pay off existing house or buy rental property first?

Question

I am VERY green when it comes to real estate investing. I am a homeowner (have been for 3 years now) of a house that I paid 122k for. I have the mortgage down to $107k, and plan on paying as much as possible on it to get it down to $0 in a year and a half or so.

I have about $30,000 cash right now in savings, and am wondering if I should go right now and begin buying another property to rent out, or if I should wait until I pay off my existing house in a year and a half. What are your thoughts?

Can't wait to hear!!!

Account Closed · Answer

Anyway, I would suggest that if your home is in an HOA, DO NOT pay the mortgage completely off: HOAs have foreclosure power over the homeowners, and houses having a mortgage are, generally speaking, less likely to be foreclosed on by the HOA, because the ability to get the money is lower. Which is part of the reason I haven't paid off my mortgage.
And to your question, I, who know nothing, am keeping my $$ for a down payment. And at that, with the market being what it is, I will need to be able to support me for 6-8 months of both mortgage payments, utilities and food until my residence sells. I MAY move into my rental in a few months and sell my residence from there... Any advice for me?

Tom NA · Answer

A couple thoughts here:

o Paying off your car, when possible, is almost always a good thing unless you have a super low interest rate.
o If you recently put in an extra $10-11k into your house and now have the balance down to $107k on a $122k purchase, this was a good thing to do.  You are still leveraged too highly on your personal home in my opinion (88%) and should pay down even more - I'm not sure you could ever refinance if necessary in today's environment.  I suspect you're throwing away money on mortgage insurance as well and also putting yourself into a situation where if your home loses any value at all, you'll be upside down on your loan.
o *Once you have a solid equity position in your personal home*, then I would look toward other avenues for investing your free cash.  Even though this is a Real Estate investing board, I would always recommend that someone first max out potential investments in (a) 401k plans, (b) IRA's, (c) ESPP if your employer offers one - before considering a rental property.  Too many tax advantages and other benefits to these to let them pass you by, especially when RE is not an easy game.  In fact, my personal recommendation, knowing that most people are really not as suited for RE as they think they may be, is to consider mutual funds and stocks before ever venturing into RE.  Personally, I had a very strong portfolio prior to ever purchasing a rental property which provided me with diversification as well as something to fall back on if I was a total failure and needed some cash.  I'll bet 9 out of 10 people do better in the market than in RE (certainly the case for me).

Rich Schroeder · Answer

You'll get tons of different opinions on this one.  But here's my humble opinion.

If I were in your shoes, I would not pay off the mortgage.  This is because of the future value of money, but more importantly cash/cashflow. If you are going to start in the rental business, you'll need cash, cashflow, and good credit. Save your money, but use it to buy rental properties. The money you would be putting towards your principle could be used to purchase rental properties and will, in turn, get your cashflow revved up. You do have to buy at the right prices, though, and learn all about the business first.
Thanks 
-Rich

Michael Shadow · Answer

I think paying off your car is a good idea.  Your car at the end of 5 years will be worth far less than you paid for it.  I would always pay off a car loan or credit card debit as fast as you can.  Mortgages are different because the object you bought will go up in value over time (even in the soft market we're in right now 15 years from now your house should be worth more).  Cars and stuff you buy with your credit card go down in value.

-Michael

Michael Shadow · Answer

I don't pay off my mortgages quickly, I want them to last as long as possible (as long as they are fixed rate).  I want this because of inflation.  if you have a $1000 mortgage today when your making payments on that mortage 20 years from now it will feel like a $400 payment because everything is more expensive and as long as your income follows suit your paying back your mortgage with dollars that are worth less than they are worth today.

Besides if the inflation rate is 4.2% and your paying 6% for your mortgage then you are really only paying 1.8% in interest , which is tax deductible which drops it to around 1%.  That is of course if you think that inflation is really 4.2%.  If you think it's 8-9% which is where most people think it is then you are really earning 2-4% interest on that borrowed money plus tax advantages.

So to answer your question, if it was me I would stop making extra payments on my house and use that money to build my savings until I can buy another rental property that is priced right and has + cash flow.

-Michael

Jason Schmidt · Answer

hmmm - i feel kind of like a fool, dropping $15k to pay off my car now, and 10-11k in the house in hopes of paying it off if I truly want to do this thing.  grrr ... so torn!  That could have been a $25k extra cushion in my pocket while doing this stuff.

Jason Schmidt · Answer

ahh wow - that is crazy confusing now.  i thought it was always best to pay it off as soon as possible.  hmmmm....