Help a Reader: House and Debt Decisions

Here's an email I recently received from a reader:

My husband and I own three homes.  We have a cash savings of $500,000.   Two homes are paid for: one in Florida on the inter coastal waterway and ocean and one in CAPE COD Chatham Massachusetts. The Chatham Massachusetts home was bought for summer income WHILE LIVING YEAR-ROUND ON THE Cape. The small cottage brings in a summer rental of net (after expenses) $7000 a year.  The Florida home requires $11,000 a year in property taxes.   The third home is our primary residence on Cape Cod has a mortgage of $441,000 down from 602,000 since 2006.   We are now in a 3/ARM @ 4.88% - started June 2009 and paying $2335 A MONTH. Our combined income is $89,000 a year after deductions.    We are paying $28,000 a year in mortgage payments. We are in the red each year, approximately $12,000 with medical and property taxes being the largest bills.

OBJECTIVE:  Lower our monthly mortgage payments so we have a better cash flow to help take care of our cost of living.   We are debt free other than this mortgage and property tax. 

#OPTION ONE: Should we take $75,000 plus closing costs (3,000) from our savings and reduce our current monthly mortgage payments from 2335.00 a month to $1800 with a 30 year fixed at 5%?   

#OPTION TWO:  Sell the home in Florida for 500,000 (a recent offer) as this home requires $11,000 a year in property taxes.  The home is too old to rent out to summer tourists. Not up to code in wiring and AC and bathrooms. Buyer intends to bull-doze the home. 

#OPTION THREE:   Pay off the entire mortgage from our current savings thereby demolishing our savings account AND sell Florida home which will replenish our savings to $490,000 (minus unforeseen expenses in closing) And put this amount back in savings (minus the expenses on our wish list – see below.  

EXPENSE THAT IS NEEDED ASAP: my husband wants to buy a used tractor for his farming, so that would reduce the 490,000 to approximately 480,000.  Moving our furniture from Florida back to the Cape another $2,000 leaving approximately 478,000.   Repairing a fence in Brewster $2500, leaving $475,000.

I am going to retire in 5 years (I am older than my husband) and my husband who is 47 will retire in 20 years.   

What's your advice for her?

Comments

[zyxuzpf]

It seems like you know what you are doing :)

I am a newbie to all the finance stuff and working just a year out of college. So I am definitely not an expert.

From listening and reading a lot of PF, I would sell the FLorida home TO pay off the primary residence. So a combo of #2 and #3. You dont want to use all your cash to pay off a mortgage and have a deal fall through...

idk, what would you do FMF?

[Sarah]

Option four: get out of the primary residence! You're paying over 30% of your income on your mortgage now, and there's no room in your budget for the inevitable increase in interest rates (don't know when this will happen, but since they currently *can't* get any lower, there's no way they won't go up again in the near to medium-term future). (I say nothing about medical bills, which are only going to go up, at least til you both hit retirement.) And I bet it's more house than you need, though it is in an expensive area.

Sell the Florida house, too. Between the two of them, you should be able to find something more reasonably priced for a primar residence.

[LotharBot]

1) Sell the Florida home. It doesn't appear to be doing anything positive for you, and its yearly costs are almost exactly the amount of your yearly shortfall (11k to 12k). This step almost single-handedly fixes your problem, and gives you a nice bucket of cash too.

2) Consider whether you really want to stay in your primary residence. If no, sell and move somewhere cheaper. If yes, consider drawing from savings (or the FL home sale) to refi into a good rate.

3) Look for some other areas to cut your expenses. Combined income of $89k after deductions (do you mean after taxes?) That should be enough to net you positive cash flow, even with your big mortgage, unless the medical costs you mentioned are HUGE.

[Andrea]

Is this your retirement fund or do you have that covered?

[jeffinwesternwa]

Sell one home, start looking CLOSE at expenses, you spend too much, $100~ here and there adds up! (I hope the rental is in a locktight LLC BTW??) you are WAY short in retirement $$, look at working to age 70!... and maximixing retirement contributions. You may decide you need to sell another home before retirement also...

