In this episode, we get into questions from a range of different financial situations. We have questions about debt payoff schedules, whether to sell stocks and invest in real estate, why “safe” investing may not be smart investing, and what to do when three-quarters of a million dollars are given to you. Scott and Mindy not only answer these questions the best they can, but they also give the “why” behind the financial decision so you can be better equipped when situations like this come up in your own life!
Welcome to the BiggerPockets Money podcast show number 290, a different kind of Finance Friday Edition, where Scott and I answer your questions direct from our Facebook group. Personal finance is personal, and if you can live with having $81,000 in debt while you are choosing to pay the minimums and investing other ways or paying slightly above the minimums and growing your liquid savings account, then do that, but if it is weighing on you and making it so you can’t even sleep at night because you have this massive student loan debt that you are just feeling is crushing your soul, then pay them down as much as possible because your health, your wellbeing, your mental state is what’s most important here.
Hello, hello, hello. My name is Mindy Jensen, and with me as always is my luminous co-host, Scott trench.
Thank you for such a glowing introduction, Mindy. Always appreciate it.
Scott and I are here to make financial independence less scary, less just for somebody else to introduce you to every money story because we truly believe financial freedom is attainable for everyone no matter when or where you’re starting.
That’s right. Whether you want to retire early and travel the world, go on to make big time investments in assets like real estate, start your own business or just get some frameworks to help make basic background decisions that affect your overall financial portfolio, we’ll help you reach your financial goals and get money out of the way so you can launch yourself towards those dreams.
Today, Scott and I are looking at the questions you have been asking us in our Facebook group. If you’re not a member of our Facebook group, you can join at facebook.com/groups/bpmoney, and have delightful money conversations with your fellow frugal freaks or money nerds or discuss spreadsheets with those who truly love the spreadsheet game like Scott and all the rest of you in our group, but there are some common threads that have been requested and asked in the group lately, and Scott and I wanted to speak at length about some of these questions that you have been having.
Just to cover all of my legal bases, my attorney makes me say the contents of this podcast are informational in nature and are not legal or tax advice, and neither Scott nor I nor BiggerPockets is engaged in the provision of legal, tax or any other advice. You should seek your own advice from professional advisors, including lawyers and accountants regarding the legal, tax, and financial implications of any financial decision you contemplate. Okay. Now, on with the show.
Scott, this first question I think is a lot of fun. The poster says, “I have a friend who came into roughly $750,000. She has no interest in real estate,” the horror, “wants to put it in an investment vehicle that is relatively safe but that still allows her to access the funds without penalty should she decide to buy a car or pay her house off.” So Scott, where should she invest her money?
Yeah. I mean, the question in 2022 is, what’s a safe investment? I think that if you can answer that question, you’re going to get very, very wealthy very, very quickly. So I don’t think there is a true answer to this question, and it goes back to, “Where should I invest in 2022?” which I think is the question at the top of everyone’s minds. My framework for answering that question has to do with just analyzing asset classes at the highest level, right?
The stock market is still really close to all time highs in terms of price-to-earnings ratios, even with a little bit of a pullback in the first couple of months here in 2022. Real estate prices have jumped dramatically over the last couple of years, 20%, 30% year appreciation with this, and it’s insane, right?
Interest rates look like they’re poised to rise, which makes bonds a really scary investment vehicle right now, right? Bond equity goes down when interest rates go up. We can have a whole show explaining about why that’s the case if we want to do that in the future.
Cash seems like a tough situation because if you’re expecting significant inflation or for that to continue over the course of this year and into next year, then putting the money in cash and sitting on it is a big risk. So I think a lot of people are really uncomfortable just like this person who posted this question right now in 2022 about where to put that money.
So perhaps the best answer is to just spread the risk across a number of different cases. So one framework that might get the wheels spinning for this person would be, “Okay. Stick a bunch of that into an index fund. Stick of it into,” we’re not interested in real estate. You could try a REIT if you did want some exposure as they call it to the real estate asset class there. You could keep some in cash and you could keep some in things like gold or commodities there that will hold their value.
I mean, if your goal is to keep this liquid and not have it go down, that might be a way. You’re not going to get rich doing that, but the question here is not, “How do I maximize my returns over 30 years and build the most wealth?” It’s, “How do I put this 750,000 into an investment vehicle that is relatively safe and still allows me to access the funds without penalty?”
If you put it in different asset classes like that, you might be able to see some wins and trade offs there as one or several of those asset classes are bumpy, but the other ones are bumpy in the opposite direction or remain stable.
Okay. I have a bit of a different take on this, and then I’m going to ask you, Scott, what you specifically are investing in, but my first comment is he asked or she asked that she wants to be allowed to access the funds without penalty. When I hear penalty, I think pre-tax investments that you’re withdrawing before the age limit that allows you to withdraw. So I just wanted to make a note that he says that the friend came into the money, I’m assuming an inheritance of some sort. So this is an after tax event and penalties wouldn’t be assessed, but this person would almost assuredly pay taxes on any gain when they withdraw the funds.
So this would be an after tax account. Let’s say that they’re putting it all into the stock market. Anytime you withdraw from an after tax account and have had a gain, you’re going to pay taxes on that gain. So there’s always going to be a penalty and I’m doing that in air quotes, but it’s not really a penalty. It’s just a tax.
