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Here's the situation: Married, late 30's, combined income around $170k. 2 toddlers. We owe $360k on a house worth $600k. Only other debt is $20k each in student loans. 401k plans are in order. We have about $140k in savings that we're not sure what to do with.

Our one short-term goal (3-5 years) is to upgrade to a custom home in a different area, which will likely cost upwards of $1.5M.

So the question is what can we do to maximize our savings in the next 3-5 years? Or anything else we can do to reach our goal as soon as possible?

Secondary question: I've heard some people say that you shouldn't ever sell a house. Won't we pretty much have to sell our current house for a down payment on the next one?

EDIT: This is in the Los Angeles area.

  • What state or country is this in? Click EDIT below your question and give us some idea where this is. – Paul Jan 28 '14 at 19:44
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    When I got married, we bought a home valued at 2.5X our income, 20% down, so the mortgage was 2X income. For the next 3 years my wife asked me if we could afford it. You are proposing to have a house worth 9 times current income. Does that really make sense? Or is this your priority? As some live in a tiny apartment and take overseas vacations 4 weeks a year. – JoeTaxpayer Jan 28 '14 at 20:25
  • I realize it's a lofty goal, and we won't do what we can't afford. But the question remains how to make the most out of our money in the meantime. – kmo20 Jan 28 '14 at 20:48
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Quick pay off the student loans. You have 140K in savings with a combined salary of 170K. You are looking to make money with the 140K, so just pay off the loans. It will turn your monthly loan payments in to a stream of money that can be used to save money for the next house.

Assume:

  • 200K salary level in 5 years.
  • you can get a mortgage for 4x salary level, this will depend on interest rate then.
  • Therefore the maximum loan amount is 800K.

The rest of the 700K needed for a 1.5 Million dollar house has to come from savings and the profit from selling the first house. If the house sells for loan balance +300K you still need 400K in savings.

Turning 140K into 400K in 5 years will funneling a large amount of your income into savings or excellent returns. Of course there is no way to predict return or what will happen to the market.

If you don't sell the first home, you can rent the house. You either hope that the rental you charge allows you a positive cash flow. Or you hope that the house appreciates in value, so you hold on to it even if the rental income is a little below break even. Of course some keep the house because they can't sell it.

In your case the equity might be more important for you to purchase the next house.

  • +1 for rental. Also note that the first house can be mortgaged to help pay for #2, and the rental income is partially counted in the borrower's payment calculation since it's income. Your lending institution can tell you how much % of gross rent they count and how that affects you. – Jerry Penner Jan 28 '14 at 20:13
  • I'm a little hesitant to spend 1/3 of our savings paying off the student loans. In the long run, sure, we would end up paying less interest on the loans, but I don't see how that would help us with our short term goal. – kmo20 Jan 28 '14 at 20:16
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A friend tweeted a similar question regarding student loans, and I responded with Student Loans and Your First Mortgage.

The punchline is that you need to be aware of the 28/36 ratios in a bank qualifying you for your mortgage. Even though you have a house, you may not be aware of this.

Simply put, 28% of gross monthly income can be used to qualify for your house burden, loan, taxes, etc. 36% for total debt. So the student loan may fit in that 8% gap, and paying it all off reduces the cash you have without helping you borrow more money.

3-5 years is short term, and to that part of the question, this money should not be invested in anything at risk. A 3 year treasury or CD would be it, in my opinion.

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To your secondary question:

Appropriately consider all estimated numbers involved with keeping the house compared to your closest estimate of what the home could sell for. Weigh out the pros and cons yourself as a stranger will not be able to 100% appreciate what you value and dislike. Remember to include insurances, taxes, HOA(s), and the actual mortgage payment. Depending on how you also plan to rent out the property, include whichever utilities you intend to cover (if any). There will also be costs for property management and upkeep as things will break overtime and tenants will not hesitate to get you (or your management) to fix them, either way that means you are paying.

I would also keep in mind while homes typically appreciate in value there is a higher risk with tenants for the value to depreciate to damages and poor upkeep. There are increased legal risks to renting, so be sure you have properly vetted whichever management you are going with. In extreme circumstances you also could be required to retain an attorney to defend yourself again litigation because whichever management team you hire will most likely defend themselves and not include you in that umbrella. My family lives in the LA area as well and a judge refused to throw out an obvious frivolous suit when my parents attempted to rent out a house. The possible renters after signing the main paperwork never showed to finish a second set of documents for renting. Parents immediately declined to rent to these people as they missed something so important without any explanation and they sued claiming racism, emotional damages, and some other really crazy things despite my parents never having met them (first meeting was between property management and renters only).

Personally and professionally, I would only suggest renting our the place and not selling if you can turn a profit after all the above mentioned costs. If renters are only paying to keep the property in the black you have yourself a non-earning asset which WILL be damaged over time and require repairs which will come out of your pocket. Also, while the property is unoccupied you also must remember it is not earning at that time.

Much of this may sound obvious, overcautious, etc... I simply wish to provide my family's experience to help you in making your decisions.

Best of luck with your endeavor.

Edit: Also, you will be required to report all earned rental income on your taxes. They will fall under the Schedule E and possibly K-1 area. I would strongly recommend consulting with an actual accountant about the impacts to you.

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Put simply, the advice to never sell a home in CA is based on

  1. rising home prices (which hasn't always been true), together with
  2. annual property taxes based on value at purchase

Note that #2 is unusual: property taxes that do not change as the home value rises came about because of a voter ballot measure, CA Prop 13.

So in California, selling your home will expose the buyer of your home to more property taxes than you had to pay.

This has some odd consequences:

  • If you get a job 30 miles away, it may be better to keep your old home and commute as selling it would cause you to pay more property taxes in the new location.
  • There are more older homes on the rental market than otherwise would be the case, because the property taxes on those old homes are very low and allow the landlord to offer a rent that easily outcompetes buying the same home but paying a big yearly tax bill.

This is all fairly unique. I know property taxes in Tennnessee change as the home increases in value.

  • That's good information. I'll upvote when I'm allowed. So wouldn't it make more sense to buy a tear-down at $500k and build a $1M home on top of it than to buy a finished $1.5M house? Then you're only paying property taxes on $1.5M? – kmo20 Jan 29 '14 at 0:12
  • Or would they re-assess it when you finish building a house? – kmo20 Jan 29 '14 at 0:16
  • I think the Prop 13 link said that construction/improvement could cause the home to be re-rated. – Paul Jan 29 '14 at 3:11
  • @kmo20 improvements are reassessed. – littleadv Jan 29 '14 at 10:11

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