Mortgage Recast Before Renting Out

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Topic Author
diverdoc
Posts: 56
Joined: Tue May 16, 2017 10:46 pm

Mortgage Recast Before Renting Out

Post by diverdoc »

Very big fan of this forum and still a little bit of a novice with posting. So please forgive me if this is the wrong place to post. I am in a novel situation and would be very interested in some advice about a potential restructure/recast on our mortgage vs investing.

We just closed escrow on our first home, a condo in a very popular area. We went back and forth with the buy vs rent situation and figured out that we essentially would be paying roughly the same for what we're currently renting for and settled on an investment property to live in that we hope to rent vs sell later. My wife and I are physicians in various stages of training. I am working independently for now under the military but will plan to enter residency in 3 years (military vs civilian) and intend to stay in the area. She will be in residency for 3 years +/- 3 more years for fellowship. In 3 years, there's some uncertainty over whether we will be able to remain in our current location for training (you go where you're selected) though our goal is to stay here because we hope to settle down in the area. Fortunately, I have the opportunity to moonlight/side hustle in the meantime. It's is hard to estimate what our additional monthly income from the side hustle will be after taxes, maybe an additional $1k-$2k, which gives us some unique opportunities with investing vs pay down. After maxing our 401ks, I'm considering starting a taxable account to fund up a large lump sum to pay down our current mortgage and then recast to lower our monthly payment--same loan term and interest rate (I doubt we can find a refi with a lower rate but will certainly investigate if we go down that route). Plan would be to save up the amount over 3 years in order to lower the monthly payment to the lowest range of what we could expect to ask for rent (including HOA/taxes/insurance) making it neutral to positive cash flow after taxes.

In three years,
Option A: we stay in the area, live in the property, and we're all the better with a higher net worth (though not tax-advantaged) and we'd just keep mortgage as is and continue maxing our tax-advantaged contributions with remainder into taxable account.
Option B: we have to relocate, we add lump sum from taxable account to principal and recast with lower monthly payments and rent out with tenants covering all costs with tax benefits of being a landlord.

Alternatively, over the next 3 years we can be really aggressive with additional tax advantaged investing through some unique retirement accounts through my wife's employer and just completely ignore any additional pay down:
Her: $18k to tax-deferred 457b, remainder of her income in a Mega backdoor Roth via after-tax in-service rollovers ($19k-$22k), $5.5k in backdoor Roth
Him: $5.5k in backdoor Roth

For an estimate, I calculated the lump sum/recast to give an annual cash-on-cash return of ~6% and $50k+ saved on interest which isn't too bad. I realize that just continuing the current terms/monthly payments with paying it down would pay it off earlier but this is moreso hedging for potential relocation down the road. Would love to hear your thoughts.
Chip
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Joined: Wed Feb 21, 2007 3:57 am

Re: Mortgage Recast Before Renting Out

Post by Chip »

Congratulations on your first home!
diverdoc wrote: Sun Sep 24, 2017 4:35 am For an estimate, I calculated the lump sum/recast to give an annual cash-on-cash return of ~6% and $50k+ saved on interest which isn't too bad. I realize that just continuing the current terms/monthly payments with paying it down would pay it off earlier but this is moreso hedging for potential relocation down the road. Would love to hear your thoughts.
How did you calculate this?

Have you read this thread about being a landlord?

I am biased, but would think the time demands on a two physician family would steer you away from being a long distance landlord. So I propose Option C if you have to move: sell the condo and take advantage of the up to $500,000 capital gain exclusion for primary residences. Rinse and repeat in the new location.

Have you considered opening a solo 401k for your side business to reduce your taxes and increase your tax-advantaged space?

Some other info that might be useful: Mortgage terms, your current tax bracket, expected future tax bracket.
Olemiss540
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Joined: Fri Aug 18, 2017 8:46 pm

Re: Mortgage Recast Before Renting Out

Post by Olemiss540 »

Chip wrote: Sun Sep 24, 2017 5:26 am Congratulations on your first home!
diverdoc wrote: Sun Sep 24, 2017 4:35 am For an estimate, I calculated the lump sum/recast to give an annual cash-on-cash return of ~6% and $50k+ saved on interest which isn't too bad. I realize that just continuing the current terms/monthly payments with paying it down would pay it off earlier but this is moreso hedging for potential relocation down the road. Would love to hear your thoughts.
How did you calculate this?

Have you read this thread about being a landlord?