Another thing that I wanted to say is that safe equals low return. Higher returns come in exchange for a higher risk, and there was a lot of chatter about the I Bonds that were paying 7.2% for the first six months starting in November of 2021, but that was for the first six months, and I think it’s a five-year commitment and you had to have them in for a year and then you could take it out before the five years early and there would be some sort of penalties which goes against her original request, but the max amount on that was only $10,000. So that’s not really even going to make big dent in her $750,000 that she has.
Again, if you’ve listened to this show before, you know I’m not a big fan of bonds because they are so safe. Safe means there’s not a lot of risk that you will lose the value of your money, but there’s also not a lot of opportunity for huge returns. I like huge returns.
I think there is a lot of risk in bonds that you’re going to lose a lot of money on paper right now, right? I mean, if interest rates go from three … Mortgage rates are right now at 4.7%, right? If interest rates go up, the equity value of those bond holdings is going to go down, right? Bond holders actually did really well over the last couple of years as interest rates plummeted because if interest rates go from 3% to 2%, that’s a huge to decrease on a percentage basis, and the equity value of those bonds goes way up.
So bonds have not been the safe haven that is going to spread risk around the portfolio. I think that they once were right. I think they’re extremely volatile and there’s a ton of leverage in bonds, in bond markets right now. They’re affected dramatically by 25-50 basis point rate hikes, for example.
I think we need to get somebody on to explain to us how bonds work exactly because I have a very loose understanding of how bonds work. I know enough to know that I don’t really want to put my money in bonds, but maybe my loose understanding of bonds is preventing me from doing something that I should. I don’t know, but yeah, I think that that’s a good idea. We should get somebody on to talk at length about bonds and how they work, but back to this woman, there’s no information about income or the age of the person. So I’m just going to give general advice.
$750,000 is a lot of money for almost anybody. I give the same basic advice over and over again because it’s proven to work over and over again. She needs to know what her annual spending is. She could be financially independent right now with this $750,000. She could be spending $250,000 a year. In which case, the 750 is nothing to her, but she’s not going to know unless she’s tracking her spending.
So she doesn’t need to necessarily track it as closely as I’m tracking it at biggerpockets.com/Mindysbudget, where I am tracking all of my spending, every dime that goes out of my pocket, because I truly want to know how much money I am spending, but she needs to have an overall idea of the money that’s going out of her pocket on an annual basis, and then she needs to make a very loose budget based on that.
Is she working? Does she plan to continue to work, and what is she investing in right now? If she’s working, I would take the money that she’s making her income right now and use that to max out her 401(k) and use that to max out her Roth IRA if she is eligible for that. If she’s younger, that’s going to be even more important because the Roth IRA grows tax-free. So the more money she can put in now, the more opportunities she has to withdraw with no penalties, with no taxes once she is of age. What is that? 59 and a half can you take out of the Roth IRA?
All of a sudden I’m drawing a blank, which is awesome as we record, but what I am doing in 2022 is the same thing that I have been doing all along is investing in VTSAX. I have my eye on the real estate market, and I am keeping track of what’s going on. If an attractive rental property pops up, if an attractive real estate opportunity pops up, I will invest in it. I just invested in Dry Land Distillers, a whiskey producer in my hometown, because it was an attractive opportunity to invest in my local city, and I really like this. I like the product that they make. I like the people that are running it. I like the city that it’s in. I want to invest in my city’s future.
So I’m looking for more opportunities like that, but I’m also doing a lot in VTSAX, Carl and his dumb Tesla, and now his favorite index is the QQQs, the Qs. So basically, we’re staying the course. We’re doing what we’re doing and we’re not really changing our minds based on what’s going on in the market, in the interest rates, and in all of that because we have a plan. We believe in the financial future of the stock market. We believe that the stock market tends to go up into the right, and that is where we are putting our money based on past performance, and past performance is not indicative of future gains, but it kind of is. I mean, I wouldn’t continue to put my money in the stock market if I didn’t believe that it was going to continue to go up.
Yeah. I think it’s great, and I completely agree with your approach, right? I think that if we take this person’s question and reframe it as, “What’s the best thing to do over a long period of time?” well, what I think and what I would do and what I have done because I’ve been fortunate enough to be in a similar position in past years to have a large sum of money that I’m coming into is great. My philosophy is that they’re making more people, but not more land. The United States is likely to be a dominant global player, and I’m going to invest in the United States and our economy long term. You can debate these assumptions, but these are fundamental, unprovable assumptions that you can debate with this, and that inflation is going to be a factor that I’m going to have to deal with across my investing lifetime.
My time horizon is 75 years. So what asset classes am I going to put that in, right? I don’t think that I have any particular ability over a long period of time to pick the best stocks or even the best real estate, necessarily. So I’ve got to have a strategy that allows me to win with average investments in that asset class over a long period of time relative to other ones, right?
So great. I can go through and say, “Bonds are not a good option for me in a scenario like this,” because bond rates are near historic all time lows, and I think that over a long period of time, bond rates are going to increase, which means that I’m going to lose money if I’m putting a lot of money into bonds on average in that asset class. That may change if bond yields ever start reaching all time highs or even the middling levels relative to historical contexts, but that’s just out for me.
