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Five-year update: a quick recap for those who don't want to read the entire thread. The mortgage money we borrowed at 5.5% and invested in 2004 was up over 17% by 2005. Even as recently as Oct 2008 it was still up 5.4% APY. This month, after a very “interesting” year, it's recovered from the negatives to achieve a five-year after-tax APY of 2.0%. Not very encouraging.
The “good” news is that the reinvested shares are now 6.5% of the total and value stocks tend to carry a higher risk premium. If this is the worst that can happen in 30 years then there still appears to be time for this investment to recover. The mortgage payments are being made from pension income and ideally we can avoid withdrawals from this part of the portfolio.
Our home mortgage itself was refinanced earlier this year at 4.5%, which means that its interest rate might even be lower than CD rates (let alone equity returns) in a few years. I was pretty sure that we wouldn't see lower rates than that during the rest of my life.
However Brewer's thread on PenFed's 5/5 ARM rates made me take yet another look at NFCU and our local banks. (We refinanced our home with a regional bank, Territorial Savings) On a whim I asked Territorial if they'd give us a competitive rate on refinancing the mortgage on our rental home. Sonovagun: for just 2.175 points they were willing to give us a 4.625% fixed-rate 30-year “investor” loan. Beats the heck out of the rental's 5.5% loan and drops our payments by nearly 19%. Better yet, the payback on the total closing costs will only be about 33 months.
I've been grumbling about being a landlord, but it could be worse. Every couple years we spend a week or two of sweat equity to change military tenants and do a little rehabbing, but the place is in great shape and we've had good tenants. I'm a tad concerned about our landlord luck reverting to the mean. But Hawaii real estate values have been dropping and probably won't recover for several years, so landlording is a good way to pass the time while waiting for the recovery.
As compelling as the refi math may be, a 33-month payback implies that we're going to keep the place for another three years. Spouse wondered if we should use the refi to take out more of our dead equity and invest the money elsewhere. [Cue the collective groan from the “pay off the mortgage or invest” crowd.] Hypothetically we could just leverage what we're already doing with our home.
Our rental's current mortgage is about 20% of the home's value and Territorial is willing to go up to 70% LTV, so I started crunching numbers. Our current rental cash-on-cash return (after mortgage payments, insurance, & taxes) is no better than 4.7%-- and that drops with every maintenance call. The refi would push that over 5.1%. That's pretty good for Hawaii but nothing like Mainland numbers. (Hawaii land is so expensive that it ties up a lot of capital.) On the other hand, even 4.7% is a lot better than current long-term CD rates. It makes a lot of sense to refi the mortgage balance to raise cash-on-cash return to 5.1%.
If we took out more cash from our dead equity, we'd be doing so at what are arguably the lowest interest rates in 45 years (and this time I really mean it). We could try to invest it in the stock market or we could chase a little less yield by putting it into a short-term bond fund. Or we could put the mortgage money into a long-term CD (say at 3.25%) and lose money for a few years (~1.25%/year) until CD rates rise with the Fed's efforts to combat the “inevitable” coming inflation. Hopefully that wouldn't take 30 years, but it could easily take four or five.
But the leverage is intimidating. If we raised the mortgage from 20% of the home's value to 70% then we'd have bigger mortgage payments eating into the rental cashflow. To get the rental's net cash-on-cash return back up to that 5.1% ratio, the invested money would have to be earning at least 6.4%. Yet the biggest CD rate we've seen in the last three years was 6.25%.
It's frustrating. Interest rates are cheap now and they're almost certainly going to go up... someday. It makes lots of sense to borrow cheap for 30 years and hope that interest rates will stay above the spread for a long time. But if we'd tried that logic starting around 2003-2004 then we'd still be waiting for interest rates to come back up.
I think we're leveraged enough. We're just going to refi the rental's existing mortgage without taking out any more cash, and keep on landlording for another three years.
Some of you may be wondering: “Hmmm. If they're loaning money at 4.625% to landlords, I wonder what their rates are for owner-occupied mortgages?” It turns out that the real inflection point on 30-year fixed-rate mortgages is 4.5%. Lower rates are available but the points are prohibitively expensive. I think we're done after this refi, and this time I really really mean it!
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Last edited by Nords; 10-11-2009 at 10:18 AM.
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