15 vs 30 year fixed mortgage

[Al3x]

Hey all, my name is Alex and I am a resident going onto fellowship for three years.  I want to refinance my mortgage before I move out of the city and move onto another one (I'll be a 2 hour drive from my condo).  I currently owe about 300k at 4.3% on a 442k condo (worth 500k right now).  I'm paying about 2400 in monthly payments (insurance+property tax+HOA+mortgage).  I am renting out one room for 1200, plan to make it 1300 when I leave and I plan on then renting out the next room for 1400.  So all in all I'd get about 2700 a month from these guys and have about 200 left over for whatever.  My question for you guys is that when I refinance, which I think i should since the interest rates are lower than what I currently owe, should I get a 15 year fixed mortgage instead of 30 year fixed?  I think I can afford rent at my new location plus putting a little extra in the condo.

To summarize for you guys.

Two options

#1 30 year fixed interest rate 3.8 monthly payment, loan amount 300k.  Payment about 2400 per month, rent it out for 2500-2700 a month.

#2 15 year fixed interest rate 3.8 monthly payment loan amount 270k (I can put some extra money down to make the monthly cheaper).  Payment about 2900, rent it out for 2500-2700 but make up the rest with whatever I have left over.

My income 84k (some passive income boosting my salary not including rent).  I don't have any med school loans, and have no other debt (car is paid off and have about 20k in a 403b and roth IRA).

I'll likely never live in the condo again, since most of my family is in this new city but the idea of owning this place as an investment property with it being paid off in 15 years instead of 30 years sounds like a great idea to me as by that time I'll be in my 40s could use the money for anything.  My goal is to save up some money during fellowship and get job and save up more money before buying a new home.  I'll moonlight my second year and make a little extra for sure.

I know I'll be strapping myself pretty thin if I go with the 15 year fixed interest rate but I think I can do it.  My rent at my new place should be about 1600 (with utilities) + whatever is left over from my condo mortgage will be about 200-400 = so about 2k a month going to mortgage plus rent.  My monthly income after taxes should be about 5.5k

Whatever I save afterwards will go to making sure I have a pretty good emergency fund incase any repairs in my condo are needed.  I'll likely higher a maintenance guy on retainer in case of any repairs are needed, I'll manage findings renters myself.  I'll need at the very least 20-40k in that emergency fund.

 

What do you guys think I should do?

-Alex

 

[jpa]

I think this is a perfect opportunity to ask: if you didn't own this house, would you take out a $500k loan for a rental property? For this particular house---a $2700 rental income on a $500k house is a really really bad return on equity.  It's much more likely that you could get double that rate of return on a cheaper property.  I know it's not one of your two options, but i really think you should pull out the $200k in equity.  If you want to look for a more suitable rental property, that's great---but these numbers don't work well for RE investing

[Al3x]

Huh, well what is an acceptable ratio? I might be undercharging rent a little but I can say it'll be by much. Well it's in an awesome part of the city, and prices are going up. Should I just hold onto it expecting a steady rise in value?

[TheGipper]

+1 I'd sell now.

I was in your position a decade ago. Decided to become a landlord. Wouldn't make that choice again for a host of reasons.

If you're set on keeping this property with a mortgage, you are at least smart to refi now. Once it's considered an investment property, refinance rates will go up.

[ENT Doc]

Option 3:  Sell.

[Al3x]

The only problem with selling now is that, I just bought it 2 years ago and to sell it now at a slightly higher price (442 now 500) will mean little profits when I take into consideration realtor cost.  What if I put my cash down into the loan (40k so I can reduce the principle further and pay less a month) and keep the place for 2-3 more years and then sell it.

I guess it is obvious I should put my money somewhere else but how do I determine the right time when to sell?

 

[TheGipper]

I think your missing the point a bit. The questions you should be asking yourselves are:

1). Would I have chose this particular property as a rental investment if I hadn't owned it first. Are there other better rental property investments? Would a more hands off, diversified crowdsourced real estate investment make more sense to me?

2) Do I enjoy and am I good at being a landlord?

3) Do I think returns will outperform just putting the money in passive index mutual funds?

4) How much is the depreciation benefit worth to me now?

Problem is, let's say you rent it out for 5 years and realize you hate being a landlord. Now if you sell, you are stuck paying long term capital gains (up to 23.8% plus state tax capital gains tax). When you realize this, you may feel "stuck" holding it till retirement.