So real estate, I think, look, like I just said, they’re making a lot more people and they’re not making a lot more land, and we’re not making enough houses. So I’m going to continue to buy real estate as part of my portfolio and just be consistent. I would place portions of this money into real estate maybe over a two or three-year period, property-by-property in cashflow, in real estate, in an area that I think has strong, long-term appreciation prospects, and then I dump a lot into index funds.
I also love the idea of investing in local businesses or small businesses, especially services-based businesses. I think there’s a lot of opportunity there. There’s a lot of these businesses that are selling for one, two, three times cash flow that especially if these small businesses are just getting started here, that I think are great opportunities. So I love the fact that you’re investing in a local distillery. That’s exactly the kind of thing that I’m going to start getting interested in. Although I admit I have not done that very much in the past.
So if I’m repeating what I did a few years ago when I had a similar opportunity, I put this money into real estate and index funds, dumped it all in there, had a cash position. I should have put it in all at once. That’s the mathematically strongest approach that Michael Kitsis came in and shared with us, but instead, I dollar cost averaged over a two or three-year period to put that money in there because I was too wimpy to put it all in at once and risk a big downturn right after I put it in. How’s that?
I think that’s great, and I think that we both have the same plan. We have decided on our investment strategy, and we are staying the course of our investment strategy regardless of market conditions at this time.
Okay. Moving on to the next question. This person shares, “I am wondering your thoughts on my financial situation. I have no consumer debt and no mortgages. My only debt is,” emphasis is mine, “a whopping $81,000 in federal student loans. The average interest rate for my loans is 4.4%.” I want to note that’s the average. He’s earning wages of 47,000 per year right now, but working on increasing this and expect to be making 65,000 in about a year. What should he do with these student loans? Pay them down as much as possible. Pay the minimums until he has significant income from investments years from now or pay slightly above minimum to make a dent but continue to build liquid savings or plan D, your other option. So Scott, where would you go first?
First of all, no right answer here. It’s going to depend on you risk tolerance and what you want to invest in. My approach, the way my mind works is I always have to play the odds, right? I could handle a bad outcome. I can’t handle a bad bet. So to me, I would look at it like, “Okay. At the very least, long-term average return of the stock market has been between eight and 10%.” Now, people can debate what they think it’s going to be going forward. I use that number, somewhere in that range, 8% to 10%, to assume long-term returns in the stock market from an index fund investment.
So right there, I’ve got arbitrage of between 3.6% and 5.6% in terms of returns that I can put money into the stock market and earn likely over a long period of time more of a return than I can paying off the student loan debt. It’s not guaranteed, and paying off student loan debt is a guaranteed 4.4% return because you’re not going to pay that interest anymore, but what I’d really do is I would really then take that logic to the next level and do exactly what Craig Curelop did, which is house hack because when you house hack, what he did is he house hacked.
He bought a duplex, rented out one side, lived in the other, in the living room behind a curtain or whatever, and rented out the room. That might be too extreme, but you can take that house hacking concept and understand, “Hey, there’s a chance to get a 200% ROI on a house hack in the early years,” right? You’re putting down 5% on a property. It appreciates 3%. You’re going to get a 60% ROI just because of that leverage factor on appreciation in the first year if things are average appreciation in that 3% range. You’re going to pay down the mortgage and you’re going to have somebody potentially helping you pay down the mortgage, which is going to reduce your cash outflows, right?
If I’m paying 2,000 a month in rent and I’m house hacking and my mortgage is 2,500 and I’m getting 1,800 in rent to help me offset that mortgage, now I’m only paying 700, and that cashflow can really add up and help you build a portfolio. That’s an aggressive approach, right? You are taking substantial financial risk in that scenario, but frankly, I think that’s what I would have done in this situation if I had student loan debt. I definitely house hacked without the student loan debt as my first major investment, but I like the way that Craig thought about it, and it’s something that you’re going to have to grapple with and think through. So you can lose on that and you are assuming substantial risk and more debt, but I think that that’s how I would be thinking about playing this game.
Craig told this story on episode 35 of our podcast. So go back and listen to episode 35 and hear him detail how he did this. He did a lot of things to generate side income and generate other streams of income to help him pay off. I think he had $85,000 in student loan debt. So it’s a similar amount, and I think he was making more income, which allowed him to buy a house to do the house hacking, but he was renting his car on Turo, and basically, anytime he could make money, he was making money, and he used the minimum of payments so that he could use the money to generate more money so that he could pay off the loans, but yeah, great episode from Craig.
I had the chance to watch his life firsthand on this because he came here to work at BiggerPockets and then graduated from BiggerPockets a few years ago. We had a graduation party, which is an unusual turnover event, but one that I’m very proud that we have here occasionally. The world is his oyster at this point, right? I mean, he’s got all the options in the world. He’s got a huge real estate portfolio and a booming agent business. So that’s the reward piece of this that’s possible from an aggressive approach like that, even from starting from a position of student loan debt. Of course, there is risk assumed and there is an all out factor that allow him to accelerate that quickly.
