I own a 2 unit rental free and clear. I've yet to have it appraised. However, Zillow estimates it at around $315k. It is in a high demand rental area. Highly rated schools. Low rental inventory.
After taxes, utilities, insurance, and setting aside $$$ for repairs I can net around $500/month.
That $500 had been going towards mortgage payments on my primary. NOT extra payments towards principle. Just the normal monthly payment.
The mortgage has 28 years left at 7%. Approximate balance of $410k. The wife and I would like to retire in 15ish years. There is no way we could pay down the mortgage in full as-is.
Selling the rental and applying the proceeds to the primary seems to make all the sense in the world. Multiple sources describe it as a "guaranteed 7% return" on the money.
The rental property isn't generating anywhere near 7% of $410k.
In theory, we can recast the mortgage, voluntarily pay extra on the principle, and own the home free and clear around the time of our retirement goal. Recast would allow us financial flexibility as needed when unexpected expenses arise.
Thus, we could downsize and buy our retirement home *without* having to sell the primary at the same time (which was a logistical nightmare when we bought our current home). We'd potentially have somewhere between $800k – $1.2million in equity.
Thoughts?
Selling Rental to Pay Down Primary
byu/MrBallistik inRealEstate
Posted by MrBallistik
9 Comments
Unless I’m misunderstanding, why wouldn’t you sell it when you’re ready to retire and collect 15 years of rental income plus 15 years appreciation in the interim?
Mortgages in the US are very favorable debt. First, the 7% “return” is fiction. The money to pay off a mortgage comes from selling an investment. If the investment is earning 8% then you are losing money just to avoid a mortgage expense payable over 28 years.
If your numbers are correct that sounds like a solid plan. It really depends on what the sell of that property goes. I would say $500 per month net is not as much as I would expect from a 2 unit rental. Have you asked comps from a realtor to verify? If that’s the case go for it! Good luck! Another thing is to think of refinancing your current mortgage in a few months. Rumor is rates will have a few drops by Aug/Sep.
Factor in the capital gains on the rental plus putting back in the depreciation—this can be a big bite out of the proceeds.
Your rental is also appreciating in value, maybe 5% per year. You have to factor that in on top of the otherwise poor cash flow. You’ll be taking a 25% tax hit on capital gains when you sell, so that’s not a 7% guaranteed return – the tax hit is knocking off some of that, probably ~4.5% adjusted return. And even worse, it’s not 7% forever – when you get a chance to refinance you can probably knock it down to 4-5% eventually. Finally, rent almost always goes up. $500 today could be $2,000 in 10 years. That’s massive acceleration of your mortgage paydown over time. So you’re better off renting.
My recommendation – keep your rental property until you’re ready to retire. Then consider selling it to pay off the mortgage. By then, you’ll have pocketed 15 years of increasing rent plus 15 years of appreciation during a time when average mortgage rate might hover around 4-5%.
I’d run the real numbers before selling, but your thinking makes sense.
If it’s worth around $315k and only nets $500/month, that’s only about $6k/year on a lot of trapped equity. Even with appreciation, that’s not a great cash return. Paying down a 7% mortgage is hard to beat, especially this close to retirement.
Before deciding, I’d check actual comps/appraisal, selling costs, capital gains/depreciation recapture, and whether rents are below market. But if the after-tax proceeds are still strong and the rental return is still weak, I’d probably sell, recast the mortgage, and keep the flexibility.
Rentals in some states appreciated barely 2% last year. Although there is no such thing as “timing the market”, with the time left on your mortgage, it makes a lot of sense to pay down the 7%. Crunch the numbers to see what you’ll save. Good luck.
I would wait the 15ish years to sell. You have no need to sell now. Based on what you said, the goal is to have no mortgage payment when you retire. So wait until you retire. No need to rush it now. That rental will probably be worth over $600k in 15 years. And your mortgage balance will be around $280k.
So sell now and you still have a mortgage payment for 15yrs, or sell in 15yrs and you pay off your mortgage AND pocket $300k.
You’re netting $500 month on a $315,000 investment. That’s less than 2%.
Something is terribly wrong.
Either that property is worth about $90,000 (75-120k range) or you’re not charging nearly enough.