I am biased, but would think the time demands on a two physician family would steer you away from being a long distance landlord. So I propose Option C if you have to move: sell the condo and take advantage of the up to $500,000 capital gain exclusion for primary residences. Rinse and repeat in the new location.

Have you considered opening a solo 401k for your side business to reduce your taxes and increase your tax-advantaged space?

Some other info that might be useful: Mortgage terms, your current tax bracket, expected future tax bracket.
+1

With a dual physician income, there is very little reason to leverage yourself to attempt at making a 6% return.

You have a very simple path to financial independence without taking on the burden of a long distance rental. Keep it simple and sock every dollar you can into index funds at your chosen AA for 15 years and reassess when your 45 or 50. With the advanced age you are going to be coming out of residency, your path to financial independence is going to be more driven by savings rate and LBYM than most.

A taxable account (once you have fully funded retirement accounts) will give you flexibility for when you and your spouse are offered partnership or if you relocate to a HCOL area and need additional down payment for a larger mortgage. Try and keep your lives simple with regards to money making schemes, you have a skill woth such a high hourly rate, maximizing your earnings on your practice will be far and away the most efficient and valuable use of your time.
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.
runner540
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Joined: Sun Feb 26, 2017 4:43 pm

Re: Mortgage Recast Before Renting Out

Post by runner540 »

What do the mortgage terms say? Would the lender be willig to recast the mortgage for a rental property vs owner-occupied?
Topic Author
diverdoc
Posts: 56
Joined: Tue May 16, 2017 10:46 pm

Re: Mortgage Recast Before Renting Out

Post by diverdoc »

Chip wrote: Sun Sep 24, 2017 5:26 am Congratulations on your first home!
diverdoc wrote: Sun Sep 24, 2017 4:35 am For an estimate, I calculated the lump sum/recast to give an annual cash-on-cash return of ~6% and $50k+ saved on interest which isn't too bad. I realize that just continuing the current terms/monthly payments with paying it down would pay it off earlier but this is moreso hedging for potential relocation down the road. Would love to hear your thoughts.
How did you calculate this?

Have you read this thread about being a landlord?

I am biased, but would think the time demands on a two physician family would steer you away from being a long distance landlord. So I propose Option C if you have to move: sell the condo and take advantage of the up to $500,000 capital gain exclusion for primary residences. Rinse and repeat in the new location.

Have you considered opening a solo 401k for your side business to reduce your taxes and increase your tax-advantaged space?

Some other info that might be useful: Mortgage terms, your current tax bracket, expected future tax bracket.
First off, thanks! We're pretty excited! I calculated COCR with ~$130k-$135k lump sum brought in to recast to drop our monthly payments by a difference of $653/mo, $7,836/yr. $7836/$130k = ~6% annual COCR. Cumulative interest was $55k lower than current loan estimate.

Mortgage terms are: current balance of $507,000, standard VA 30-year fixed rate of 3.75%, no pre-payment penalties or balloon payments.
Current tax bracket: 25%, state is pro-rated for side hustle work estimated at 5-6%, hoping to come in at under 28% bracket with side work but I won't sweat it
Expected future tax bracket: 33-35%, state likely 9%

Unfortunately since the work is per diem and not an independent contractor, I'm not eligible for a solo 401k so my tax-advantaged space maxes at $18k in my 401k and $5,500 in a backdoor Roth--though we have some options for my wife as I mentioned.

Thanks for the link, I'll take a look. I acknowledge we're in uncharted territory in becoming a landlord. It's definitely something I will look into over these next few years before making a decision to go that route. In regards to time management, I'm planning to go into a more lifestyle-oriented field and actually have an interest in the real estate/property management business but agree the timing might not work for us. I agree that taking advantage of capital gains on selling primary residence is appealing if we have to move. I'm not sure if we'd come out ahead after taking into account our closing costs/reno/maintenance/commission fees in 3 years--not saying its impossible in our area but no one can predict when the next housing bubble with burst.
Topic Author
diverdoc
Posts: 56
Joined: Tue May 16, 2017 10:46 pm

Re: Mortgage Recast Before Renting Out

Post by diverdoc »

Olemiss540 wrote: Sun Sep 24, 2017 7:43 am
With a dual physician income, there is very little reason to leverage yourself to attempt at making a 6% return.

You have a very simple path to financial independence without taking on the burden of a long distance rental. Keep it simple and sock every dollar you can into index funds at your chosen AA for 15 years and reassess when your 45 or 50. With the advanced age you are going to be coming out of residency, your path to financial independence is going to be more driven by savings rate and LBYM than most.