Yeah. He did things that other people weren’t necessarily willing to do. He was living behind a screen. He was sleeping on the couch. Is that something that you want to do? Maybe, maybe not. I don’t want to rent portions of my house out on Airbnb because I have small children, and I just don’t want strangers in my house, but he didn’t have kids and it was no big deal for him. So it’s just what are you comfortable with and what are you willing to do to get rid of the loans.
Another thing that I want to point out is on episode 267 we interviewed Robert Farrington from the College Investor, and he was talking about the federal student loans, not private student loans, and this doesn’t apply if you have refinanced your student loans, but if you have a federal student loan right now, there is a moratorium on your repayment. Your payment is currently at 0%. So it’s basically on hold.
It is going through April 30th or May 1st or whatever, and they are fully expecting it to be pushed back, but as of the date of this recording, they have not yet pushed that back. So there are other ways for you to use that money if you are in a federal student loan. Again, Robert is very well-versed on this, and he shared a lot of information on episode 267 when we talked about the student loan and how to prepare. That episode was recorded right before they pushed that back, and it was more of how to prepare for the student loans to be repaid.
Scott, another thing that I want to throw out there, again, sounding like a broken record, is personal finance is personal. If you can live with having $81,000 in debt while you are choosing to pay the minimums and investing other ways or paying slightly above the minimums and growing your liquid savings account, then do that, but if it is weighing on you and making it so you can’t even sleep at night because you have this massive student loan debt that you are just feeling is crushing your soul, then pay them down as much as per possible because your health, your wellbeing, your mental state is what’s most important here.
So that’s where I’m going to leave with that. The next question is an offshoot of this one. Actually, Scott, I’m going to ask you to make your comment about when the interest rate is less than 4%, you leave it when it’s more than 7%, you pay it off, and I can’t remember your numbers ever. What is your mantra on that?
Yeah. Well, I think that when you have a low interest rate and you can call it less than 4%, I generally wouldn’t pay that off early for the most part. In the 5% to 7% range, it’s a gray area. Maybe you can arbitrage it, maybe you can’t. If you’re over 7% or 8%, okay, now you’re getting a guaranteed 7% or 8% return, right?
So I think that the stock market is a risky 8% to 10% return over a long period of time, and it’s less certain. So I would just start paying off the debt at that higher interest rate unless I had a really great opportunity like a house hack, for example, that I might do before doing that, but in that red zone, the red zone being 7%, 8% plus on interest rate, I would be thinking about other things.
By the way, that may move over time in a high inflation environment and rising interest rate environment, right? So that framework might not apply in two, three years. If interest rates rise to 6%, 7%, 8%, 9%, 10% like they were a few decades ago, then we’ll have to rebalance that.
I’ll come back and ask you for your new opinion. Okay. So this next question is an offshoot of that with different interest rates. She says, “I’m in the interview process for a new job, and I’m super excited to have a 401(k) option. Should I wait to contribute to my 401(k) until I pay down all my debt? I will be debt-free within seven to 12 months with my current plan if I put most of my savings toward debt. The debt is varying interest rates, a few credit cards with $2,500 total in balances, and 22.99% plus interest rates.” So that right there I’m going to stop with the question and say pay that off as soon as you can with whatever money you have in savings. Pay off your 22% interest rate credit cards as soon as you can.
“Another card with $1,500 balance that is at 0% until July and then goes to 22%.” So that one, because it’s at 0%, I would leave it at 0%. Again, with credit cards, you want to make the minimum payment that you have to until the interest rate kicks up higher, but with the highest rates, pay those off as soon as you can.
“So another credit card that is at 0% until July and then goes up to 22%, a card at $500 at 7.99%, and the student loans I’m not sure what the interest rates are on those, they’re in forbearance and they’re all 0% right now. I can’t find out what it was before the forbearance, but I don’t think they are very high. Total debt is about $14,000.”
So I think, Scott, you’re going to be in agreement with me. Absolutely knock out the $2,500 at the 22% interest right now, then go after the $500 at 8%, and then you’re probably going to be at the $1,500 balance and nearing July when it’s going back up to the 22%. If you can crank that out before July when you’re paying 0% on that, I would do that.
Again, back to the student loan comment, they’re in forbearance right now, you don’t have to pay anything on them. Back to episode 267 with Robert Farrington, he said, “Right now, I wouldn’t suggest paying more on your student loans than you have to,” which is currently $0 because they could continue to extend it out, and especially if you have other debt. If you don’t have any other debt, if you want to crank pay out these student loans now, now is a great time to pay them off at 0%, but if you do have a lot of other debt, focus on those first.
Yeah. For me, this is pretty clear cut. I would pay off the credit card debt and not contribute to the 401(k) in this particular situation. A framework behind that is that 22.99% interest rate against the $2,500, that’s compounding directly against what I call financial runway, financial runway being the amount of time that you can survive without a paycheck, right? So if you spend $3,000 a month and you have $3,000 in the bank, you have one month of financial runway. If you have $30,000 in the bank and you spend $3,000 a month, you have 10 months of financial runway, right?
