Pay off first home with house hacking or invest in another?

Question

Hi there! Looking for some advice, so I'll try to provide as much info as possible. My fiancée and I purchased our first home in 2017, and accidentally stumbled into about $125,000 of equity with it. It was a foreclosed HUD home, we bought it for $125,000, and it's now worth about $250,000. We currently owe about $102,000 on the mortgage, with an interest rate of 3.75%. We've also been house hacking with it, even before we knew what that meant. Our expenses are about $1,400 monthly (plus the occasional oil fill up). We have 3 roommates, and their rent totals $1,900. So we have $500 income most months (oil is so expensive). I also work a part time job and bring home between $300-400 weekly from that, and we have savings in the $60,000 range. We're looking at purchasing another home, and are unsure which route we want to take. We're considering the following options:

1) Purchasing a single family/duplex and renting it out, continuing to live in and house hack our current house and building equity slowly.

2) Purchasing a duplex, rent out one side and live in the other, rent out current house. With this option, we're wondering if it's better to offer it as a 3 bed 1.5 bath with 2 bonus rooms (which we live out of), or rework one of the rooms into an actual bedroom to make it a 4 bed.

With either option, we're also wondering if it's best to have the cashflow of our current house to offset any unexpected expenses, or if we should pay extra and try to pay off our current house as soon as possible. One intangible factor is that we'd really like to live in a new area, so if numbers end up being comparable, we'd end up looking out of state for the duplex to rent half of. Any wisdom or insight would be highly appreciated, as this would be my first big real estate move! Thank you!

Carlos Valencia · Answer

Hi Kevin,

it seems like your off to great start. That's always great when you accidentally stumble on something great especially in real estate. I would leave your current house and rent it out completely. Many people rent theres out by the room to get the most rent out of their property instead of renting to family because theres only so much you can get on rents when a family lives there. Take your savings and try to find another home to house hack with 3.5% -5% down and rinse and repeat. Many people use this strategy as it seems to be the least risky. You can use your rents to help qualify from the current house if you leave but only 75% of the rents the other 25% is used for vacancy thats why they dont allow full 100% to be used for income. Once you file your taxes with that rental then you can use 100% of the net after expenses. Sometimes it can be positive and sometimes it can be negative it all depends on how you do your tax planning for when you file taxes.

@Albert Bui @Matthew Kwan

Tanner Lewis · Answer

Whatever you do, DO NOT make additional payments to your 3.75% rate mortgage. It simply is not worth the opportunity cost.

Taz Zettergren · Answer

@Kevin DiMaggio  That 3.75% rate is something that will rarely happen again, I wouldn't pay a penny more than your mortgage on that one. If it's feasible I'd keep house hacking because that will give you the best return over the long run.

Congrats on such a successful investment! Best of luck on your next move

Wale Lawal · Answer

@Kevin DiMaggio

It sounds like you're in a great position to leverage your existing equity and income to make another real estate investment. Here's some advice to consider for each of your options:Purchasing a single family/duplex and renting it out: This option allows you to continue building equity in your current home while also diversifying your real estate portfolio. Look for properties in areas with strong rental demand and potential for appreciation. Calculate the potential cash flow and return on investment to ensure it aligns with your financial goals.Purchasing a duplex and house hacking: This option offers the advantage of living in one unit while renting out the other, potentially covering most or all of your housing expenses. Consider the layout of the duplex and whether reconfiguring one of the rooms into an additional bedroom would significantly increase rental income. Evaluate the rental market in your area to determine the optimal configuration for maximizing rental income.The choice between using cash flow from your current house to cover expenses or pay off the mortgage faster depends on your long-term financial goals and risk tolerance. If you prefer more liquidity, using cash flow to build savings may be a prudent choice. If you prioritize debt reduction and long-term financial security, allocating extra funds towards paying off your mortgage can help achieve your goal sooner. Exploring out-of-state options for a duplex can be a viable strategy, but it's important to weigh the pros and cons based on your financial situation, investment objectives, and personal preferences.

