Need advice for refinancing out of a 5/1 ARM in NJ

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Need advice for refinancing out of a 5/1 ARM in NJ

Laura Levine
Investor · Hawthorne, NJ · Member since 2014 · 57 posts · 13 votes

Good morning! My husband and I bought a fixer upper duplex in 8/14 with a 5% down FHA 5/1ARM at 3.75% (we are living in one unit). We did a massive reno on it and should now have the 20% equity needed to refinance and get rid of the PMI. We also have about $30k on credit cards with 0% interest that expires between 12/15-2/16, so we need to pay that off. We plan to continue living in the house for a few years and then use it as a long-term rental. Here are the options that I've come up with my limited mortgage knowledge, but I'd love to hear if there is something I've missed and/or which option you think would be our best. We were planning on sticking with a traditional 30 yr. to try to take advantage of low interest rates.

1. Refinance into a traditional 30yr. Use extra cash from dropped PMI (about $200-300/m to pay down credit cards). Then roll over any extra amount into another 0% card when the rates expire. Probably, makes the least sense at this point?

2. Cash-out refi and use the cash to pay the credit cards, but then obviously have a higher mortgage (but maybe this makes sense to lock in the low interest rate?).  Then do I pay taxes on the "cash-out" part?

3. Refinance into traditional 30yr and then do a home equity loan to pay off the cards (interest would be tax deductible).

*We are looking for the options which would also have the least total and out-of-pocket expenses

*Also, I believe I read that I can file to get a refund on some of the pre-paid PMI, is that true?

Our future goals include continuing to buy B&H properties at a rate of one every 3-5 years, and thus needing the cash for the 25% down payments.

Thanks for your help!

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  • Robert Sepulveda
    Lender · Newport Beach, CA · Member since 2013 · 264 posts · 97 votes
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    Figure a max of 80% of the value in your home is the amount of cash out you can take. That's a good number for you anyways since it's what you need to avoid mortgage insurance. if you needed more money, you could do a new cash out with FHA up to 85% and the new MI is lower now by 40%.

    I would max your cash out and use that money toward the other properties and pay down your debt separately from the cash flow. It's usually best to use debt to acquire assets. Only pay down other debt with the cash out if it's inhibiting your savings

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  • Holden Latimer
    Investor · Salt Lake City, UT · Member since 2014 · 68 posts · 25 votes
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    @Laura Levine I am pretty certain that proceeds from a refinance are not taxed. The reason this cash-out is not taxed is because it is simply a shift in assets. If you think about it on a balance sheet the increase in cash will be offset by an equally large increase in long term debt. The IRS does not consider the pulled-out cash income.

    @Robert Sepulveda Great point. I completely agree that, if at all possible, debt should be paid off from cash flow and refinance proceeds should be used to acquire other assets. In this case though, if a large portion of the renovation was funded with a credit card, it may be best to use a portion of the proceeds to pay off that debt.

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  • Jesse T.
    Herndon, VA · Member since 2014 · 1k+ posts · 324 votes
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    Originally posted by @Holden Latimer:

    @Laura Levine I am pretty certain that proceeds from a refinance are not taxed. The reason this cash-out is not taxed is because it is simply a shift in assets. If you think about it on a balance sheet the increase in cash will be offset by an equally large increase in long term debt. The IRS does not consider the pulled-out cash income.

    @Robert Sepulveda Great point. I completely agree that, if at all possible, debt should be paid off from cash flow and refinance proceeds should be used to acquire other assets. In this case though, if a large portion of the renovation was funded with a credit card, it may be best to use a portion of the proceeds to pay off that debt.

     The principal from a cash-out will not be taxed.  What comes into question is if the interest is deductible.  Since this is a primary residence(and no business/investment loans) there are 2 possibilities of deducting interest.

    1. Home acquisition debt - interest on the amount of the mortgage taken out to acquire the property plus any amounts for home improvements in the last 24 months

    2. Home equity debt - interest on up to 100K in principal can be deducted if it does not meet the acquisition test

    Full details:

    http://www.irs.gov/publications/p936/ar02.html#en_...