I like to get to, as a step in the process of building wealth, I had this drive to get to a year of financial runway because I thought a lot of options would multiply before me, and I think there’s a really good return on that that you can’t calculate in some ways. This is compounding against the ability to accumulate that runway, right? That runway has got to be accessible outside of these retirement accounts. Not everyone agrees with that, but that’s how I viewed it for my journey getting started here.
I would pay off that credit card debt at the 22.99%, then I’d pay off the other one that’s going to go to 22.99% in July, and then I’d pay off the 8% as well because that’s still a very high interest rate relative to the options on the 401(k).
Actually, let me say this. I might start taking the match from my employer after I paid off the credit card debt at 23%. When I had the next level of debt at 8%, I might start taking the match at that point because the match is such a great return if your employer offers a 401(k) match, and I would continue to take that match while paying the remaining high interest rate debt down.
If my student loans were in the 4% range after I’d paid off the 23% debt and the 8% debt, I would then maybe not aggressively prepay the student loan debt and instead consider investing more in the 401(k) or in other stock market index funds or a house hack or building runway.
Yup. I agree with that. I forgot the 401(k) part of the question. I was just focused on the 22% interest rate. That should be illegal to charge 22% on a credit card, but nobody asked me. Okay.
Moving on to real estate because that is our thing. “Where I live in the DC Metro area, rents are cheaper than buying. So I have decided to rent in the school district I wanted my daughter to attend. I have money saved for a good down payment for a house, but I’m debating if it’s worth buying or just keep renting for much less. Buying a rental is an option that I’ve been contemplating, but it scares me a little not having a house of my own. Has anyone been in a similar situation and what did you do?”
Before I can hear your house hacking wheels turning, I know that the DC area doesn’t have a ton of duplexes. So I don’t think that that is an option for her, but I want to point out that renting is a valid option for your housing needs, especially in an area where rents are significantly cheaper than buying. The problem is you run into these exponentially increasing housing prices. Rents will eventually catch up to housing prices. Rents will start to go up. There is a shortage of housing because we haven’t been building since 2008. So rents will eventually start to go up, and a good way to hedge your bet on this is to buy a rental in a market that isn’t your expensive home market.
You don’t have to own a home, own a rental in your current market, and it’s perfectly valid to buy a rental property and own a rental property while being a renter yourself. In fact, Scott, do we know anybody who owns rental properties while being a renter themselves? Could it be the CEO of biggerpockets.com?
Yeah. Exactly. I rent my primary residence due to essentially this conundrum here. I paradoxically also own lots of investment property here in Denver, Colorado. So I’m bullish on the market. Why do I do that? Well, with my primary residence, I view my housing as an expense, right? So what’s the cheapest way to live the lifestyle that I want to live, right?
This person says, “Renting is cheaper than buying in my area.” Well, let’s dive into that. Why can renting be cheaper than buying, right? Let’s suppose I buy a house for $500,000, right? If I turn around and sell that house tomorrow, I’ve got to pay two agents, the listing agent and the buyer agent, and I might have to pay them up to 6% on the proceeds of that purchase, right?
I’m going to have to spend another 1% to 2% of that $500,000 purchase price on other seller paid closing costs. By the way, when I bought the property, I’m paying 1% to 2% of the property purchase price and buy our closing costs.
So day one, even though technically I haven’t lost all that equity, I’m really down $50,000 immediately after buying that property if I were to attempt to turn around and sell it the next week, right? That is one of the major expenses in buying a house. That expense is defrayed over a period of years as appreciation on average kicks in as I’m amortizing my loan with part of my mortgage payment, the principal portion of my mortgage payment, right?
Over time, owning can become cheaper than renting, but to me, again, I go back to what’s the right bet to make here. In a year when home prices go up 30%, buying a home was probably going to be better than renting for everyone who’s bought in the last two years for the most part, right? I probably should have bought if I’d known what the market was going to do two years ago instead of rented for the last two years. I would’ve been better off financially, but to me, that would’ve been the wrong bet. The long-term average appreciation rate is around 3.4%, and that says that the breakeven point between renting and buying is somewhere between five and seven years on average in many markets around the country.
It’s obviously going to depend on appreciation rates in your market, the spread between mortgage payments and rents in your market. Property taxes, all these other different types of things are going to come into that, but I as a general rule of thumb say, “Okay. If I’m planning to live in a property for more than seven years, I’m going to buy not because it’s going to be cheaper than renting. If I’m going to live in a property for less than five years, it’s probably going to be better to rent than buy, and if I’m going to be middle, I’ve got that gray zone,” where it’s a preference in what you believe the housing market’s going to do in that area with that. So there’s no right answer.
That would be a general rule of thumb. Lots of exceptions to that. So you got to do your own research, but that’s how I’d think about the situation. I think it’s perfectly fair in this person’s situation to think that renting is cheaper than buying, especially if they don’t plan to be there for a long period of time.
Yup. I think that we are both in agreement here. Rental is a valid housing choice in a high-priced market. Rental is a valid housing choice if you’re not going to be there a long time. Rental is a valid housing choice if you just don’t want to make the commitment. I mean, there’s a lot of costs involved in owning a house just as the owner that aren’t there for you as the renter. Ask me about my $700 furnace repair last year, last month.
