Should I pay off mortgage to purchase investment property?

Question

Hi. I currently own a primary residence and a second house in another state which my nephew and his family live in. I'm interested in buying an investment property but am worried about my LTV. The house my nephew lives in has $50k left on the mortgage and I'm wondering if I should pay that off so it doesn't work against me. Selling to my nephew is not an option at this point because he doesn't have good enough credit to get a mortgage. My only other debt is mortgage on 1st house and a car loan. Appreciate any advice.

Kevin Futrell · Answer

You need to really look at the transaction costs. You likely paid up to $2k for the existing loan. A loan on a new property might be $8k (low end) on a loan for a $500k property. Selling the house, you can incur roughly 10% in services, fees, and taxes. Unless you have a property in mind, your cash maybe sitting on the sideline until you find something worth investing in.

I’m across the Sound from you and I did that. Sold two duplexes thinking I will find a bigger property that would cash flow better. My cash is still earning me nothing 2 years later. I’m to the point that I’m just going to start building fourplexes instead of waiting for something to come along. Construction wasn’t part of the plan, I just can’t justify buying right now with the inflated prices.

I shouldn’t say my money is on the sidelines, I paid off the home I’m in and waiting to get back in the game.

D Glaze · Answer

@Kevin Futrell - thanks, Kevin. Nephew is covering my mortgage payments in monthly rental payments to me. I'd love to just pay the mortgage off and have him continue to pay me but I also see that having that cash for a bigger down payment (on new investment property) is probably a good idea. Also, @Jim Goebel, I live in Seattle so a 380k mortgage is actually pretty cheap for here!

Kevin Futrell · Answer

I don’t know enough of the situation, but it reads as though the nephew isn’t paying rent. You should look at the property he is in and think about whether or not it’s worth keeping as an investment property. It might make sense to keep it, if you have low interest rates and can get a decent cash flow.

There are transaction cost for obtaining new debt as well as selling/buying property.

Jim Goebel · Answer

@D Glaze

That's helpful (for my understanding).  I think most lenders primarily look at your debt to income ratio - so it's going to be hard for me to weigh in because #1 I'm not a lender, but #2 we don't have a feel for your income part of the picture.

I will say that you owning a property that's not making money (with your nephew etc) is concerning.

If I were you, I'd talk to a banker and see what your options are re: qualification for future financing.

I don't know much about the area that you live in but 380k does sound like a large mortgage (payment) to me that may not be optimal.

Jacob Sampson · Answer

I wouldn't pay it off.  Use the cash to put down on the investment.  reach out to several local banks and see what they tell you.  No need to worry about LTV until you know it is actually a problem.  Talk to a bank.  You need good data to make good decisions.

D Glaze · Answer

@Jim Goebel - thanks for the response, Jim. I'm probably mangling terms here. I want to purchase an investment property but worried that my two mortgages will lower what I'll qualify for. Primary mortgage is about 380k (market value is about 480k) and 2nd property is 50k (market value about 86k). Unfortunately, my 2nd property that my nephew lives in isn't a money-maker for me; I just helped him out because I was in a position to do so. So I'm wondering if I should just pay off the 2nd property to get that debt off the books. I clearly have a lot of learning to do about investing. :)

Jim Goebel · Answer

@D Glaze

I don't understand your statement ' am worried about my LTV.'

On what, your primary residence?

I don't see how LTV would be a consideration in your upcoming decisions.

If you're looking to get into an investment property, I'd be thinking about evaluating your 2nd property with your nephew separately (ie: what to do there, is the property producing income like you want, its long term appreciation prospects, etc)

Hope that helps....