I say cut it loose now.

[AZdoc68]

I used to own a couple of rental condo properties.  I soon hated RE investing.

My advice:  unless you really like RE investing I would dump it.  You're going to be 2 hours drive away so who's going to handle the maintenance and repair issues?  Remember the carrying cost of residential real estate is typically about 3% of market value per year ABOVE principal + interest.  The CCs are stuff like utilities, prop taxes, HOA fees, maint/repair, insurance, etc.  This does not include your time and attention in managing tenants and tracking rents.

In addition, if you're going to have a rental property you should NEVER OWN IT IN YOUR OWN NAME, especially as a doctor.  All you need is for some disgruntled tenant to sue you for a slip and fall because you are perceived as a deep pocket.  Form an LLC if you're going to keep it.

[adventure]

 

jpa wrote:

I think this is a perfect opportunity to ask: if you didn’t own this house, would you take out a $500k loan for a rental property? For this particular house—a $2700 rental income on a $500k house is a really really bad return on equity.  It’s much more likely that you could get double that rate of return on a cheaper property.  I know it’s not one of your two options, but i really think you should pull out the $200k in equity.  If you want to look for a more suitable rental property, that’s great—but these numbers don’t work well for RE investing

Click to expand...

Don't forget, OP is leveraging money to get a return, so it might not be such a bad deal.

Al3x - you need to consider a few things.

1. Cashflow to make it work. (that likely means 30yr, or sell). You can also pay more than the 30yr monthly payments, but you can't pay less than the 15. Also, keeping that emergency fund, and general extra for when you don't have full occupancy for a month, etc.

2. You have to depreciate it, if you aren't living in it. This technically improves your tax situation at the end of the year -aka you "lost"  money (it's older, it depreciated) on the home, so (ideally) you earned less, or even "lost" money on the property (from a tax perspective), but you are actually gaining cashflow, and equity. However, when it stops being a rental property - when you sell (or move back in), you have to pay 25% of the depreciation back to Uncle Sam. (unless you do a 1031 rollover into the next rental).

3. Do you really need to refinance this one? Also, if you refinance while living in in, great, you can likely do that.. However trying to refinance as a "rental" means an entirely different set of lending terms, because it isn't a house, it's an investment. Depending on your timeline, you could refinance and/or get a home equity loan (or line of credit) to use as a down payment on the next house? Those can be often be accomplished even if you aren't living in the place.

4. If you know the guys who will rent it now, fine, that might work great. Perhaps after they rent it for a year, it'd be time to sell. You'd have a bit more equity, you can sell on a better timeline, and you don't have to start being a landlord with folks you don't know at all.

5. Will you have time to deal w/ a rental?

6. What are you investment goals? You should have an IPS, and make sure this fits in accordingly. If it does, great. If not, use the equity for something else. And enjoy the better debt to income ratio, when you need it.

 

[Craigy]

To the original question of 15 vs 30, if the interest rate is the same, why would you choose 15.  Just choose 30 and make extra payments if you want.

[DMFA]

Strongly consider selling.  Shouldn't have bought in the first place, but here we are...

Real estate investing with single-family units can be more trouble than it's worth.  It should be looked at primarily as a cash flow instrument as opposed to a bought-and-held asset, meaning your return should be considerably higher than your expenses plus a set amount for contingencies ($200/month is minimal; all it takes is $2,400/yr of expenses and you're at a loss).  You should also get umbrella insurance for whatever your homeowner's doesn't cover.

I know that a lot of people are influenced by Rich Dad Poor Dad, but it was written with someone in mind who is purely entrepreneurial, has time to do the job, and is comfortable with a high amount of leverage.  You also have enough work to do as a fellow, plus more work to do if you're moonlighting...do you want/need to add the work and time onto your already busy schedule which could be better spent on other things, like leisure and family?

Why even refinance?  It is likely to cost you money to do so, which is usually added onto the principal, meaning more interest to accrue, meaning a higher rent than one might otherwise think.  Why put more money down to make a 15-yr fixed payment cheaper?  Should or could that instant cash not be better applied elsewhere?  What rate of return are you expecting on the appreciation of the property alone?  Your monthly payment after that refi would be maybe a couple hundred less per month, and based on the cost of the refi, it could take you years to make that up.

