Refi on multi-unit, shorter term with lower rate worth the risk?

Question

We just found out we qualified for a 15 year refi @4 % on a 2 unit property (it's actually 3 units but it's on the records as 2). The monthly payment would be almost exactly what the rents bring in. So any repairs, any vacancies, etc will be out of pocket...until we raise the rents. Our rents are under market value by about 20-25% so we have room to raise them over time. However, it feels a little risky because the rental market could tank and we may not have much of a cushion. Another option is to go with a 20 year loan which will lower the payment by approx $500/month. We could keep our plan of paying on the 15 year schedule unless something catastrophic happens (rents tank). The trade-off is that the loan would be at 4.4%. So we end up paying a lot more interest over time.

We live in, and the property is in the california bay area, so we are talking about a large chunk of money.

What would you do?

We live in, and the property is in the california bay area, so we are talking about a large chunk of money.

What would you do?

Matthew J. · Answer

Haha a Maserati, some might say that is a good investment! (as long as it never leaves your garage!)

Ok Amy, sorry I missed the "refi" was thinking it was a purchase.  I'm going to agree with Andrew and Dylan, take the 20 year don't stress yourself, if things change and income goes substantially up and rates don't go much higher you can always refinance to a 15 year.  Money is worth more now then tomorrow,  anything extra you can invest it or throw it at the principal or worst case scenario not struggle when you have to make a major repair or one day if something unforeseen happens.  Keep in mind the rate of inflation as well, the money you spend today will most likely be stronger then the money you spend tomorrow.  You can easily see where the inflation is heading cash in your pocket is better in my opinion.

Cordially,

MJ

Amy T. · Answer

Thanks all. We're looking into the 20 year :)

Amy T. · Answer

Thanks everyone.

Andrew - we're not taking any cash out, so no reserve. Our goal is pay down, pay down, pay down.  We have taken cash out in the past to invest in another property and that deal went bad (good riddance 2009). We have a chunk of equity in the property, but not as much as we should had we not pulled cash out way back when. So we are less likely to leverage this property again. If all goes as planned and we get this paid off in 15 years, the cash flow could be half our retirement.

We have a tiny reserve built by rental income- maybe $3k. We have been putting extra on principle.  I have just returned to work part-time so we can build up a reserve, but would obviously rather that go to kids college tuitions (only 3 years away) than rental, but it will be there nonetheless.

Andrew Johnson · Answer

@Amy Taylor Personally, I'd opt for the 20 year term even if the rate is higher.  Your cash-flow is a little better and you get the stretch out the timeline for paying mortgage interest.  As long as they don't change the tax code (who knows) you'll want to that there to offset the rental income.  Ol' California has fairly high marginal tax rates so it's no fun paying taxes on that additional income.

Devil's advocate for the 15 year option, even if the market did tank you just took out a bunch of money in the refinance.  So you should have a hefty reserve fund set aside for any "what-if" scenarios that might not be so fun to deal with.  Unless you're planning on blowing it on a Maserati ;-)

Dylan Vargas · Answer

@Amy Taylor Sorry, let me be more clear. I meant lower payment and higher rate. The lower payment will give you more cash and peace of mind.

Dylan Vargas · Answer

@Amy Taylor Welcome! You both seemed very disciplined about paying extra. Therefore, I would get the lower rate to have cash flow and help with any downturn. Now you are helping hedge and will feel a little more protected. Pay extra as cash flow allows. You will probably get some great appreciation along the way. A cushion of cash flow helps on the stress about money! Just my two cents. Congrats on the deal!

Amy T. · Answer

Thank you for your opinion Andrew.

Matthew - we already own the property, we are just deciding on our refinance (which we need to do, it's currently an adjustable rate and we want a fixed rate before rates go up). Right now the rents cover the monthly mortgage and then some. I always pay extra on the principal. It's just a matter of how much a lower interest rate is worth, and how tight do we want to make our payment with income to get that lower rate. We want the best rate possible but don't want to get ourselves in trouble by not having much cushion. We should be able to handle normal repairs and the occasional vacancy without it causing a big financial burden. 2 of our 3 renters have been there 6+ years and we have 1 brand new renter.

We are self-employed and we hope this property will be a big part of our retirement income. So getting it paid off in 15 years would be ideal (we are 41 and 45).

Matthew J. · Answer

Amy,

I hope the weather is good in Cali!

The rental market tanking should not be your biggest concern.....the rental market is only going to increase in our current geopolitical and economic world.  Demand for rent is high and home buyers are low that is why the FHA program and HAMP even still exist.

I think your bigger concern should be your cap rate and your liquid / income.  I personally would not invest into a property if it is going to require me to change my life style for the worse.  Find a property with a better cap or arrange for the current seller to have the rentals increased and lock the renters into a lease.  If you can easily float maintenance cost without changing your lifestyle by all means do a 15 year. Typically I would not make a purchase on a investment property if it's rentals can not float it's own mortgage and basic maintenance.  You do not want repairs cutting into your basic living income or your investment dreams are going to become investment nightmares....... Just my two cents.

Cordially,

MJ

Andrew B. · Answer

From an investment standpoint, you do not want to increase your cash outflows. You should leverage your money so that you can maximize your return.

Refi on multi-unit, shorter term with lower rate worth the risk?

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