Pay down to 80% LTV or pay off 'bad debt'?

Question

Hey BP,

I'm currently in the process of selling my primary residence and purchasing a new home closer into town.

As of now, I'm using the proceeds from selling my home to put down 10% on the new home.

Additionally, I have a flip that is scheduled to close next month (after the other two have closed).

I don't currently have enough to put down 20% on the home I'm buying but will receive approximately 100k from the sale of the flip.

I'm debating between using some of that 100k to pay down my new mortgage to 80% LTV or just eliminating my wife and I's 'bad debts' and having a clean slate.

I'm also wondering if I should use that 100k to turn around and invest in another project.

Any thoughts?

Cheers,

Jack

Steven D. · Answer

Be aware that if you close with 10% down and then pay the mortgage down to 80% LTV or lower there sometimes will still be a 2 year seasoning period in which you can't get the PMI removed. Verify with your lender and loan documents before you pursue this option as it may not have the outcome you are hoping for. Bad debt is most likely the best thing to pay off first.

Garrett Hogan · Answer

What is the bad debt and more importantly what is the interest percentage costing you on that debt. I would start with whichever has the highest percent interest, typically credit cards. You can also Google the snowball method for debt reduction. The snowball method teaches you to build your emergency fund first, and then list your debts from smallest to largest and pay them off accordingly. The thought process is that each debt you payoff will encourage you to keep tackling the larger debts until youre completely debt free.

Mike H. · Answer

First off, I did the same double take as Cara I think. It looked like you were saying you were going to get rid of your wife. What I would say to that is that is the worst thing you can possibly do for your finances. If you think its expensive to have a wife, multiply that by 10 and thats what it costs to be free of one (i.e. divorce costs). :-)

Humor aside. One thing that might make sense is to use your profits from the sale of your first house and your flip to pay down the mortgage so you're under the 80% and can avoid the PMI. Then turn around and get a HELOC on your home and you can make your other decisions from there.

Personally, there's no way I would pay off the student loans given how they tend to be fairly reasonable in terms of rates. But again, that only stands if you plan on investing the money in real estate instead.

If you're not going to invest any money in real estate, then why not pay off the debt?

If you are going to invest, then maybe pay off your credit card when the rate kicks up and get a heloc to use towards your real estate.

The advantage of a heloc for you would be that if you're doing another flip, you could pull that money out for the down payment on the flip. Flip the house. Then turn around and pay the heloc off again. So you're only paying interest on the heloc when you're using it.

Matt K. · Answer

I'd use the 100k to invest, assuming you can easily service the current debt. It's going to take you far longer to re save that money then it is to pay it off monthly, it's likely you could easily outperform the 6.5% interest.... and for sure the 1.5/0%.

Jackson Tate · Answer

Cara, I just now noticed that my post does read that way...oops...hopefully my wife doesn't read it that way.

I think the consensus is to take care of the bad debt first. I've always sort of thought that's what we would do because it would certainly simplify life and finances, and it's hard to put a price on that.

Kevin Romines · Answer

In this case it sounds like you will have mortgage insurance because you are putting down less than 20%. However in most cases, MI can be tax deductible. Don't get me wrong, a tax deduction is never as good as the total debt that your taking the deduction for, its always a percentage of that debt. But that said, without knowing the specifics about your balances, and payments versus the MI payment, I would lean toward paying down or off the consumer debt.

Most mortgage companies will allow you to do a mortgage pay down at least once a year, typically paying down at least $10,000 or more. Some recast your loan with that lump sum payment. If you are just paying the balance down to get rid of MI you may be required to pay an additional 10-12% off to get there. it just depends on the type of mortgage loan that it is?

Just sit down and put on paper what the results of all options are and the best scenario will be revealed to you in doing that?

Thomas S. · Answer

Concentrate on your bad debt first. Once you begin investing and hit the inevitable rough patches you do not want a bad debt albatross holding you back.

Be nice if eliminating a wife/spouse was as easy as eliminating bad debt. More often than not one is the source of the other.

Cara Lonsdale · Answer

Don't eliminate your wife.  I'm sure she's not all that bad of a debt!  LOL.  As I read that, it made me giggle, until I completed the sentence on the next line that referred to bad debt.  So, thanks for that chuckle.

OK, now onto more serious things.... This is really a choice best made from comparing options side by side.

First, the bad debt can sometimes get in the way of your DTI (Debt to Income) ratios, so is that an issue to consider?

Is the lower payment of not having mortgage insurance (PMI or MIP, depending on the loan type) worth more than the absence of the bad debt?  In other words, where is the $XXX better spent?  Let's say the mortgage insurance adds $100 to your loan.  If you were to pay off the bad debt, would it result in a $100 or more per month savings?  If the answer is yes, then there is an argument for paying the bad debt and taking on the mortgage insurance.

And so forth.  So, I would have all of the options in front of me, and compare them.  Take into account what each one GAINS you (lower payment, increased loan amount approvals, etc), and what each one CHEATS you of (DTI Ratios, paying MI, etc) and make the decision based on your needs.

I hope that helps.

Jackson Tate · Answer

Garrett, bad debt consists of two vehicles, two student loans, and a credit card.

Credit card is interest free for another 6 months.

Other rates range from 1.5 to 6.8%

I know the debt snowball is Dave Ramsey's philosophy, pay off every last bit of debt before doing anything else.

Pay down to 80% LTV or pay off 'bad debt'?

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