Should I Refinance?
I often get this question when screening questions from prospects or during financial planning workshops. Like so many personal finance questions, these are unanswerable without more information provided by the questioner.
Should I retire?
Should I get married this year?
Should I exercise my stock options?
These contingent questions are useless when no additional information is provided. So, “should I refinance?” is a loaded question for me because a mortgage refinancing strategy can have a variety of purposes, and that the success of your refinance depends on a range of factors that vary with your purpose.
Let’s look at five good reasons to refinance your mortgage:
1. Lower your Interest Cost
Most borrowers contemplating the refinance of a fixed-rate mortgage want to know whether the financial gain from a lower interest rate more than offsets the refinance costs. This is less important as a motivation than it was a year ago because of the rise in rates that has since occurred. It remains relevant, however, to borrowers with older higher-rate mortgages who for one reason or another failed to refinance when rates were at their lowest.
It’s important to run the numbers to measure the benefits of a rate-reduction refinance relative to the refinance costs. Whether you have one mortgage that will be refinanced into another mortgage, have both a first and a second mortgage that will be refinanced into one new mortgage or have one mortgage carrying private mortgage insurance and will be refinancing into a combination first and second mortgage without mortgage insurance.
2. Liquidity – I need to Raise Cash
Another reason borrowers refinance is to raise cash. While cash-out refinances are priced higher than rate-reduction refinances, this is not in itself a deterrent to the borrower who needs cash. What matters to that borrower is whether the cost of the cash-out refinance is larger or smaller than the cost of raising the same amount of cash with a second mortgage.
3. Risk Management – Reduce the Risk of Higher Rates on an ARM
Borrowers who now have an adjustable rate mortgage (ARM) and are concerned about rising interest rates have their own reason for considering a refinance. They want to know whether the likely loss from retaining their ARM exceeds the cost of eliminating the risk by refinancing into a fixed-rate mortgage.
4. Cash-in Refinance
Some borrowers have mortgage interest rates above the current market but they can’t refinance into a lower rate because their house value has depreciated. They want to know whether paying down the balance on their existing fixed-rate mortgage in order to lower the cost of refinancing into another fixed-rate mortgage would yield a satisfactory rate of return.
5. Eliminate High-Cost Short-Term Debt
Borrowers who are burdened with short-term debt may want to know whether it pays to consolidate such debt in a cash-out refinance. Here the borrower is comparing the cost of consolidating the short-term debt in a new and larger first mortgage, or in a second mortgage.
Don’t make assumptions or rely on a generalized rule of thumb. Instead run the numbers and see if the refinance will actually improve your balance sheet or cash flow.
Q&A: What are my tenant rights in Los Angeles?
Proposition 10 has failed at the ballot box, leaving the state’s limits on rent control intact. Proposition 10 would have repealed a California law that limits how cities enact rent control. Its defeat is a blow to tenant activists in Los Angeles, and a win for landlords.
With the resurgence of cities as centers of economic energy and vitality, a majority of millennials are opting to live in urban areas over the suburbs or rural communities. Sixty-two percent indicate they prefer to live in the type of mixed-use communities found in urban centers, where they can be close to shops, restaurants and offices. They are currently living in these urban areas at a higher rate than any other generation, and 40 percent say they would like to live in an urban area in the future. As a result, for the first time since the 1920s growth in U.S. cities outpaces growth outside of them. So, it’s important for tenants to understand their rights.
The city of Los Angeles is one of just 15 California cities with rent control regulations on the books, and the local rules do more than keep down monthly payments for tenants. They also provide protections from eviction and financial resources in the event a renter is forced to move out of their apartment. Let’s be clear, the City of LA does not have rent control. There are no limits on how much an apartment here can cost unlike rent-controlled units in other cities. Instead, LA has the Rent Stabilization Ordinance (RSO).
If you do not live in Santa Monica, West Hollywood, Beverly Hills, or the city of Los Angeles, whether your apartment is rent-controlled depends mainly on what type of housing it is and when it was built. Single-family homes are almost never subject to rent control (though they are in rare cases in Santa Monica and West Hollywood); duplexes, triplexes, and apartment buildings, on the other hand, are fair game. Date of construction also matters. In Los Angeles, only buildings built and occupied before October 1, 1978 have rent control restrictions. The date varies city-to-city. In Santa Monica, it’s April 10, 1979; in West Hollywood, it’s July 1, 1979; in Beverly Hills it’s February 1, 1995. In the city of Los Angeles, it’s easy to check on the date of construction for your building—and whether it’s covered by the RSO. Just enter your address into ZIMAS (http://zimas.lacity.org/), the city’s property database. An outline of the property will appear on the map and a sidebar will pop up on the lefthand side of the screen. In the “assessor” tab, you’ll find the building’s date of construction and in the “housing” tab you can find out whether it’s under rent control.
