Investor · Billings, MT · Member since 2014 · 8 posts · 3 votes
Hello everyone. This is my first post and I appreciate any replies. My wife and I just moved into a new house in July and converted our previous home into a rental property. We have 25% equity in the rental house with a monthly payment of $988/month (no PMI) at 4.5% over 30 years. Our new house has a $2200/month payment (4.125% over 30 years) and we put down only 5%. The rental house is renting for $1595/month. I want to get your guys' opinions on where I should concentrate my extra cash. I have a nice $5000 savings for the rental property so I am not worried about that. I want to know if I should work on paying down my primary residence at least to the point of ridding of the $150/month PMI (would cost ~$50,000 to get to the point of 20% equity), work on paying off my first rental (I still owe $146,000 on the rental), or concentrate on saving for another rental property.
I feel like I should be working on saving for another property but I know how people can get that warm/fuzzy feeling by having a property paid off. What do you guys recommend? Additional properties, pay off rental, pay down to rid of PMI or a combination. Thank you so much again and I look forward to the replies.
You might also want to look into the rules of your PMI. I know that mine is 5years & 80%. So even though my property is already bellow the 80% mark I still have to wait 2 more years to drop the PMI.
An accountant could look at your overall position and give the best advice. If it were me, I would buy another rental. But, only if I could afford the mortgage if it is vacant. If your properties cash flow well enough then really the renter is paying your PMI for you. I'm not sure what properties cost in Montana, but I'm pretty sure that $50K could go towards down payments on more rentals. Let your renter pay for the first rental.
You might also want to look into the rules of your PMI. I know that mine is 5years & 80%. So even though my property is already bellow the 80% mark I still have to wait 2 more years to drop the PMI.
Thank you all for the replies thus far. Depending on the month we sit at between 20-25% of net income being spent on our primary home (including taxes, insurance, PMI, etc).
There are two conventional gems of wisdom that I use to guide my decisions. (Admittedly, I've only started applying them in the last couple of years.)
First, put uninvested money where the highest interest rate is (right on, @Wilson Churchill !). If my best rate is buying a new rental to get a 16% cash return, I put my money there. If my best rate is paying down a credit card with a 12% APY rate, then I put my money there (the problem I'm currently solving). In your case, I would see what kind of return I would get on paying down the mortgage on the rental to get a lower monthly payment.
Second, once money is put into the investment column, never take it out. That means, I won't use income from the rental to pay off a credit card. Rather, I'd use that money to pay down a rental or save it to buy another rental, or put it into an investment that will earn another passive income stream. (I credit Kiyosaki with this one.)
As an engineer, I'm a numbers guy by nature, so the math behind these tips makes a lot of sense to me. Investing is all about math. Once you know how to work the numbers, it all becomes pretty clear. I only wish I had come to my senses earlier in life. I didn't have the internet to help me out when I was young.
Personally( and our current plan) is acquiring as many properties as possible. Than when we max out 30 year loans or houses don't make sense any more. I plan on paying off the pm I.
@Christian M. Not many people can say their primary home is only 20% to 25% of their net income. Unless you have a bunch of car payments or cc payments, you should have a lot of disposable available to invest. If I was in your situation I'd save up for a 25% DP on your next investment property. Normally I'd say pay down your mortgage to get rid of the PMI, but you have a long ways to go on that being 50k.
Thank you all for the replies. Yes, the ~$50K to get rid of the PMI on my new house is daunting. I would imagine I could buy at least 2 more rental properties using that $50K instead. I like that idea. I will take it month-to-month. What I am also hoping is that my new house will go up in value to where I won't have to actually pay that $50K but instead can passively rely on its value going up and ridding of PMI that way. I am confident that once my housing development finishes getting built on (I have 2 vacant lots that surround my house) that the value of my house should increase drastically. We also feel good that we were able to buy our house for less than appraised value and I am hoping that the market will keep going up to accelerate us getting rid of PMI even faster. Thanks again everyone.
Rusty, you bring up a good point with PMI requirements. I will need to research if there is a clause with my loan as to how long PMI needs to be in place regardless of being at 80% LTV or not. Thanks for your insight.
