Use Two Lines of Credit or Use One and Sell Mutual Funds

[retiringby50]

Should I sell the mutual funds or take out two lines of credit?

Background
Not sure what we've done here, but I'm refusing to have buyer's remorse! We want to remodel our current house because we feel we will live in it "forever." Family is here, we're entrenched in the community, etc., and there is no better place to live than in a suburb of San Francisco. Even if DD grows up and moves away for her job, we're staying here, so we want to have our home done in a way to fit our needs. Construction will cost $120K and take 9 months (conservative estimates - I've already added 20% on top of what we think it will be in both cost and time). Due to the excavation, dust, etc., we won't live in it while remodelling.

My husband, who is adverse to paying rent, decides that we're going to buy another house to move in. Otherwise, we'd either be paying about $22K in rent ($2400 x 9 months). We offered and got the home. Unless the inspection stinks, it's ours in 15 days! In case anyone is curious, it was $500K for a 4 bedroom, 3 bath, single family detached home; in move-in condition, it's worth about $750K. But it also needs some work (carpet, paint, possible some bathroom/kitchen work). Conservatively, about $50K and will probably take about 2 months. We would be using this as rental property after we move back.

Coincidentally, I have two lines of credit available on my current home that equals $500K! I owe about $200K on this home, and it's worth about $750K. I have about $450K in mutual funds that I had just invested in... January 2008! My initial thought was to use one of the $250K lines of credit and sell $250K of mutual funds to pay for the home, but what do you think?

1. Is there a strategy here that I need to know about? Is it better to not use both equity lines of credit?!
2. If I should sell my mutual funds, is there a strategy to it? Do it all at once, spread it out over the next two weeks?
3. When selling, do I pick the funds that have lost the most money? Or does it really matter in the end? I guess I DO need to make sure I don't sell anything w/gains (I doubt there are any anyway) so that I don't pay short term capital gains tax.
4. Anything else?

As always, thanks!

 

[Animorph]

I'd go with the two lines of credit and keep the mutual funds, but you need to have a good margin of safety to do that. I'd expect to earn more than the loan cost from the mutual funds over the next few years. I've invested my HELOC starting late October last year with good results so far. But I also have almost 2 years of living expenses sitting in cash and plenty of home equity left.

If you do sell, I'd wait for the market to be hitting monthly highs to catch a little extra gain. Selling all or part is up to you. Short-term losses are good, but make sure you don't unbalance your asset allocation.

 

[deepc]

Would also say to go with the credit, especially if selling the mutual funds results in a loss. After all, you did buy the mutual funds with a longer term outlook than one year, right?

Guess it's too late to say that the purchase could result in being the biggest mistake you're about to make. You say it's worth $750k in move-in condition, but you're about to set its price point at $500k. Doubt anyone would pay you a $250k premium a year from now for carpet, paint, and a little reno work, but you know your market.

Renting, and living way below your means since it's only temporary, would be a good option. You're more flexible, because your main home's renovation will take longer than they say. I mean, just think of the closing costs of your $500k house amortized over the time you'll really need it. And will you rent the house when you're done or will you try to sell in this market? Even better there's ways to live in a house getting worked on that may not be the most enjoyable, but it's only temporary.

Last, $120k doesn't seem like a whole lot of budget for 9 months of work. A roof on a tiny house around here goes $12-20K. Are you sure they're not low-balling the estimate and will catch you up on change orders and non-included necessities (like appliances, flooring, fixtures, paint, etc?)

 

[retiringby50]

Guess it's too late to say that the purchase could result in being the biggest mistake you're about to make.

I'm definitely aware of this because it's a scary thing - it seems like all our money is in real estate! Our plan is to hold onto this house for the long-term as in next 20 years type of thing, although I've told DH that I don't want to deal with being a landlord when we're old, and this new one might end up being the house that we give to our child (haven't quite figured out the pros/cons of that decision yet, but she's only 11!).

I'm actually surprised that both of you mentioned to take out the lines of credit - figured that was an automatic no-no for whatever reason (like "OMG, what are you thinking?!). Hoping to hear from others, even if it's the same answers. Thanks everyone!

 

[Animorph]

I'm surprised you haven't heard the "OMG, what are you thinking" yet. I thought those of us willing to use HELOC's for investing were fairly rare on this forum. So hopefully one of them will come up with an answer to balance us out.

Given that most people expect higher market returns than home loans usually charge in interest, the default should be borrow and invest. The problem is the risk involved since you are not getting historical average returns and you are not doing this a whole bunch of times that might average out to something decent.

One problem is if the lender lowers the limit on your unused line of credit. For that reason I have my living expenses in cash and my HELOC just about fully used and invested, instead of having the cash invested and withdrawing from the HELOC as needed. Kind of pricey for me, but things were not looking good at the end of 2008 for lines of credit. Of course that allowed me to buy a few ETF's on 11/20/08 and sell my original more expensive shares later, so it's not all risk reduction.

Make sure your taxes work out the way you want as well. Home purchase loans are better tax-wise. Investment loans can offset investment income (regular dividends), but their deductability isn't as good.

 

[Darryl]

OMG what are you thinking.

The house you are buying is not worth 750k, the market just confirmed it's value is 500k.

You are wise to pad the cost and time estimate to the upside, unfortunately only using 20% could prove to be wildly optimistic on your part.

