10years remaining on rental, should I refi to a 30 and cash flow?

Question

I did the HARP loan back during the crash and turned my 30 year note to a 15 with plans on living in the house until paid.  Situation changed and purchased a new home and decided to rent out my home in question.   Dilemma I face now is that I am in a negative Cash Flow situation.. but my amortization is double..  here are the numbers.

Loan Balance $181,568

Appraisal $259,000

Payment $2,079.04 (mtg/tax/ins)

Term remaining 10yr/2mos @ 3.625%

most recent payment applied $552 interest / $1,244 Principal / $282 escrow

Rent $1,700

My thinking, before BP, was to take the loss each month and consider it an investment of $500/mo and then when the house is paid off it will clear $1700-$2000 month.  I want to keep the home because I built it in 2003 and its a solid home in great neighborhood.  I've factored CAPX and all that..

My question is..  should I refi to a 30yr down so I can CashFlow, or do I keep doing what I'm doing since my investment is turning money, just not in my pocket..   I keep running back and forth in my head on what to do.. would love any input.

Goals are to buy additional properties.  I am 43 and would love the satisfaction of having this home paid by age 52...  or do I refi, build my portfolio and by the time this house would of been paid off.. I may have enough properties to cover the "Principal" amount I'm earning now..   Understanding the tax breaks and utilizing debt as leverage..

Chris Mason · Answer

Your payment will drop by ~$800 if you refinance, putting it in the black ~$300 according to your current P&L numbers.

But if you're going to pay a bunch extra each month anyways to still pay it off in 10 years, and that $500 negative each month isn't causing you financial  harm, I'd say do not refinance.

Chris Mason · Answer

No way to know if this is applicable to you without seeing your tax returns, but depending on how badly you are shorting Uncle Sam of his cut (& in which specific ways you are doing it on the tax paperwork), it's also true that, to quote myself, "you've often got to be right with Uncle Sam before Aunt Fannie Mae is going to lend you any of her cheap money."

John Nachtigall · Answer

I have been interested in this because everyone loves 30 years mortgages so much, but you pay a lot more in interest.   So I figure this is a math problem, and what else do I have to do on Saturday, so I plugged it into a spreadsheet. (I have social issues, but that is another conversation)

Note:  I did not use discounted cash flow, so a real banker would have different numbers.   This is a crude estimate.   But since they both have positive cash flow for 20 of the 30 years, it is not a tremendous error.

Assumptions:  2% rise in rent, expenses, taxes, and insurance each year.   Also 2% rise in equity every year, but that does not matter since the house is the same in every scenario.   Assumed $500 in expenses add in taxes and insurance of 282 and total expenses are 782 to start (46%)

Results 10 year mortgage:

Cash flow starts at -878 a month,   it is 1119 when the mortgage is paid in 10 year.   It is 1663 at year 30

Total interest paid is 36,061.   Total cash flow at year 30 is 230,245.   Equity is 470,000    So total money made is $664,184

Results 30 year mortgage (starting now)

Cash flow starts at $44 a month, It is 245 at year 10 and the same 1663 at year 30.

Total interest paid is 131521.   Total cash flow at year 30 is 134784.   Equity is still 470000.   Total money maid is 473263.

Other notes

Straight cash flow crosses over at month 251 (20.9 years).    After that month,, 10 year has earned more cumulative cash flow

If you compare when Cash Flow pays the interest, it is month 231 for 1 year, but month 358 for 30 year.   So all that cash flow basically pays the interest for the 30 year.

Conclusion:  I would say, looking at the numbers, that if you buy and hold, your total wealth earned is about 30% higher if you keep the 10 year mortgage and hold for 30 years.

Note 2:   I did not compare to a 3rd scenario where you sold and used the 76,000 to buy a cash flow property.   I will say that to make 664,184 in 30 years with 76,000 you need to get 7.5% a year, which is a little higher than the lifetime S&P 500 appreciation of 7%.   Just another example of the competitiveness of real estate as an investment.

Final note, a very modest 2% per year goes from 1700 per month to 3080 in year 30.   Raising rents every year even a modest amount makes a huge difference.   going to 3% a year earns an extra 100,000 in 30 years, so a total of 742000.   So raise rents even a modest amount each year.   It pays.

Thomas S. · Answer

The reality is that holding on to the property will not likely make you any money. Your negative cash flow will/is far greater than you think. When you include all expenses down the road it will more than eat up your present "imaginary" cash flow. That fact on top of the possibility of the markets turning makes this a property that should be offloaded to capture the present equity. Reinvest in a positive cash flow property asap.

It simply does not work as a investment.

Bradley Chiakas · Answer

Great analysis!  One small point, did you factor in any appreciation (investment not property) on the positive or negative cash flow?  7% S&P would be good.  Seeing as how you earn cash flow earlier on the 30 year, total money made may be slightly higher.  You are also losing opportunity in the negative cash flow from beginning of the 10 year.

Bradley Chiakas · Answer

I'm not shorting Uncle Sam at all. I am following the tax code and the way it is written. Some examples, I own about $900k in assets, and depreciation alone allows me to deduct over $30k.  Also, there is a foreign income exclusion act that allows any international income to be tax free up to about $100k (2016 figure).

I don't think I'll take the approach of giving away money to the government so that big banks can lend me money.  I'll stick with my low rates and follow Dave Ramsey's advice.

Kurt Traynor · Answer

wow @John Nachtigall, you HAVE thought about this!!  Thanks for the info and the in depth analysis...

Bradley Chiakas · Answer

Awesome info! I had no idea there are government guidelines. I have $122k of annual passive income. However, I am extrenely thorough in my expense tracking, and also take depreciation, etc. I end up offsetting nearly all of my tax liability with deductions. Therefore, my "qualifying" income is nearly $0. My next step is to speak to local lenders. I have done some research online, and its seems a bit sketchy for some of local reviews for smaller lenders.

10years remaining on rental, should I refi to a 30 and cash flow?

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