Finally making money-- Who should I pay first?

[eyeballguy]

Hi everyone,

I am a 36 year old recently graduated optometrist. My 32 year old wife has just begun a 4 year medical residency program. Together, we have $387,000 of student debt at rates ranging from 5% to 7.9%. Because of our low incomes, we don't need to make student debt payments in 2013.

Currently, we have $2,000 a month to spend on debts and investments. When I get a full time job, we hope to have $3,000 per month. In 4 years, after my wife finishes her program, our combined income should be around $300-400k, so we should be able to make much higher payments.

Also, I'm renting out a townhouse I own. I no longer live in the state where the property is, but we hope to return there in 4 years. I am losing about $527 per year renting it out. (Financials listed at end of message.)

What would you do in my shoes?

1) Use money to pay off highest interest school loans (7.9%)
2) Use money to invest in Traditional or Roth IRAs. (To lower taxable income)
3) Use money to pay off first mortgage (5.5% fixed)
4) Use money to pay off second mortgage (3.25% variable)
5) Refinance townhouse to have extra money to do any option above.
6) Sell townhouse to have money to do any option above.
7) (Insert other good ideas here)


2012 Townhouse Rental Income
--------------------------------
$17232 Rent
--Total-------------------------$17232


2012 Townhouse Rental Expenses
--------------------------------
$538 Insurance
$4320 Homeowner Fees
$957 Repairs/Upkeep (higher than usual in 2012)
$3046 Property Management Fee
$3805 Real Estate Tax
$5093 1st & 2nd mortgage interest
--Total--------------------------$17759

Final question: Is the townhouse rental even a good investment? Even if I pay off my first and second mortgages, I only make $4,500 net a year (not counting appreciation). That doesn't seem like much when the value of the property is about $300,000.

[bjl584]

The first thing that I would do is look into selling the townhouse. It's out of state, you may or may not return to the area, and you are losing $500+ a month on it.

[siggy_freud]

The first thing that I would do is look into selling the townhouse. It's out of state, you may or may not return to the area, and you are losing $500+ a month on it.

He's losing $500 per year on it if I read it right. That's not much of a loss considering the how much equity you're retaining by having someone else pay for 90% of the mortgage. Yes, it IS a loss, but may be acceptable with a long-term outlook. Anything you can do to turn it into a profit?

[bjl584]

He's losing $500 per year on it if I read it right. That's not much of a loss considering the how much equity you're retaining by having someone else pay for 90% of the mortgage. Yes, it IS a loss, but may be acceptable with a long-term outlook. Anything you can do to turn it into a profit?

I see that now. Still, I wouldn't want the burden of being a long-distance landlord while servicing $400,000 of student loan debt. Sell the condo and simplify your life.

[riverwed070707]

Hi everyone,

I am a 36 year old recently graduated optometrist. My 32 year old wife has just begun a 4 year medical residency program. Together, we have $387,000 of student debt at rates ranging from 5% to 7.9%. Because of our low incomes, we don't need to make student debt payments in 2013.

Currently, we have $2,000 a month to spend on debts and investments. When I get a full time job, we hope to have $3,000 per month. In 4 years, after my wife finishes her program, our combined income should be around $300-400k, so we should be able to make much higher payments.

Also, I'm renting out a townhouse I own. I no longer live in the state where the property is, but we hope to return there in 4 years. I am losing about $527 per year renting it out. (Financials listed at end of message.)

What would you do in my shoes?

1) Use money to pay off highest interest school loans (7.9%)
2) Use money to invest in Traditional or Roth IRAs. (To lower taxable income)
3) Use money to pay off first mortgage (5.5% fixed)
4) Use money to pay off second mortgage (3.25% variable)
5) Refinance townhouse to have extra money to do any option above.
6) Sell townhouse to have money to do any option above.
7) (Insert other good ideas here)


2012 Townhouse Rental Income
--------------------------------
$17232 Rent
--Total-------------------------$17232


2012 Townhouse Rental Expenses
--------------------------------
$538 Insurance
$4320 Homeowner Fees
$957 Repairs/Upkeep (higher than usual in 2012)
$3046 Property Management Fee
$3805 Real Estate Tax
$5093 1st & 2nd mortgage interest
--Total--------------------------$17759

Final question: Is the townhouse rental even a good investment? Even if I pay off my first and second mortgages, I only make $4,500 net a year (not counting appreciation). That doesn't seem like much when the value of the property is about $300,000.