Thank you all for the replies. Yes, the ~$50K to get rid of the PMI on my new house is daunting. I would imagine I could buy at least 2 more rental properties using that $50K instead. I like that idea. I will take it month-to-month. What I am also hoping is that my new house will go up in value to where I won't have to actually pay that $50K but instead can passively rely on its value going up and ridding of PMI that way. I am confident that once my housing development finishes getting built on (I have 2 vacant lots that surround my house) that the value of my house should increase drastically. We also feel good that we were able to buy our house for less than appraised value and I am hoping that the market will keep going up to accelerate us getting rid of PMI even faster. Thanks again everyone.
Yes, check your loan requirements. My FHA loan requires 20% equity AND 5 years minimum paying PMI. I've heard conventional loan PMI requirements can be different. Best wished to you buying more investment properties.
@Christian M. I would get those warm fuzzies by buying more property as long as your get a better rate of return on your new property than you would by paying down your existing property.
@Christian McPherson You are making some good moves financially. Living below your means so you have money to invest, and attempting investments (sfr and vacant land) will, if nothing else, give you hands on education. Ultimately my advice boils down to doing three things 1) understand your investor personality (risk tolerance, goals, resources, etc.), 2) develop a plan to meet these goals, 3) sticking to the plan, compare investment choices you have that are most likely to achieve goals (as @Brian Rossiter says its all math). Beyond this I am going to ramble a little.
First, let me do a little back-o-the-napkin math with some guesses. Both homes might be a great appreciation play (Billings is a stable increasing market), but I don't like to bet on the market, lets just focus on cash returns. 50% rule says you are will pay about $800 of rent on expenses. Taxes and insurance (part of the 800) are buried in your $988 payment, I am going to guess about 240. So Rent 1595 - 800 expenses - 748 loan (not incl. tax&ins) = $47. Cash ROI =47*12/50,000 = 1.1%, amortization (you are probably paying 200 a month on principle with minimum payment) = 4.8%. You are making 5.9% on the 50k equity and most of this is adding equity which you can only get at if you refinance and pay fees (or sell). This actually is not bad with the potential for appreciation, but not great compared to other opportunities. However, to take advantage of other opportunities you need knowledge. What you will learn running this rental for the next year or two will be priceless.
Now, assuming you have $1000 a month from income to put toward investing. If you pay down the loan on your rental you earn 4.5% with no additional appreciation benefit (in fact your appreciation is less magnified when spread over the equity you have in the place). This is low risk, but low liquidity investment, with tax disadvantages.
If you pay down your primary residence loan, you will earn 4.125% for the next 40-50 months, then the additional $150/mo savings will add 3.6% (considering 50k basis). 7.8%, not bad, but that is on the tail end, initially just 4.125. Also, consider the missed opportunity cost over the next four years. This also is low risk, low liquidity and tax disadvantages
If you stack up those dollars and look for other deals??? Deals exist (yes even in Billings, I have seen them) where a $20,000 downpayment can get you 8% cash return, 8% amortization, all profits tax deferred, and the potential for appreciation.
I don't really have advice, just trying to give you a framework for comparison. Really all this is step 3 I mentioned above. If, after taking a good look at your investor personality and developing a strategic plan, you could find that you would prefer a very safe but slow building investment. I have a colleague that hates bank financing and tries to do everything all cash. On the other hand I love bank financing and 30 year fixed at 4.5% makes me tingly. Nothing wrong with either approach as long as you take a good self assessment and have a plan.
Thank you Patrick for the reply. I appreciate the analysis of the three scenarios. It does appear that saving for another buy is the way to go. I am still building equity with my current homes, the rental home of which is being paid for by someone else while I save for that next buy! I also have my rental property in pristine condition, so I am hoping to avoid a lot of maintenance issues. My tenants also signed a year lease so I will (hopefully) not have to worry about vacancy for at least a year. My wife and I have been joking back and forth because our rental house now is nicer than it ever was when we lived in it. I did a lot of work to the house before we rented it out. I even had a home inspection and radon test done to see if there was anything glaring that could be a problem in the near future. We also had a huge hail storm in May and I got a new roof, new siding on one side of my house and new gutters for only the cost of my insurance deductible. I also will get a new outdoor AC unit in the spring as the hail destroyed the coil on my old one. So, it makes me feel good that my rental house is in great shape and I hope I don't run in to any problems in the near future with it and that my tenants pay their rent.....fingers crossed.