Should I take out a loan on my rental property or sell it to pay off my debt?
I own a rental property that once was my private residence. I have paid off the mortgage and currently rent it. I personally rent a condo in another area and use the rental income to pay my rent. I earn about $45,000 per year and am single with no dependents.
I am about $14,000 in credit card debt and want to pay it off. Should I sell my rental property since it has doubled in value, use the profit to pay off my debt to avoid paying the interest, and then invest in another rental property? I'd also like to buy a home in my area. The maintenance on the rental home is beginning to become costly and with personal responsibilities and the lengthy drive to the home, it is becoming difficult to maintain. Should I take out a loan on my rental property or sell it to pay off my debt?
Joshua Escalante Troesh was voted the #1 advisor nationally by the Advisor Insights audience.*
You should start by determining if owning this rental property is in your long-term life plan (without considering the credit card debt). From your question, it sounds like the property is causing you more difficulties than you'd like. At the same time, the property is paying for your rent, which is a significant increase in your income. If you'd rather not have the difficulties of owning the rental property, then sell it and use some of the proceeds to pay off the credit card debt. If you do want to own the property, then explore an alternative method of quickly paying off the debt. Below are my comments on some of the issues to consider.
Maintenance Costs
While the maintenance costs may seem like a hassle, they are a normal part of owning a rental property or a rental property business. Property investors are often surprised by the maintenance costs of their properties during their first decade or so of being a landlord.
The most common thing I see with clients who are property investors is they have not calculated the routine maintenance nor the capital repairs necessary to maintain the rental income. Owning a rental property makes you a business owner, and like all businesses, there are expenses in addition to revenues.
I do a hefty analysis on client’s rental properties and many are surprised by the actual expected internal rate of return when all expenses are factored in. At the same time, most do not sell their rental properties because they do fit into the overall financial plan even with the lowered rate of return.
Transaction Costs of Sale & Purchase
Generally, selling property just to pay off the credit card debt would be a very costly. Selling a real estate asset comes with a lot of transaction costs; including realtor commissions, title fees, and other costs. These costs can eat up between 5% to 10% of the value of the property, which will likely be much more than the interest cost on the credit cards. Depending on the rest of your financial plan, this cost could be devastating or a minor inconvenience.
Lifestyle & Career Considerations
The biggest question, though, is whether you want the rental property itself. You’ve expressed the drive is making it difficult to maintain the property, but how is the distance of the rental property impacting your lifestyle or you career? Consider how often you are passing on social activities or spending time with family because of the need to drive to the rental property. Also consider if the time spent on the rental property is impacting your career. While the rental income is nice, consider if there are ways to use the time spent managing the property to further education, build new skills, or take on more responsibility at work to increase your income. If you’d rather not have a property so far from your current home, then selling it may be the best option regardless of the credit card debt.
Alternatives for Paying Cards Off
A loan against your property would likely have lower costs than selling and buy the new property, plus would preserve your ownership of the asset (if you still want that property). You should also, however, consider simply putting an extra $500 to $1,000 per month toward the credit card debt to pay it off within a year or two. You are effectively living rent-free because the rental property is paying for your condo, which should allow you to devote more of your income toward getting out of debt quickly. Once the credit card debt is paid off you may be able to think more clearly about the rental property and how it fits into your life.