What to do with 60K?

Question

Hi All, Here's a scenario I would like some thinking power on.

Depending on the choices I make, at the end of this year I may have somewhere around $60K-90K to deploy. Also, at the end of the year, my situation should look something like this:

One recently purchased personal residence (using up about 15-20K of the above funds)
One recently converted rental with 55K mortgage renting for 750/month
One paid and clear rental renting for 550-600/month

My debts could (and will likely) include:

Converted rental mortgage 55K at 3.75% + PMI with PI 260, TI 220/month
60K in student loan debts at 4.75 to 6.8 percent  about 650/month payment
15K car note at 3 percent about 270/month payment
Will probably need to buy another car for my wife (cost TBD)

I could sell my paid and clear rental easily for 35K. I don't like these student loans hovering over my head and killing my DTI ratio. If I sold my rental, I could pay all or most of my student loans off and have a big DP for another rental with a mortgage. I would probably end up with a nicer rental in a better area, but possibly not as profitable, and then there is the whole free and clear vs leverage argument. I could pay off my current home to be converted to a rental (55K) but that is stretched out over a long 30 years at 3.75% interest. I could pay of the car, but it is not costing me much at 3%, however, it does significantly affect my DTI ratio while I am paying on it.

I could pay nothing off and try to squeeze another fully cash paid rental into my portfolio, or I could pay some stuff off and put a DP on another rental. I don't foresee paying nothing off as I feel the need to do at least some debt reduction (somewhere around 30K).

I would like to get everyone's opinion on what they would do in this situation.

Thanks!

Rob K. · Answer

I know that others will disagree with me, but I'm not a fan of debt. Especially consumer debt. I would use that money you can save this year to pay off the car and the student loans and buy a $2,000 beater for cash. You could give the 15K car to your wife and drive the beater. By the end of 2013, you have three houses (one of which is paid for), two cars paid for, and no student loans. You could then use your income in 2014 to buy more houses, with or without mortgages. You DTI would be low and your house payments would be minimal. If you had your job income and two rent payments coming in and only two mortgage payments going out, you will be in good shape.

I'm sure at least 30 people will disagree with me and that's fine. I'm just letting you know how I would handle it. I can see both sides of the whole debt discussion. For me, I sleep a lot better at night knowing that I'm not on a house of cards.

J Scott · Answer

I'm going to just ditto what Mark said above...

The only thing I would add is that -- while low-cost debt is not a bad thing, in my opinion -- I'm not a fan of keeping student loan debt any longer than necessary.  It can't be discharged in a bankruptcy, so in a worst-case situation, it can have much longer-term affect on your credit and finances than other types of debt.

Kyle Hipp · Answer

I agree with Mark for the most part. I didn't put paying off the car loan as it is already in progress and really low interest. After a year or two it might get low enough that you just wanna knock it out.

From Brian's original post I took it to mean that over the working year he will have $60,000 - $90,000 in investable income. I am not hard and fast either on spending down to $5,000. Opportunity must be valued but not focused on 100% at the detriment of the overall goal in a stong financial base. Great post.

Steven Hamilton II · Answer

If the car note is on the vehicle used for business you will want to be sure that in addition to the standard mileage rate you are deducting the interest paid on the vehicle as well.

-Steven

Mark Reynolds · Answer

Well, you don't give us certain key information. How old are you? How much do you like your job? How much do you like managing the existing rental property?

Assuming that you are pretty young (large student loan balance) and that you don't mind the property management woes (no mention otherwise-- if you were tired of it I think we'd have heard). I would lever up the paid-for house. Pay off the most expensive student loans (but probably not all of them) and use the cash available to buy another rental at a steep discount since you don't need a mortgage. 6 months later when rented with a good tenant lever it up and do it again.

Again, in your youth you should be trying to trade high priced debt for cheaper debt. Cheapest debt is always long term mortgage rates. All that debt will be a good deal when you get to pay it back with cheaper dollars after the impending inflation from the government's policy of cheap money kicks in.

When you need to buy the wife's car buy a used car for cash-- car loan rates appear cheap but they are not because you're borrowing money for an asset that looses value rapidly. Your 3% car loan is a lot more expensive when you use the VALUE of the car after payment 10 as the denominator not the price you paid for it.

Now if you are approaching retirement age or hate your job most of that advice may be wrong.

James H. · Answer

I am not a fan of the 15 year note. I have a job and get paid bi-weekly and budget as such. I do bi-weekly mortgage payments (no cost for the privledge) and that alone reduces the loan term by 7-8 years because I'm basically paying and extra two mortgage payments per year. Rounding that payment up some nominal amount each month also will shave another few years off. So, I'm basically doing the same thing as a 15 year note, but it is at my option. I can pull back if times get tight and more importantly, I have a lower debt obligation counting against my DTI. When comparing my strategy to locking into a 15 year, I feel the benefits of the 30 year with the options far outweigh a couple fractions of a percent of interest. But that's a whole different topic.

The more I think about it, the more I think it would be best to keep the paid rental, apply about 30K to my SL's and split the remainder between the car and a DP for another rental. Then my situation will be 30K in SL's, a nearly, if not totally paid off car, two rentals with mortgages and one paid and clear mortgage. Then we can decide if we need another car or not and how to hand that purchase.

It is at this approximately one year time frame too, that my wife wants to have kids, lol!