The Los Angeles Rent Stabilization Ordinance (RSO), addresses allowable rent increases for rent controlled units, which can range from 3% to 8% and for July 1, 2017 through June 30, 2018 landlords can raise the rent once every 12 months by the annual allowable increase of 3%. What tenants fail to acknowledge is the landlord’s right to raise the rent by an additional one percent (1%) for each of the two utilities supplied (gas and/or electricity). What is even more surprising with the RSO is at the same time the landlord raises the rent, if the written lease so provides, the landlord may also raise the security deposit (and last month’s rent if applicable) once every 12 months by the annual allowable percentage increase (previously 3%). And a landlord who is planning to improve his rental, may apply for special rent increases based on an application for Primary Renovation, Capital Improvements, Rehabilitation, or a “Just and Reasonable” rent adjustment which must be submitted to and approved by the Rental Board.
As a Los Angeles tenant, there are (3) additional items to be aware of:
1) If a landlord serves a written thirty (30) Day Notice of Rent Increase and provides the tenant a copy of the Registration Certificate, they may collect $12.25 from each tenant in June (50% of the annual $24.51 registration fee paid to the Rent Stabilization Division) and also collect the annual $43.32 Systematic Code Enforcement Program (SCEP) fee if paid in full by the landlord by increasing the rent $3.61 per month.
2) The special circumstances which allow the landlord to raise the rent substantially. The Landlord can raise the rent by 10% percent (within the first 60 days) for each additional tenant / occupant of a rental unit exceeding the number of initial occupants allowed in the original rental agreement. The Landlord can raise the rent nineteen percent (19%), plus 2% if the landlord provides the gas and electricity, If a landlord has not increased the rent since May 31, 1976.
3) Though the RSO provides that the rent may be raised to any amount upon re-rental if vacancy is based on certain reasons, there are certain vacancies that the Los Angeles RSO requires the rent to a new tenant to remain the same as that for the prior tenant. Examples include: (1) an eviction to recover the unit for the use of the landlord, his immediate family. or a resident manager; (2) an eviction based on the prior tenant’s illegal acts; (2) an eviction based on the tenant’s refusal to sign a new lease with the same terms as are in the RSO; and (3) an eviction based on the tenant’s refusal to allow the landlord reasonable access to the unit.
Tenants living in rent-controlled units can be evicted, but benefit from stronger legal protections than those living in non-rent-controlled buildings. This is referred to as a “just-cause eviction.” The city outlines fourteen legal reasons for a landlord to evict someone from a rent-stabilized unit. Eight of these are the result of actions (or inactions) by the tenant. The other six are not attributable to any faults of the tenant, but they are allowed nonetheless. Failure to pay rent, violating the terms of the lease, being a nuisance, using the apartment for illegal activity and not being the person who signed the lease (or someone approved to live in the unit) are five obvious reasons for an at-fault eviction. California law states a landlord can move to evict a tenant with only three-day advance written notice for these faults. In turn, tenants have up to three days to correct them to avoid eviction.
The only other common cause for eviction is through California’s Ellis Act, which allows landlords to mass-evict tenants when taking a property off the rental market. That could mean tearing the building down, for instance, or redeveloping it as for-sale condos. In these cases, landlords are required to pay relocation fees to help tenants find and move into a new place. Fees range from $8,050 to $20,050. The amount depends on how long tenants have lived in the building, how old they are, and how much money they earn.
Passed in 1985, the Ellis Act is another piece of legislation despised by tenant advocates, who argue that it encourages property owners to replace affordable apartments with new construction or pricey for-sale units. According to a report from the Coalition for Economic Survival, more than 23,000 apartments in Los Angeles have been cleared of renters between 2001 and 2017. In Beverly Hills, eviction protections are weaker, but landlords still have to cover a tenant’s moving expenses when asking them to move out through no fault of their own. After an Ellis Act eviction, a building must remain out of the market for five years. Yet the L.A. Tenants Union has found units available on AirBnB immediately after an eviction, as well as instances of new tenants moving in while evicted tenants move out, and emptied buildings being immediately sold to developers to build new apartments in their place. Whatever the reasons for a no-fault eviction, the landlord is required to compensate a tenant for relocation. According to HCID, payment “depends on whether the tenant is an Eligible or Qualified tenant, the length of tenancy, and the tenant’s income.” A Qualified tenant is 62 or older, disabled, or has minor dependents living with them. All other tenants are considered Eligible. Current relocation rates run $7,550–$19,500 per leaseholder.