As for paying it off sooner, for an investment house, owning free-and-clear vs still having the mortgage is just another asset in just another form.  You may as well just raise rent or put future extra money into the principal; the unpaid mortgage principal is just leverage on the equity, just like if you took a personal loan to buy stocks.  Whether you have that $500K in the home equity vs in a brokerage account is fungible.

You're using some concerning language reflective of incomplete reasoning: a lot of "I think I can afford," "strapping myself pretty thin," but mostly "resident going onto fellowship for three years" plus considering moonlighting.  This is a big undertaking with many uncertainties while you're about to be going through another big undertaking with many uncertainties.

Either don't refinance and rent it for higher, or just sell it.  If you're breaking even with renting it out, then you're at least having some of your mortgage being paid off for you, but it *has* to be worth the time and effort you're putting into it...which is tough to do when you're in training or working two jobs already.

[Marko-ER]

Agree with all of the above.  Sell.  I have been in your shoes not that long ago, bought a house in year 2 of 4 in residency, preparing to stay for another 2-3 years for fellowship.  Wound up taking a different (shorter, less intense yet better) fellowship nearby and cashed out.  Yeah, those %ages for commission, loosing out on lower interest rates may sound painful, but nowhere near as painful as all the "what ifs":  what if the RE market in your area tanks and looses money, what if you wound up with a vacancy, what if you wind up with a "nightmare" tenant, what if your tenants do not get along (sounds like you have a roommate situation going), what if your tenants wind up using the property as airbnb sublease rental and what if you wind up getting sued... the list goes on & on.  There is a HUGE difference between being a tenant (live-in landlord) and being 2 hours away.  You have been there for 2+ years as your primary residence, you won't pay any taxes on appreciation; thank your lucky stars the place appreciated in value and cash out.  To add to the uncertainty -- you do not know where you are going to be (geographically) after the fellowship.  If you want to & you do your research, you can get a discount realtor like redfin (charging 1.5% instead of 3%) or if the market is particularly hot and you are willing to do research and legwork, you can also sell it yourself (that's what I did).

[Marko-ER]

One more thing:  what you would do with that money after you cash out?  Easy -- ROTH every year, max out your 401k/403b to 18K also on ROTH.  A number of training institutions also include fellows as eligible for profit-sharing After-tax plan (up to 54K/year), max those puppies out too.  Take advantage of your lower tax rates as a fellow for 3 years, while you can.  AMT is a biatch!

[AZdoc68]

DMFA wrote:

Strongly consider selling.  Shouldn’t have bought in the first place, but here we are…

Real estate investing with single-family units can be more trouble than it’s worth.  It should be looked at primarily as a cash flow instrument as opposed to a bought-and-held asset, meaning your return should be considerably higher than your expenses plus a set amount for contingencies ($200/month is minimal; all it takes is $2,400/yr of expenses and you’re at a loss).  You should also get umbrella insurance for whatever your homeowner’s doesn’t cover.

I know that a lot of people are influenced by Rich Dad Poor Dad, but it was written with someone in mind who is purely entrepreneurial, has time to do the job, and is comfortable with a high amount of leverage.  You also have enough work to do as a fellow, plus more work to do if you’re moonlighting…do you want/need to add the work and time onto your already busy schedule which could be better spent on other things, like leisure and family?

Why even refinance?  It is likely to cost you money to do so, which is usually added onto the principal, meaning more interest to accrue, meaning a higher rent than one might otherwise think.  Why put more money down to make a 15-yr fixed payment cheaper?  Should or could that instant cash not be better applied elsewhere?  What rate of return are you expecting on the appreciation of the property alone?  Your monthly payment after that refi would be maybe a couple hundred less per month, and based on the cost of the refi, it could take you years to make that up.

As for paying it off sooner, for an investment house, owning free-and-clear vs still having the mortgage is just another asset in just another form.  You may as well just raise rent or put future extra money into the principal; the unpaid mortgage principal is just leverage on the equity, just like if you took a personal loan to buy stocks.  Whether you have that $500K in the home equity vs in a brokerage account is fungible.

You’re using some concerning language reflective of incomplete reasoning: a lot of “I think I can afford,” “strapping myself pretty thin,” but mostly “resident going onto fellowship for three years” plus considering moonlighting.  This is a big undertaking with many uncertainties while you’re about to be going through another big undertaking with many uncertainties.

Either don’t refinance and rent it for higher, or just sell it.  If you’re breaking even with renting it out, then you’re at least having some of your mortgage being paid off for you, but it *has* to be worth the time and effort you’re putting into it…which is tough to do when you’re in training or working two jobs already.

