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Buy another or pay down?

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Money Talk > Real Estate

What should I do while back in the US?
Buy a rental at 20% down
33%
 33%  [ 1 ]
Pay down wife's car; never buy a house while you still have debt
0%
 0%  [ 0 ]
Pay down your primary mortgage; peace of mind is most important
0%
 0%  [ 0 ]
Forget all that! Pay off your primary mortage first.
0%
 0%  [ 0 ]
Stop your retirement savings! Put all you can into real estate rentals
33%
 33%  [ 1 ]
Are you stupid?! Look at my comment to see what I suggest, instead.
33%
 33%  [ 1 ]
Total Votes : 3

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Wino
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Buy another or pay down?  Reply with quote  

Oldguy, I think this thread is tailor-made for your input.

I am returning to the US in about two weeks for a short holiday. I'm going to have a fairly large amount of money (all declared and legal; I don't play the try-to-beat-the-system game). I need to decide what to do while I'm back.

My wife just bought a fairly expensive car with an auto loan. We're paying it off at about $2500 per month, which won't affect any of my ability to pay any other loans or debts, including those contemplated in the following paragraphs. The car was a compromise which included us not selling our primary residence to buy a much, much (add a few more "muches) larger and more expensive place.

My current house payment is about 4% of my take home pay (not a typo: 4%). Other than the car and the mortgage, I have no debt. Call total debt load less than one year's salary, total. Interest rates are 1.2% on the car and 4.1% on the house; I could get lower on the house but I'll pay it off instead in the next year or so (would've been less time if not for the car compromise).

My dilemma comes from trying to decide what to do next. I can continue to fund my retirement funds (all after taxes). I think I want to put at least $5K per month there. I also want to buy a rental house. There is a neighborhood I've identified that I believe will be accelerating its value over the next three to five years. I have made this call on the last two houses I've purchased, and the worst outcome was more than doubling the value in less than six years, with 2008 being one of those years. The other tripled in value in 8 years. I have an eye for these things, I guess.

What I'm thinking: Take my bonus and use it as a down payment on a rental house. I would only put 20% down, as I detest PMI, no matter what spreadsheets might say. I see it as absolutely wasted money, and any returns I might get as speculative. I keep paying off the car and my primary residence at my present rate, both being paid off in about 15 months or less.

So, with 20% down, I can reasonably get a $150K house (a bit above median in the neighborhood I'm looking at), and then get the house into rentable condition. I've never been a landlord. I think that as long as I cover the mortgage, I can "eat" the maintenance and taxes for a few years until the equity comes up on the house through appraisal increases. I'm not really yet looking at rental income next year, but more at acquiring rental properties for when I retire. I expect to make money on these rents (or sell for appraisal increase) within two to three years.

So what do you think? Buy a rental and finance most of it? I've never bought a rental property ("Second house?"), so I assume I'm looking at around 5% to 5.5% rates, since it is not my primary residence.

Absolutely nothing above will dramatically impact my DCA into my primary retirement accounts. I am putting what most folks would consider as "insane amounts" into my Vanguard and Fidelity accounts, and won't be touching that money. DW has come on board to help me escape Dubai sooner rather than later. The $95K tax break is great, but... well, "Money is like oxygen: As long as you have enough for your needs, it doesn't really matter if you have extra, but if you run short of either, they both become very important in a very short period of time."

Absolutely any sincere questions, comments, input, or warnings are welcome. I'm going in to a new phase of my life, and I'm fairly ignorant about what I'm up against.
Post Sat Nov 02, 2013 12:30 pm
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oldguy
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quote:
Interest rates are 1.2% on the car and 4.1% on the house; I could get lower on the house but I'll pay it off instead in the next year or so (would've been less time if not for the car compromise).


I would avoid that fixation to prepay your "long, low" loans (Dave Ramsey?). Why on earth would you prepay a 1.2% note? Or a 4.1% note? Retain the use of that cheap capital and put it to work elsewhere - remember, that is 'locked in' capital, the loan companies can't call you some day and ask you to prepay, pay more per month, etc - you have fixed rate, fixed term contracts. Wealth is built by wisely and carefully leveraging borrowed capital.

quote:
The car was a compromise which included us not selling our primary residence to buy a much, much (add a few more "muches) larger and more expensive place.


