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I recently (2+ years ago) purchased my first home, and we are financed with an 7:1 ARM loan as well as a HELOC as a second mortgage. I also have excellent (760+) credit. My family is growing and I need to upgrade my current home to a larger, longer-term property in a neighborhood with better schools (young kids growing up). The housing market is definitely a Seller's market, and home values are rapidly rising. Due to this, I have accumulated a significant amount of value in our current home.

I'm considering the following scenario, and would like experience or fact-based advice on what factors I should consider when making this decision:

  • Cash-out refinance the first home to pay off the HELOC and get a fixed-rate single loan on the first property
  • Take additional cash out of the refinance of the first home to accelerate saving or simply pay for the down-payment on a second property
  • Purchase and move to a second property of greater cost and value to first
  • Convert the first property into a rental/investment property

Are there certain timelines, fees, taxes, etc. that would make this plan be a complete farce, or does this plan hold water?

What kind of financial analysis would make you comfortable about this decision?

At what point does it make sense to become a landlord?

Also, when calculating the 20% down of a new property, does that need to be liquid funds, or can that be based on the value of the home you are selling?

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What kind of financial analysis would make you comfortable about this decision?

The HELOC and ARM are the biggest red flags to me in your current situation. While I don't expect interest rates to skyrocket in the near future, they introduce an interest rate risk that is easy to get rid of. Getting rid of the HELOC and converting to a fixed mortgage would be my first priority.

If you also want to upgrade to a new home at the same time (meaning buy a new home contingent on the sale of your first, paying off the HELOC and mortgage), that's fine, but make sure that you can comfortably afford the payment on a fixed-rate mortgage with at least 20% down.

I would not take additional cash out of your equity just to save it. You're going to pay more in interest that you're going to get in savings.

From there things get trickier.

While many people would keep the first property on a mortgage and rent it out, I am not willing to be a landlord for a part-time job, especially when the interest on the mortgage gouges my return on the rent. PLus leverage increases the risks as well - all it takes is to go one or two months without rent and you can find yourself unable to make a mortgage payment, wrecking your credit and possibly risking foreclosure.

So my options in order of precedence would be:

  1. Cash-out refinance the first home to pay off the HELOC and get a fixed-rate single loan on the first property
  2. Purchase and move to a second property of greater cost and value to first
  3. Take additional cash out of the refinance of the first home to accelerate saving or simply pay for the down-payment on a second property
  4. Convert the first property into a rental/investment property

At what point does it make sense to become a landlord?

The complicated answer is when the benefits (rent, appreciation) relative to the costs (maintenance, interest, taxes, etc.) and risks (lost rent, bad renters, home value variance) give you a better return that you could find in investments of similar risk. The simple answer is when you can pay cash for it. That takes interest and lost rent out of the equation.

Again, some are willing to take those risks and pay 20% down on rental property. Some are able to make it work. Some of those go broke or lose their properties.

when calculating the 20% down of a new property, does that need to be liquid funds, or can that be based on the value of the home you are selling

You can make the purchase of the new home contingent on the sale of the first if you need to get the equity out of it to make the 20%. Do NOT refinance the first just to pull out the equity to make a down payment. It's not worth the fees of a refinance.

  • At what point does it make sense to become a landlord? Also, when calculating the 20% down of a new property, does that need to be liquid funds, or can that be based on the value of the home you are selling? – chisaipete May 10 '17 at 22:53
  • I added answers to your additional questions. I would recommend adding them to your original question so it's more visible to other answerers – D Stanley May 10 '17 at 23:20
  • One more clarification: If I'm willing to make the purchase of a new home contingent on the sale of the first, and I need to use the equity to make the 20% down, is it valid to calculate current equity based on home value and use it as a reasonable estimate of my down-payment capability? – chisaipete May 12 '17 at 17:58
  • You could use that as a rough estimate. Your actual equity will be determined by what you sell the house for minus what you owe. I would probably be a little conservative as there's a good chance you won't get your offer price. – D Stanley May 12 '17 at 18:01
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and I need to upgrade my current home to a larger, longer-term property

Would selling your current home give you (at least) a 20% DP on the new home?

Take additional cash out of the refinance of the first home to accelerate saving

Dittoing D Stanley, that makes no sense.

Purchase and move to a second property of greater cost and value to first

You'll need to find the new house at the same time you're selling the existing home, and write the new-home purchase contract in such a way that you can back out in case the purchaser of your home backs out.

  • Yeah, I now read that sentence and see how insane the "accelerate saving" comment was. :) Also, are you referring to contingencies in the contract? – chisaipete May 11 '17 at 18:37
  • Yes, sale contingencies. Heck, your house might have some damage which prevents the same. – RonJohn May 11 '17 at 18:44
  • You mean, once inspected there may be damage which the buyer wants corrected before purchasing? That sort of thing? – chisaipete May 11 '17 at 19:36
  • @chisaipete correct. For example, where I live, that might be termites or sagging foundation. – RonJohn May 11 '17 at 19:51

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