Click to expand...

Yeah, I got on that Rich Dad, Poor Dad kick years ago and soon learned better.  I'm not saying there aren't people who love RE investing and do it well, there obviously are, but not me.  That book and others like it make it sound a lot easier than it is.  It requires a lot more time and attention than most doctors have available given their career and family.

The carrying costs of residential real estate (basically everything except principal and interest) average about 3% of market value per value.  And that happens to be approx the average annual rate of price appreciation too--about 3%/yr.  So don't kid yourself that you just buy something, rent it out, and voila you're rich in 10-20 years.  Not true.

You really only make money on rents and saving some tax cost thru depreciation (which is recaptured when you sell).  For me, the thought of having unoccupied rental time while I am paying a mortgage and carrying costs on a property I don't even use would drive me crazy.  I hate debt and I despise paying interest to other people.

[Zaphod]

AZdoc68 wrote:

DMFA wrote:

Strongly consider selling.  Shouldn’t have bought in the first place, but here we are…

Real estate investing with single-family units can be more trouble than it’s worth.  It should be looked at primarily as a cash flow instrument as opposed to a bought-and-held asset, meaning your return should be considerably higher than your expenses plus a set amount for contingencies ($200/month is minimal; all it takes is $2,400/yr of expenses and you’re at a loss).  You should also get umbrella insurance for whatever your homeowner’s doesn’t cover.

I know that a lot of people are influenced by Rich Dad Poor Dad, but it was written with someone in mind who is purely entrepreneurial, has time to do the job, and is comfortable with a high amount of leverage.  You also have enough work to do as a fellow, plus more work to do if you’re moonlighting…do you want/need to add the work and time onto your already busy schedule which could be better spent on other things, like leisure and family?

Why even refinance?  It is likely to cost you money to do so, which is usually added onto the principal, meaning more interest to accrue, meaning a higher rent than one might otherwise think.  Why put more money down to make a 15-yr fixed payment cheaper?  Should or could that instant cash not be better applied elsewhere?  What rate of return are you expecting on the appreciation of the property alone?  Your monthly payment after that refi would be maybe a couple hundred less per month, and based on the cost of the refi, it could take you years to make that up.

As for paying it off sooner, for an investment house, owning free-and-clear vs still having the mortgage is just another asset in just another form.  You may as well just raise rent or put future extra money into the principal; the unpaid mortgage principal is just leverage on the equity, just like if you took a personal loan to buy stocks.  Whether you have that $500K in the home equity vs in a brokerage account is fungible.

You’re using some concerning language reflective of incomplete reasoning: a lot of “I think I can afford,” “strapping myself pretty thin,” but mostly “resident going onto fellowship for three years” plus considering moonlighting.  This is a big undertaking with many uncertainties while you’re about to be going through another big undertaking with many uncertainties.

Either don’t refinance and rent it for higher, or just sell it.  If you’re breaking even with renting it out, then you’re at least having some of your mortgage being paid off for you, but it *has* to be worth the time and effort you’re putting into it…which is tough to do when you’re in training or working two jobs already.

Click to expand…

Yeah, I got on that Rich Dad, Poor Dad kick years ago and soon learned better.  I’m not saying there aren’t people who love RE investing and do it well, there obviously are, but not me.  That book and others like it make it sound a lot easier than it is.  It requires a lot more time and attention than most doctors have available given their career and family.

The carrying costs of residential real estate (basically everything except principal and interest) average about 3% of market value per value.  And that happens to be approx the average annual rate of price appreciation too–about 3%/yr.  So don’t kid yourself that you just buy something, rent it out, and voila you’re rich in 10-20 years.  Not true.

You really only make money on rents and saving some tax cost thru depreciation (which is recaptured when you sell).  For me, the thought of having unoccupied rental time while I am paying a mortgage and carrying costs on a property I don’t even use would drive me crazy.  I hate debt and I despise paying interest to other people.

Click to expand...

You are building up value in an asset at a discounted price that can be rolled into other assets very tax advantaged using 1031.

However, I kind of agree, I dislike being a landlord as my supposed property manager has not been a great or responsive intermediary.

Its also just so much easier from a time/effort standpoint to get return in the market. Point, click, and forget. Theres the correlated bit to it all but thats largely narrowed over time, and there are much clearer non correlated assets if you're willing to do the mental work to understand them and implement it.