Remember, we just witnessed the Boomer generation go thru "save nothing, keep up with the Joneses at all costs" - new cars every 3 years, ever bigger McMansions as soon as you can qualify, yada. Hopefully, those of you in younger generations won't repeat that folly? Very Happy


quote:
I would only put 20% down, as I detest PMI, no matter what spreadsheets might say. I see it as absolutely wasted money,


But use logic & math, don't base your future on emotion (detest?). Eg, in some cases, it might be better to split your 20% lump into two 10%-down payments and get a pair of houses started - in that case PMI is money well spent to accelerate a purchase program and get under contract while 5.5% money is available.
Post Mon Nov 04, 2013 6:30 pm
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littleroc02us
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Just my two cents, but right now I'm working with my credit union on getting a mortgage on a rental property and they are being very creative by me applying for the loan as a vacation home, which will allow it to receive a 30 year @ 4.31% instead of a point higher. I'm hoping to buy sometime between now and January whenever the right deal pops up. As for cash flow on your rental, I've been a member at Bigger Pockets forum for a while and they have some good spreadsheets that allow you to do the math and punch in your individual numbers to get an approximate result on Cap rates and cash on cash.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Mon Nov 04, 2013 8:23 pm
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Wino
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quote:
Originally posted by oldguy
Why on earth would you prepay a 1.2% note? Or a 4.1% note?

This comes down to the purpose of wealth-building. You are building wealth to be rich. I am building wealth to have a comfortable and secure retirement. If I have no debt and 5 or six rental houses in addition to my primary residence, and all of them are paid off or very close to being paid off, plus I have a few hundred thousand in other savings, then I feel I'll be secure in my retirement regardless of whatever happens to the economy (short of utter collapse). People will still need to live in houses. Rents will track inflation. Appraisal values will go up unless I buy in a "wrong" neighborhood; realizing I was possibly in one, I'd sell that house and buy another elsewhere.

Therefore, my course guarantees my future in the face of nearly any uncertainty. If the market absolutely crashes tomorrow, or we have a Cyprus-style "haircut" with stock market holdings, you're screwed, while I'd be still in the same situation. And don't even say, "Can't happen," because absolutely no one knows about tomorrow.

quote:
Originally posted by oldguy
But use logic & math...

I have done so, as you can see above. My goal is not your goal. I get $95K tax-free over here. I can buy a house with that. Reasonably, I can buy a house every year with that money (or 1.5 years, as I'm looking at $120K to $150K houses) and then have that rental income for the rest of my life without any risk. I do not count "failed air conditioner" as a risk, as that's a certainty, over time. It is a cost of doing the rental business.

You acknowledge and accept risk as part of your equation. I have my risk in the stock market. I want to balance that with a logical, low-risk, moderate-return investment of real estate. Housing prices (when not in a bubble; as they are not, in Houston) go up reasonably as quickly as the stock market. I do not need to multiply that by two, and subtract finance costs just to make even more money.

I hope I have answered your points adequately. No, we won't be buying any more new cars. I'll go to Carmax for my car when I get back, or look for private sales elsewhere, so the car is a one-time aberration.

quote:
Originally posted by littleroc02us
I'm working with my credit union on getting a mortgage on a rental property and they are being very creative by me applying for the loan as a vacation home...

I plan to buy several such houses and pay them off fairly quickly, I don't see the need to "fudge" the application process. I plan to finance-to-buy, fix it up, then cash-flow the pay-off, followed by another finance-to-purchase and pay off.

My objective is to buy five or six such houses over the next 10 years. That's the ambitious plan. I'll settle for having 4 houses paid off in 10 years instead. I would prefer rental income and equity to volatile stock market-based gains that may disappear or seriously diminish.

I've bought and sold several houses. I believe I know what to look for, and what pitfalls to avoid, as far as actual house value is concerned. I've tentatively identified a neighborhood that I believe to be poised to have a mini-boom over the next few years. If I buy now, I get in before the appraisal increases, rather than later.

