Got some cash, pay down house or invest it?
February 6, 2016 2:02 PM   Subscribe

After some moderate success I'm about to take some money out of my business. After catching up on my own personal retirement savings I have enough leftover to do a few things with. My leading two candidates are, first, I can either pay down our house, taking it from a 30 year fixed @ 3.75% (2 years in) to a 15 year fixed at about 3.25%. Option two is to invest the money in either Real Estate or Equities or both. Looking for some armchair financial planning to see if I'm missing something.

Investing I'd likely split between a real estate investment property and the rest into some index funds. Upside is that I think financially this may be the better way to maximize wealth. With a rental property the hope to get a cash flow positive investment with decent equity gains. We're in Berkeley and while there's a lot of naysayers and doomsayers, the real-estate market has been a consistent winner from an equity investment perspective in this area if you're in for the long term. The downside here is the risk of taking some losses, particularly with stocks. I'm a bit horrified on what most of the current crop of presidential canddiates could do to the economy should they win the white house.

Related, I might be able to take out a similar amount again next year. So this might be a what should I do first question (Which to me means pay down the house) but that's not set in stone and there's a lot of variables.

Also is there an option 3 I'm missing?
posted by anonymous to Work & Money (13 answers total) 3 users marked this as a favorite
Depends on your current age. And the amount of time you have to invest in your purchases. The difference being when that 15 year mortgage clears. Will you be ready to retire or will you still be working? And any kind of investment which requires active involvement like real estate will require a time commitment - research is required and a baseline needs to be determined to determine which is the most efficient path. Good Luck.
posted by ptm at 2:13 PM on February 6, 2016

The real estate route should only be done if you can afford to buy the home in cash, getting a second mortgage for a rental property is a horrible, horrible idea especially if your business is your main source of income. A turn down in either your business, a lack of renters or hell, just an unexpected emergency can quickly turn into foreclosure and that can quickly spiral out of control into your personal life. Dave Ramsey did the same thing, and I truly believe it's one of his most heartfelt pieces of advice, that rental properties should only be bought in cash - he bought on mortgages before and then his house of cards fell, throwing every rental property into foreclosure, then eventually bankruptcy. Everyone that I've ever talked to about rental properties has said the same thing, even those that turned out OK have said that it was idiotic and short sighted to take a mortgage on a rental property (not including the higher mortgage rates as well).

On to a more measurable argument, a rental property on average only returns around 5% and that's when you know what you're doing. Taking into account unexpected repairs, jackass tenants, normal wear and tear, major maintenance (replacing a roof can run anywhere from 12,000-20+) and you can quickly find yourself in the red. There will always be a need for landlords - true, but it's also a major consideration and can turn easily into a second full time job. I wouldn't even recommend it if you're not extremely handy as hiring contractors for everything will quickly put you into the red.

I've told the story on here before about why I'll never be a landlord but I think it bears repeating - when I was growing up, my parents had inherited a few houses that they had flipped and starting renting out. One of the better properties we took care of quite a bit, I remember spending most Saturday's there in addition to a few hours during the week putting work and getting it fixed up and brought up to code. I would estimate we spent a few thousand in repairs and easily over a hundred hours in sweat equity. We rented out to a family whose son was in the same baseball league as me, did the background checks, everything checks out so we rent out to them and for the first few months, everything is great - we randomly check in, get the rent checks on time, this is awesome, right? Wrong, around Christmas time, the rent was late - well OK, she's a single mom, it's Christmas, so we'll give her some extra time to collect the rent. We get busy with the holiday and don't make a special trip up to the home. She insists she'll get us the rent, she's been a great renter for the previous term, we think all is kosher. Well second week of January rolls around and still no rent, so we take the trip up. Nothing could prepare us for what we saw - the beautiful house we spent hours fixing up was absolutely trashed, like abandoned for years trashed. Windows were smashed, graffiti was on the walls, walls were ripped down to the studs, the copper wiring was ripped out, and pipes were frozen (thank god they didn't burst). Long story short, our awesome tenant was actually a recovering heroin addict who was never in trouble with the cops so nothing ever showed on the background check. She relapsed and left every tweaker come and stay. In less then a month, our house was destroyed and anything we could recoup in damages was never going to come close to repaying or repairing it. We sold all rental properties shortly after.
posted by lpcxa0 at 4:17 PM on February 6, 2016 [1 favorite]

Pay down your mortgage. It's a sure thing and peace of mind as opposed to something that may or may not pay off and worries. And next year, if you get to take more money out of your business, pay down the mortgage again. When you have the mortgage paid off, that's when you get to play with both the money you take out of your business and the monthly income that's been freed up because it's no longer needed for a mortgage payment.
posted by orange swan at 4:48 PM on February 6, 2016 [1 favorite]

First off, congratulations on what sounds like a flourishing business venture. That's a huge accomplishment.

It's hard to offer meaningful advice with so little information, but I'd say Option 3 might be: don't refinance, just pay extra against your current mortgage. (Because re-fi fees can be significant, I don't think you'd be gaining anything for only a half-percent advantage--you'll just be putting your money in the pockets of the processors.) (On preview, what orange swan said.)

Other options: if you have any other debt, I'd pay that down first, since it's likely to be more costly than your mortgage debt. If you don't have 6-9 month's living expenses in an emergency fund, I'd forget about all of the above and put this year's draw-down from your business in a savings account.

On investing in equities, index funds/ETFs are the way to go, but your investing time horizon and ability to handle downturns (aka risk/uncertainty) matter.
posted by Short Attention Sp at 4:50 PM on February 6, 2016 [1 favorite]

I'm a bit horrified on what most of the current crop of presidential candidates could do to the economy should they win the white house.

