Wifey and I plan on buying a condo in SF area, and now wondering if we should: Question 1:
sell off the old condo and make a larger down payment to the new place.
keep the old condo as rental property and make smaller (20%) to the new place.
I’m not sure what factors should be taken to answer this question. Old place is in Rivermark area. General cosensus I’ve been hearing here and elsewhere is to keep it and rent out, but we’re only making 20% down for the new place, so the mortgage is fairly high.
Let’s say we decided to keep the old condo and rent out, which mortgage (we have 50% LTV on the old condo) more advantageous to pay back early. At first glance it looks like we should pay back whichever that has higher mortgage rates, but since the rent coming in from old place would be income-taxed, I’m not sure if making profits from rents is a good thing vs. paying off for primary residence…
Q1: Renting out the old condo will most likely earn you some extra income because you have such a low LTV. Cash flow is likely to be positive, is it? That’s money you can use to pay mortgage for the new place. Since you didn’t mention any worry about qualifying for the new mortgage, your income must be high enough to make payments for both mortgages. If that’s the case, keeping both condos is the way to go.
Q2: Most likely you won’t pay a cent of income tax on your rental income. You can deduct 1/27 of your old condo’s value every year as depreciation. Tax code assumes your condo will be completely worthless in 27.5 years and you get to deduct part of that “loss” every year against rental income. That with all the other costs like mortgage interests, HOA, insurance etc will show a paper loss. You won’t have to pay anything for many, many years to come.
The cash flow is juuuust above water, with conservative rent prices. We did get a pre-approval for the new place assuming the old place is not rented out, so I wasn’t worrying about that. I guess we are so used to paying low mortgage and saving the rest that having a large mortgage payment seems scary.
What are other arguments for this? It seems that, if we sell off the old property, the reduced amount of interest (for the new place) is larger than the principal/equity gained (on the old place). What am I missing here? Appreciation of the old place?
Interesting. I was leaning towards paying off the primary home (larger mortgage amount) first because that would decrease our monthly expense (either by recast or refinance), since the old place is already cash flow positive.
But also, you are confusing future money and present value. The reduced interests payment is future money, worth less if you discount with inflation rate. The equity gain of old condo you mentioned is most likely what its value is today.
To compare apple to apple, you need to do net present value calculation of reduced interests payment on the new condo, and compare it against the present value of your old condo. It will sharply reduce the interests saving, if not eliminate it altogether. Especially with 30 year fixed mortgage. Do you think inflation will be as low as today’s 10 years from now? How sure are you? If it’s even 1% higher than today the discounting to NPV will wipe out a lot of the reduced interests payment saving.
Max out mortgage loan for rental property (you want to lose money :), well at least on paper, and cash flow positive… sound incongruent but possible because of depreciation charges… there are tax implications and P&L computation in the future, ignore them for now).
Minimize mortgage loan for primary residence. Attempt to payoff your primary residence mortgage (good for health, unless you’re a savvy investor who know where to deploy your money for greater return). Paying off is a form of forced disciplined savings :), f… the money… health first.
Primary home is tax deductible and always interest rate less than Rental home.
I am doing opposite,as of now, when I plan for retirement.
Maximize Primary Mortgage(3.625%) as I am getting low mortgage rate and tax deduction
Minimize Rental Mortgage (4.25%) as I get higher cash flow. 75% of rent becomes cash flow, accumulated loss+depreciation makes no tax for next 15 years. This positive cash flow takes care of 50% of my primary home PITI.
What is wrong with this move or idea? Or Am I missing something here?
Jet Li is one of my favorite martial arts actor. He advises us to put health ahead of money during this public appearance, http://www.cmoney.tw/notes/note-detail.aspx?nid=62307 . He suffered internal injury during his early acting and might now have to sit on a wheelchair for the rest of his life.
Be careful not to work too hard for money, impairing your health. Might end up spending all the hard earned money for medical care towards the rest of your life.
Debt financed growth is old school… was taught as a best practice in business schools… professors are now cautioning… is good so long the tide is high… you would be caught naked when the tide goes down.
Nothing wrong. From the pure financial portfolio management is ok. I’ve brought in personal feelings for primary residence I separate personal residence from investment. Any further discussion, need to talk about capital structure and capital budgeting
Sorry, there is one more thing that I need to mention, just in case you might be there:
For primary residence, mortgage interest claim for taxable income greater than $300k (includes rentals* ) would be reduced as income increased, up to 80% of mortgage interest. That is, for extremely high income, can only claim 20% of mortgage interest. *Make sure you don’t end up making money
Let’s dig into the math a little bit. It seems we have high math literacy on the forum here.
Let’s say the difference in new condo payment is 30K a year. The two scenarios are having old condo sold off and lowering the new condo payment, vs keeping both but paying more in new condo payment.
Now that 30K difference is constant for 30 years. But 30K in year number 30 is worth a lot less than 30K at year number 1. Because inflation eats into your money. So you need to “discount” it with inflation.
Let’s say inflation rate is 2%:
Year 1: 30K / 102%
Year 2: 30K / 102%^2
Year 30: 30K / 102%^30
So you add them all up, that’s your total difference in payment, in today’s money. That’s a geometric series, and we have a formula to get to the sum. That’s 30K * 22.27.
So you can’t multiply 30K with 30 because you are paying for 30 years. You are multiplying with a smaller number, in this case 22, because of inflation. If inflation rate is higher the discounting will be more severe.
Compare this with your old condo value today, which is higher?
Ah. This makes perfect sense. If our income stays at or more than the current level for 10 yrs, it definitely makes more sense to rent out the old place and bite the higher mortgage today. Thanks for the rigor, manch.