Should I refinance our rental property at a lower rate and put monthly savings into 401k (employer matches)?

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I had originally posted this question under “Renting and Real Estate”, but the circumstances have changed.

I’ve inherited $ 40k and trying to see what the best use is for it. I have a small rental property that was valued at $ 435k in 2007 when I took out cash to make down payment on our current house. I refinanced $ 344k on the rental at 6.625%. I have an opportunity to refi it at 5.25% which will cost 3.375 discount points/origination fee and other closing cost. However, most current bank appraisal for this property came in at $ 355k which means I need to come up with about $ 65k (borrow $ 25k at 4.5% from HELOC) to close the loan. Current mortgage balance on the rental is $ 336k. Based on a simple calculation, I will save about $ 615/month and about 2 years to recoup all of the closing costs to breakeven.

Does it make sense to refinance our rental property, use my inherited $ 40k and borrow $ 25k from HELOC, save ~ $ 7,380/year on rental mortgage and set aside part of the savings into my 401k (employer matches)? Of course, I’ll be making monthly payments to payoff the borrowed $ 25k HELOC.

2 Comments
  1. Reply
    goo_head_83
    April 29, 2011 at 11:47 pm

    To me, that sounds a little too risky. Ask yourself how your job and your spouse’s job is right now. Could you afford to continue making these payments if one of you lost your job? Right now is a great time to do stuff like this, but unless you are financially sound and could make it with one income then I would suggest doing something else.

  2. Reply
    Lauren F
    April 30, 2011 at 12:34 am

    I think you should shop around a little. The almost 4 points here is close to $ 12,000 in fees. That is quite high. You can do better if you shop around.

    Now in answer to your question.
    1. First, make sure there are no taxes due on the money you inherited. If it was stock, and investment, or a piece of property, there might be capital gains due on it that you should resolve before putting it into place.

    2. If you are not currently participating to get the full match in your 401k, then absolutely *** no brainer . Do not refi **** . Use the inheritance to help fund your 401k because the employer match is 100% free money which is worth more than the intererst rates you are paying.

    3. Talk with a tax advisor. Since this is rental property, all the interest you pay is business interest, therefore fully deductible. You want to understand what your true after-tax cost of this interest is.

    4. Third, run all your numbers through a payment calculator, such as bankrate.com. As far as I can tell, you are probably paying close to $ 2,200 a month principal and interest on your existing mortgage. If you pay close to $ 12,000 to refinance, and use your 40,000 inheritance, you will trade this $ 2,200 a month payment for a $ 1,601 payment on the new first mortgage and a $ 160 a month payment on the Heloc. This is a new combined cost of $ 1761, and your savings before tax considerations is around $ 438 a month. This means it will not be nearly as much of a savings as you hoped. And, your math does not include the avoided earnings your $ 40,000 could earn if invested somewhere. If it earned just 4% in an investment, that would be $ 133 a month or lost income to take into consideration.

    5. Go over your rental property with an experienced house inspector or realtor and make an inventory of all of the major systems and equipment in the house and determine if any will need major overhaul or replacement in the next three years. If they will, you may want to keep some of this cash handy. Same is true of your own home and cars. Don’t tie up this windfall into investments that are very difficult to take money back out of, like houses and 401ks.

    6. If you have any other consumer debt – such as credit cards or car loans, pay those off first. They have no tax deduction, and are probably a higher interest rate than what you would pay on your HELOC, so you would be better off getting rid of those.

    7. Decide how long you are going to keep this property. If less than 4 years, it is probably not worth the cost to refi.

    Personally, I would hesitate before committing all of this $ 40,000 to either a house or a 401k. While these are both great investments over time, once you put money into a 401k or as a paydown against a mortgage, it is costly and difficult, if not impossible, to get it back out. And, your HELOC is probably a variable rate loan, which means you could end up spending more than 4.5% on that loan at a time when you might not have cash to pay it down.

    I would increase your 401k for both you and your spouse, to get the employer match and tax savings, then pay down consumer/car debt second, then set aside an emergency fund for any major equipment repairs/replacements. Then, if anything is left, look at refinancing the house.

    Good luck.

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