In order to make rent-controlled units available to new tenants, landlords often resort to “cash for keys” offers, in which they effectively pay tenants to leave. Under LA’s rent control laws, this is legal as long as landlords first inform tenants of their rights and notify the city of the agreement. Tenants have 30 days to cancel the agreement in case their landlord isn’t following through with the terms of the buyout. There’s also no reason that tenants have to agree to the offer. Those who wish to continue living in their current apartment can simply turn the money down.
If a tenant does not live in rent-stabilized housing, a landlord may evict them for any reason. However, the law requires that tenants receive advance written notice depending on the length of occupancy. A landlord terminating a month-to-month tenancy must offer sixty-day notice to someone who has lived in a unit for more than a year, or thirty-day notice for less than a year. Usually, that notice does not have to state the landlord’s reason for eviction. This is one of the key arguments for expansion of RSO: anyone in a unit built after 1978 is susceptible to a sudden eviction with nary an explanation. Trying to secure new housing on a sixty-day notice in the middle of a worsening affordability crisis only adds to the anxieties and vulnerabilities of tenants across the city.
House Hacking— Could be One of Best Investment You Can Make
Ready to start your own rental empire? The first step is to buy a property with more than one unit. For the average American, one of their biggest expenses is their mortgage payment, or their rent. According to the Bureau of Labor Statistics, roughly half of the typical American’s expenses come from just two categories – housing and transportation (excluding taxes), with 33% of total spending on housing alone. This payment is holding them back from accumulating significant savings, and the financial freedom that more capital to invest could provide them. What most people don’t know, is that this payment is optional. It’s possible to own your own building for less than $10,000 down, and never have to make another payment again. It’s not easy, and you’re going to have to put in a lot of sweat equity, but it will save you hundreds of thousands of dollars over 30 years. This investment is called a house hack. If you’ve never heard of house hacking, pay attention.
The concept of house hacking is simple. You buy a duplex, triplex, or quadplex with an FHA loan (3.5% down), and your tenant’s rent covers all or most of your mortgage and other expenses. If it’s done right, you can drastically increase your available capital for investing every month. If it’s done wrong, you can purchase a money pit of a property that’s hard to manage and will cost you more than renting. If you’re not willing to take a bit of a risk, this investment probably isn’t for you. For whatever reason, the FHA, and even the VA, considers any property with four units or less as a single purchase. This means you can buy a duplex, triplex, or fourplex with an FHA loan or a VA loan. In order to qualify, you have to live at the property, using it as a primary residence. That’s where the multi-unit part of the plan comes into play: You live in one of the units and rent out the rest.
It’s one of the easiest and most efficient means one can use to move towards early financial freedom while working a full-time job. In this situation, the owner now has a stabilized property that allows him/her to live for free, still have capital to repair their building as needed and is now free to invest what they would have been spending on rent. In fact, in a year or two, the owner can refinance into a traditional mortgage, and house hack a new property. You might be able to continue to acquire a rental property capable of sustaining early financial freedom in less than 10 years, depending on the market and real estate cycle. And, it’s no harder to buy a house-hack than it is to buy a home, financially speaking. It’s important to note that older building with major capital expenditures coming soon might be have enough cashflow to breakeven so looking for a with newer plumbing, electrical, sewer, HVAC, and a new roof.
Can you buy a second FHA home?
Once you are stable with your first property, you might want to purchase another property to rent out or move into. In this scenario, it’s tempting to use the FHA program again. However, that option may be limited.
You can obtain a second home, but it’s done on a case-by-case basis. You usually need to show need, such as relocating for a job, or prove that your expanding family can’t fit into your old home anymore.
FHA loan requirements are also such that you might not be able to count the income you receive from your rental property in your application. Unless you have 25 percent equity in your home, your income from renting out an FHA home might not be taken into consideration.
For many people, though, living in that first FHA property provides them the resources they need to take the next step. If your tenant is covering your own housing costs, that can help you build a large fund to use as a down payment on another property down the road.
You can use a program like FHA loans to get started as a landlord. It takes a couple years to really get going, but it’s one way start the process immediately — even if you don’t have a lot of money.