Yeah. Now, one last thing. The reason why I can buy a real estate investment property and rent is because my strategy allows me to hold the rental property for 30 years, right? So because I’m going to hold for so long, I mean, I probably won’t hold for 30 years, but because my strategy allows for me to do that on each property, then I’m able to defray those costs the way I just described there, right?
So I don’t have to live in the property. If I was going to buy a place, I would then rent out after I moved out and keep it. That would change my math, but after house hacking for seven years, it’s time for me to live in a place that I actually want to live in and like and enjoy with my wife. That’s my privilege as I’ve now built that wealth over the last seven to 10 years doing that investing. So to get the lifestyle options that I wanted, a house hack or a property that would make more sense as a rental wasn’t an option at this point.
That’s fair. What I’m hearing you say, Scott, is that you looked at all the options. You didn’t jump in with both feet, without exploring the different possibilities. You made a conscious decision based on the information you had at the time and what you wanted to do and what you could comfortably afford. That’s really what wealth allows you to do is make decisions based on what you want to do and what you can comfortably afford instead of what you have to do based on the only options you have.
Okay. Moving on. “Has anybody ever used a bridge loan to close on a new primary residence? We found a home we want, but would either have to sell stocks or use a bridge loan to get the down payment prior to selling our current home. With the hot market, we don’t think concurrent close or a selling contingency will work. What are the pros and cons between bridge loan versus selling stocks at high, long-term capital gains rates? Are there any other financing options right now?”
So I really want to stress this point. With the hot market, we don’t think concurrent close or a selling contingency will work. Right now, in the hottest market that the real estate world has ever, ever, ever, ever, ever seen, you will have a near impossible time getting even your contract accepted, and your contract has to have basically no contingencies in it. Having a selling contingency is going to almost never be accepted in this current market.
So having an alternate financing is a almost must. If you have not already sold house, then you should have other financing. Something that Carl and I did with this house that we’re in right now is we had another house and we got a HELOC on that other house, which allowed us to, and we got a HELOC, we each borrowed $50,000 from our 401(k)s and we sold a collectible car to amass the cash to buy this house because those were the options available to us. Being able to close with cash allowed us to get a super deal on this house, and it was a couple of years ago. We would never get this deal now, but there’s a lot of creative financing, and a bridge loan is a loan that your lender extends to you knowing that you are going to sell your current house after you buy the first house.
So it bridges the gap between the two houses, and it’s like a lien on both houses until you have sold the first house. Not every lender will offer this property. You definitely want to find somebody who is familiar with this and can work fast to get this. If selling your property and then finding another house is not an option for you, you want to start looking for a bridge lender right now who can do this for you, but with regards to a bridge loan versus selling stocks, I like the bridge loan a whole lot more.
Yes, it’s going to have a higher interest rate, but it’s a real short-term interest rate, and selling stocks means you’re going to pay capital gains taxes, which is long-term capital gains, hovers around 15% depending on your income, but you’re also losing all that growth when you sell your stocks. I mean, you can go in and buy them back again, I guess.
I mean, are your stocks even up right now? Maybe they’re down. Maybe you’re going to sell them at a loss. There’s a lot of things to consider, but I just don’t like to sell stocks in general when there’s another option like a bridge loan, which is a short-term solution with a slightly higher interest rate. I mean, what are you paying? Even if you’re paying 8% or 10%, you’re doing that for a couple of months while you’re selling your house. In this market, you buy the new house, you list your old house, it’s instantly for sale. You might end up paying one month of interest on that bridge loan.
So I had this issue, and I think I made a mistake here, but here’s what my thought process was when I had this issue and I’m trying to close on a rental property. I needed to come up with a cash. I sold the stocks and I incurred the capital gains tax. My rationale was, “Hey, I’m going to invest for the very long term. If I pay the capital gains tax and then rebuy when I get my cash back out from that deal,” which I did, I was able to refinance out shortly later from another property and repay that, “well, I’m just at a higher basis now with the new stocks that I purchased back.”
So I’m going to pay the taxes if they’re in my after tax brokerage account at some point in my life, right? So do I really care if it’s now versus later at that point. Are capital gains tax going to be higher later from that point? So I think that as long as you are not going to have a liquidity crunch in the short term with that, everyone talks about deferring taxes, deferring taxes, deferring taxes in all that. Maybe there’s a reason why it’s six of one and half a dozen of the other as my mom used to say with that. It’s the same thing for that.
So I’m not sure if I made the right choice there. If you don’t want to pay capital gains taxes, a bridge loan is a reasonable option, but I would encourage listeners to attempt to avoid this problem altogether with different avenues here. One is, as Mindy said, sell your home first, right? When you’re selling your home because the market’s so hot, there’s an opportunity to have a lease back period that until you’re able to find your new housing arrangement.
A lot of folks I know are doing essentially that. That will make this problem go away because then you’ll be able to sell your home, have the cash, buy the next one with everything in order, and then move out once you have purchased the next property and everybody’s happy and you just make that a part of your terms that you’re asking for and the offers for the home you’re listing. So that’s one.