[Mark C]

Do NOT pay off any mortgage with your retirement savings!!. Despite what FMF and all too many commenters like to advise, a house on average appreciates only slighty better than inflation (3.5% vs 3.0% per year over 20-30 years), unless you are lucky enough to live in the next boomtown or boom area. In 5, 10, 20 years you decide to move, you will pay a higher price for your next home of similar size and construction due to inflation. Unless you want to leave your kids a paid-off home, then don't pay it off too soon. Your best bet is to always maintain at least 25% in equity of current market value, including any needed repairs, so that when you do sell, you can get out quickly at a competitive price. Have we learned anything from the recent real estate bubble?? It's like trying to time the stock market. Equities, tax-free municipal bonds, and even the lowly CD will pay a better return over the long term than a house at the rate of inflation. Remember that you can retire at 62 and live another THIRTY productive years.

SELL the Florida home!! It's a clear DANGER signal to hear that despite it's value, the place needs a lot of repairs and upgrades just to meet code and obtain rental income. It has bad wiring??? Danger!! Retirees especially should beware contractors that take advantage and swindle people out of their life savings, never to complete the work. Don't think it can't happen to you. If you have a firm offer of $500,000, you sell it and build up your retirment savings. Married couples can sell home for up to $1,000,000 tax free, although there are limits to second and third homes and other investment property. The house in Florida is not worth the stress, even if you had a million dollars in savings. If you want to live in Florida, find a place that's already been fixed up. Take the proceeds from the sale of the Florida home and fix anything needing fixing in your Cape Cod and other home. Think about reasonable upgrades because YOU want to enjoy them, rather than what you think you can get back in dollars. Do you like staying at home, or would you rather travel?

How much of the "cash" savings do you have in various accounts? 401k? Roth IRA? Traditional? Brokerage? CDs?, etc. What type of lifestyle in retirement are you trying to achieve based on your pre-retirement lifestyle and expenses? Do you have pension? How long do you want to work (for full social security, etc.) Do you and your young husband have separate accounts and prenuptual? Do you have living wills? Answering these questions will help to put a dollar amount on what you need at retirement age and an all-imporant financial strategy. A million dollars at age 62 might not be enough to maintain or improve your retirement lifestyle...ITS NEVER ALL ABOUT JUST THE MONEY!!

There are always costs that you can cut. It sounds like you've saved for retirement and emergencies, but how much was due to your own frugal diligence, and was there an inheritance or profit from sale of real estate? It all boils down to what lifestyle you want in retirement.

If you want to stay and live in Cape Cod for another 20-years, that's fine, but remember there are much lower cost places to live (and much warmer) that will allow you to live an exciting lifestyle. Look at New Mexico or Austin, TX (Hill country), the Gulf coast, or the Southeast like NC/SC/VA/GA for good weather, recreation, medical care, and entertainment options. Cape Cod is very expensive, and if you sell it at any time, including today's market, you'll find a better house with more land elsewhere, if that's what you want. In retirement you may want to downsize and spend the money on travel, hobbies, or charitable activities that provide fullfilment. You might even like South Dakota!

[Old Limey]

Living full time in Florida versus living full time in Massachusetts as retirees are obviously very different lifestyles because of climate.
I would think the first decision to make is to mentally skip forward 5 years and decide whether you are going to be happy spending the remainder of your life in your primary home. As a 75 year old that has been retired for 18 years I can tell you that "Climate" becomes an increasingly important issue in old age, the second very important issue is the close availability of hiqh quality, affordable, "Healthcare". Additionally by the time you are both retired you should be debt free, have sufficient capital that can be invested to generate income that along with social security will more than cover your expected living costs.

Once you have discussed these two issues and reached a very thoughtful consensus you will then be in a good position to make the smartest possible decision regarding your real estate, your finances, the ability of your husband to retire debt free, and the future lifestyle that will make you both content and happy.

My wife and I are only 18 months apart in age but our physical capabilities are quite different - something that is very common indeed with older couples that we know. We live in a small city of 100,000 population in the San Francisco Bay Area. The climate is wonderful and we have every amenity that one could ask for in close proximity and are only 45 and 5 miles away from two major airports which is very convenient when taking vacations abroad.