If the remodel is important go for it by selling the funds and remodeling with cash. Don't want to sell the funds? You can remodel at any time in the next 20 yrs while you live there. Husband is unwilling to spend 22k in rent, but is okay with transaction costs and market risk of buying an additional house to avoid paying rent? Very aggressive and gutsy move on his part. Good luck with that.
Startegy:
1. Don't create your own liquidity crisis
2. Maintain your AA, cannot forecast direction of market you have to decide on lump sum sale or stepping out of it in stages.
3. Maintain your AA per your risk tolerance and your longterm plan.
4. As you sell these funds at a loss you will get some tax relief and carryovers for years, assuming the law stays the same.

 

[2B]

I second Darryl. Why would you buy another house for 9 months of inconvenience? The rent is a minor part of the cost involved versus the risk of having a second money pit in a single market.

The rent you would pay won't be as much as your fix up costs for the new house. Your commission when you sell house #2 will be in the $30,000 range. You'll be paying all sorts of wonderful interest on all your new loans.

We all know real estate only goes up and it's real easy to sell.

 

[retiringby50]

Thanks for the comments. Regarding the home value, at the high it was $950K+, but the house is worth about $750K now if it wasn't in its scary state (comps, actuals, listing price, 1/2 mile from where we live now, etc.). The only reason we got it was because we put down an all-cash offer right away, gave low # of days for the contingencies, and short escrow time. Today the agent kept the open house that he had already advertised (he tells people who come in that it's pending), because it's a way for him to meet people, and there were probably 50 people coming through the house during the 1 hour we were there meeting w/the contractor. The negative part is that I'm sure the contractor (we've used several times in the family) is going to quote an amount that is much higher than the $50K I was hoping for. Selling the house would be way later though, if it even happens at all.

My accountant's suggestion is to use both lines of credit but refinance when we move in as a principal property to get rid of 1 line of credit since the HELOCs are not fixed rates.

 

[2B]

My accountant's suggestion is to use both lines of credit but refinance when we move in as a principal property to get rid of 1 line of credit since the HELOCs are not fixed rates.

Danger Will Robinson Danger Danger Danger

 

[deepc]

Just reread your original post and see you intend to use this new house as a rental down the road. The usual make/break is that the house costs 15 times the annual rent (very more or less figure).

Can you really expect to rent this house for over $3k a month when you also say that you could rent for 2,400?

It sounds as if the realtor doesn't expect the deal to go through, and if there is such high demand for the house why did he let it go so cheap? Things don't add up.

 

[retiringby50]

We've already done the deed, so now I just need to learn more on what to do next... plus, hey if it comes up again, I'll know what not to do!

Danger Will Robinson Danger Danger Danger

Please help me understand why it's not a good idea. And how would you suggest financing using the info given? Thanks!

The usual make/break is that the house costs 15 times the annual rent (very more or less figure). Can you really expect to rent this house for over $3k a month when you also say that you could rent for 2,400? It sounds as if the realtor doesn't expect the deal to go through, and if there is such high demand for the house why did he let it go so cheap? Things don't add up.

Hmm, didn't know the rule of thumb, but good to know for the future. Thanks! $3K might be reasonable, but we hadn't really thought of how much we'd rent it out for yet. There are only a few houses in the area for rent, and I saw a smaller house w/1 less bedroom for $2,500 and 1 that looks equal for $3K... whether they'll get that or not is another thing. The $2,400 that we were thinking of paying would have been for a 3 bedroom home, so it'd be smaller than the house we bought. Property was bank owned. 10+ offers were submitted. I heard they didn't accept higher offers, so I'm assuming we got it because of our terms.

 

[FIREd]

In case anyone is curious, it was $500K for a 4 bedroom, 3 bath, single family detached home; in move-in condition, it's worth about $750K.

I wish I could say that with stocks! I bought VGTSX for $11 a share but it's really worth $15! Or Quicken says my portfolio is worth $500K, but it's really worth $800K!

 

[2B]

Please help me understand why it's not a good idea. And how would you suggest financing using the info given? Thanks!

Debt in one form that will be turned into debt in another form. You may not get refinanced like you think. Your HELOC interest may go up. One of many things may happen that suddenly puts your much higher debt level into a crisis. You have a plan but life doesn't always follow it. I see a much higher level of risk.

 

[deepc]

Hmm, didn't know the rule of thumb, but good to know for the future. Thanks! $3K might be reasonable, but we hadn't really thought of how much we'd rent it out for yet. There are only a few houses in the area for rent, and I saw a smaller house w/1 less bedroom for $2,500 and 1 that looks equal for $3K... whether they'll get that or not is another thing. The $2,400 that we were thinking of paying would have been for a 3 bedroom home, so it'd be smaller than the house we bought. Property was bank owned. 10+ offers were submitted. I heard they didn't accept higher offers, so I'm assuming we got it because of our terms.

To be honest I fudged the numbers in your favor. The usual rule of thumb is 12-15 times the annual rent, and your cost will likely be closer to 600k than the 550k I used. Using 12x and 600k you need to see about 4200 a month to make it a go. You're about to put yourself under a huge load of debt and inconvenience.

What can you do? Your only other option than going ahead is to back out of the deal. Sure it'll cost you earnest money, but unless you put down a whole lot that's less than you stand to lose otherwise. This is a principle termed "sunk cost" and although it's hard to admit a mistake it's better than throwing more money away.