The second option here would be a bridge loan, yes, could be a better option if you want to avoid capital gains taxes and avoid the decision that I went through or you can take out a loan against your stock portfolio for a temporary time period. Many of these brokerages like E-Trade and Robinhood offer 1%, 2%, 3% loan programs. You can borrow up to 50% or some percentage of your stock portfolio depending on what you own and how volatile it is and all that kind of stuff, but you own index funds, you’re probably going to be able to get 40%, 50% of your portfolio, and you’re going to be able to borrow that at 1%, 2%, 3% interest rates. That’s a great option that I would go to before the bridge loan.
I’d also try the HELOC as Mindy mentioned before the bridge loan, just they’re cheaper sources of debt. If you’re truly going to use it for a short period of time to bridge a gap, those might be better alternatives to save you a little bit of interest.
Those are really great alternatives, Scott. I actually have a line of credit against my stock portfolio, but I forgot about that option. It’s relatively new, but yeah. The capital gains, that’s something to consider is where is the market at right now, and you can’t predict where the market’s going to be, but it would sure stink to sell it when it’s down, and then by the time you get the money back out, you’ve refinanced your mortgage or whatever, the market is way high and you’ve missed out on that growth.
Another thing I just didn’t know, and this is something I should go and investigate now for whenever a future situation arises, is if taking that bridge loan and/or taking out another loan against your stock portfolio, whether that has some impact on your ability to borrow for the new home purchase and affects your debt-to-income ratio. So something to look into and talk to your lender that you’re going to use to purchase the new home with about. Having a mortgage on your primary that is not yet sold and having a bridge loan and/or a loan against your stock portfolio, personal loan, and having a second mortgage, that may put you in some debt-to-income ratio trouble if you’re not careful. So something to talk of about with your lender.
I did not want to disrupt the process and even go there with that because I was not fully informed. I decided, “Maybe it’s six of one and half a dozen of the other. I’m just selling a portion of my stock portfolio, eating the capital gain this year, buying the property and rebuying, I’ll just be at a higher basis, and I’m paying the tax today instead of 10 years from now,” whatever it is I would liquidate.
Yeah, but if you have the time, if you’re thinking about doing this, this may not work for the person actually asking the question, but if you’re listening and you’re thinking about doing this, call up a lender. Have a conversation with them. Ask them these questions. Ask them. Another great question to ask your lender is, “What am I not asking?” or “What should I be asking?” or “What information should I know about this program?” You want to be the most informed that you can, “What other options are out there for me because I don’t want to put myself in this position where I have to scramble to buy a house?”
Something I wanted to tag onto Scott is when you sell your house, you can put in there that you would like, in Colorado it’s called a post-closing occupancy agreement or a rent back from your buyers. If the buyer is buying it as their primary residents, they have 60 days to move in per the terms of their mortgage. So you want to make sure that you have found your new home and have moved out within 60 days, and that can put some pressure on you in this market.
So again, there’s just a lot of things to consider, and what you want to avoid most of all is making a rash decision. So if you’re thinking about moving, start gathering information now.
Really good perspective. Thanks, Mindy.
Okay. “I am thinking about pulling money out of my taxable Vanguard to finish the basement on the house I just purchased in November to maximize the value to resale in two years. I’m thinking around $20,000, and it will add two bedrooms, a bath, and a large family room, an additional 1,450 finished square feet. Does this seem worth it? I’ll have to pay long-term gains on the money. However, I’m not extremely confident in the stock market currently, not that the housing market isn’t also wild. Also, I do construction for a living and plan to do most of the work myself before everyone says 20,000 won’t do it.”
So that was my first thought is $20,000 isn’t going to cover it because my friend just got a quote for $130,000 to do her basement. Now, Carl and I did our basement. I want to say we’re 25 into the basement. We put a kitchen down there. We didn’t do bathrooms or we didn’t do bedrooms, we did a small bathroom, and it’s not 1,400 square feet, but paying long-term capital gains on adding 1,450 finished square feet. This one, I almost think that it’s worth it unless he has another way to get the money simply because he has the ability to do the work himself.
The market is going so bananas right now that it’s almost a sure bet that he’s going to make money on this as long as he does the work properly, and I’m assuming that he will. It just seems like if he’s putting in two bedrooms and a bath, he could almost use that, rent that out now to generate income to maybe even cover the long-term capital gains and then sell it for a profit in two years for an even larger profit because he has more finished square feet.
Obviously, this individual will have to do the math on what they think the after repair value of their primary will be, but I really like the idea of a project like this, right? You work a full-time job and you’re refinishing your house during that period. You’d like to think that it’s very conceivable. You could add a minimum of $100,000 in value to a house by adding that level of that amount of value depending on your market. I guess that’s too general, but in Denver, you’d think that that would be a really good opportunity to do that, and that would all be essentially tax-free because of the person’s living in the property and doing what is essentially a live-in flip.
So I think a live-in flip or a house hack is generally going to be a stronger bet than putting money into the stock market. So I’d be completely aligned with the approach of pulling the money out and doing this. I don’t think that this person will, in reality, have to pull out 20K and do the project. I think that more likely there will be phases where they will have to pull out several thousand dollars chunks if they’re doing the work themselves for materials at various times.
So you also could see a situation over a one to two-year project where this person is actually just spent managing their budget and cashflow from their other sources of income like their job, and able to essentially cashflow large amounts of the improvements here without having to make this choice.