Can you clarify this rental situation? You say $5093 is the first and second mortgage *interest* -- are you not paying any principal on the loans? Or do you really have a $425 mortgage payment (between 2 mortgages) and rent your house for $1400+/mo? If you're not paying principal on the loans and you're losing money every month you need to sell this ASAP. Sure is a whole lot of fees!

Regarding the first question, I think we need more info. What is your retirement situation like? Given your age, if your retirement is behind or non-existant, I think that needs to be your focus. But if you've been plannign for retirement while attending school and that situation is under control then focus on those loans. I can't begin to digest how long it would take to pay that kind of debt. Additionally, I do hope that her next 4 years are planned to be paid out of pocket and not with MORE loans. If that is not the plan, she should strongly consider altering her plan to minimize the financial impact. Adding more debt to an already obscene amount is not the right answer. Are you really going to be paying your student loans in retirement? Seems to defeat the purpose of working toward a high paying job.

[eyeballguy]

More information

Thanks for the feedback, everyone. Here's some more information:

We're both career changers, and even though we've racked up a tremendous amount of debt, at least our income potential will jump tremendously in 4 years. In the future, I hope to maintain our frugal lifestyle and pay off our debt as soon as possible.

Also, we've only managed to save $74,000 in Roth IRAs and the equity I've built up in my townhouse for retirement. I know I am behind here.

Concerning the townhouse, the first mortgage is a 15 year loan (5.5%) which is scheduled to be fully paid off in 4 years ($67,000). When I don't have to pay that interest, we will make a profit of about $2,800 per year.

If we pay off the second mortgage (home-equity loan) (3.25%), our income will increase by an additional $1750 per year (for a total of about $4550). (I am not sure if I should pay off the 2nd mortgage quickly because the interest rate is so low-- but it is variable, too!)

Every month I pay nearly $1700 a month for a mortgage payment to keep the townhouse. So I've got a pretty high negative cash flow. But we're frugal, so I've been able to keep afloat.

We are not taking loans out to service our debt. In fact, for the first time in YEARs I am finally able to pay my bills-- And that feels good.

What do you think?

[eyeballguy]

Clarification

And just to clarify, I do not have 2 mortgages on 2 separate properties. I have a first mortgage and a home-equity loan on my single rental property.

I currently pay about $900 a month to live in an apartment. It's within walking distance of the hospital, so we only need 1 car since my wife can walk to the hospital.

One concern I have about selling my townhouse is that I will get killed by taxes. At this point, it's considered a business investment. I purchased the townhouse for $200,000 in 1999. Now it is likely worth $300,000.

And should I wait until the real estate market gets better?

What do you think?

[eyeballguy]

Even more information

Also, it's really no headache to manage the rental property. My property manager takes care of almost everything. I'm just wondering if I could be using my money wiser instead of paying off the negative cash flow. (Although building up equity is nice and the allure of easy income in 4 years is sure nice...)

Finally, if I sell the townhouse, I'm not sure how much money I'd get. Once you pay off the first mortgage, the home equity loan, pay taxes, realtor fees... would I really end up with much money?

[Bob B.]

Finally, if I sell the townhouse, I'm not sure how much money I'd get. Once you pay off the first mortgage, the home equity loan, pay taxes, realtor fees... would I really end up with much money?

Put those figures (or estimates of those figures) into a spread sheet. What do you come up with? Remember, you only pay capital gains taxes on the gain, or the profit.

I think the capital gains rate for most tax payers is 15% (depends on your tax bracket). And, you can deduct realtor fees, other costs associated with selling the house, and improvements from the gain.

[Petunia 100]

You also have to recapture the depreciation, at ordinary income tax rates.

