Read Estate: Never pay off land?

[ErnestGoesToWSOP]

Hi Jamazon,


I think I can explain the refinancing concept to you. I'll use my current situation with land I bought and a home I am building on the land. I have considered moving into the home myself and selling it as well. Whichever option I choose will have major tax implications.

I bought the land for 200k and I project to build the home for 300k and in my current market I could sell the home for 675k-750k. My profit would be about175k if I sold it right away with a 35% tax hit of 61k. So I would take home about 114k.

I could also sell my old house and move into the new home.
I would refinance and pay off my construction loan and land loan of 500k. I would be making payments on the 500k loan but my house would be worth 675-750k. I could then open up a home equity line of credit on the value of the home and could have access to about 200k of equity in my home to reinvest in more projects. I wouldn't be taxed on this money, I would only have to pay interest on the equity i used. I also believe that the interest on a HELOC is tax deductible.

As far as putting a down payment on your home, I would highly recommend doing 100% financing via an 80-20 loan.
When I bought my first home, I considered putting 10% because I thought you HAD to put a DP on a house. Not true.
My mortgage broker did some calculations and my mortgage payment was almost exactly the same if I had two loans(80%-20% loan) or if I put 10% down and financed the remaining 90%. The reason the payments were the same because I eliminted Private Mortgage Insurance since they viewed my 20% 2nd loan as a down payment.

Now if you lack discipline and feel the money is better locked up in your home, then go ahead and put a big down payment, but most investors can get better than 6-8% return.
For me the money is better used doing more projects, buying more homes, and playing in the stock market. I hope I helped.

-Ernest

[ElaineMonster]

[ QUOTE ]
Now if you lack discipline and feel the money is better locked up in your home, then go ahead and put a big down payment, but most investors can get better than 6-8% return.


[/ QUOTE ]

That's a little unfair. Traditional wisdom is to pay off your home ASAP. And plenty of wise people still recommend it. It is your home, afterall, and shouldn't be treated purely as an investment. A decision to pay down your mortgage shouldn't be called a "lack of discipline."

I know before that I told the OP to only put down 20% or less but I'm rethinking that. I came up with a list of considerations. If these apply, you might want to put more down on the house:
- You have a low tolerance for risk
- You have a high interest loan (7% or higher)
- If tax benefits outweigh potential investment returns
- If your investor takes a big cut (1% or more)
- You have a low fixed income and need to reduce all monthly expenses
- You enjoy debt-free living; you receive psychological benefit from owning things free and clear

If these apply, you might want to put less down on the house:
- Your income varies drastically and you need liquid assets to cover the low income months AND your loan interest rate is low
- Your house is in a flood zone :/
- You're afraid the IRS will seize your home (They can only get the equity you have in your home, so the less equity, the less appealing it is to them. Though, this won't protect the money you invest, just that you can probably still keep your home).
- If tax benefits to invest outweigh tax benefits to pay down mortgage (think retirement accounts)

[ErnestGoesToWSOP]

ElaineMonster,

I didn't mean to sound harsh with "lack of discipline". Many sophisticated home owners know they can make more if they invested their extra mortgage payment instead of paying down their homes, but they don't because they realize they might end up spending the money instead of socking it away in a mutual fund or other investment vehicle. They know they "lack the discipline" to put the money away and fear they might spend it so they put it in their home since they can't touch it and withdraw the money.
These people they are better off doing this. If you have the discipline you shouldn't be paying off your home quickly. Just my opinion.

-Ernest

[Biloxi]

Dont u end up paying much more cash , the longer you have to pay for your home?
I realize for some rentals it may be best to get a low mortgage payment to max out current income, but for non-investment properties im thinking the faster the better. But I dont know much

[Misfire]

The problem with borrowing on your home at ~6% to invest at a higher rate (say 12%) is that you're taking on the risk of a 12% investment for the return of a 6% investment. It's not just about your tolerance for risk, it's your tolerance for risk at a given return.

[ QUOTE ]
- You're afraid the IRS will seize your home (They can only get the equity you have in your home, so the less equity, the less appealing it is to them. Though, this won't protect the money you invest, just that you can probably still keep your home).


[/ QUOTE ]

If the IRS is after you, you're probably not in a good position to be buying real estate in the first place.

[ElaineMonster]

[ QUOTE ]

If the IRS is after you, you're probably not in a good position to be buying real estate in the first place.

[/ QUOTE ]
True, it's just something I came across and thought was interesting because it's the opposite of what I originally thought. I assumed, like many people, that the IRS doesn't seize homes anymore and so I thought it would make sense for people who don't pay their taxes and thus are afraid of the IRS taking away their gambling profits, to put an excess cash into the home, where it would be "safe" from the IRS. But I was wrong.

Anyway, here is a really good article that explains who should pay more down and who should just stick to the minimum payment and invest elsewhere.

[ElaineMonster]

[ QUOTE ]

Anyway, here is a really good article that explains who should pay more down and who should just stick to the minimum payment and invest elsewhere.

[/ QUOTE ]

It's pretty simple I think. The calculator at the bottom of this article says it all.
You must compare your 1) loan interest rate with your 2) tax rate and 3) your expected return on alternative investments. 3 variables = different answers for different people.

[eastbay]

[ QUOTE ]
The problem with borrowing on your home at ~6% to invest at a higher rate (say 12%) is that you're taking on the risk of a 12% investment for the return of a 6% investment. It's not just about your tolerance for risk, it's your tolerance for risk at a given return.


[/ QUOTE ]

Exactly. This point is too often brushed under the rug in these discussions.

eastbay

[Nonononono]

[ QUOTE ]
... most investors can get better than 6-8% return.


[/ QUOTE ] Huh? Over 5 years, the total U.S. stock market as measured by the Vanguard index fund is up 4% annually. Vanguard's best-performing bond fund is up a little over 7% annually, but the most aggressive, the junk bond fund, has only returned 3% a year. Money-market funds are up 2% annually.

And stock and bond investments can be highly volatile. Paying off a mortgage effectively offers a high risk-free return. I realize there are tax advantages associated with home mortgages, but in general I don't understand the merits of borrowing money to invest in stocks.

[tagtastic]

I think the answer to the question can't be found until you know the markets in question. At the moment a good number of very expensive real estate markets are projected to fall dramatically, while many smaller markets are projected to gain as usual.

Paying off less up front and keeping larger mortgage may be good advice for a very experienced investor, but generating more than 6-8% annually is no small task for the average joe. IMO the average family's best investment they will ever make is a home (not that it needs to be this way, but this is the reality). Avoiding as much interest as possible should be paramount to the average buyer.

If I could afford it I'd probably pay cash for a home right now.