So, would you follow my plan (aggressively paying off debt, but buying now to start "early" with the ideal target neighborhood, in my estimation), or pay off all my debt before starting my plan, hoping to find another such ideal target neighborhood in one to two years? I guess that's what this comes down to.
Post Tue Nov 05, 2013 3:59 am
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littleroc02us
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I would pay off all of your debt first so that your in a better disposable income position. In fact I'm so conservative that I have paid off all of my debt and my mortgage to the point where my payment to my mortgage/insurance/taxes is only 18% of my income. What this allows me to do is to aggressively invest in retirement and to save income for investement properties.

I like your idea of buying up to 10 properties and allowing the cash flow to pay off the mortgages. That is actually the same exact strategy I plan on doing. The only difference is that I plan on allowing the cash flow to build up an emergency fund of 5k for the rental property in case the furnace goes or something like that.

So again, I like what your doing, I would just rid of all of your debt except your primary mortgage so long as it's a small portion of your income. Just think how wealthy you could be if all of your properties are paid for and all your doing is collecting checks for rent.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Tue Nov 05, 2013 3:33 pm
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clydewolf
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quote:
Originally posted by littleroc02us
J right now I'm working with my credit union on getting a mortgage on a rental property and they are being very creative by me applying for the loan as a vacation home,

As your vacation home, you can not deduct the mortgage interest as an expense on Schedule E. The mortgage interest can be deducted on your Schedule A.

What's the difference? You want your AGI to be a low number so you can qualify for more tax incentives. Having the mortgage interest deducted on Schedule E, will lower your income or increase your loss on the rental and thus your AGI.
Deducting that mortgage interest on Schedule A, will only lower your taxable income.
Post Tue Nov 05, 2013 4:12 pm
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oldguy
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quote:
That's the ambitious plan. I'll settle for having 4 houses paid off in 10 years instead. I would prefer rental income and equity to volatile stock market-based gains that may disappear or seriously diminish.


I think you're caulght up in the emotion that "houses are good, I can see them, stocks are bad cuz they go up & down". Actually, risk & return are directly proportional, that applies to ALL investing, no free lunches. (a stock certificate is paper that says that you own part of a company, a deed is paper that says that you own a house - and when it burns down you show the paper to an insurance company.)

In my case, I used the rental houses as ATM's over the past 35 yrs, whenever one had a bunch of built-up equity I refi'd and invested the money in the SP500 Index. I kept my cash-flow near zero (avoided taxable rental income during my working years) and allowed the money (both houses & index) to grow tax-deferred. My result is that the stock index far out-paced the rental houses - the houses grew by a factor of 2 to 7 depending on what yr I sold them. But the equity that was moved to the index fund was far better, factors of 20 & 30.

As for your theory that a paid-for house is 'safe' and a loan is 'risky' - not always. In an era of hyperinflation (jimmy Carter), salaries and house values were doubling at a furious pace. (People grabbed their weekly paycheck and rushed to the store to buy stuff before the prices went up). But my loans were fixed, both the rates and 30 yr term. I could go to a bank with a pile of inflated cash, pay off a house note for less than 50 cents on the dollar, and the lender would have to accept my payoff.

In that case, it was better to be the borrower - the lenders were forced to helplessly watch the real value of their outstanding loans fall drastically - and they had no way to call back that money so that they could re-invest it. Meanwhile I had 6 mortgages (and I still keep mortgages & keep the cash in the market).
Post Tue Nov 05, 2013 4:34 pm
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Wino
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quote:
Originally posted by littleroc02us
I would pay off all of your debt first so that you're in a better disposable income position.

I have enough income to pay down the car and two houses aggressively. If I took my bonus and put it toward the car, I could have it paid off more quickly, but I think that at 1.19%, it's not in my best interest to pay that one down any more quickly than I am already doing. Even with a three year note (they didn't have 24 month notes), my payments are less than 10% of my take home pay. Along with 5% on my house, I still have 85% of my income to use for mutual funds and real estate. Even if you count 50% toward living expenses (nowhere near that in reality), I still have 35% for mutual funds and real estate.

I pay about 25% toward mutual funds. I think I can reasonably use the last 10% toward another mortgage without unnecessarily stressing my budget. Even with that having been said, I am not slowing my investing or pay down while I make this decision. I have nearly come to the decision that if I can find the "ideal" house, I'm going to buy it, but if I don't find it, I'll just keep paying down debt and look again later for an "ideal" house for my purposes.
quote:
Originally posted by oldguy

I think you're caught up in the emotion that "houses are good. I can see them. Stocks are bad cuz they go up & down".