Then lastly, you also have the choice that we’ve outlined earlier of in some cases borrowing at a very low rate with those personal loans against portions of the stock portfolio if there’s a large stock balance.
Then finally, one more point, I know I just said lastly, but I’m going to go and have a second lastly point on this. I think this is where we come back to the concept of financial runway, right? So if you’re building financial runway and have $20,000-$25,000 built up before you commit to these long-term investing approaches, I think it helps make these choices that much more accessible because you’re not having to make trade offs between one investment versus the other. No. The financial runway is for this purpose, right? This is a huge opportunity to potentially add a lot of value to their financial position, and that could come out of cash savings account or a money market account or something that’s very liquid and is intended to be used for something like this. That can be a really freeing way to build your financial position.
I’m going to throw a couple of more options for paying for this out. So I also do construction for a living and plan to do most of the work myself. I wonder if he could pick up a side job or 20 and pay for this because I don’t know if you’ve tried to hire a contractor lately, Scott, but they’re in short supply. So perhaps he could go do some side businesses or side jobs and generate the income without selling-
Go practice on somebody else’s house before doing your own.
Yeah, without selling the stock or something that I have done to fund my own rehabs, the big box stores like Home Depot and Lowe’s will offer no payment, I’m sorry, no interest on credit card payments, their own store credit card payments up to six, 12, 18, 24 months, depending on how much you’re spending. So if you’re going to be making the materials purchases anyway, plan around a promotion like that where you can either get a discount or get the no payments. You could potentially get no payments for up to two years and then, I’m sorry, not no payments, it’s no interest. It’s not no payments. You get the no interest for two years. It’s a free loan. You buy the materials, you do the work yourself, you make the minimum payments on the card, and then you do have to pay off the total amount before the last payment is due.
Otherwise, you owe the entire amount of interest on the entire amount for the entire time. So definitely read the fine print, but that could be a way to fund this deal so that you don’t have to pull out the stocks. I mean, there’s a lot of options. Also, how much is the house worth? Has it increased in value so much that you could get a HELOC and pull from that as needed? There’s a lot of options available for funding. So look around and see what you can do.
Okay. Scott, I think we have time for one more question before we wrap up. It says, “We purchased our home for $435,000 almost 10 years ago, and added a pool for $55,000. Right now, our Texas School District is highly sought after and we could sell for about $800,000. We have no mortgage. We’d love to downsize and use the gains to purchase rentals, but there is nothing available in our school district for us to move into. Would you stick it out for the remaining 15 years we have left with our kids or sell while it’s hot and hope we can move into a smaller house in the next few months or something else? The reason I wanted to ask this question is because I think a lot of people are going to find themselves essentially ‘stuck’,” and again, air quotes around stuck, “in their current home because of housing prices.
You buy a house thinking, ‘Oh, I’ll move in a few years. I’ll upsize in a few years,’ but all of a sudden, the market has increased so much that you either can’t afford the new house or it’s such a hot market there’s nothing to buy, you’re overpaying, and people say, ‘There’s no such thing as overpay because it’s worth what everybody will pay,’ blah, blah, blah,” but they are in a real pickle right now because they have so much equity in this home. Oh, they have no mortgage so they have total equity, $800,000.
I would recommend getting a HELOC and starting to look for a smaller house now so that they could take the money, buy the new house, and then sell the house when they find it. They wouldn’t need the bridge loan because their equity is the bridge loan, but I would-
I would’ve never thought that. I think that’s a great move. Yeah. That’s it. I love the idea to downsize. That’s going to save them a lot of money. If they need the liquidity, they just take out a HELOC up to most of their property’s LTV. Then when they buy the new place, sell, and they don’t have that liquidity problem in between, and they can buy the place and go from there. So I think that’s a perfect answer to that question, in my opinion. I love it.
Yeah. Then they can calmly look for a new house. They can calmly sell their house. If it doesn’t work out, they don’t have to be frantic or be paying rent when they don’t want to. They clearly value having no housing payment because they have no mortgage after 10 years. So that’s what I would do. Okay.
I would do the same thing. I would listen to Mindy on that one.
Well, thanks, Scott. Okay. That brings us to the end of the questions that we grabbed from our Facebook group, but we invite you to join us in facebook.com/group/bpmoney and chat with your fellow frugal weirdos and money nerds and money fanatics, and fi freaks. I make it sound so weird, but it’s just people who are like you who want to talk about money and optimizing their life or spending money on things that are important to them. There is no wrong answer. We appreciate all commentary as long as it’s nice, and if you’re not nice, I’ll kick you out. So if you want to be nice and talk about money, come on over. We’d love to have you.
Yeah, and please give us feedback on whether you think this format of just Q&A for audience questions is a good one and you like it and you’d like us to do more of it.
We would love to do more of this. We could even do a college show if you’d like to hear your voice on the radio. Oh, I guess it’s a podcast not a radio. I’m so old. Okay. Scott, should we get out of here?
Let’s do it.
From episode 290 of the BiggerPockets Money podcast, he is Scott Trench, and I am Mindy Jensen saying, “Shine on you, bright stars.”