AM I READY? or do I need to pay off some debt first?

Question

My wife and I built our home a little over 2 years ago, appraised at 265k during construction for loan purposes, assessed this year at 284k. (I think it would appraise for 280K no problem now based off comps in the area that have sold or are listed this year)  I currently owe 189k. and 28yrs left on a 30yr note.   We also own a SFH rental our previous home that was appraised at 46k when we bought it that we owe 24k on 7yrs left and 4k on a home equity loan we used to fix it up when we lived there it only cash flows about $25/mo (it was on the market for over 2 yrs in a town of 400 ppl)     So we have about 113k in equity in our 2 homes together.   Other than the 2 homes we owe on still, we bought a brand new vehicle that we owe 39k on (0% apr) and I own 9k on a credit card.     I do have about 30K in mutual funds and 70k in retirement 401K and Roth IRA's, however I do not want to pull out those funds.

We want to get into Buy-and-Hold Single Family Homes all with in 1 hr driving distance.   We recently found a HUD home listed for 30k (I plan to offer 28.5k 5% off asking) that I estimate needs 4k in updates unless plumbing or HVAC is bad (No electric or water) so be super conservative (10k).  38.5k total.   Rent in the area is 750-850 depending solely on how nice I fix it up.   So it hovers right around the 2% rule.

$ 800 Rent - 50% cost (does this usually equate the same for SFR or is it some what different) = $400 - $165/monthly mortgage should cash flow $235/month if I did that right?

I am thinking of taking out 25k in a home equity line of credit and paying off my 4k line of credit on the current rental plus 9k down for 20% and closing then the other 12k will be available for repairs.    WOULD YOU DO IT?  Or would you do it differently?  Why am I so scared to make the jump?

Ask me anything I may have forgot.

Thanks in advance!

Michael B. · Answer

My take is that the issue is a little deeper, and I realize this won't be a popular note. But you asked for advice:

Financial success is about living on less than you make and successfully investing the difference. That rarely involves buying a $40k car on credit. Nor does it involve keeping credit card debt.

I know this will not be popular, but spend some time getting ready to invest. Get on a budget that allows you to save at least 20% of your take home pay on a monthly basis. Spend as long as it takes to knock out the credit cards and the car. I'd also take care of the home equity loan that's been out there a while.

Being an undercapitalized landlord is no fun. They usually come to bad ends when unexpected expenses and vacancies hit. Don't be an undercapitalized landlord. Get your expenses under control. Knock out your consumer debts and don't incur more. Build reserves of at least 6 months for both your home and the rental. Then you'll be ready to invest, but not now.

Christopher Derr · Answer

@James H. Yes my vehicle is 0% for 60 Months.   I would be upside down on it if I sold it so I don't plan on it.  Our last vehicle lasted 10 years and my wife works in the home so we usually don't put more than 10k miles a year on it so it should last another 10.  I understand this doesn't change my debt obligation.

My and My wifes combined income is about 105k/yr

Income $8,750

Debt - Current Residence $ 1,450, Auto loan $650, Credit Card $100, Mortgage on rental $350, HELOC $100. Total $2,650

$2,650/$8,750 = 30.28% DTI ratio

I wish I could sell that House, I tried for 2 years while it was rented to a friend with 3 total looks 2 of which were the first month It wasn't bought as an investment property it was our residence for 5 years before we built our new home.  The good news is the new renters may want to buy after a yr.

@Michael B.   Don't worry about offending me or offering up honest opinions thats why I asked.   People need to hear the honest truth more often than not and if I thought I had it all figured out I wouldn't have even asked, I would have just asked which deal was the best.

A little back ground on my consumer debt.  Rental house was a previous house we couldn't sell, Home equity on that house was taken out to remodel and paid off but never closed.  Credit cards were at $0 when we built the new house.  I had 50k down for the build. Bid was 240k it came in at 280k  The builder under bid the house and got cancer in the middle of the build.  He ran out of money before it was complete and I bought all the supply's to finish the house on the home equity line of credit from the old house and my credit card (labor was free for the last 30 days) thinking at the time I could sell my rental house and use the profit to pay off everything.   HELOC was at 7k and C.C. was at 12.5k 2 years ago when We finished the house, I've since paid off 3k of the heloc and 3.5k of the C.C.

The car no excuse just what we wanted.

Unfortunately the circumstances dictated some of my debt because I really thought I was doing good going into the build having 50K saved up to put down.

I am not typically a spend first kind of guy (our new family vehicle was our 1 vice) I drive a 2002 ford focus with 200k miles ive had for 6 years and bought cash.  The house was only 16.5% of DTI.  And was suppose to be 15% until the under bid.

I don't think I have a problem (although no one ever does) with spending.  But what I have gathered from both of you and probably the smartest thing is to get the Credit Card and Home Equity paid off first and get some more cash reserves then re-evaluate. Not to mention I have 3 mortgages so I would probably have a tougher time getting a 4th.

I am currently at 12% on my employer 401k and match is only 7%, I put $100 extra in another Roth IRA and $100 in a mutual fund so if I pause everything beyond the match it will free up another $500/month to hit it harder.  I do have $4,500 in a savings account (about 3 months reserves), $2,200 in a money market account, and $23,000 in a non-retirement Mutual fund, I could just knock out the Home Equity and C.C. with that but I don't want to pay the long term capital gains or add it to my income for the year or I start to lose my rental expense tax breaks over 100k.

Thanks for the input guys, got some debt snowballing to tackle!  Gives me more time to research and learn :)

James H. · Answer

This all depends on how much income you make and how much cash you have in reserves.

I would never take out debt against real estate for anything besides real estate. My guess is that your car loan is probably at a super low interest rate and if that is what you want to drive, and if it would sell for a loss anyways, just leave it alone. However, if the car note effects your DTI ratio so that you can't get an additional mortgage, then you need to consider doing something about it. A 39K car loan would blow my DTI out of the water, because I don't have enough income to support it. You might.

I would never take out debt on my home to pay off a credit card either. Rather, I would just work hard to pay it off as quick as possible.

Also, consider that if you take out a home equity loan, you can't use borrowed funds for a down payment on a new house. That means that cash from the home equity loan will have to "season" in your bank account for at least 6 months before the bank lets you use it for DP and/or closing costs.

Also, back to the DTI ratio, that home equity loan will count against your DTI ratio. So make sure you have your ratios figured out. Different banks have different overlays and most are more strict than the government minimums, although not all. Bottom line: have your financing plan figured out from beginning to end, including how each decision effects the entire process.

The little house in the small town doesn't appear to do much for you at $25 a month. I would consider selling it to use that money on a new property that has at least $100/month cash flow (based on 50% rule analysis). You could also use the extra money to pay off your credit card and then use the leftover money to reinvest. Selling that house would also free you of a mortgage so you could get more mortgages.

My gut tells me that if you are having a hard time paying back the 4K line of credit and the 9K credit card, your income might have a fair amount of strain on it and you are not quite flush enough to get into a new deal comfortably. That might be why you are afraid to make a move.

Andrew S. · Answer

I am very much a beginner (no deals yet other than my homes I bought and one I built) but my immediate thought is get rid of the credit card debt.  That $39,000 vehicle loan is big given the other debt you have.  I would take a home equity loan, get rid of the credit card debt first thing.

AM I READY? or do I need to pay off some debt first?

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