$400,000 Cash: Pay Off Rental v. New Home Down Payment

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Topic Author
brich79
Posts: 14
Joined: Wed Jan 15, 2020 12:01 pm

$400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by brich79 » Wed Jan 15, 2020 12:46 pm

Greetings! This is my first post on BH, but I've been reading for years. I hate seeing redundant threads, but I couldn't find a recent one that covered my situation.

We're in the process of selling our house. I'm trying to figure out the best approach for distributing the equity when we sell. So, here goes:

Life Status
  • I'm 40 and my wife is 34
  • 2 Kids: 3.5 and 1.5 years old
  • Location: Atlanta, GA
  • Vacation Rental Property: Destin, FL
  • Household Income: $350,000 (pre-tax)
  • We currently save/invest 25% of our net income
  • Our emergency fund covers 6 months of living expenses
Current Primary Residence
  • Value: $725,000
  • Mortgage Balance: $240,000
  • Estimated Cash After Sale: $400,000
Vacation Rental Property
  • Value: $440,000
  • Mortgage Balance: $293,000
  • Loan: 30-year fixed at 3.5% (refinanced in Fall 2019)
  • Average Annual Cashflow: $20,000 (excluding P/I)
Future Residence (Budget)
  • Value: $550,000
Options
  • Put $400,000 down on new primary residence and finance $150,000
  • Put a smaller mount down and invest the balance
  • Pay off the vacation rental property mortgage and put 20% down on new house
Let's just say my wife is risk-averse, and she's the boss. It would be hard to make a compelling case for the second approach since the returns in the market are never guaranteed. Plus, she (we) like the psychological advantage of having an almost-paid-for house and the breathing room that offers. The third option would add ~$14,000/year in net income. Right now, the rental breaks even on cashflow when you factor in the P/I. So that extra $14,000/year would cover ~5 months of mortgage payments (~$2,700/month for PTI). This option also offers breathing room.

Sorry for the long post. First-world problems, I know. I just can't seem to find one approach that is significantly better than the others. So it may just come down to personal preference and risk tolerance. And if that's the case, just tell me and we can shut this thread down :)
Last edited by brich79 on Thu Jan 16, 2020 9:41 am, edited 1 time in total.

MikeZ
Posts: 269
Joined: Sun Dec 07, 2014 9:17 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by MikeZ » Wed Jan 15, 2020 4:13 pm

Not to change the subject, but the rental house does not seem to be generating all that great of a return. Can you provide some more info on how you see it fitting in with your goals and performace expectations?

Topic Author
brich79
Posts: 14
Joined: Wed Jan 15, 2020 12:01 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by brich79 » Wed Jan 15, 2020 4:31 pm

Great question. We didn't really buy it for the returns (at least not in the short-term). It's a beachfront condo that's a 5-hour drive from home. We use it ourselves 2-3 weeks per year, so that's $4-5,000 we don't have to pay to rent a place. We put $100,000 into it 5 years ago, and we're basically happy with it breaking even as the value appreciates and renters donate to the equity. The bonus is we can use it anytime we want.

In short, we don't really expect it to "perform" as it relates to cashflow (if that makes sense). If we sold it now and annualized the profits over the 5 years we've had it, it would be about a 7% return. And if it continues to appreciate, that number goes up. Let's call it a long-term play :happy

MikeZ
Posts: 269
Joined: Sun Dec 07, 2014 9:17 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by MikeZ » Wed Jan 15, 2020 4:36 pm

And you can handle a hurricane hit, leaving it vacant for a year+? E.g., drive over to Mexico Beach....

Plano
Posts: 23
Joined: Sun Nov 03, 2019 4:21 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by Plano » Wed Jan 15, 2020 6:46 pm

I would first see if the mortgage terms are any better for $150K vs. $440K, and how those compare to the 3.5% you have on the rental. It sounds like you've decided against option 2, so it just comes down to picking the better mortgage.

tbone555
Posts: 61
Joined: Thu Apr 13, 2017 1:28 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by tbone555 » Wed Jan 15, 2020 6:55 pm

I vote for putting it towards your next primary residence. Let the vacation rental break even for the foreseeable future.

User avatar
unclescrooge
Posts: 4196
Joined: Thu Jun 07, 2012 7:00 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by unclescrooge » Wed Jan 15, 2020 8:42 pm

tbone555 wrote:
Wed Jan 15, 2020 6:55 pm
I vote for putting it towards your next primary residence. Let the vacation rental break even for the foreseeable future.
+1

MikeZ
Posts: 269
Joined: Sun Dec 07, 2014 9:17 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by MikeZ » Wed Jan 15, 2020 10:31 pm

There are a lot of factors to think about. Personally, I have thought a lot of a beachfront investment property in the FL panhandle but I could never come to the conclusion that they are a great investment and it was better to just rent and invest in other real estate.