I am certainly not a farmer and have no need for a tractor (a rototiller is fine) but I keep myself busy on a 1/3 acre lot, growing most of our own fruits and vegetables and tending to a Japanese style garden with fish pond, waterfall, and lots of plants. The area is also ideal for my favorite recreation which is hiking in the many beautiful state and county parks that abound in the Bay Area.

Retirement is very much a team experience because you are together all of the time and each partner has to be happy for it to keep working indefinitely so you both need to be aboard when making these major decisions.

[Michael Goode]

The question presents its own answer. Sell the Florida house. Use the money to pay off the mortgage and put the rest into retirement savings. With the money saved on expenses on that house you can spend a lot of nights at a nice resort when vacationing in Florida.

[WR]

When was the last time you lived in the Florida Home? 2 of the past 5 years? You'll need to figure out what your BASIS is on each of the properties and what Capital Gains taxes you may need to pay on a sale.

If you want to sell The Florida property (Which I recommend), You should move there and Live there as your primary residence for 2 years and then sell. By move I mean really move there, car, drivers license, mail delivered, etc. (you can still *visit* the cape as much as you want --hint-hint, but your primary residence is FLA and after 2 years, sell it.

If the 500k offer is unusually high for the area, you might just want to suck it up and pay the cap gains tax.

If you have lived there 2 out of the past 5 years (strict) then you can get the 500k (married filing jointly) Cap gains exclusion

[Mark]

@WR: Under the new implementation of the rules for cap gains on homes, you can no longer avoid the tax by living there two yearsout of five. The IRS will pro-rate the gains.

[Steve]

Oh, that I would have these kinds of problems ...

Just sold our primary residence in anticipation of a collapsing market (up in the Great White North) and to make sure that we have enough headroom to have a significant amount to stash away after paying bills.

[ICT]

I didn't realize that you could grow anything, besides scrubby pines, in the sandy soil on the cape, let alone have enough land to call a farm and need a tractor.
I agree with everyone that the house in FL sounds like more trouble than it's worth.

[Oscar At Real Life Money Management]

I agree with Michael. Sale the Florida house with the little amount of time you spend there you can rent something. This would be the safest and best scenario you can take depending on other unknowns.

[CPA Abroad]

@Mark, if I remember correctly there is a grandfather provision for the 2 and 5 rule, so it may, I stress may, be available to them.

However, I doubt the would be owner would want to wait 2 years to bulldoze it just for them to work the tax system. If you will owe taxes on it, get them to gross up the purchase price to help make you whole. But, based on FL real estate, it is very likely they could be selling at a loss.

One thought no one has mentioned is why you own the FL home. Do you like to visit, have friends/family in the area, etc.? How much would it cost you to rent a house for a couple weeks a year down there? 11k? More, less? Even at 2k a week that gives you 5 weeks and 1k left over. And the costs you mention are 1 time costs. Getting rid of 11k a year saves you 11k EVERY year going forward.

If it were me, I would sell the FL house, and depending on your retirement savings put some towards retirement and some towards reducing your mortgage. I just got an e-mail from ING for 3.88% 5 year ARM with free bi-weekly payments. Yes it is an ARM, but you already have one of those, this one is longer with a lower rate, and if you can lower your payment to a more than manageable amount, and then pay more per month, you could knock off a major amount of principal in 5 years. You have already shown yourself capable at doing that in your explanation.

[jim]

I would go with option 3. That should leave you with lots of cash in the bank and cut your expenses by around $3k a month.

[bhleigh]

I agree with fast-forward a few years to see where you would like to be. Keep in mind what the other retiree said about climate and healthcare. What does the FL home appraise for? Is $500K a good offer after you factor in remodeling/updating costs? If it is a good deal, sell the home. Talk to a tax attorney about capital gains from an investment/second property. I would take the proceeds from the FL home minus the tractor (most important thing ;p ) and other expenses which should be $475K and look to using half to pay-off your current primary residence and refinance into a better mortgage. Take the remaining portion and put it away for retirement. So after doing these things you have a new $230K 15yr mortgage, $750K in savings/retirement, and monthly expenses brought back to a reasonable amount.

