Investment property refinance following a low appraisal?

Question

Before I met my wife, I bought a house in April 2007, using a mortgage from my credit union. In December 2011 I refinanced this mortgage into a 4.625% fixed conforming 25-year mortgage with a Lender. Current biweekly mortgage payment is $745.04.

My wife & I bought our new primary residence in April 2013. We retained 'my' first house as an investment property. We've had a great tenant in there since June 2013 and are about to negotiate another year of lease effective June 2015. Between mortgage, utilities, taxes, minor repairs, and insurance vs. rent, we're rolling just about even and we've enjoyed the nice deprecation bump at tax time. So far, so good.

The current outstanding principal on the mortgage is $184,050.51. A payoff statement effective 4/1 suggests I'd need to bring $184,809.87 to a refinance.

Some weeks ago I saw rates were low, and we got locked in for a 15-year fixed refinance @ 3.5%. An appraisal was ordered and conducted, and the property came in at only $230,000 - far short of the $240k-$250k we expected.

With the 75% rule, the lender can not loan me more than $172,500. With closing costs and miscellaneous fees rolled in, my wife and I would be looking at writing a check for $17,251.35 at signing, including about $6k in closing costs and reserves.

We've already paid for the appraisal ($600) to it's a sunk cost if we walk away.

We hold a 0% promotional balance on our credit card through April 2016 (currently $15k). Besides the current refinance, the next-highest interest rate we carry is our primary residence (3.63%) with another lender.

I'm able to borrow up to $32k from my 401(K) at 3.75% annually.

I'm struggling with what to do. Obviously I want to find better comps in the immediate area to refute the low appraisal, but the appraiser does not work for me, and I'm told any effort here is unlikely to have any effect on the appraised value. Let the rest of this question assume we can borrow no more than $172,500 for the refinance.

All else being equal, do I:

1. Do nothing. Hold on to the current mortgage @ 4.625%. Swallow the $600 appraisal charge.
2. Do nothing, but prepay some principal to sweeten #1 above. How much?
3. Refinance. Come up with $17K in a month or so - very possible without borrowing from the 401(K), absolutely an option with borrowing.
4. Something else?

Any thoughts appreciated, thanks. Let me know if any more detail is needed. I have the latest GFE and piles of other documents in front of me.

Answer 1

Definitely don't borrow from your 401K. If you quit or get laid off, you have to repay the whole amount back immediately, plus you are borrowing from your opportunity cost. The stock market should be good at least through the end of this year.

As one of the commentators already stated, have you calculated your net savings by reducing the interest rate? You will be paying closing costs and not all of these are deductible (only the points are). When calculating the savings, you have to ask yourself how long you will be hanging on the property? Are you likely to be long term landlords, or do you have any ideas on selling in the near future?

You can reduce the cost and principal by throwing the equivalent of one to two extra mortgage payments a year to get the repayment period down significantly (by years). In this way, you are not married to a higher payment (as you would be if you refinanced to a 15 year term).

I would tend to go with a) eat the appraisal cost, not refinance, and b) throw extra money towards principal to get the term of the loan to be reduced.

Answer 2

The new payment on $172,500 3.5% 15yr would be $1233/mo compared to $1614/mo now (26 bi-weekly payments, but 12 months.)

Assuming the difference is nearly all interest, the savings is closer to $285/mo than 381.

Note, actual savings are different, the actual savings is based on the difference in interest over the year. Since the term will be changing, I'm looking at cash flow, which is the larger concern, in my opinion.

$17,000/285 is 60 months. This is your break even time to payoff the $17000, higher actually since the $17K will be accruing interest.

I didn't see any mention of closing costs or other expenses. Obviously, that has to be factored in as well.

I think the trade off isn't worth it. As the other answers suggest, the rental is too close to break-even now. The cost of repairs on two houses is an issue. In my opinion, it's less about the expenses being huge than being random. You don't get billed $35/mo to paint the house. You wake up, see too many spots showing wear, and get a $3000 bill. Same for all high cost items, Roof, HVAC, etc.

You are permitted to borrow 50% of your 401(k) balance, so you have $64K in the account. I don't know your age, this might be great or a bit low.

I'd keep saving, not putting any extra toward either mortgage until I had an emergency fund that was more than sufficient. The fund needs to handle the unexpected expenses as well as the months of unemployment. In general, 6-9 months of these expenses is recommended.

To be clear, there are times a 401(k) loan can make sense. I just don't see that it does now.

(Disclaimer - when analyzing refis there are two approaches. The first is to look at interest saved. After all, interest is the expense, principal payments go right to your balance sheet. The second is purely cash flow, in which case one might justify a higher rate, and going from 15 to 30 years, but freeing up cash that can be better deployed. Even though the rate goes up say 1/2%, the payment drops due to the term. Take that savings and deposit to a matched 401(k) and the numbers may work out very well. I offer this to explain why the math above may not be consistent with other answers of mine.)

Answer 3

If I was you I would not borrow from my 401K and shred the credit card offer. Both are very risky ventures, and you are already in a situation that is risky. Doing either will increase your risk significantly.

I'd also consider selling the rental house. You seem to be cutting very close on the numbers if you can't raise 17K in cash to refi the house. What happens if you need a roof on the rental, and an HVAC in your current home?

My assumption is that you will not sell the home, okay I get it. I would recommend either giving your tenant a better deal then the have now, or something very similar. Having a good tenant is an asset.