? If so then this could be a good option. But rates - and your payment - could go up. So you need to have a decent cushion in reserves as well as in your own budget. Especially since rentals can come with cash flow headaches of their own. Ask me about the $30,000 plumbing repair I just had to do on a $130K rental.

My verdict:
Option 3. If cash flow gets tight you can always refi into a 30 year loan down the road if you really need to. Don't do it to begin with though. Plans can change. I would say that getting a fixed home equity term note is your best bet, but a line of credit enables you to be more flexible and ease into landlording. You may plan to buy 5-6 properties but only find 1-2 in the first 6 months. No point paying interest on a home equity term loan balance you don't yet need.

And since your first mortgage is still amortizing pretty aggressively, it's not crazy to cash out a bit of your equity to do other things with. Effectively it's the same thing as having a 30 year mortgage and having more cash flow to invest. You've just opted to reduce your cash flow with the 15 year am and are now wanting to reverse that decision. Adding a line of credit does this without requiring you to do a full, expensive refi. Home equity loans are much cheaper to get than a first mortgage which requires a full lenders title policy.

Good luck!
"An investment in knowledge pays the best interest." - Benjamin Franklin
Topic Author
Streptococcus
Posts: 425
Joined: Wed Jan 02, 2013 11:17 pm

Re: 15 vs 30 year refinance vs cash out refinance

Post by Streptococcus »

Meg77 wrote: Sat Sep 16, 2017 5:59 pm This is an interesting choice. I am a banker and also have 7 rental units (I used to have 10 but sold 3 in the last year). I work with lots of RE investors and totally understand where you're coming from, so I'm not going to weigh in on whether I think you should buy rentals or cash out your home equity to do so. There are plenty of threads on that if you're interested.

To your question - here are the pros and cons of each choice as I see it.
Streptococcus wrote: Fri Sep 15, 2017 5:27 pm I currently have a 15 year loan at 3.5%, payment ~ 2230$ per month...And I have about 200K equity imprisoned in my house.
First - this is a good place to be in of course. Good mortgage rate (great after tax rate assuming you itemize), conservative amortization schedule, good equity. I am in a similar boat with a 2.75% mortgage on a 15 year fixed homestead with $150k in equity I could borrow while still staying under the banks' 80% LTV limits. I get where you're coming from by thinking you could be putting that equity to better use.
Streptococcus wrote: Fri Sep 15, 2017 5:27 pm 1. You cash out refinance the house for 30 years at 4.1%, monthly payment is ~2230$, the same as my current loan and you cash out ~140K for real estate investing. We bought our house cheap and did a lot of renovations so it acquired a lot of value.
This makes a lot of sense. You keep your payment the same but access the $140k for other purposes. You fix your rate and payment, reducing risk and payment uncertainty.

The downside of course is that you jack up your interest rate by 17% and more than double the amount of time it'll take you to pay off your home (which will be a great ease to your cash flow ultimately, enabling you to save a lot more each month and simultaneously requiring you to have much less saved in order to retire). And you're paying more interest on the whole loan - not just the additional portion you cash out. And you may not even need the cashed out portion all at once - having all that cash burning a hole in savings might push you to buy a rental that doesn't actually look that good. Otherwise you're paying interest on a loan to have extra cash in the bank though.