If you look down the road 15 years, you are retired, your husband is retired, you own both your homes outright, and you have $100K left in your savings/retirement (assuming you take out $45K/year and don't make any interest). I'm no expert and this is just my opinion. Thoughts?

[Ada]

Sell the Florida house. Once you figure out what the after-tax proceeds are (and the sale has actually gone through), refinance and pay off enough of your mortgage on the primary house to make it affordable on your husband's income only with a 15-year fixed-rate mortgage. That way your primary mortgage will be paid off before he retires, and you'll still have a nice lump of cash set aside.

[Funny about Money]

Get rid of the piece of junk in Florida. Not to code? Wiring violations? Can't rent it? Someone wants to give you 500 grand so he can bulldoze it? Take the money and run!

Do not move your Florida furniture to the Cape. Get over whatever sentimentality you harbor for it: it's just stuff. Estate-sale it in Florida. Hire a company to come in and sell everything out the door. Whatever they can't unload, they'll usually haul to a charity.

Even though I'm usually a pay-off-the-mortgage freak, I'm afraid I have to agree with Mark C: at this time of life, with one of you on the verge of retirement and the other engaged in farming, a famously dangerous occupation that puts him at high risk of a crippling injury, do not do not DO NOT use your savings to pay off a mortgage!!!!!!!

Use the proceeds from the sale of the Florida house to refinance or pay off the primary residence in Mass. Consider unloading the rental cottage, too, and using any cash from that sale to beat down the debt on the residence. At the very least, try to get the cottage rented year-round, if at all possible.

About WR's well-taken point that you'll pay capital gains tax on the Florida house if you've not lived there f/t two of the past five years, I think by the time you've ponied up $22,000 in property tax AND covered maintenance and repairs for what sounds like a crumbling property AND paid and paid and paid on the Mass. mortgage, those expenses could be equal to (or even more than) the capital gains tax. You'd need to sit down & figure it out, though, to arrive at a cogent decision.

[Holly]

Agree w/most of what Funny about Money said except to pay off the primary mortgage w/proceeds from the FL house...You should put the proceeds of the FL house to work for you in investments since your husband is relatively young. There will be lots of time for investments to work towards substantial gains. I would also sell the cottage in MA since $7000 net is not worth justifying tying up what that cash could do for you, again, in investments. Make things easy on yourself. If you have children or family, you may have a little $ leftover to leave them (trust fund).

Think about downsizing to a warmer climate (I would forget about being too close to the coast since storms and erosion seems to be getting worse and prop. insurance and taxes are thru the roof). Look at VA or NC or SC. Also important to find a retiree-friendly state with a lower cost-of-living where you can escape state taxes/pension and possibly SS taxes...

Good Luck!

[Funny about Money]

Yeah, good thought, Holly! If the interest rate on the primary residence is pretty low, it would make a lot of sense to invest the money now.

Depends on one's personal circumstances and the economy's Magic Eight-Ball, though. At one point, when I coveted a house that cost more than I could get by selling my present dwelling, my financial adviser suggested that I get a low-interest mortgage, invest the proceeds from the sale of the present house, and use the income from investments to pay the mortgage. Since the income would be more than the payments (he argued), the money would still earn a little and not be tied up in principal.

This was, we might add, before the crash. I was glad I didn't take his advice and didn't buy the house, since my investments took the heaviest hit they'd suffered in all that fund's 30+ years, and I was very glad I owned my home outright when the layoff came.

There are a couple of sites, and also Fred Brock's slightly out-of-date book, Retire on Less Than You Think, that will give you some clues to states with lower property and income taxes. Try googling "taxes by state."

[Mark]

Why are so many people obsessed with real estate. I mean, c'mon, you guys don't make that much money, yet you own three (fairly expensive) homes. We've all seen that real estate speculation, as you are doing, is not a one way street. Geez, try diversifying. It is people like you who helped contribute to this mess...by buying too much real estate relative to your income.