cash flow on a rental property
I have a rental property in Florida that, due to increased insurance
costs and tax increases, has my payments higher than my rents. The
mortgage has 11 years remaining at 5.25 percent and I can't push
the rent any higher than it is now. Should I refinance for 30 years,
do a home equity line of credit (interest only) and pay off the
existing loan or get a home equity loan and pay off the existing?
I hate to get rid of a great investment.
-- Scott Strategic
If the negative cash flow from the investment property isn't too
painful, there's something to be said for looking at the cash outflow
as an additional investment in the property and holding on to the
For that to make sense, you have to expect the continued appreciation
in the property value to be sufficient to justify that additional
investment. If you feel that the property's potential rental income
has capped out, that could signal some trouble ahead in property
values, as well. It might be time to get rid of that great investment.
Refinancing to extend the mortgage term will reduce the monthly
payment but result in you paying higher total interest expense over
the longer term. The following hypothetical example shows the difference
in interest expense but ignores the after-tax impact of mortgage
||Refinancing 5/1 interest-only
|Loan term (years)
* Assumes interest rate stays constant
over loan term with no principal reduction
Home equity lines of credit, or HELOC, and home equity
loan rates have moved higher as the Fed has continued to raise its
targeted federal funds rate. These loans are usually tied to the
prime lending rate, which is currently 7.5 percent. The national
average interest rate for a HELOC is 7.66 percent and is 7.56 percent
for a home equity loan. Although you'll pay more in closing costs
on a new first mortgage than you would on a home equity loan or
line, it's a tough sell to move from 5.25 percent on your current
mortgage to 7.5 percent on a second mortgage.
Property taxes and homeowners insurance aren't likely
to move lower over time, so your negative cash flow issue is likely
to grow over the years. I can't speak to what will happen to the
appraised value of your Florida property over time, but it's hard
to expect property values to continue to grow at recent rates.
There are too many open variables for me to do the
math, but if you decide to keep the property, I'd suggest that you
take out a HELOC to just finance the negative cash flow on the property
rather than using it to pay off the existing mortgage or getting
a new first mortgage. You've bought some time while keeping the
great rate on the existing loan.
In your shoes, I'd run all this by my accountant.
I'd make sure that I had a read on the negative
cash flow on an after-tax basis, a forecast of the expected return
on equity if you hold the property long-term. While you're there,
make sure to discuss the tax impact of selling now and also raise
the possibility of a 1031
like-kind exchange to invest in a different property -- postponing
all or part of the tax impact of selling this property.
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