Using a HELOC to pay off a mortgage is an interesting debate.
What’s a HELOC?
A HELOC is a home equity line of credit. If you have equity in your home, you can take out a loan from your bank using that equity as collateral.
Paying off a mortgage with a HELOC is paying off a loan with another loan.
While I’m not so sure paying off a mortgage is the smartest financial move anymore (I used to believe it was), doing it using another loan certainly an idea worth exploring.
I’m going to summarize the issues in a fair and balanced slightly biased way.
So Should I?
My final answer on this is that you should not use a HELOC to pay off a mortgage. HELOCs are variable rate loans instead of fixed rate like a (good) mortgage. HELOC interest is not tax-deductible in most cases. The line of credit can be frozen or reduced by the bank at any time. Also, even if you are making lower, interest only payments on your HELOC, it eventually will revert to a principal plus interest payment that you may not be ready for.
You will often see articles on how to payoff your mortgage early. People seem to make up their minds it’s the best course of action.
What about the question: Should I pay off my mortgage early? Here is my take on both sides of the argument.
Reasons NOT to payoff a mortgage are: It’s an inflation hedge, you can write off the interest, maintaining liquidity is important, and the money would be better off invested in higher yielding opportunities. Good reasons to pay off a mortgage include peace of mind and primary residence equity having special protection from creditors and bankruptcy in many states. Poor, but often cited reasons to pay off the mortgage are decreasing expenses and gain a risk-free return equal to the interest rate.
I rushed through listing these answers. I go into more detail below.
Before You Payoff a Mortgage Early
We will assume you have an emergency fund, your high interest debt like credit cards is paid off, and you are fully maxing out all retirement savings account opportunities.
This means you are contributing the max to your IRA, your spouse’s IRA if you have one, and your 401K, TSP, or equivalent vehicle. You should not bother paying off a mortgage if you have not done these basic things first.
In the end, I’m partial to keeping the mortgage. I feel like the evidence is strongly stacked against keeping it.
It’s a little ironic, because I paid off my primary residence in 6 ½ years. I also have 20 paid-off single family homes.
Yeah, that’s a little psycho.
This certainly qualifies me, however, to make a fair judgement on the subject.
Since I’m partial to keeping the mortgage, I’ll explore the pros of keeping the mortgage first.
As a military member, the largest difficulty I had was finding the best places to invest in real estate. I moved every 1 to 3 years, so I didn’t have an obvious choice. Through a lot of trial and error, I figured out a system that has worked well for me. It goes against the conventional wisdom on picking the best markets for real estate investing. That’s why it works!
How to Find the Best Markets
The secret to finding the best places to invest, especially in this advanced real estate cycle, is two things. First, you must gain a strong knowledge of the market you are going to invest in. This means you or somebody you trust needs to be your boots on the ground in that location. This will allow you to buy the right house in the right neighborhood in any city you end up choosing. Second, prioritize cash flow over appreciation. Make sure the property you buy will cash flow well, and never sacrifice that for a hope that you will get a large amount of appreciation.
Finding the Best Cities to Invest – Common Advice
To understand the significance of the advice I’m giving, I want to share the advice every other website would give you if you googled “How to choose the best city for real estate investing.”
O yeah. I’ll also tell you why those websites are all wrong.
All the other websites will tell you the most important things to consider in choosing a real estate market to invest in are items such as these:
1. Population Growth
2. Job Growth
3. Housing Appreciation
4. Low Unemployment
5. Low Rental Vacancies
These blogs will sometimes teach you how to lookup these statistics showing you which websites to use so you can pick the best markets to invest in real estate.
What do I know about long distance real estate investing?
As a military member:
I’ve moved every 1 to 3 years while investing in real estate
I currently have 20 paid-off single family homes
I’ve self-managed and used management companies
I bought 16 properties while living overseas
I read a blog post this morning that said investing long distance requires a slightly different approach than normal real estate investing.
It’s a different ball game altogether.
The secret to mastering long distance real estate investing is getting these 5 things right:
The Importance of Boots on the Ground
The Best Real Estate Agent for Long Distance Investing
Choosing a Property Manager from Long Distance
Choosing the Right Property from Long Distance
Managing Contractors from Long Distance
The Importance of Boots on the Ground
This is where I feel a lot of new investors make their first mistake.
They are neglecting the importance of having boots on the ground.
There have been good books written about long distance real estate investing and how easy it can be done using video, pictures, docusign, and aligning yourself with a great “team.”
This all sounds great, and might work for an experienced investor.
I can tell you from a practical standpoint, however, that nothing replaces the importance of having boots on the ground that you can trust in the location you are investing.
Whether it is a contractor trying to rip you off, tenant trashing a house, or just a need to respond quickly to an emergent situation at your property, there is nothing like having someone you trust that can tell you what is actually going on with your property.
With the TSP Modernization Act going into effect on September 15, 2019, there are new withdrawal rules. These expanded options greatly enhance your ability to access your money both before and after you are eligible for tax and penalty-free withdrawals.
The major changes are:
Choose if your withdrawals come from traditional, Roth, or both balances
Up to four in-service withdrawals per year
Multiple post-separation partial withdrawals
No longer must make a full withdrawal at 70 ½.
Can take monthly, quarterly, or annual payments and make changes to it anytime
These are a summary of the big changes, but there is plenty more to know about each one of these and how to fully take advantage of them. We will do a deeper dive into each topic and add some more info on new withdrawal options from the TSP Modernization Act.
Before these changes, whenever you made a withdrawal from your TSP, it came out of both your Roth and your traditional balances proportionally.