A taxable account (once you have fully funded retirement accounts) will give you flexibility for when you and your spouse are offered partnership or if you relocate to a HCOL area and need additional down payment for a larger mortgage. Try and keep your lives simple with regards to money making schemes, you have a skill woth such a high hourly rate, maximizing your earnings on your practice will be far and away the most efficient and valuable use of your time.
Thanks for your reply! I don't necessarily see it so much as leverage (loan amount and term is the same) as I do as simply building equity and streamlining cash flow to meet expenses if we had to move out. We're currently living one of the top 5 HCOL areas in the US, so aside from moving to another HCOL, any move would be a step-down in expenses. I agree our primary job will always be our biggest breadwinner for many years to come. My planned specialty is much more lifestyle oriented than your prototypical 60-80hr physician which frees up time for other endeavors such as additional medical-related clinical/legal work and/or real estate/property management (side business I'm interested in). Our savings rate will be roughly 45-50% over the next 3 years. We definitely only contribute to index funds. We're planning to maximize at the least our 401ks (and probably backdoor Roth too). The X-factor is to either save up a liquid taxable account for flexibility (lump sump prepayment/recast, new home down payment, or just keep for our net worth) or to go for the more tax advantaged space in my wife's 457b/after-tax DCP plans.
Topic Author
diverdoc
Posts: 56
Joined: Tue May 16, 2017 10:46 pm

Re: Mortgage Recast Before Renting Out

Post by diverdoc »

runner540 wrote: Sun Sep 24, 2017 7:49 am What do the mortgage terms say? Would the lender be willig to recast the mortgage for a rental property vs owner-occupied?
Would recast prior to moving out and renting it.
Chip
Posts: 3994
Joined: Wed Feb 21, 2007 3:57 am

Re: Mortgage Recast Before Renting Out

Post by Chip »

diverdoc wrote: Sun Sep 24, 2017 1:00 pm First off, thanks! We're pretty excited! I calculated COCR with ~$130k-$135k lump sum brought in to recast to drop our monthly payments by a difference of $653/mo, $7,836/yr. $7836/$130k = ~6% annual COCR. Cumulative interest was $55k lower than current loan estimate.

Mortgage terms are: current balance of $507,000, standard VA 30-year fixed rate of 3.75%, no pre-payment penalties or balloon payments.
I may be a little slow on the uptake, but I wouldn't calculate a return that way. To me your total return consists of the return on your side fund during the three years before you pay down/recast the mortgage plus the 3.75% interest you avoid on the principal you've repaid from the time of repayment until the property is sold. Plus/minus tax effects, of course.

It doesn't seem likely you're ever going to be in any sort of cash flow squeeze, so this seems a bit more complex than necessary. Why not just pay down the loan as extra cash becomes available? Then refinance/recast when the time comes.
Current tax bracket: 25%, state is pro-rated for side hustle work estimated at 5-6%, hoping to come in at under 28% bracket with side work but I won't sweat it
Expected future tax bracket: 33-35%, state likely 9%
If you have a Roth option for the 401k that might be a more appropriate choice for now given the expected rise in your tax brackets. But it also depends on your expected tax rate in retirement. Kind of difficult to nail that down now. :)
Thanks for the link, I'll take a look. I acknowledge we're in uncharted territory in becoming a landlord. It's definitely something I will look into over these next few years before making a decision to go that route. In regards to time management, I'm planning to go into a more lifestyle-oriented field and actually have an interest in the real estate/property management business but agree the timing might not work for us.
The thread I linked discusses this at length. There's a world of difference between treating it as a business (as you aspire to do) and just sort of falling into it, as many seem to do. But no matter what I would be very wary of long distance landlording, especially with your first property. I went through it and it wasn't pretty. If you think renovation costs are significant for a house you lived in, try adding them up for a house that's been through 3 bad renters in a row. :annoyed You can always buy a property in your new location if you still have the itch.
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ResearchMed
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Re: Mortgage Recast Before Renting Out

Post by ResearchMed »

diverdoc wrote: Sun Sep 24, 2017 1:19 pm
runner540 wrote: Sun Sep 24, 2017 7:49 am What do the mortgage terms say? Would the lender be willig to recast the mortgage for a rental property vs owner-occupied?
Would recast prior to moving out and renting it.
Do the financing docs say anything about how long you are expected to live there?

