Should I sell or turn primary residence into rental? Refinance?

Question

I need help! Ready to get started investing in both flips and rentals. However, we have about $100,000 of debt in Parent Plus and other student loans ranging from 4% - 8% COMPOUND interest rates. Our house is worth about $400,000 - $420,000 and we owe $185,000 (4.12%) - most equity is due to rapid appreciation over the last 5 years or so. We've had it on the market since the end of July and market is slow now and we don't want to keep reducing price. The goal was to sell, pay off the mortgage & debt, then have about $70,000 left over with which to buy another primary residence (smaller and cheaper), using about $25,000 for down payment, and then use the rest to purchase rental which would require 20% down, right.

Then, I started thinking....if we could either refinance or get a HELOC or home equity loan, we could re-structure that student loan debt stopping the compound interest and getting a lower interest rate altogether, stay in our home and then, in the new year, make this house the rental (without having to put 20% down as investment because we would already have the loan) and purchase a NEW primary residence with only 3 - 5% down. We would then have kept a great home that has been fixed up, that we know inside and out, the neighborhood, etc..., would still have over $100,000 equity in it and wouldn't have been able to purchase as an investment rental with the proceeds from the planned sale. Still follow me? Our current mortgage is $1670. The house would probably rent for $2500 - $2700 per month. If we get HELOC or cash out refinance, we could have a total debt payment of maybe $2200 a month or less, rather than $2600 a month, with lower interest rate.

Does this make more sense than selling and paying off the debt, since we want to have a rental property anyway?

With a cash-out refi, our interest rate would not be much lower than the 4.12% we have now, plus there are about $3000 of closing costs. Does that make a HELOC or home equity loan a better choice for paying off the student loan debt?

Is it correct for me to think of this as a way to eliminate the cost, time and potential headache involved in selling this house and ultimately purchasing and fixing up another rental property, by considering that the expected profit of the sale ($70,000) is functioning as a down payment on a $420,000 rental home (the one we already own!) ?

What am I missing?

Greg Scott · Answer

Rachel:

I have 9 rent properties in DFW.  The sweet spot in that market are homes in the $100 to $200K range.   Properties below that amount can be in difficult neighborhoods with security concerns.  Houses above that range just don't cash flow well.   Why?  You can't rent a $400K house for 2x a $200K house.   You are better off owning two $200K rentals.

Here is my recommendation.

- Sell the house and pocket the $215K

- Set aside $70K for your next property

- Pay off most or all of your student loan

- That leaves you with about $45K for investing.   This is plenty to get started

- With the first $500, join Lifestyles Unlimited.  They are a real estate education and mentoring group with thousands of members and they have a large office right in your back yard.   Las Colinas.   My wife and I have already flown into DFW 3 times this year to attend events at their office  They are that good.

- After you learn the ropes, go out and buy 2 SF rent properties to generate $1000/mo cash flow and use that to start saving for property #3.

You will be amazed at how fast your wealth and passive income will grow.

Mike Dymski · Answer

Sell.  Google section 121 home sale exclusion.  You don't want to lose that exclusion for a highly appreciated primary residence.  Others have covered the lack of cash flow.

There are many posts on BP about renting a prior residence and 95% of them are not good ideas.

Manish Bahety · Answer

@Rachel Deering Lot of great advice by several good people. You mention that you have multiple student loans from 4 to 8% compound interest rates. If you sell the house, you may want to pay off the highest interest loan, provided there are no significant pre-payment penalties.

@Mike Dymski makes a great point. You don't want to lose the tax advantage that is available on gains realized from sale of a primary residence. If you convert it to rental now and after several years you decide to sell it while it's an investment property, you will pay significant taxes on the capital gain or you will be forced to look for a 1031 exchange to avoid the tax.

Rachel Deering · Answer

@Matt Ott @Mike Dymski  Thanks for the feedback. One other thing I have to consider is the comfort level of my husband who is too busy working all the time to be able to spend time on this. He shares the same goal and enthusiasm for investing, but is ten years older than me and is our sole provider right now. There is no income if he doesn’t work, and he worries about me being saddled with that debt should something happen to him. For the record, I am 55, he is 65, and I hate words like “empty-nester”, “retirement”, “downsizing”. Ugh!  We are finally to the point where we can start providing for our own dreams and goals instead of those of our young adult children! But we’ve got some catching up to do financially. Thanks again for all the advice!

Greg Scott · Answer

@Matt Ott makes a good point.   I just assumed that you would want to pay down your student loan debt.  Most people have a hard time with the idea of carrying debt, particularly student loan debt, and given you are new to investing, you might not yet have the confidence you can achieve double digit returns.  So, it is true that if I were in your shoes, I would put as much cash towards investing as possible.  That student loan debt is relatively cheap.

Andrew Herrig · Answer

@Rachel Deering If you want to buy a primary residence you can eventually turn into a rental, I'd look for something in the $125-200k range where the monthly rent is close to 1% of the purchase price or better (for example a $150k house that rents for $1500 per month).

Not sure what part of Dallas you are in, but you can find this in parts of East Dallas, Garland, Richardson, Rowlett, Allen, Farmers Branch, Carrollton, etc.

If you need a good realtor for when you re-list in the spring, send me a PM. My wife is a realtor and lists our flips as well as helps regular clients buy and sell. We are in East Dallas, but know the greater Dallas area pretty well since we have done rentals/flips pretty much everywhere. Since it's a $400k listing, she could probably discount it down from the normal 3%.

Even if you aren't looking for a realtor, feel free to reach out for an opinion on what to list for. I have an addiction to evaluating real estate...

Andrew Herrig · Answer

@Rachel Deering I would agree with @Greg Scott that you are better off selling the house and buying a cheaper rental. You can do much better than a 0.7% rent/price ratio ($2,700/$400,000) in a lower priced property. Plus selling your primary residence is a nice tax free gain.

But it depends what you want. If you like living in your current house and are only moving to make some money to pay down debt, refinancing your current mortgage is a good way to go as well.

As far as the student loan debt, I would consider keeping some of the lower interest debt if you are interested in getting into rentals. Consider it loaning yourself money at 4% - assuming you can get 10-15% return on that money from a rental property, it is a good investment.

Rachel Deering · Answer

@Andrew Herrig @Greg Scott Thank you guys so much! I really appreciate your input. So, at this point I will probably take it off the market and relist with a different realtor in March 2018 (our current listing agent is a musician friend whose day job is commercial real estate and he offered to list for 1.5% fee) We do have to live somewhere and willing to downgrade to get the investing thing going. Are there any considerations to keep in mind when finding a temporary primary residence? Just one that can ultimately be turned into a rental?  Thanks again!

Should I sell or turn primary residence into rental? Refinance?

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