Oops, We Have a Mortgage Again

That's the title of our terrible Brittany Spears spoof. But it's true, kind of. After aggressively paying off the mortgage on our primary residence a mere three years after buying our first home, mostly thanks to Dave Ramsey and his crazy baby step number six, we're now in the process of a cash-out refi and tapping that equity, so we can end up right back where we started with a one hundred thousand dollar mortgage.

No one ever said we knew what we were doing with money.

Why would we do such a thing? Isn't being debt free just the bee's knees?

As with most of the big financial moves we make, there isn't one single and satisfying answer. Instead, we have are a few smaller answers that join up, like a Voltron made-of-dorky-financial-answers, and, together, help make good financial decisions and, you know, defend the universe.

Debt Free Ain't All It's Cracked Up to Be
I suppose debt freedom is supposed to feel something like financial nirvana but, if it ever was, it sure wore off quick. After paying off the mortgage back in 2013, we've regressed back to the emotional mean, or at least forgotten whatever having a mortgage and a monthly bill feels like.

For better or worse, there isn't an emotional desire to be debt free any longer.

Opportunity Costs
It's nice to avoid paying the interest rate (4.25%) on our old fifteen mortgage. But since the market historically performs better than that, especially over a 15 or 30 year mortgage period, there isn't a great logical reason to pay off a mortgage early since that typically will only increase your opportunity costs.

In short, paying off our mortgage early was not an optimal financial decision. But since those are sunk costs, gone forever with nothing to do about it, all we can do now is evaluate what's best going forward.

Luckily, the same analysis applies. If applying extra funds to investments instead of a mortgage payoff was a good strategy before, it also applies to getting a mortgage and investing the funds now (with one caveat that we'll get to later).

Money is Cheap
It doesn't hurt that the rate we locked in at is now even lower than that of our first mortgage, at 3.625%, and that's on a 30 year mortgage instead of a 15.

Now, there are definitely some upfront costs. Factor in the underwriting, appraisal, title insurance and other various fees that unfortunately come along with a mortgage, and we're looking at around three grand to borrow $100,000 of our own equity. Not great.

But, the money we invest should make back this three thousand in fairly short order. Certainly we should come out ahead over thirty years.

Arizona Property has Rebounded
When we purchased our home in 2010, we bought it for $132,000. We conservatively figure the house is worth $100,000 more now, somewhere around $230,000.

Depending on how comfortable you are with mental accounting, you could say that we're borrowing the $100,000 from the property's gains, rather than the $100,000 we used to pay off the original mortgage. While that sort of thinking is a shell game, it's a fun and somewhat comforting one for this homeowner to play.

Buying another House and, I suppose, Another Rental
The reason we're tapping this equity now is that we want to buy another house, a new primary residence, and to turn our current house into a rental property. We will try to start a family in the next year or two, and we'd like a house that would better suit us when we have a family (better school district, maybe something newer without lead paint, etc.). And, if we're being real, this first house was our starter house. We want a nicer kitchen and bathrooms, a little more space, and just a nicer home all around.

If we take out the loan now, we get a better rate than if we no longer live in the house and it's already a rental (by about a 1% difference in rate, since rentals get worse mortgage rates). This has a couple benefits for us. One, the rental will perform better if we have lower costs for the loan (coupled with the fact that we'll be local and can choose to be our own property managers, if we want to). Two, this also allows us to use some of the funds from the loan to serve as the down-payment for the next house. So, figure we will invest about $40,000 of the $100,000 borrowed, and use the remaining $60,000 as a down-payment. (I know this is typically not advisable or even allowed with some banks, but it's technically "our" money that we're accessing via the loan and, hey, the underwriter is already on board.)

The Bottom Line: We're Leveraging Up
After being anti-debt proponents for so long, we're going in the opposite direction and borrowing, both for our primary residence and for what will be our third rental property.

This has risks, as does all borrowing. Simply put, we are going to have four mortgages to pay, instead of the two we have now. To share some numbers, here is what our total debt will look like after we have all our loans:

Rental Property 1 (Indianapolis): $71,000, renting for $1,125/month
Rental Property 2 (Indianapolis): $64,000, renting for $1,000/month
Rental Property 3 (Scottsdale): $100,000, rent TBD (estimated between $1,100 and $1,300/month)
Primary Residence (probably Tempe): TBD, estimated between $240,000 and $280,000 ($300,000 to $350,000 purchase, with 20% down)


My thoughts on this debt falls into two buckets. For the rental properties, I'm completely fine with taking on debt when the numbers point to an income producing asset. Leverage makes the rentals more profitable and limits opportunity costs. We aim to limit the debt so that the monthly payments are so far below the monthly rent that we're able to save 20% of all rents just to save for future maintenance and vacancy, while still pulling good profits from each house. Adding a third rental will actually add to our income streams, bringing in another few hundred a month.

It's the next primary residence that I'm not quite as sure about, from a purely financial sense. We want a new house, without a doubt. The decision is in large part emotional or want based, since our current home is fine: it keeps the water off our heads, has three bedrooms and two bathrooms (though no suite) and is in a good neighborhood that doesn't even require us to lock the doors when we leave the house. We just want something nicer. A bigger kitchen with an island and fancy counters and cabinets made of solid wood, and a big old farm table in the dining room that we can play board games on.

But despite our genuine-but-first-world wants, I'm still not entirely sure how they fit into hitting financial independence in five years. Shamefully, I haven't run the numbers, because I know that buying an expensive house doesn't make reaching financial independence easier. It probably means working beyond our initial timeline so that we can pay off that new big mortgage.

An alternative might be to fix up our current home: putting in a new kitchen, renovating bathrooms, and maybe even an addition so we can have a big master with a suite. That has costs, too, but nowhere near an additional $300,000 or $350,000.

We've noticed some lifestyle creep in our lives in the past two years, like fancier groceries and more international vacations. But this new house would be a major deviation, as it would add a big honking four figure monthly expense to the budget, at least until we pay off the big honking six figure debt.

What do you think, readers? Are we foolish for leveraging up on our current property?

More importantly, is the loan for our current property potentially acceptable, but ought we reconsider buying a more expensive primary residence so close to early retirement?

Honest opinions are genuinely welcome. We are not seeking affirmation of our current plans but, instead, wise counsel from trusted readers. Thank you, as always, for reading.


*Photo is from Nick Kenrick at Flickr Creative Commons.