One factor to think is that the interest on the investment property is fully deductible and likely won't change so your basically discounting your investment property income by your marginal tax rate.

On random thought is if instead of getting a small mortgage on your primary residence is to get a HLOC on your vacation property and use that plus your cash from selling your home with the goal of paying off the HLOC fast. That would give you a full cash offer and lower closing costs. I would say that for your income and home you are talking about purchasing, I would rethink if your saving rate is high enough.

Topic Author
brich79
Posts: 14
Joined: Wed Jan 15, 2020 12:01 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by brich79 » Thu Jan 16, 2020 9:26 am

Plano wrote:
Wed Jan 15, 2020 6:46 pm
I would first see if the mortgage terms are any better for $150K vs. $440K, and how those compare to the 3.5% you have on the rental. It sounds like you've decided against option 2, so it just comes down to picking the better mortgage.
Good point. Before I posted this, I read through several recent threads where people say they got a better rate by putting 25%+ down versus 20%. But that nothing changed over 30%. So, I'll definitely look at this. Thanks!

And it's not necessarily that I've decided against option 2, it's just that I know my wife :happy

1130Super
Posts: 155
Joined: Thu Nov 07, 2019 8:59 am
Location: Minnesota

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by 1130Super » Thu Jan 16, 2020 9:34 am

Keep rental mortgage. Do you itemize or take standard deduction? Interest on a rental is deductible even if you take standard deduction. Also the small chance you get sued for anything the equity in your primary home is a lot harder to get taken then equity In a rental. 3.5% is also a good rate

User avatar
Brianmcg321
Posts: 472
Joined: Mon Jul 15, 2019 8:23 am

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by Brianmcg321 » Thu Jan 16, 2020 9:39 am

I would put it all on primary residence.
Rules to investing: | 1. Don't lose money. | 2. Don't forget rule number 1.

Topic Author
brich79
Posts: 14
Joined: Wed Jan 15, 2020 12:01 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by brich79 » Thu Jan 16, 2020 9:41 am

MikeZ wrote:
Wed Jan 15, 2020 10:31 pm
There are a lot of factors to think about. Personally, I have thought a lot of a beachfront investment property in the FL panhandle but I could never come to the conclusion that they are a great investment and it was better to just rent and invest in other real estate.

One factor to think is that the interest on the investment property is fully deductible and likely won't change so your basically discounting your investment property income by your marginal tax rate.

On random thought is if instead of getting a small mortgage on your primary residence is to get a HLOC on your vacation property and use that plus your cash from selling your home with the goal of paying off the HLOC fast. That would give you a full cash offer and lower closing costs. I would say that for your income and home you are talking about purchasing, I would rethink if your saving rate is high enough.
You're absolutely right about your first point. If you look at FL panhandle beachfront property strictly as a part of your investment strategy, then you're better off renting. We treat it more as an emotional investment that doubles as a (non-liquid) savings account.

Regarding a HELOC, I'm glad you brought that up. I've used one in the past for something similar and it worked out well. We paid it off in ~12 months. That may actually be a great option if we find a home in the range where it would give us enough cash.

Also, we are ratcheting up our savings rate. We're actually at ~25% right now (I was wrong and edited my original post). But plan to up that a little after all this house business. And then when the kids start getting out of private daycare and into a good public school system in 18 months, it's going to feel like we won the lottery...

Topic Author
brich79
Posts: 14
Joined: Wed Jan 15, 2020 12:01 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by brich79 » Thu Jan 16, 2020 9:42 am

1130Super wrote:
Thu Jan 16, 2020 9:34 am
Keep rental mortgage. Do you itemize or take standard deduction? Interest on a rental is deductible even if you take standard deduction. Also the small chance you get sued for anything the equity in your primary home is a lot harder to get taken then equity In a rental. 3.5% is also a good rate
We itemize.

alaskantraveler
Posts: 272
Joined: Wed May 11, 2016 12:26 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by alaskantraveler » Thu Jan 16, 2020 11:53 am

You state your wife is risk adverse. Why not a combo of the first two options? Pay 20 to 30% down on the property and finance into a 15 year loan. Rates are around 2.75% right now. With interest rates that low it hard not to want to invest the rest.

Paying down the rental property is likely the least desirable option as it will increase your tax liability.

Topic Author
brich79
Posts: 14
Joined: Wed Jan 15, 2020 12:01 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by brich79 » Thu Jan 16, 2020 12:17 pm

alaskantraveler wrote:
Thu Jan 16, 2020 11:53 am
You state your wife is risk adverse. Why not a combo of the first two options? Pay 20 to 30% down on the property and finance into a 15 year loan. Rates are around 2.75% right now. With interest rates that low it hard not to want to invest the rest.