And not to nit pick... but you already seem to know you are planning to violate the terms of the new mortgage.
That's quite different from someone who has a new mortgage (or refi/recast), and *then* finds out there is an employment transfer or such.

RM
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Topic Author
diverdoc
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Re: Mortgage Recast Before Renting Out

Post by diverdoc »

Chip wrote: Sun Sep 24, 2017 1:54 pm I may be a little slow on the uptake, but I wouldn't calculate a return that way. To me your total return consists of the return on your side fund during the three years before you pay down/recast the mortgage plus the 3.75% interest you avoid on the principal you've repaid from the time of repayment until the property is sold. Plus/minus tax effects, of course.

It doesn't seem likely you're ever going to be in any sort of cash flow squeeze, so this seems a bit more complex than necessary. Why not just pay down the loan as extra cash becomes available? Then refinance/recast when the time comes.

If you have a Roth option for the 401k that might be a more appropriate choice for now given the expected rise in your tax brackets. But it also depends on your expected tax rate in retirement. Kind of difficult to nail that down now. :)

The thread I linked discusses this at length. There's a world of difference between treating it as a business (as you aspire to do) and just sort of falling into it, as many seem to do. But no matter what I would be very wary of long distance landlording, especially with your first property. I went through it and it wasn't pretty. If you think renovation costs are significant for a house you lived in, try adding them up for a house that's been through 3 bad renters in a row. :annoyed You can always buy a property in your new location if you still have the itch.
I've gone back and forth on the 401k Roth vs Traditional. I've done a mix of both this year in anticipation of the increased side income (it's paying physician hour wage so not nominal amount) that's now both federal and state taxable and the downside of filing separately (that's another discussion but its financially sound for our student loans). I'm more on the FI/RE track so I do anticipate there will be some Roth conversions in our future and a lower tax bracket into retirement. Only time will tell I suppose if it was the right decision.

I'm not necessarily looking at any return from the accumulation phase, looking more so at return after. From what I could find the return quoted is purely from a cash flow perspective. This exercise is for anticipating smoothing out cash flow because there is a potential for negative cash flow from renting--not just the time/money spent on managing/renovating for renters (I've read the post and also am sorry to hear your personal experience, yikes!), but the actual fixed expenses of the property mortgage, taxes, HOA. I suppose there's a small silver lining that taxes, mortgage interest, maintenance, and HOA are tax deductible for investment properties.

If you're looking at a return on investment with net return, it definitely gets more complex. Here's one scenario:
-Applying $130k to mortgage and recasting decreases monthly payments by $653, annually by $7,836, interest saved on life of loan $55k
-Keeping $130k with annual return of 4% real takes 1.35 years to earn the first $7,836, 11 years to yield $7,836 annually.
-In 27 years, a static $130k with 4% real annual return grows to $374,838
-$7,836 (new theoretical increased cash flow) contributed annually for 27 years with 4% real return grows to $406,304

It's probably not the best calculation but a return on investment for recast (the net difference of the two above scenarios + interest saved on lump sum over the initial investment over 27 years) yields 2.46%. That's probably very minimal return, but its net positive and can solve a potential cash flow problem short term. In reality, by about 6 years we will be 3-4x our current income and will likely pay it down well before the current loan schedule. Or we could just sell the place though I do believe with its location it has great potential as a rental. As I said we plan to stay in the area and even if we had to be long distance landlords for 3 years (it may be a painful 3 years), we plan to return which would be better in the long run.
Topic Author
diverdoc
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Re: Mortgage Recast Before Renting Out

Post by diverdoc »

ResearchMed wrote: Sun Sep 24, 2017 1:58 pm
Do the financing docs say anything about how long you are expected to live there?

And not to nit pick... but you already seem to know you are planning to violate the terms of the new mortgage.
That's quite different from someone who has a new mortgage (or refi/recast), and *then* finds out there is an employment transfer or such.

RM
The recast would still be the same loan--terms and all, just resetting the amortization schedule. I don't see how that's a violation of terms to reset the payment schedule right before moving out in order to free up cash flow. We aren't knowingly trying to violate our mortgage terms as we will be occupying the property for at least 3 years and have no intention of moving out unless we are forced to relocate for our professional training. But, you do bring up a good point about whether there'd be a contractual violation, I will definitely look in more detail at the mortgage docs. From what I've seen, primary occupancy anywhere from 60 days up to 1 year prior to renting out a property is acceptable without penalty. But I'll verify on the loan docs.
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