To cash-out or Not To Cash-out?

Question

Hi all,

Here is the long and skinny… in 2019 my wife and I purchased a AZ home using a VA loan. After 9 months of sweat equity and renovation, I was offered a great job out of state we did not want to turn down.

Fast forward to now, the AZ house cash flows about $200 after expenses and based on the PHX market, has also increased in value. No appraisal, strictly an approximation based on comps.

Between my wife’s student loans, a car note, and hospital bills (healthy child-birth) there is approximately $60k in debts.

AZ house note: $209k

Current rate: 2.35% VA IRRRL

Cash flow: $200/ month

Approximate AZ Value- $325k (guestimation)

$60k debt: $1,700/month expenses

Should we consider a conventional cash-out to clear some of the debts?

The freed cash could go towards other investments/savings/peace of mind. We own our primary residence (2/2 condo) now, which we will outgrow in a few years.

I’m leaning toward the cash-out, however my wife is more hesitant. We’d love to hear the pros and cons to both sides.

As always, I look forward to learning from this great group! Thank you

AP

Bud Gaffney · Answer

@Alex Pirila hold it forever

Anthony Dooley · Answer

Why not sell before the market goes lower? Why keep a house in another state that only makes $200? If you increase the debt on the house, will your $200 net cash flow cover the new loan payment? This house is not making you wealthy. You bought it as a residence, not a business and therefore you should sell it. Pay off some of your consumer debt and you will save more than $200 in debt service each month. Buy an actual rental property in your current location if you want to be a landlord.

Jon Kelly · Answer

Low debt to income is meaningless if you have $0 in capital to invest. If he pays it all off then it will take years to save up for the next property. Carrying debt at <5% isn't a bad thing if you can buy an investment property with an IRR >12%.

Steve Vaughan · Answer

I'd sell it if I didn't plan on moving back.  Definitely sell while your gain is still tax free.

Moving peas to different shells (from consumer debt to house debt) just masks a symptom.  Behavior doesn't change without effort.  It would be healthier to buckle down and pay it off by cutting back.

But I wouldn't keep a house with this low of an ROE.  $200/mo is not worth a landlord leash.

Jon Kelly · Answer

@Alex Pirila Selling would be a great option. As @Anthony Dooley mentioned, if you refinance and pull cash out then your mortgage payment increases and the property has negative cashflow.

I would re-underwrite the deal and ask yourself if you would buy it as an investment in its current state... A $325k property with <$200/mo in cash flow seems. The COC return is less than 3%... The answer is "NO" you would not buy it.

Sell the property, pay down a portion (no reason to pay it all off) of your personal debt with the highest interest first and buy another investment property.

Anthony Dooley · Answer

That's cool, but I have to disagree again. I think most people would agree with me that an additional $1,500 per month is not zero capital. I also think any lending institution would agree that zero debt to income makes you a less risky borrower. I'm not trying to be confrontational, but where I'm from $1,500 for 10 months looks like $15,000. This could be used to put down on another investment. To your success.

Angel Dejesus · Answer

@Alex Pirila

All great options. I would also input. If you’re not going to park your money in another investment because the prices of homes are skyrocketed and investments don’t make sense. Then look into doing something creative. Like seller carry back or a lease option or a wrap around. Your cashflow will increase many ways. And that frees you up from being a landlord and your debt to income dramatically lowers.

Happy thanksgiving and Good luck.

Jon Kelly · Answer

haha, that's brilliant - zero debt to income makes you a less risky borrower. Not too many people would disagree there.

Making an investment vs. paying off all debt is a question people ask all the time. All I'm doing is suggesting a different approach. There's pros / cons to each, which is what @Alex Pirila was interested in.

What happens if you don't make an investment and that additional $1,500 goes to buying the bigger house, new car, larger TV... oh and then all of a sudden you're back up to $60k in debt without an investment property... oops

Joe Splitrock · Answer

@Alex Pirila just be aware that using cash out refinance to pay personal debt likely means the interest on that portion is not tax deductible. Deductibility follows use per the IRS. Per tracing rules, you want to keep careful track of how that money is spent. You can still claim the portion of interest up to the original purchase price loan pay off. For example a $200K house purchase refinanced at $250K, you can deduct interest on the $200K portion, so 4/5 of the interest is deductible.

I would use the cash out to buy another cash flowing property and then you can deduct the interest against the new property. Use the cash flow to pay down personal debt.

Anthony Dooley · Answer

According to the OP, he only has $60K in consumer debt which costs him $1,700 per month. By paying off the $60K and losing the $200 cash flow from the rental, he improves his position by $1,500 per month. In my opinion, that is a very good reason to pay it all off. His debt to income drastically improves as well.

To cash-out or Not To Cash-out?

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