Refi primary residence to turn into long term rental?

Question

Hi BP -
My primary residence is currently on year 3 of a 15yr mortgage at 3.125%. I'm looking to buy my next home which will be a non home sale contingent purchase. My question is whether it makes sense to refinance my current home on a 30yr at 4.5-4.75% (as an investor + rates are ticking up) in order to cash flow as a long term rental. Is that additional interest really worth it over the life of the loan, just to get cash flow? On the flip side, I've always been taught to never have negative cash flow. Am I thinking straight? I'm between these scenarios:

1. Rent as-is with current 15yr owner occupant loan -- estimate negative cash flow

2. Rent unit with refinanced 30yr investor loan -- estimate decent positive cash flow

3. Sell property and deploy equity elsewhere -- have future investing goals of mult-fam buy and hold

Thanks!

1. Rent as-is with current 15yr owner occupant loan -- estimate negative cash flow

2. Rent unit with refinanced 30yr investor loan -- estimate decent positive cash flow

3. Sell property and deploy equity elsewhere -- have future investing goals of mult-fam buy and hold

Thanks!

Darius Ogloza · Answer

You pose a very interesting question.  You will be increasing the total cost of your investment by paying a greater amount of interest (albeit deductible as an expense so the total cost should be calculated on an after tax basis).  Paying more for something rather than less is usually a mistake UNLESS (i) you do not have sufficient cash to "feed the alligator" every month, or (ii) there is some useful purpose for that cash (i.e. you can incur greater investment returns on the cash that exceed the after-tax cost of the additional interest payments).  Do not refinance simply to be able to brag to your friends or on a website that you have a "positive cash flow" property because unless you can earn more by investing the cash in your hands than the cost of the interest, you are just fooling yourself.  Of course, if you don;t have the money to cover the additional principal payments on the 15 year note, then you have to do what you have to do.  Good luck.

John Warren · Answer

@Andrew Everett I am not a fan of negative cash flow once you are stabilized. The interest rate question doesn't matter as much if your first property still cash flows while you are redeploying the equity on a second asset.

A lot of investors mistake this concept since all good BRRR deals will be negative cash flow for a bit. At the same time, they won't be negative cash flow forever. With your home, you are looking to turn it into a rental so it really needs to cash flow. Yes, sometimes homes appreciate, but what if they don't? The only thing you are getting is debt paydown.

The other angle to consider here is the primary residence exclusion. If you sell while this is your primary residence, then any gains will be tax free within the limits. For most of us on here, we aren't making 250k or 500k worth of gains so the best time to sell your primary residence is normally right when you move out or after the first tenant move out in about year 2 or 3.

Andrew Everett · Answer

@John Warren Thank you for the advice!

Matthew Herrington · Answer

@Andrew Everett talk to your lender. And then talk to 3 more. You can determine both the total finance rate and the total finance charge for each lending scenario and each lender! These are routine calculations that include closing costs and fees that appear on your loan estimates. These numbers are your cost of capital and when done correctly allow you to directly compare the cost and find the lowest priced lending option. If you determine the finance charge for the new 30 year mortgage you can compare with the remaining charge on the 15 year loan. These will be solid numbers you can apply toward figuring out the most profitable option. But also remember the reason for the negative cash flow lesson: Passive Positive Income is exactly that, your investment will survive without any outside contribution and there is much less risk. The 15 year option is likely be the most profitable in the long run but you run the risk of crashing and burning if you can't make up the negative cash flow at some point in the next 12 years. Good Luck!

Scott Johnson · Answer

One of my mentors uses a "tax-averse" method of investing, that I'd like to throw out here. Let's say you kept your 15 years and it did cashflow, albeit for a small amount. Remember there are three other forces that work in your favor: Interest Deduction, Depreciation, & Loan Paydown

- Interest Deduction: Shorter loan term --> Higher Interest Payment --> Higher Write-Off

- Depreciation: Even more to write off that you didn't spend

- Loan Paydown: Shorter loan term --> Loan pays down faster --> you pull out tax-free cash faster

This may be a method that could be used when you rent your old house after buying a new one. That said, this still would not justify a negative cash flow position to me. The property still needs to be able to hold its own.If you'd like more in-dept assistance, post some numbers from your rental analysis.

I hope this helps!

Corby Goade · Answer

Unless you NEED the money, I'd rent and deal with negative cash flow if I had to. You won't get cheaper money as an investor. You're already ahead of the game by having a property with owner occupy terms- you get rich from holding, not selling.

Secondly- many new investors under estimate market rents. I'd find a NARPM affiliate in your market and see if they can help you determine the true market rent for your property.

Good luck!

Andrew Everett · Answer

@Darius Ogloza Thank you!

Zachary McCloud · Answer

Following, I am in the exact same position!

Refi primary residence to turn into long term rental?

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