I'd be more worried about what happens if interest rates keep rising. This has multiple effects -- it's harder for businesses (startups) to secure additional funding, and it's harder for buyers to secure a loan. Which means on the margin fewer renters and buyers of real property. If you look at a chart of price history, California property is fairly swing-ey compared to the country as a whole.

There's also liquidity to be concerned with. If an opportunity arises, you can sell fractions of your stake in investment markets, and do so at very little expense. Your liquidity options in home equity are far costlier. You can take out a HELOC, and pay fees (google research suggests up to 2-5% of the loan). Or you can sell it and buy a smaller home at the expense of moving and a 6% Realtor charge.
posted by pwnguin at 5:24 PM on February 6, 2016

Similar situation here a few years ago, elected to pay down the mortgage from 30 year @ 4.25% to 15 year at 3%.

A really big reason for this was not financial but emotional: paying off the mortgage in 15 years would match some age/life milestones, paying off in 30 years did not.

Of the leftover money, a big chunk went into TIAA-CREF because I want them to manage it and don't want to think about it.

The leftover went to a Maserati.

Kidding: a bunch went into a new roof and solar panel system for the house, as that seemed investment-like (pay now, benefit later).

The remainder is kept in a rainy-day fund 1% CD at the local credit union.

If you enjoy it, play the market. I used to, but no longer do, so I now like the idea of stable things that "just happen".
posted by soylent00FF00 at 5:38 PM on February 6, 2016

A vote for equities here. I think we are historically low interest rate levels, especially compared to typical stock market returns. Your mortgage guarantees you access to money at a fixed rate of 3.75 You have to factor in before/after tax when you compare them, but i'm guessing that it would be fairly easy for you to make an after-tax return in equities of more than 3.75%. Also, most equity investments (I recommend low-cost mutual funds, especially Vanguard) are really liquid so if your business runs into the trouble, you can get access to your money much more easily and cheaply than if it was invested in your mortgage. (This is a disadvantage if you have a problem with spending money that is supposed to be your savings. in that case, paying down your mortgage is probably safer.)
posted by metahawk at 5:56 PM on February 6, 2016

Dave Ramsey has some questionable advice for people above a certain level of financial stability, but this question of his hits home:

"If you owned your house today, would you mortgage it to invest in stocks? Because that's exactly what you're doing when you buy stocks before paying down your mortgage."
posted by samthemander at 8:12 PM on February 6, 2016 [3 favorites]

Pay off the house as much as you can.
posted by LoveHam at 8:13 PM on February 6, 2016

Pay down your mortgage. It's a sure thing and peace of mind as opposed to something that may or may not pay off and worries. And next year, if you get to take more money out of your business, pay down the mortgage again. When you have the mortgage paid off, that's when you get to play with both the money you take out of your business and the monthly income that's been freed up because it's no longer needed for a mortgage payment.

I would do this. (In fact, I am doing this, though sadly incrementally.) Numerically I think that the argument is almost certainly in favor of index funds, but I really want the flexibility and assurance of owning the house free and clear. It isn't worth refinancing unless the new rate is a lot lower and the fees pencil out, and there are advantages to having the lower payment of a 30 year mortgage in case things get tight down the road.

I've never owned a rental but when I have looked into it, the numbers only made sense if I was able to buy in cash. Needing a mortgage cut into the margins too much to have it make any sense, at least when I was looking at options a little while back.
posted by Dip Flash at 5:26 AM on February 7, 2016

Take the time to think about your goals. Do the numbers. You'll have taxes and insurance. If you buy real estate to rent, do you have the skills to deal with repairs? Even if you can hire people, you have to know how to get the right work done, the right way. You have to put in effort to find good tenants; bad tenants can wreck a property and cost you a lot of money.
posted by theora55 at 7:59 AM on February 7, 2016

I don't think the half a point spread btwn 3.25 and 3.75 is going to justify the expense of a re-fi. I was given the advise of not doing a re-fi unless I could get a point and a half change. You could turn your 30 year into a 15 year by paying it down.
I don't know all the particulars of your situation, but I am 57 and want to get this house paid off inside of 8 years.
On rentals, I am a very small time landlord, I rent out the first house I bought, it is a duplex. I own it free and clear. Even when I lived upstairs and rented out the bottom, I still ended up with bad tenants. Imagine opening up a full refrigerator (worth around 1000 bux) when the power got cut weeks ago when the tenant said they were going on "vacation". Truckloads of crap to haul to the dump, etc. Or the young lady that pounded on my door one night telling me *I* needed to get a plumber there stat because she had broken the toilet. I mean she physically broke the bottom part of the toilet. She expected me to pay for the repair.
Several thousands in repairs when she left.
I now have two very nice tenants over there that I charge less than market rate so I don't have to deal with problems. Still, two new washer dryer stacks last year - figure 2500 bux. A/C systems are due to die any day now.
I'm very handy, live three blocks away, and sometimes, it can still be a PITA. Or you can pay a management company 10% or so, and have tradespeople do all your repair$.
posted by rudd135 at 7:17 PM on February 7, 2016

Here's another vote for the mortgage. A few years ago we went from a 30-year to a 15-year (at 2.875!). We invest in our retirement and put some money into a brokerage account, too, but even with the mortgage rate that low we still aggressively attack principal whenever we can.

The commonly-repeated benchmark is that you should expect 6-7%/year over the long run if you invest in index funds and let them simmer. So that would mean that if you are using your money to pay down 3% interest debt instead of investing it you are wrong on the math. But there's a big psychological benefit to owning your house outright that should factor into your analysis. And with all of the uncertainty out there at the moment who the heck knows what the market is going to do in the next several years.
posted by AgentRocket at 8:51 AM on February 8, 2016

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