Paying down the rental property is likely the least desirable option as it will increase your tax liability.
I guess that's pretty much what my Option 2 is (I was kind of vague in my description).

That being said, I'm glad I started this thread. Something in your reply got my gears spinning. The one thing my wife is aggressive about is saving for our kids college (or whatever the future of higher ed is in 18 years). We have 529 funds for each of them (and yes, I know how a lot of BHs feel about 529s). We have grandparents, aunts, etc. that like to send in checks from time to time, so it works for us. But what my gears are spinning about is super-funding their 529s. We get a state of GA tax deduction for the first ~$4,000 if we use the state plan (I'd have to roll them over from where they are now). But we could super-fund each 529 with $55,000 each, which would allow us to put in an additional $4,000 for the next 5 years to get the tax benefit and hit the $15,000 annual limit. [Edited to add: Or maybe if we superfunded with $75,000 then we'd automatically get the $4,000 state tax deduction for the next 5 years. Need to check on how that works.]

Or something like that. Then do the rest down on the house with a 15-year mortgage. We'd be contributing less to the 529 each month which would free up cash for the higher mortgage payment. Meanwhile, that's 15+ years of growth on a large chunk of money. I could maybe sell that...

Financologist
Posts: 83
Joined: Wed Jan 01, 2020 11:16 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by Financologist » Sun Jan 19, 2020 12:52 am

Sell rental asap.
Pay cash for new home.

Now you have no mortgage, own your home free and clear and have lots of cash to invest, save and vacation anywhere you like, including Florida.

You also have less to manage and worry about.. especially if heaven forbid there is a weather event that affects your property.

This is also lower risk than your previous position, which hopefully pleases your wife. Quite a lot of Florida real estate exposure currently.. equity in Florida can evaporate quicker than a rain drop on a Sarasota sidewalk.

msk
Posts: 1448
Joined: Mon Aug 15, 2016 10:40 am

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by msk » Sun Jan 19, 2020 1:03 am

Brianmcg321 wrote:
Thu Jan 16, 2020 9:39 am
I would put it all on primary residence.
+1. I find it baffling that a BH at your age and income is still carrying a mortgage on his home. As for the beach property it's either an investment or a toy. Nothing wrong with either approach in my view. Decide which and act accordingly. If investment then do you even use Airbnb? If toy, recognize it as such and simply enjoy the (expensive in terms of opportunity cost) 365 day availability.

reln
Posts: 51
Joined: Fri Apr 19, 2019 4:01 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by reln » Sun Jan 19, 2020 1:04 am

Financologist wrote:
Sun Jan 19, 2020 12:52 am
Sell rental asap.
Pay cash for new home.

Now you have no mortgage, own your home free and clear and have lots of cash to invest, save and vacation anywhere you like, including Florida.

You also have less to manage and worry about.. especially if heaven forbid there is a weather event that affects your property.

This is also lower risk than your previous position, which hopefully pleases your wife. Quite a lot of Florida real estate exposure currently.. equity in Florida can evaporate quicker than a rain drop on a Sarasota sidewalk.
Agreed.

Topic Author
brich79
Posts: 14
Joined: Wed Jan 15, 2020 12:01 pm

Re: $400,000 Cash: Pay Off Rental v. New Home Down Payment

Post by brich79 » Mon Jan 20, 2020 3:42 pm

msk wrote:
Sun Jan 19, 2020 1:03 am
Brianmcg321 wrote:
Thu Jan 16, 2020 9:39 am
I would put it all on primary residence.
+1. I find it baffling that a BH at your age and income is still carrying a mortgage on his home. As for the beach property it's either an investment or a toy. Nothing wrong with either approach in my view. Decide which and act accordingly. If investment then do you even use Airbnb? If toy, recognize it as such and simply enjoy the (expensive in terms of opportunity cost) 365 day availability.
Trust me, there are many things much more baffling about my financial history than that. This forum ain't for the faint of heart :D

Let's take the beach property out of the equation. It's in the on-premises rental program, so we just cash the monthly check and use it a few times a year. But my eyes are opening. We may sell it in the next year or two and use that cash in a smarter way.

But for now, I'm trying to figure out the primary residence situation. I keep running the numbers, and the scenario where we super-fund our 2 kids' 529 funds with $75k each and never touch them again looks intriguing. Especially with the current mortgage interest rates. That would free up the $1,100/month we currently put into their funds but would only add ~ $700 to a mortgage payment. That leaves an extra $400/month to invest. I know we can lock in paying less interest by putting it all in the house and we can't guarantee 6% returns in the 529s. But it's still intriguing...

Am I missing anything major? Or not considering something that makes this a totally stupid idea? I may be 40, but I'm still pretty new to the BH school of thought. So take it easy on an inquisitive kindergartener :D

Post Reply