Another consideration: do you itemize your deductions to file taxes, and if so does your new projected mortgage interest payment exceed the standard deduction? Would it still if a new tax plan dramatically increases the standard deduction as has been proposed? If not, you're not getting any tax advantages on your home mortgage. It could be better to establish a new loan for rental investing that you could fully deduct as rental mortgage interest on schedule E regardless of whether you itemize individually.
Streptococcus wrote: Fri Sep 15, 2017 5:27 pm 2. You simply refinance your house for 30 years without cashing out. It would be 30years at 4%, monthly payment $ 1500 per month. The advantage of this is that I would lower my mortgage by $730 per month and invest the difference. But I don't like paying too much interest to the bank. We will be in that house for less than 5 years. I would then use a HELOC as real estate investment down payment.
I veto this choice. There's no reason to pay closing costs to refinance a mortgage on your home AND get a heloc - especially if you're not going to be there that long. Cutting your mortgage payment doesn't get you very far toward your actual goal - which is to come up with a lump sum to put down on investment property. This sounds like a mortgage banker trying to sell you on two loans, one of which you don't need.
Streptococcus wrote: Fri Sep 15, 2017 5:27 pm 3. You leave your mortgage alone and simply use a HELOC/LOC to invest in real estate.
My husband and I have talked about getting a home equity line of credit to invest in some RE investments going forward when/if we don't have the cash. However we would then pay the line down within a year rather than adding money to taxable investments. This is really the best/responsible way to use a line of credit. They are designed to revolve - to be drawn up and down as needed. Interest and payments are usually variable as a result. If you plan to draw the whole thing up and leave it outstanding for years then you don't need and shouldn't get a line of credit - you want a home equity term loan that will have a fixed interest rate and payment schedule. Source of funds (type of loan) should match use of funds. You don't buy a house on a credit card, and buying a rental with a HELOC is effectively the same thing.

So the answer to this one depends on your personal cash flow. If you get a $140k HELOC and draw it up over 12 months to put down payments on several properties, how long would it take you to pay down that line? Could you do so from your own income within a year or two even assuming all the properties break even? If so then this could be a good option. But rates - and your payment - could go up. So you need to have a decent cushion in reserves as well as in your own budget. Especially since rentals can come with cash flow headaches of their own. Ask me about the $30,000 plumbing repair I just had to do on a $130K rental.

My verdict:
Option 3. If cash flow gets tight you can always refi into a 30 year loan down the road if you really need to. Don't do it to begin with though. Plans can change. I would say that getting a fixed home equity term note is your best bet, but a line of credit enables you to be more flexible and ease into landlording. You may plan to buy 5-6 properties but only find 1-2 in the first 6 months. No point paying interest on a home equity term loan balance you don't yet need.

And since your first mortgage is still amortizing pretty aggressively, it's not crazy to cash out a bit of your equity to do other things with. Effectively it's the same thing as having a 30 year mortgage and having more cash flow to invest. You've just opted to reduce your cash flow with the 15 year am and are now wanting to reverse that decision. Adding a line of credit does this without requiring you to do a full, expensive refi. Home equity loans are much cheaper to get than a first mortgage which requires a full lenders title policy.

Good luck!
Meg77, That was so beautifully and brilliantly commented. Thank you very much. I will indeed go with option 3. Keep my mortgage intact for now, use my HELOC and/orLOC to pay the downpayments and repay it within the year. We save more than 6 figure a year from our day job so that gives us a lot of flexibility.
Again, Thank you.
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: 15 vs 30 year refinance vs cash out refinance

Post by grabiner »

ryman554 wrote: Sat Sep 16, 2017 5:07 pm
grabiner wrote: Fri Sep 15, 2017 9:34 pm You should not focus on how much interest you are paying to the bank, but on how your debt costs you (in interest) versus how much it benefits you (in the return). I could pay off my mortgage, but I get a benefit from keeping the mortgage because it allows me to invest more (and I don't take any more risks, as I count my mortgage as a negative bond in my asset allocation).
I respect you a lot, you've given me lots of good advice here even if you don't recall, but *if* treating your house as a negative bond, how does it allow you to invest more?

Assume 1.25M in assets and 500k home with a mortgage of 250k.

AA = 80/20 and pay off the mortgage. You have 800k in stocks and 200k in bonds.
AA = 80/20 and don't pay off the mortgage. You need to have 250 locked up in bonds to account for the -250k in mortgage "negative bonds". That leaves you with 1M left to invest, 800k in stocks and an additional in bonds. So, to keep your AA the same, you need 800k in stocks and 450k in bonds.

Unless your bonds are earning more tax-adjusted than your mortgage, or I did my math incorrectly, I don't see how having the additional money to invest is a benefit.
My investments do earn more tax-adjusted than the mortgage, at the same risk level. Most often, this happens to investors who are not maxing out retirement accounts; borrowing for tax-deductible interest and earning tax-free returns on bonds in an IRA or 401(k) is often a net benefit.

