Does this make sense?

Question

My wife and I are newbie investors.  This thought came to me the other day....

My wife and I have around $160k in total debt-student loans, cars, credit cards from a failed business venture, etc. costing us about $2800 pm to make the min payments.  Interest rates vary from 0%-18% (8.3% is the overall avg).  Some of the debts will pay off within a year or two, the majority spread out over several years.  We can afford the payments w my W2, but barely have anything left to pay extra after everyday living expenses.  I figure it will take us about 12yrs to get everything paid off if we continue the payments.  Our credit is still excellent but we are also going through a short sale.

We will be moving to my mom's house, which she owns free and clear (around $180k value), and is looking to sell it and move out of state in a year or so.  So I was thinking if we could take a 15yr cash-out refi and pay off all, or most, of our debt, our PITI would be around $1500.  If we paid an extra $500 pm, we could be on pace to pay it off in about 10yrs, and have a more managable monthly payment.  This would also allow us to save our credit and we could, within 2 yrs, take a mortgage in our name and, in turn, rent it out down the line for $1200 pm.  We could then continue to pay the $1500 extra and have the house paid off, and be completely debt free in less than 7yrs and have a cash flowing house to go with it.

This seems too easy.  I know we will lose the tax benis of paying off the student loans but will gain one when we have the mort in our name.  Other than the risk of losing the house if we fail to make payments, what other pitfalls am I overlooking?Thank you in advance,

Jon

Scott McMahan · Answer

So you're saying that you would have your mother deed her house into your name and you mortgage away the equity to pay off your debts? Maybe I misread your post?
	
	If that is what you're suggesting, I highly discourage it. Having done something similar to my mother when I was 23, I too had the best of intentions when I did it, and it did not work out as I intended. The result for me became one of my biggest regrets in my life. And I've seen so many similar stories in working with desperate sellers. Our relationships with our mothers is sacred. It's a bad idea to make them surety for our debts.

Jon Fed · Answer

Gentlemen,

Thank you for your advice.  I knew I was overlooking something.  Guess we'll have to keep plugin away!  Thank you.

Fed

Adam Johns · Answer

@Jon Fed not to get all up in your business (but you did post it for advice), but from what I read above, are you the only one working? If so, and there's not some sort of medical reason for your wife to not be working, I suggest you try to cut your spending where you can, and she gets a job of some sort. Even if it's minimum wage and she brings home $200 a week, that's still an extra $800 toward the debt without putting your mom's house at risk.

You have to look at what you stand to lose if something happens and payments are missed. If you don't pay a credit card, there are limits to what they can come after you for. If you don't pay the loan on the house, your mom loses the home.

Also, if you're not familiar, look into Dave Ramsey's Total Money Makeover. I don't agree with some of what he says, but his "debt snowball" makes some sense. He'd have you eating rice and beans and putting budgeted cash into envelopes, but it's up to you how deep you want to go with it.

Hard for anybody to give you solid advice without knowing your situation fully, but I think all can agree that your proposed plan comes with too much risk for your mother.

Wayne Brooks · Answer

A short sale will also cause you some financing issues for a few years.

Edward Burns · Answer

So you want her to finance the house taking out a loan for $160K, give you that money to pay off your debt.  Then you would buy the house for $180K taking out $160K Loan.  That would pay off your mothers mortgage.  Thus it still amounts to your mother paying off your debts and her losing $160K in the transaction.

Jon Fed · Answer

I never said I would have the house deeded to me, that was Scott's suggestion.  I am saying to keep the cash-out refi in her name.  On paper, we would have no debt.  Then we can use my W2 to qualify to buy the house from her, paying her off and transfering the debt back to us.

Mike H. · Answer

I'm going to have to agree with Michael S. as well.

The numbers aren't adding up there. In 2 years, you'll still owe well over 100k. So how will you be able to refinance it in 2 years and pay your mom her money? You may be able to get a loan on the house but, if you do, you will need to pay her 180k and your refi will likely only get you an additional 20 or 30k.

Here's what he's looking at based on what you're saying:

1) You get a 150k loan amortized over 15 yrs on the 180k house. 
	2) You make additional payments of 500/month.
	3) In 2 years, you'll still owe about 125k on that loan.
	And here is where you lose us:
	4) You're going to then refi the house again for the max (150k)
	and pay off your mom. What doesn't make sense is that when you refi it again, you have to pay off the existing 125k and then you'll only have about 25k left to give to your mom.  How is she getting her money out of her house? With what you described, she isn't.

So when you ask "does this make sense". Yea. Its actually a fantastic plan for you. You get a 180k asset for nothing and then you're going to use that to borrow against so you can pay off your debts and lower your payments.

Here's the thing. Its great for you. And maybe its fine with your mom since she would clearly be helping you save a boatload of interest on your debt. But she's clearly not going to be getting her 180k to buy another house any time soon.

She may be able to get 20 or 30k from this scenario to use toward the house. And maybe she's fine with giving you all that equity too. But at the end of the day, she's the one thats paying for your sins.

If you're doing a short sale, why not just go all the way and declare bankruptcy and leave your mom's house out of it completely? Do you make too much for a bankruptcy to go through? Otherwise, that would seem to be a much better solution that essentially having your mom pay for the debt.

Michael Seeker · Answer

I still don't understand how the math works on this.

You take out a home equity loan of ~160K on your moms house to pay off your debt.  You now have $1500/mo payment on that ~$160K loan.  You're effectively refinancing your debt using your moms house as collateral.  How do you think you'll be able to get a mortgage on the property in 2 years time without repaying that $160K in debt?

What I'm getting from your description is that you're looking at $160K in debt right now.  Generously speaking, you might pay off $50K of that in 2 years.  Fast forward to October 2015 - you've still got $110K of debt that is secured by your mom's house - how do you expect to borrow another $180K + 2 years of appreciation against the house in the form of a mortgage?  You're looking at putting 290K of debt on a house worth only 180-190K which just won't work.

Either you're leaving out an important piece of the puzzle or this plan doesn't make any sense.

Jon Fed · Answer

Michael,

I mentioned that as soon as we could qualify for a loan, we would buy the house from my mom, and pay her full market value.  She could take the money and buy a new house where she wants to move to.

Scott McMahan · Answer

What I would recommend much more is to keep studying, and create an additional income doing something you love. If you love the idea of flipping houses, find a partner and/or hard money lender to finance the purchase and rehab of a property with a ton of equity. Put half of your share of the profits into paying down the debt, and the other half in savings. If you have enough in savings to do another deal with a HML without a partner, then do another deal. You can do this while working your job. It may take time, but if you love it, you'll find the way to succeed with it. By creating an additional income stream and redeeming yourself of your debts by your own fruition, you'll have a radically stronger foundation than if you had risked your mother's equity.

Does this make sense?

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