ETA: I am wrong about it being taxed as ordinary income. I just looked it up, it is taxed at a maximum rate of 25%.

[BMEPhDinCO]

Sell the townhouse - if it is an "investment", you shouldn't be loosing money on it. The other option would be raise the rent another $50 a month to cover your loss. If you do sell it, don't worry about the taxes, a married couple has $500k exemption before you have to pay for taxes on a house sale.

You should do a quick zillow or similar search to see what it is "worth" based on recent sales around it and the condition/upgrades you have done.

It sounds to me like you are in a bit of a "holding pattern" for another 4 years before things happen - in that case, I'd put your extra into your Roths, they are far behind what they should be.

Good luck with your new career and hopefully your wife's in a few years!

[sblatner]

Sell the townhouse - if it is an "investment", you shouldn't be loosing money on it. The other option would be raise the rent another $50 a month to cover your loss. If you do sell it, don't worry about the taxes, a married couple has $500k exemption before you have to pay for taxes on a house sale.

You should do a quick zillow or similar search to see what it is "worth" based on recent sales around it and the condition/upgrades you have done.

It sounds to me like you are in a bit of a "holding pattern" for another 4 years before things happen - in that case, I'd put your extra into your Roths, they are far behind what they should be.

Good luck with your new career and hopefully your wife's in a few years!

I believe the $500k exemption only applies if you have lived in the house for 2 of the last five years.

[Petunia 100]

Sell the townhouse - if it is an "investment", you shouldn't be loosing money on it. The other option would be raise the rent another $50 a month to cover your loss. If you do sell it, don't worry about the taxes, a married couple has $500k exemption before you have to pay for taxes on a house sale.

The townhouse has been a rental since 1999, and as such does not qualify as a principal residence. The exclusion does not apply to rental property.

[siggy_freud]

Sell the townhouse - if it is an "investment", you shouldn't be loosing money on it.

I think it's incorrect to frame his bottom line on the townhome like this. He's not losing money on the townhome. What he's doing is investing in a long-term account (the property itself), that will hopefully appreciate. If I'm reading the OP's statement right, it's costing him $500 a year to own the townhome. But how much principle is that renter paying FOR him in a year. I bet it's a lot more than $500 bucks. So you can't really just say he's flat out losing money, because he's not. He just won't see a return on the money until he sells. If he can afford it, hold it. Unless you're forced to it doesn't make sense to sell near the bottom of the market.

[I-78 Commute]

OP also said he would return to where the townhouse is in 4 years. So one question I would have is would you move into the townhouse when you do move back?

It sounds like you have a cash flow issue and a retirement issue. You could sell the townhouse now, clear what you can clear and then alleviate the cash flow issue (and start putting more of that cash flow into retirement and at the higher interest student loans.) I wouldn't be against carrying the townhouse long term though if you think it will continue to appreciate. If it's still +100k after the rollercoaster since 1999 it hasn't done that badly.

If you're not going to move back into the townhouse what does your liquid savings look like? You could start parking money away for a house and then + the additional income + the townhouse appreciation(I can't imagine it would lose money over the next 4 years) would put you into something you could easily afford (and I would definitely go 15 on that mortgage if that's what you decide to do. You'd be 55 and she'd be 51 when you would pay that off so no mortgage in retirement.) If the rate is low enough on the 15 you could put money in a lot of other places for the long term.

If you do plan on moving back into the townhouse and stay there then you have to figure how long it would take you to pay off the loans vs refinancing to see which way you'd come out ahead more quickly. At 300-400k with the first mortgage cleared and the 2nd one on its way out at ages 40 and 36 you'd have a ton of options. I'm not a fan of variables but rates are really stagnant right now. At your income level you should be able to clear it relatively quickly if you keep other expenses down (which it sounds like you already have.)

Do you plan on having kids? If you do you could open a 529 and start parking money away and get the tax breaks there. The 529 can be opened in you or your wife's name and then you can add your kid(s) when you have them. A jumpstart on college savings is never a bad thing plus they can help your AGI.

Just trying to think outside the box.