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  • Laura Levine
    OP
    Investor · Hawthorne, NJ · Member since 2014 · 57 posts · 13 votes
    11y

    Thanks for your feedback @Robert Sepulveda and @Holden Latimer.  It sounds like it might be best to hold tight and just pay down the credit cards for now with cash flow, so then I'll have the equity available when we are ready to buy the next place?

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  • Laura Levine
    OP
    Investor · Hawthorne, NJ · Member since 2014 · 57 posts · 13 votes
    11y

    @Jesse T. Thanks for the information!  I was a little confused about the ability to deduct the interest on expenses incurred as part of home improvements.  Is that only if it's from a bank loan?  I'm assuming I can't deduct interest from credit cards that I put the expenses on, right?

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  • Jesse T.
    Herndon, VA · Member since 2014 · 1k+ posts · 324 votes
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    Originally posted by @Laura Levine:

    @Jesse T. Thanks for the information!  I was a little confused about the ability to deduct the interest on expenses incurred as part of home improvements.  Is that only if it's from a bank loan?  I'm assuming I can't deduct interest from credit cards that I put the expenses on, right?

    The credit card interest is not deductible, however expenses used to improve the home can be financed as part of a re-finance and are considered deductible.

    So to make a concrete example with some numbers.

    If you borrowed 250K and the balance is now 240K and you spent 50K for renovations(significant improvements) you can deduct the interest on 290K(240K(current balance) + 50K) of the new loan as "Acquisition debt".  

    You can borrow up to an additional 100K as a home equity loan and still deduct the interest.  I think in your example you should be fine with deducting all the reported interest. 

    Are you renting out the other unit in the duplex?  The interest gets deducted(from rental income) it just does in different places and only once.

    From the IRS publication:

    Mortgage treated as used to buy, build, or improve home. A mortgage secured by a qualified home may be treated as home acquisition debt, even if you do not actually use the proceeds to buy, build, or substantially improve the home. This applies in the following situations.

    1. You buy your home within 90 days before or after the date you take out the mortgage. The home acquisition debt is limited to the home's cost, plus the cost of any substantial improvements within the limit described below in (2) or (3). (See Example 1 later.)
    2. You build or improve your home and take out the mortgage before the work is completed. The home acquisition debt is limited to the amount of the expenses incurred within 24 months before the date of the mortgage.
    3. You build or improve your home and take out the mortgage within 90 days after the work is completed. The home acquisition debt is limited to the amount of the expenses incurred within the period beginning 24 months before the work is completed and ending on the date of the mortgage. (See Example 2 later.)
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  • Laura Levine
    OP
    Investor · Hawthorne, NJ · Member since 2014 · 57 posts · 13 votes
    11y

    @Jesse T.  Thank you SO much for the detailed feedback, it helps so much...especially with the use of the concrete numbers.  So, when I go to refinance, how would I include the reno debt?  Would it still be considered a traditional mortgage, or would I be looking at a different product now?

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  • Jesse T.
    Herndon, VA · Member since 2014 · 1k+ posts · 324 votes
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    Originally posted by @Laura Levine:

    @Jesse T.  Thank you SO much for the detailed feedback, it helps so much...especially with the use of the concrete numbers.  So, when I go to refinance, how would I include the reno debt?  Would it still be considered a traditional mortgage, or would I be looking at a different product now?

     For the lender's point of view it is a standard mortgage.  Just in terms of the tax treatment - it could get more complicated.  It sounds like the principal would all be some form of acquisition debt - so you can give the mortgage interest the standard treatment.

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  • Jerry PadillaBusiness Member
    Lender · Rochester, NY · Member since 2014 · 3k+ posts · 1k+ votes
    11y

    @Laura Levine

    In my opinion.... From a lender and investor prospective.....

    • If you have decent equity, I would refinance and get rid of the PMI and go conventional. You can get another FHA mortgage later if you need to then as well.
    • If you have enough equity to cash out and pay off credit card debt - that is not going to be tax deductible - where mortgage interest is tax deductible - I would go that route.
    • http://www.biggerpockets.com/blogs/5110/blog_posts... Here is some info on cash out refinancing.
    • You will not pay any taxes as far as I know and we are doing cash out financing as well right now on our properties. You can always consult with your CPA with those kinds of questions. 
    [email protected]585-204-6923
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