For me, the mortgage itself is essentially break-even. My 11-year mortgage at 2.625% is 1.89% after 28% federal tax. The mortgage has a 5-year duration, so an equivalent bond investment to paying it off would be Admiral shares of Vanguard Intermediate-Term Tax-Exempt, currently yielding 1.71%. If I had enough cash, there would be a small benefit to paying it off. However, my taxable account is all stock, so I would have a large capital gain if I paid off the mortgage (and then moved an equal amount from bonds to stock in my retirement account to keep the same stock risk). Conversely, if I made small additional payments, those payments would have an 11-year duration, and 11-year bonds yield much more than 1.89%, so this is also not worthwhile.

And my comment for the OP was based on his alternative use of the mortgage; by taking a larger mortgage on his home, he could take a smaller mortgage on the rental properties, and the rental mortgages would be at a higher rate.
Wiki David Grabiner
fundseeker
Posts: 1076
Joined: Mon Dec 24, 2007 8:02 am

Re: 15 vs 30 year refinance vs cash out refinance

Post by fundseeker »

Meg77 wrote: Sat Sep 16, 2017 5:59 pm Especially since rentals can come with cash flow headaches of their own. Ask me about the $30,000 plumbing repair I just had to do on a $130K rental.
Ouch! The OP may not want to hear about such problems, but I'd be interested in some details. :)
User avatar
Meg77
Posts: 2835
Joined: Fri May 22, 2009 1:09 pm
Location: Dallas, TX

Re: 15 vs 30 year refinance vs cash out refinance

Post by Meg77 »

fundseeker wrote: Sun Sep 17, 2017 7:32 pm
Meg77 wrote: Sat Sep 16, 2017 5:59 pm Especially since rentals can come with cash flow headaches of their own. Ask me about the $30,000 plumbing repair I just had to do on a $130K rental.
Ouch! The OP may not want to hear about such problems, but I'd be interested in some details. :)
It was not a fun spring I can tell you! I filed three insurance claims for three different rentals, none of which paid me a dime. Two were hail/roof damage claims where the repairs weren't quite expensive enough to reach beyond my 3% ($6500ish) deductibles. I filed for the plumbing nightmare as well just to see, but as expected the problem was not covered.

This was a duplex built in the 60's that I've owned since 2008 without any major issues beyond having to get a new roof put on last year after a hailstorm and some substantial renovations when a long term tenant moved out right after I bought it. This past spring the tenants complained of toilets not flushing and water backing up into the bathtub. Plumbers did the usual work to no avail. Camera showed cracked pipes getting filled with dirt/mud from outside. I got several bids and the cost was going to be around $15K to burrow under the house and replace the broken pipes. We did that, but the problem persisted. They had to burrow further and replace the line all the way to the curb as well as some additional pipes under the other unit. Total cost including putting the tenants up in a hotel for a few days was about $30K.

I had been thinking of selling this unit for 6 months prior which really added insult to injury. My returns were decent but not enough to compensate for the risks of an older, higher maintenance home. Plus it wasn't ever going to be a long term hold - which was my goal - since I'm in my 30's and it was already so old. Wish I'd sold sooner, but as luck would have it I got a cash offer within days of listing it - for exactly $30,000 above the list price.
"An investment in knowledge pays the best interest." - Benjamin Franklin
fundseeker
Posts: 1076
Joined: Mon Dec 24, 2007 8:02 am

Re: 15 vs 30 year refinance vs cash out refinance

Post by fundseeker »

Yeah, that doesn't sound fun! It definitely shows how unexpected things can happen and be expensive. Glad it sorta worked out. Thanks for sharing!
User avatar
peterinjapan
Posts: 605
Joined: Fri May 15, 2015 8:41 am
Location: Japan!

Re: 15 vs 30 year refinance vs cash out refinance

Post by peterinjapan »

I always, always do 15 year on mortgages. The extra 1% or so is worth it, and forcing myself to be on top of my debt is a good thing. Only got another 3.8 years to go on Mom's house, and another year to pay off my first investment condo.
Post Reply