No, I'm caught up in the logic that "I have enough in mutual funds, real estate will be a good area to balance my portfolio." I expect to be around 60% stock market and 40% real estate when I retire. I don't like bonds, so I won't be investing there at all. The more I learn about bonds, the less I like them. My present assessment is that bonds are investing in both a decline in the market as well as the ability of someone else to make financial decisions.

I have also used very conservative figures in my calculations. My primary residence is not part of those calculations.

I am paying off the debt quickly because it is debt. I don't like debt. It can be leveraged, certainly, but as Dave Ramsey says, "One hundred percent of foreclosures have mortgages." No mortgage, and all I'm liable for is taxes and maintenance. I like the security of that more than I would like to see another five hundred thousand dollars in a mutual fund.

I have no intention of ever using my houses to leverage investments. I do not need to do so. I would prefer to retire comfortably and diversified than to retire rich but leveraged, and all of that in one vehicle alone. If my rental income is enough to live on, then my mutual funds and real estate valuations will continue to increase my on-paper wealth, with zero risk. I don't need the money, so even if I lose it all, I have lost nothing I need.

I don't ignore the "risk" side of the statement "Risk and reward are proportional." I want to eliminate that side as much as possible, as to how much it can impact me. I am more than willing to accept less unnecessary reward to eliminate even more risk.
Post Wed Nov 06, 2013 3:08 am
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littleroc02us
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quote:
Originally posted by clydewolf
quote:
Originally posted by littleroc02us
J right now I'm working with my credit union on getting a mortgage on a rental property and they are being very creative by me applying for the loan as a vacation home,

As your vacation home, you can not deduct the mortgage interest as an expense on Schedule E. The mortgage interest can be deducted on your Schedule A.




Actually things have changed in this circumstance because the home I'm looking at is for investment and not vacation and because it is to close to my primary it will fall under investment property interest rates which right now is 5.25%.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Wed Nov 06, 2013 5:11 pm
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littleroc02us
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A reminder to everyone, that most foreclosures occur with people who have mortgages.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Wed Nov 06, 2013 5:13 pm
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coaster
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quote:
Originally posted by littleroc02us
A reminder to everyone, that most foreclosures occur with people who have mortgages.

Laughing Laughing Laughing Marcus, you're a hoot!! Cool

~Tim~
Post Thu Nov 07, 2013 5:08 am
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Wino
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Just a quick update.

I'm back in Dubai. I bought nothing. DW and I decided to pay off all of our debt before we embark upon any real estate adventures. By my calculations, I'm less than a year away from setting aside funds for down payments.

I found another neighborhood. It's "on the wrong side of the tracks," but it's within a mile of an "ideal" neighborhood. I found a lot that's over 17000 square feet and unrestricted for $51K. You have to realize that lots of 5500 ft^^2 are going for nearly $300K less than a mile away. Quick math says that this property could be worth $1M in today's dollars in just a few years if this neighborhood takes off like its neighbor.

Houston real estate will never be a "fun" endeavor. I now have three neighborhoods selected, and two are prime candidates for my plan. The one above is the "not one of the two" candidates, but it's sorely tempting. $51K is not "nothing," but it's certainly not enough to make or break one's retirement plans.
Post Fri Dec 06, 2013 11:41 pm
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coaster
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Thing I noticed about Houston is there seemed to be little or no zoning....nice neighborhoods directly abutted ramshackle neighborhoods; residential neighborhoods directly abutted commercial and industrial neighborhoods. Seemed like anybody could plop anything down wherever they wanted. Though ... that was over 20 years ago. Maybe it's different now. I think to buy on the "wrong side of the tracks" you need to have a pretty good sense of whether the "nice" is growing in size and the "ramshackle" is diminishing; ie whether the money's coming in or whether it's leaving the area you want to buy in. I presume you've got that sense.... Wink

Thanks for the update, in any case.

~Tim~
Post Sat Dec 07, 2013 6:26 am
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Natalia Smith
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Very informative and useful information has been shared in this thread. I am happy to find so important information here in this post.
Post Thu Dec 12, 2013 10:49 am
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