Finding Your House Hack
Finding a good property to house hack isn’t easy, but it can be done if you’re persistent. Have strict parameters. For example, don’t look at a property unless the total rent is at least 1% of the purchase price of the building. Ideally, closer to two percent, but a 1% deal can still cash flow. In certain markets, like St. Louis, it’s possible to find deals closer to 2 or 3% price to rent, but that might not be in an area you want to live in or manage. If you’re starting out, interview several realtors, and find one that has experience working with investors, and ask them to help you find your first property.
Your realtor should set you up with MLS alerts, so every deal that meets your criteria will be sent to your email. If you like a property, it’s time to schedule a showing. When you view a new property, be sure to inspect the following:
• Age of the roof
• Plumbing
• Sewer
• HVAC
• Tuckpointing
• Major cracks
• Water in the basement
• Do doors and windows open easily?
• Condition of the windows
• Is any paint peeling
• How nice are the kitchen and bathrooms (these rent houses)
It’s unlikely that you’ll find a property at a good price where all of these are in good condition, so you need to budget the cost of repairs into your projections. After you view a building you can make an estimate of the major repairs that will be needed, and make a more accurate model of how much to save for repairs and maintenance every month. While it’s very tempting to offer on a nice property, you can’t get emotionally invested. This is a business, and needs to be treated as such. Only buy something that makes a lot of sense on paper, because it’s probably going to do a lot worse in reality. You want an investment with enough margin for things to go wrong and you still end up OK. Buying a property that barely cash flows on paper is a recipe for disaster. Once you’ve found your property, a good agent will help you make the right offer. Be sure to include a personal letter to the owner for every offer that you make. If two offers are equal, the offer with a convincing letter is probably going to win the house. You can reuse the same letter on every house you offer on, and just make minor tweaks based on the situation. Assuming the offer is accepted, you’re officially under contract!
Financing: Know FHA loan requirements
Before you commit to house hacking, it’s important to understand what happens when you use FHA loans to buy properties. You can make this strategy work with just about any type of loan. However, FHA home loans are especially good because of the low down payment option. With this type of loan, you can pay as little as 3.5 percent for a down payment. For many people, that’s much more affordable than trying to come up with 10 or 20 percent to put down.
On top of that, FHA loan requirements are more flexible when it comes to your credit. It’s possible to qualify for 3.5 percent down with a credit score as low as 580. Even though it helps to have good credit, you can still become a landlord with less than perfect credit. There are limits to how much you can borrow. The FHA sets loan maximums based on home prices in the area. It’s done on a county-by-county basis, so talk to a mortgage professional about the limit in your neighborhood. Depending on the FHA loan limits and the cost of properties, you might be limited to a duplex for your first house hacking experience.
Next, you need to commit to living in the home for at least year. You must also move into the home within 60 days of closing.
Finally, you need to make your FHA loan payments on time and in full each month. I recommend saving up a buffer fund. That way, if your rental unit is empty for a few months, your finances aren’t strained. I can’t stress enough the importance of being able to afford your mortgage, even if you plan to rent out the other unit(s). Financing for a house hack is a bit more difficult than a conventional loan. FHA properties have to pass a more rigorous inspection, and peeling paint isn’t allowed. While this can limit some potential deals, it’s possible to do the work before you close, or use an FHA 203k renovation loan. A good agent and lender will be able to help you navigate through the FHA financing process. Before you schedule any showings, it’s important to get pre-approved, or your offers won’t be taken seriously.
Why House Hacking is so Awesome
Buying an owner-occupied investment property and renting out the additional bedrooms and/or units is probably the single most effective hack that a median wage-earner can make to begin moving towards financial freedom rapidly. It takes the largest expense in your life and wipes it out entirely. Why would you bother to remain disciplined day in and day out with the fun stuff in your life, when you can automatically save yourself tens of thousands of dollars per year through the combinatorial benefits of house hacking?
House hacking leaves the purchaser with three excellent options if done correctly:
1. It allows the house hacker to live happily at low cost indefinitely.
2. It allows the house hacker to move away and retain the property as a cash flowing rental.
3. Like every homeowner in the country, the purchase retains the right to sell the property.
Few people have all three of those excellent options. Few people are able to move anywhere they want at a moment’s notice and convert their home into an excellent cash flowing rental property. This is the ultimate low-risk, high-reward way to buy your first or next property if you aspire to early financial freedom and want to accelerate your wealth accumulation.