What that means is, if 25% of your total balance was in your traditional TSP, when you took a $1000 withdrawal, 25% of that, or $250, would be from your traditional TSP balance, and the other $750 from Roth TSP.
These both are treated different for tax reasons. If you withdrew this after separating from federal service and after 59 ½ years old, the $250 from traditional would be taxable income. The $750 from your Roth TSP would not be taxable income.
This post was originally published on August 8, 2018. I updated, lengthened, and added a table of contents to it.
Investing in rental property with VA Loan is a tricky subject. There are many rules that dictate how a VA should be used. Investing with a VA loan, even in multi-family, is possible. I will show you how to do it so you can get rental income.
The VA doesn’t say you can use the VA loan for investing, but if you understand the rules, and buy properties as you move from assignment to assignment in the military, it is possible.
You can’t just buy a home and make it a rental property without living in it first. There is an occupancy rule I’ll be discussing.
You can, however, buy a house at your current assignment using your VA benefit, live in it for a short period of time, turn it into a rental property when you leave, and buy a house at your next assignment with a VA loan repeating the entire process.
Another possibility for investing with a VA loan is buying a 2, 3, or 4-plex using your VA benefit and living in one of the units for a short period of time. When you move on to your next assignment, you’ll be able to turn the entire property into an rental property legally.
Let’s start digging into the details!
The first thing we need to understand is the occupancy rule.
The TSP Loan program lets you borrow money from your own TSP account while you are either in the armed forces or employed by the federal government.
HOW IT WORKS
When you borrow the money, it comes out of your actual TSP account. It can be any amount between $1,000 and $50,000, not to exceed your contributions and earnings from those contributions. It does not include any agency contributions (blended retirement system or BRS) or earnings from agency contributions.
As you are repaying this loan, it is repaid with interest through payroll deductions back into your own TSP account. This means that this large amount of money will not be growing tax advantaged in your TSP account during the time period you have borrowed it. You lose the opportunity for that growth. More on this later.
Keep in mind, even though you are paying interest, it’s a low, low rate and you pay it back to yourself, so it’s not really a cost to you. The interest, however, is not tax-deductible.
To be eligible for a TSP loan, the following must apply:
Employed by uniformed services or federal government
In pay status
Only have one outstanding general purpose loan and one outstanding residential loan from any one TSP account at a time
Have at least $1,000 in your TSP account not counting agency contributions and earnings
Have not repaid a TSP loan of the same type within the past 60 days
Not had a taxable distribution of a loan within the past 12 months unless it was the result of your separation from Federal service
The 1031 exchange (26 U.S. Code 1031), otherwise known as a like-kind exchange, or Starker exchange, is one of the most important tools for a real estate investor. I’ve seen too many military members not aware of this rule.
I’ve actually talked with military members who have sold their investment properties and had no idea they could defer the capital gains through this exchange. I don’t want this to happen to anyone.
Let’s get clear on it!
When you sell real estate, Uncle Sam wants it’s cut of your profits.
There are only two ways to avoid paying the profits, or capital gains, on a real estate sale.
The other exception is for real estate investors, which we are focusing on with the 1031 exchange.
The 1031 exchange got its name from the section of the IRS tax code it comes from. This is the section that allows for a like-kind exchange that defers the tax liability of the sale into the next asset.
Keep in mind, the 1031 exchange, or “like-kind” exchange used to apply to items other than real estate. As of December 2017, a tax reform law that passed limits exchanges to only real estate.
You may also hear the exchange called a Starker Exchange named after T.J. Starker, who successfully sued the U.S. government in 1979.
Before that, the exchange of real estate actually had to be simultaneous. Now, you can typically have 180 days between the sale of the property and the purchase of the replacement property.
Thanks Mr. Starker!
8 CRUCIAL RULES
First, we need to understand what type of real estate can be substituted for what.
You may not have to pay tax on all or part of the gain from the sale of your main home. This is where you live most of the time. A main home can be a:
Actually, everybody can get this break on capital gains on the sale of a home under certain circumstances, but military members get an additional benefit that makes it much easier to meet the requirements.
Unfortunately, many CPA and “tax professionals” are unaware of this military benefit.
WHAT IS THE CAPITAL GAINS TAX?
Cars, stocks, and bonds are capital assets. A home is also considered a capital asset because it is a significant piece of property. When you sell it for more than you paid, it’s called a capital gain.
When you sell a stock for more than you paid, you’ll need to report that to the IRS and pay taxes on the capital gain. Primary homes get excluded from this as long as it fits certain criteria called the ownership and use test.
OWNERSHIP AND USE TEST
To be eligible for excluding capital gains on your primary residence, you must be the ownership and use test, as outlined in Publication 3 – Armed Forces Tax Guide. You will be eligible for the exclusion if, during the 5-year period ending on the date of sale, you:
Owned the home for at least 2 years (the ownership test)
Lived in the home as your main home for at least 2 years (the use test)
If you don’t fully meet these two tests, you still may be eligible for a partial exclusion. See IRS Pub. 523 for more details, and consult a smart tax advisor.
This is commonly explained as you have lived in your primary residence 2 of the last 5 years.
HOW MUCH CAN YOU EXCLUDE?
It seems like it should be unlimited, right?
Dream on. The USGOV would never allow that!
You can exclude up to $250,000 of capital gains if filing single / $500,000 if filing jointly.
This exclusion is allowed each time you sell your main home, but generally not more than once every two years.
WHERE MEMBERS OF ARMED FORCES GET AN ADDITIONAL BENEFIT