Mark Reynolds · Answer

Kyle Hipp's advice for 15 year loans is excellent. As is everybody's advice to avoid debt on consumer items. I wouldn't pay off the car loan only because those docs usually have some disguised pre-payment penalty that makes it unwise to do so. That water is under the bridge.

On the other hand I would disagree with Kyle about running down to $5,000 cash. This is a buyers market if you've got cash to spend. I am buying REO's for as little as $10-15,000 in OK neighborhoods because I can buy them cash-- put your tenant in and then refi those.

Now I am older than you so I'm currently financing on 5 year terms-- everything I buy must be able to pay off all acquisition and rehab in 5 years or I take a pass.

But for a young guy 15 years is probably good.  Besides the payment on a 15 year loan isn't that much more than a 30.

James H. · Answer

Thanks for your replies. Great advice so far. Mark Reynolds, doesn't my bountiful youth present itself in my avatar? lol. I'm 33 y/o and I don't mind managing my rental. However, the rental is in a low income neighborhood and I don't know how it will play out over time.

I don't want to owe money on that house. I have a philosophy (not yet tested) that it is bad to have mortages on low income housing, okay on middle range housing and good on nice housing.

As far as the new car, that is TBD. I have a paid off pickup that I can drive if I want, but with my commute, the gas comes out to about another car payment, insurance, maintenance, etc. We can buy used, we can buy cash, whatever. That is not entirely my decision. We live in a big city and I'm not going to drive a beater that might leave me on the side of the road. The peace of mind factor is not worth driving a 2,000 car.

I have trouble with the idea of paying off the exising car note. I think it is just psychological, though. I feel like it would be better to pay off student loan debts with extra money before paying off the car. My SL's are all split up, so I can pay some off and my payment will go down. If I send 15K to pay off the car, my monthly obligation will be reduced by 270. If I paid the same amount to my SL's, it would go down by about 160. So I get more bang for my buck in the 5 year term on the car loan, but the student loans are at a higher interest rate and amortized over 10 years rather than 5. Plus, they dont' do anything for me (anymore). My car at least gets me form a to b. I can sell the car even if it does depreciate and I take a couple thousand loss...I can't sell the SL's. The car will depreciate at the same rate whether I owe money on it or not. At 3 percent interest. It basically costs me 500/year (less each year) to have 15K at my disposal rather than a paid off and still depreciating car. The biggest problem I see with the car note is that it is short term debt that has a greater impact on my DTI.

I'm thinking maybe some combination. Maybe I pay off the car (or maybe pay off a portion and refi the rest into a smaller payment), pay off about 15-20K in SL's, keep the existing rental and use the rest for a DP on another nicer rental. I still have the option to sell the existing rental if I want to change directions with that.

FWIW, I am all in to my paid and clear rental for 26K including a carport I recently added. I have not had any maintenance costs in 16 months except air filters, although the roof is old and the plumbing is cast iron. If I sold it for 35K, I would have 9K profit plus netted 7200 in rents after paying taxes and insurance. So in 16 months I will have turned 26K into 42,200, which is not a bad return. That brings me to another concern, though, if I don't roll that money into another house, I will take an unwanted, possibley unecessary, tax hit....

Aaron Junck · Answer

I agree with everyone. Only difference is keep in mind when tax time comes the vehicle you are paying on every month isn't helping minimize your taxes ( unless) it's for business. I am sure you know the benefits of the rentals come tax time. Also if you do sell a rental think of the tax implications you would have since you would be cashing it out to pay off personal debt.

But, yes , IMO I am not a fan of personal debt . I am however ok will business debt as long as it makes sense($) and you have cash reserve set aside so you can sleep at night during rough times.

Kyle Hipp · Answer

I am 27 and I see ourselves in similair boats. I do not take on any consumer debt. I have paid off all student loans, no debt on cars, just mortgages. It keeps my DTI in check and keeps me nimble on the financial needs of running a real estate rental business.

The last thing I do is focus on 15 year mortgages. At my age it is a heck of a lot better to have a $100,000 mortgage down to $73,000 after 5 years instead of sitting at $90,000. It allows so many more options and at the end of the day it holds me to strict criteria. That if I can't buy a property at $100/door cashflow on a 15 year note it isn't worth it.

With your $60,000 - $90,000, I would pay off your student loan debt, buy the wife a vehicle with cash. Still purchase the house for yourselves but on a 15 year note. Attempt to pull cash out and refi on the paid for property on a 15 year note.

All during this process I would try to keep at least $5,000 in cash so you can proceed with another property if you get a good seller finance offer. This process may seem like spining your wheels when you want to put your REI career in gear but I see having a solid financial base as extremely important. This solid base will give you so much more flexability, which is why I recommend the 15 year notes so much. Even as well as I think I watch my money I know looking at a $17,000 difference in what my loan balance would be I know I prolly squandered a decent amount of that extra $250/m in cashflow. Whereas if it went to mortgage reduction, I now have much less worries on whether I can refi again or not. I could pull money out. I could combine with a struggling property to refi. I just have a lot more options and I love options.

In the end if you have no comsumer debt and just mortgages it will be a lot easier to have a high cashflow. It is combining your business and personal life that makes the difference. This might delay your career for the first year or two but by implimenting this it really allows you to accelerate you REI later and that is what is important to me.

What to do with 60K?

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