Dan M. · Answer

Hello Kevin,

There's a lot to consider.  First off congrats on doing what your doing now, that's a big stepping stone and I wish I did the same thing starting out.  I guess you really have to decide where your planning to move to. That comes first. Start looking at listings on zillow realtor.com trulia whatever and find that area. Then find out if the house your looking for exists. Many areas saw huge appreciation I think its challenging at best to find a duplex where one side pays the whole mortgage anywhere in the country.

Look at paying into your debt like this: Your making 3.75% ( technically after taxes only  about .75 of that ) on your money when you pay that debt down. You can put money into no risk 4 week treasury bills right now for over 5% ( technically about 4 when you consider taxes ). Its a safe bet that you can make more than 3.75% on your money somewhere else with little to no risk.

Ultimately though it comes down to what you and your partner want to do. Instead of getting caught up on the numbers figure out an area , see if its feasible, drive to it and look at the area, then see if your willing to take the jump to actually move to that location.

Carlos Scarpero · Answer

Option two would be cheaper from a lending perspective. Option 1 would be an investment property with higher rates and down payment requirements.

Kevin DiMaggio · Answer

This is extraordinarily helpful, thank you. Having these options laid out in detail helps a ton. I think I'm leaning towards the 2nd option, and I'm going to dive deeper into the best financial way to make it happen. Thanks so much for taking the time!

William Sing · Answer

Hi Kevin,

Congratulations on the success you’ve experienced with your first property! Thought I'd put in my two cents. It sounds like you've set a solid foundation for your real estate journey. Regarding your options, both have their unique benefits, and your decision might come down to your personal goals and comfort with managing properties.

• Continuing to House Hack: Staying in your current home and purchasing another single family or duplex to rent out can be a great way to expand your portfolio while maintaining the comfortable cash flow you’re accustomed to. Given the equity you’ve built and the cash reserves you have, this option might allow you to leverage better financing terms for the new property. You could also look into using a HELOC (Home Equity Line of Credit) on your current home to fund part of your next investment, thereby keeping your savings intact.
• Moving and Renting Out the Current Home: Transitioning into a duplex, living in one unit while renting the other, plus renting out your current house, can significantly accelerate your investment pace. This would shift your income sources and could potentially maximize your rental income. However, it involves more management and higher stakes with multiple properties. As for the current home, converting a bonus room into a real bedroom could enhance its rental appeal and value, depending on local demand for larger rental units.

Paying Off the Mortgage vs. Investing: Given the relatively low interest rate of 3.75% on your current home, and considering the income it generates exceeds the mortgage and expenses, it might be more beneficial to keep leveraging that property as is rather than rushing to pay it off. The extra cash flow could be used to cover any unexpected expenses in your new property or further invest in upgrades that increase rental yields.

Since you mentioned an interest in living in a new area, exploring out-of-state opportunities could align with both personal and investment goals. Just ensure you factor in the challenges of managing properties remotely or consider a reliable property management solution.

Ultimately, your choice should align with your long-term financial goals, risk tolerance, and lifestyle preferences. Diversifying your investment while maintaining manageable debt and cash flow seems like a promising strategy.

Best of luck with your next big move in real estate!

Warm regards,

Kevin DiMaggio · Answer

Thank you for the advice! These are strategies that are on my radar, but I definitely have to research. I'm still pretty new to all of this. Thank you for taking the time to help me out!

Bryan Montross · Answer

@Kevin DiMaggio I think everyone has given you some sound advice. I just want to add one additional thing to think about. That is the capital gains exclusion for selling your primary residence.

If you live in your house for 2 of the last 5 years you get a capital gains exclusion up to $250K if single, $500K if married. Since you have built up equity it might be something to consider. I would potentially buy the duplex and live in one side. You can take advantage of the low down payment. Rent your current house for 2 years and then look at selling it using a combination of 1031 exchange and the Section 121 exclusion to buy a new property that might cashflow better. Or sell it using the 121 exclusion and buy your next primary residence house hack keeping the duplex. There are a lot of options.

You can always keep your current house and just use 1031 exchanges to continue to defer the taxes, or if you just sell it later down the road pay the capital gains tax, but this is one way to try to keep more of your money.

Like I said, just one more thing to consider. Make sure you talk to your CPA and seek counsel if you are going to do these strategies as there are specific rules you need to follow.

Pay off first home with house hacking or invest in another?

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