Make the move ….

house on moundGuys, as the economy improves (if it improves) interest rates will surely rise, as they already are in other countries.

If you haven’t already done so, seriously think about buying some fire-sale real-estate and locking in the the interest rate for 30 years; one strategy – especially if the banks won’t let you take out a 30 year fixed rate mortgage on an investment – is to buy your NEXT home now (it need not be any bigger/better than your current), taking the 30 year fixed on that one, and keeping your current as a rental.

I’m not sure if that’s exactly what Lee was thinking when he asked:

Although the market in our area has held up fairly well through this housing crisis, it’s definitely a buyers market.  I don’t think I’d get top value for my home.  So, I’ve seriously been considering renting it out after we move.  If I did rent it, then I could go a couple different routes:

1. Refinance current home to 30 year (to help cash flow) and take enough cash out to put 20% down on our new home.

2. Refinance current home to a 30 year but take no cash out to get the payment down to a very low amount to have a very good positive cash flow.  Then put 20% down out of pocket on the new home.

3. Take out a home equity loan on the current home just to cover the 20% down payment on the new home loan (30 year).

4. Just go ahead and sell our current home so I can take advantage of the tax free capital gains … I could then use part of it to put 20% down on our next home … and use the remaining as a down payment on one or two rental properties.

5. I have to throw in one scenario just because of that little guy I call Mr. Conservative that sits on one of my shoulders, lol!  I could just pay my current home off within the next 2 years or so, then rent it out with a large cash flow, and use that cash flow to pay the mortgage of the new home we buy.

6. Maybe something I’m not even thinking of?

I think I see a case of paralysis by analysis coming on, so we had better head this off at the pass …

… while I can’t give direct personal advice (as I told Lee), I can point out that in cases like this it’s always good to ask yourself a couple of key questions before Mr. Conservative starts to get very vocal (in your subconscious) and you end up taking no action at all, so I suggested that Lee run some numbers:

a) What would be the situation on your current home, if you just took out a new (or refi) FIXED rate 30 yr mortgage, and put tenants in … what would be your new monthly mortgage payment and what monthly rent could you conservatively [it’s good to have Mr Conservative on your shoulders] expect?

b) After pocketing the excess of 75% of rents over mortgage from a) above – or, making up the deficit on the excess of mortgage over 75% of the rent – how much per month do you think you could save from your other sources of income assuming for the moment that you have FREE accommodation for yourself somewhere?

[AJC: the 75% of rents is to allow a buffer for vacancies and other costs of renting … just a very rough approx. for now]

Once you answer these two questions, my feeling is that the best scenario for you will become obvious … I hope 🙂

In Lee’s case, here are his current numbers:

3 bed / 2 bath 1450 sq ft. home in a great location.
Cost Basis: $158,000
Current value: $210,000
$96,000 (9 years 6 months) remaining on a 15 yr mortgage @ 4.625%
Current P&I repayment: $1,042 per month

And, if he refinanced the $96k remaining balance his bank has given him two options for a 30-year fixed loan:

$508/month @ 4.875% Closing costs: $2,000
$493/month @ 4.625% Closing costs: $2,700

For rent, Lee thinks “being ultra conservative” $900/month to $1100/month, which means:

Using 75% of excess over mortgage ($300) and assume living in FREE accommodations, I could easily save $3,000/month because that’s what I save currently even with my $1042 mortgage.  Throw in not paying our current mortgage and having $300 in additional cash flow and $4,000+/month would not be unreasonable.

For now those are the numbers, although I have to say the 75% of excess over mortgage number is probably high considering taxes and insurance on this place are about $200/month.  But as you said, these are rough numbers for now.

So, Lee is getting closer to being able to make a meaningful decision; here are the steps that I suggested:

STEP 1: OK, it seems to me that if you decided to keep your current home as a rental, you would lose money if you stuck to your your current $1k pm mortgage, and produce a positive cashflow of $100 to $200 p.m. if you refinanced.

STEP 2: It seems to me that your $3k pm savings rate will be enough to cover the expected $200k mortgage on your new home. Right? BTW: You WILL fix for 30 years, too (because this will become an ideal 2nd rental, eventually)?

STEP 3: Next, all you need to think about is how to raise the deposit; well, if you don’t have it now, go back to Step 1 and revisit these numbers, assuming that you refi, say, $150k instead of $96k. I’m guessing that you’ll be close to B/E – or, a slight monthly loss – on the rental?

STEP 4: You keep 25% of the rent (plus another $200, say) to cover taxes, ins, and contingencies PLUS you have plenty of excess monthly savings to cover you, until this ‘provisioning fund’ builds up.

Now, what do YOU think Lee should do?! Here’s what he thinks:

I think the smartest thing would be to refi without taking any equity out so that I have a nice cushion of cash flow.  I would then need to come out of pocket with the down payment for the new home which I should be able to do, and even if I need a little help, I could always get a small home equity loan on the rental temporarily.  But I feel pretty confident I could raise enough cash to cover the down payment without having to do that.

My next step…develop my plan of action.

Take Lee’s advice: model these questions to develop a plan of action that works for you … and, take it! 🙂

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6 thoughts on “Make the move ….

  1. I would love to be able to lock in 30 year financing at current interest rates – but that is not possible in Hong Kong. (I’m currently paying a floating rate of about 1% so I can’t complain too much.)

    I’d also love to be able to buy bombed out real estate in the US with such financing (but probably only in states that are in reasonable financial condition (less vulnerable to potential increases in property taxes) and which have favourable demographics. That said, I would be very reluctant to invest in real estate in a place where I do not live and which I do not visit at least annually.

  2. Wouldn’t the increase in interest rate bring about a decrease in home prices?

    If home X is priced at $1mil now, it is because after factoring a 1% loan and a 3% rental yield, you get positive cashflow.

    However, if interest rate rise to 3% or even more, it might result in a neutral or negative cashflow.

    Like yourself, you always do your calculation to have a positive cashflow. 2 years out, when you are considering Home X and it is selling at $1 mil still while the loan rate is 3% and rental yield is 3%, you as the buyer will want to have home X pried at around probably $900k so that rental yield will increase to cover the loan rate and offer positive cashflow.

  3. @ Trainnee – 30 yr Fixed interest rates are a ‘peculiar’ US quirk that every investor should be trying to take advantage of.

    Investing ‘hands off’ shouldn’t be a deterrent for anybody: I saw one quadraplex for the first time in 5 yrs yesterday, and it was renovated entirely while I was in another country!

    @ WJ – Within a range: if interest rates pop above , say, 8% to 10%, property prices can become ‘deflated’ … under that, they are not as sensitive to interest rate adjustments as one might think.

  4. I agree with wj. The government is running out of gimmicks. I would say get your cash house in order and wait because this recovery is long from over. Here in California the u-6 unemployment (unemployed + under employed + those who have given up) rate is above 20%.

    The blood bath is coming, get your cash house in order now.

  5. And may I add the CRE is hitting the wall. Retail and commercial RE is highly leveraged and will be affected by this economy. Wall street may be riding high but main street is still in the basement and until jobs return more NOD’s and REO will hit the market of all sizes.

    my motto “You dream about owning an ant hill you get an ant hill. You dream of owning an empire – you get an empire”

    If you have a stable job and you got some hard cash. You should be able to take advantage of this market rather nicely.

  6. I agree that now is the time to invest if you are in a position to buy into this market that has been over sold, and yes interest rates will eventually go up. I don’t think rates will start to increase until the economy is rebounding. I don’t believe that will be happening until late 2010. That being said if you can get creative in a market like this do so.

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