Good Debt?

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Good Debt?

Mortgage by Rev Dan Catt.

Photo credit: revdancatt

Sounds like Mark has embraced the concept of ‘good debt’ pretty quickly; I wonder where he intends to live when he converts his current home to a rental? I am also wondering why he is planning to ‘flip’ it in 2 -3 years for another?


I must admit, I came from a culture where debt is frowned upon. This apply to mortgages as well.  I’ve never hear of the concept of a good debt until recently. What kind of debt do I have?

For starters, I don’t carry a credit card balance so I don’t have any credit card debt. The only time I did carry a balance is when it was 0% many years ago right after college. I was a poor student!

I had brief moments where I have an auto loan. The first one only lasted 9 months and the latest auto loan is paid off using a HELOC I obtained from my home which is a much lower rate and it is tax deductible.

Here is my current debt situation:

1) Primary mortgage on my current residence. The balance is about $92K @ 4.75%. It is an ARM that will reset next year but I’m only planning to keep this property for 2-3 years. The cost of refinancing is not too attractive for that time frame. Alternatively, since this is an ING Orange Mortgage product, I can just pay $750 to get the current rate for another 5 years. Currently it is at 4.5%. The ARM is tied to the 1 Year Constant Maturity Treasury Rate + a margin of 2.5%. It is currently at 0.62%. If it resets today, it will be lower than 4.75%. That’s why I’m not too keen on refinancing.

2) HELOC on my current residence. I took out a $25K credit line from my local credit union. I used about $10K to pay off the auto loan and about $7K for investments. The rate that they are charging is Prime Rate -1% which is currently at 2.25%. This is definitely a steal and I’m repaying this slowly.

3) Future primary mortgage. I’ll be taking up more “good debt” end of this month. I just identified a property from a builder and completed the purchase agreement and obtained financing for it. The mortgage amount will be at $183K @ 4.999% fixed for 30 years.  There is actually an interesting story behind this deal which deserves its own post. I will get to it, I promise.

I planned to convert my current residence into a rental very soon. There is some up front cost like minor repairs and replacing the 15 year old heating / cooling system. I will just rent it out for 2-3 years and will plan to sell it during that time frame to avoid some tax liability. That will  eliminate debt (1) and (2) but I will be purchasing another property at that time, hopefully.

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Reader Comments

Why not just hang on to the first rental and simply go after another rental Mark, instead of flipping it in 2-3 years?

Scott, in principle I agree with your approach. Keep building passive streams of income.

However, I understand why Mark is considering selling in a couple years. I’m going through the same decision making on my rental property (it sounds so weird to call my prior home that, but in a good way).

My consideration is the tax free capital gains rules for primary residences. If you’ve lived in a home 2 of the last 5 years, you can sell it and keep the gains tax free. There are some limitations on the law, but I believe a married couple can protect up to 500K in profits this way.

A 1031 exchange is a similar way to protect gains in investment property but its more akin to an IRA/401K where you can roll over the funds to another investment and DEFER the taxes until later.

In my case the decision centers around the question…”Do I want to protect $250K in gains from all tax or do I want to just defer the tax on $250K in gains?”

My obvious answer is “I don’t want to pay ANY TAX!”

So the scenario could likely be, sell before the time limits run out and then reallocate the gains to new investment.

My assumption is that Mark is considering a similar question.

@ Jeff – What happens if you keep the ex-home-now-rental for, say, 7 years? Do you then have to pay CGT on it?

I know what you mean Jeff about those tax laws with CGT. I learned those a few years back myself. My only concern was that 2-3 years might be too soon for Mark to resale. After purchasing fees, seller fees, will make the point mute, while buying and holding for the long term will increase his annual compound growth rate overall, the true goal to get to your number faster!

@ Adrian – The answer to your question is yes…at some point.

In my case, I have to make a decision in three years. That will be that last point where I can say I’ve lived in home for 2 years within the last 5.

If I sell then I can take the gain (~250K in my case) completely tax free and then use it as I like. Could be a little bit of REI, a little bit of stocks, a little bit of businesses…whatever. But I have the entire gain to invest rather than only 85% of the gain.

If I don’t sell at the three year point, then I have a couple of options.

I could keep it as a passive income stream (currently about $400/month).

Or, I could sell it. A sale at this point could either be taxed at normal capital gains rates (15%) and invest it as I like. Or the tax could be deferred until later (via 1031 exchange) but that requires you to invest all the money in real estate within 180 days.

Both of these options represent a $37,500 loss to Uncle Sam that could be prevented if the property is sold within the “2 in 5” rule.

@ Scott – Regardless of the fees, 15% is still 15%. I view it as a loss that I can avoid by selling the property within the rules and then moving 100% of the profits into new investment.

Lets look at a hypothetical…

If I sell the propety I could potentially increase the total number of properties I own dramatically. Imagine the compounding and passive income stream potential if I took the $250K out of one property and divided it up into $25K down payments on 10 different properties.

So one property conceivably becomes 10. Giving up that $37500 would rob me of 1.5 properties that I might have acquired other wise in this example.

Some might say that a 1031 exchange will let me hold on to that $37500 now so I could still get all 10 properties. My response to that would be “Yes, but I’ll still owe the money.”

Given the choice of having 10 properties and owing Uncle Sam nothing, or having 10 properties and owing Uncle Sam $37K….which would you choose?

I know what I’m going to try to do.

@ Mark – How long have you lived in your current home that you plan to rent?

Oh I definitely agree with you on your case Jeff. I was really referring to Mark’s case in his plans to purchase a house to own for 2-3 years and then sell 😉

You no doubt got a good deal on a foreclosure that you can ‘cash out’ tax free and use to invest. I was just curious as to Mark’s plans.

@ Scott – I may have misinterpreted Mark’s post. I understood him to mean that he’s going to convert his current home into a rental (for 2-3 years) and is planning to buy a new house to live in later this month.

You have a very valid point about buying a home (to live in or rent) with an intention of selling within in 2-3 years. That can be a tough one to make profitable.

I’ve assumed that Mark is doing the same as I…converting a current home (with several years of ownership/equity) while purchasing new.

I hope I didn’t cloud the conversation by using my example as a discussion point. I did that because I think Mark is in a similar situation.

I think it’s time for Mark to jump in with the details of his situation, and time for me to sit on my fingers for a bit. 🙂

@All – Thanks for the feedback!

@Scott – Point taken, I left out an important piece of information. I’ve lived in my current property for 6 years. It will sell more than the price I paid.

@Jeff – I’m in the same boat. The reasons I’m not keeping the property:
* The tax concerns that Jeff raise
* It is break-even now but HOA dues have been increasing. It is $145 currently compared to $115 when I first owned this property.
* The property is 15 years old. Appliances are getting old.
* They are building an aquatic center nearby in the next 2-3 years. Expecting property to rise in value.

Summary: I’m essentially swapping an old property for a new one in 2-3 years time. The property that I’m going to acquire end of this month will cash flow positive when I’m ready to rent it out and buy another newer property.

@ Mark – It looks like you have balanced the CGT concession against the costs of flipping and decided that is the way to go. Can’t argue with the numbers 🙂

If you do decide to keep the current, you can always replace the appliances and claim the depreciation expense …. but, that’s another discussion.

BTW: if the HELOC’s purpose was to buy the car, then you should probably shift that portion of your debt to the ‘car loan’ section of your NWiQ profile:

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