Break even point for TSP real estate loan?

[VirginiaBob]

Anyone ever figure out above what mortgage interest rate will result in a financial benefit in using a TSP loan for a home mortgage. It obviously will vary based on your tax bracket, but lets assume 15%.

Probably a calculator could be made showing (total payments to TSP loan) vs. (total payments to mortgage loan - tax benefit) and final TSP account balances in both scenarious assuming an 8% rate of return on TSP account.

[SkyPilot]

That would be a really useful tool!

[ChemEng]

Its more than just the factors you mention...

You also have to consider the opportunity cost of not having your money in the TSP. This can be as high as 15-20% a year it "costs" to take a loan from your TSP. Add to it the cost of repaying the loan in after tax dollars, and the opportunities get slimmer.

The only way that I think the number would agree with this is if either the market is in a serious bear mode like 2001 OR your investment's guaranteed rate of return is extremely high. Im guessing around 30% or so.

[VirginiaBob]

The goal would be to do better than average returns (8%), not 15-20% returns. Since a mortgage is pretty much for the long term, this is not a completely unreasonable assumption. And even if the markets did average 15-20% returns, the other 50%+ of your account funds that are still in the TSP (the matching funds) would be more than enough to fund your retirement. It's all about risk analysis.

[ChemEng]

My point was that the money you borrow from your TSP account would need to generate those high rates of returns to compensate for *not* having it in the account.

There may be "good" reasons to do a TSP loan, but I think from a returns perspective youll find that it rarely makes sense.

Ill run the numbers tomorrow, and we can go from there.

[VirginiaBob]

My point was that the money you borrow from your TSP account would need to generate those high rates of returns to compensate for *not* having it in the account.

There may be "good" reasons to do a TSP loan, but I think from a returns perspective youll find that it rarely makes sense.

Ill run the numbers tomorrow, and we can go from there.

Which is all fine and good and we could debate the merits of whether it is a good idea or not to take out a TSP loan for days or months or weeks or years, but that is not the purpose of this thread. That debate is already taking place on countless other threads.
The purpose of this thread is to develop a calculator to determine what the benefit or loss is for taking out a TSP real estate loan, given a certain TSP loan interest rate, given a certain tax bracket, given a certain expected TSP return rate, and given a certain loan amount, a certain mortgage interest rate all as inputs into a calculator.

[ChemEng]

Heres the spreadsheet I set up to work the problem.

The variables that you can change are highlighted in yellow.

To determine the break even point, use the goalseek function in excel as described in the spreadsheet.

I couldnt remember whether home loans were 10 or 15 year notes, so I ran the simulation for both. (The answer is the same either way.)

1768

[VirginiaBob]

Thanks for the calculator.

Another thing to add would be to consider if TSP/Mortgage payment is lower than the non-TSP/Mortgage payment, then investing the difference in a taxable account.

[ChemEng]

Im not tracking what you mean by TSP/Mortgage versus non-TSP/Mortgage. Can you clarify?

[VirginiaBob]

TSP/mortgage is the amount that you are paying per month towards the $50000 TSP loan

non-TSP/mortgage is the amount that you would have paid if the $50000 was on your mortgage instead.

For example, let's say the payments to your TSP loan are $400 per month. Your other choice would be to use a conventional mortgage instead of a TSP loan, which let's say are $500 per month. The difference between the 2 is $100 which the disciplined investor would put in a taxable account.

[VirginiaBob]

Ok, I wrote a calculator, and the break even point for my scenario above ($50K, 15 years, 15% tax bracket, 8% interest in TSP and taxable account) is a mortgage interest rate of 9.75%. My calculator is rough around the edges, but mathmatically correct. Feel free to clean it up if you want.

[ChemEng]

Ok, I wrote a calculator, and the break even point for my scenario above ($50K, 15 years, 15% tax bracket, 8% interest in TSP and taxable account) is a mortgage interest rate of 9.75%. My calculator is rough around the edges, but mathmatically correct. Feel free to clean it up if you want.

Im not sure about some things with your spreadsheet, but there must be a fundamental difference in our methodology to yeild such different results.

Just some quick observations:
1. You didnt account for the property tax you would have to pay with the additional property purchase.
2. You also didnt account for the equity accrual in your equation. I would think this would be a big reason for making this choice.
3. Why did you assume only an 8% TSP return? That is awfully low estimate considering the 15 year investment perspective...

[VirginiaBob]

Im not sure about some things with your spreadsheet, but there must be a fundamental difference in our methodology to yeild such different results.

Just some quick observations:
1. You didnt account for the property tax you would have to pay with the additional property purchase.
2. You also didnt account for the equity accrual in your equation. I would think this would be a big reason for making this choice.
3. Why did you assume only an 8% TSP return? That is awfully low estimate considering the 15 year investment perspective...

1. My assumption was that I would not be buying a different (more expensive house) with or without the TSP loan. I'd be buying the same house in either case. My goal is not to be mortgaged to the max and additionally have a TSP loan.

2. See answer to 1, it is the same house in either case.

3. You could adjust to different returns in the spreadsheet. I ran the numbers and that is what I would need (8%) to have 85% of my salary when I retire.

[VirginiaBob]

FYI, if you were to use the 1928-2006 historical return average of the S&P of 11.77%, the break even point would be a 14.8% mortgage.

[pyriel]

Can any of you do a spreadsheet for me since i'm so impressed on how you guys did that. Here are the condition.

50k in TSP. Borrowed 20k to purchase a rental property.
Property was bought for 110k, 6.75% apr, 30 years mortgage, 4k closing, 16k renovation, monthly payment of $713 monthly mortgage, $100 monthly insurance, $87 monthly property tax. Rental monthly is $1500. Vacancy rate of 1 month for every 24 months rented. Appreciation factor of 2% per year. Maintenance rate of $100 per month.

Which is better? Pls dont forget the 4.5% interest for TSP Loan payment that is going back to the lendee. Tnx

P

[Bullishreturn]

Virbob:
your spreadsheet didn't include:

1.Property taxes, nor the growth in property taxes over the period.
2. Insurance, nor the growth of insurance over the period.
3. Routine maintenance (new roof, water heater, etc).
4. Utilities of any kind. Assume at least the vacant months will fall back on you.
5. Eviction court costs for a bad tenant (been there, done that.)
6. periodic unexpected special assesments from the local govt for various things.
7. Tax rates on capital gains upon sale at the end of the period, accountant fees for tax preparation.

It's a nice thought- but I think there may be a lot more costs involved in rental property than you have put in your spread sheet.

[VirginiaBob]

Virbob:
your spreadsheet didn't include:

1.Property taxes, nor the growth in property taxes over the period.
2. Insurance, nor the growth of insurance over the period.
3. Routine maintenance (new roof, water heater, etc).
4. Utilities of any kind. Assume at least the vacant months will fall back on you.
5. Eviction court costs for a bad tenant (been there, done that.)
6. periodic unexpected special assesments from the local govt for various things.
7. Tax rates on capital gains upon sale at the end of the period, accountant fees for tax preparation.

It's a nice thought- but I think there may be a lot more costs involved in rental property than you have put in your spread sheet.

1. The property taxes would go up on the property no matter if I use the TSP loan or a conventional mortgage. As I said before, I'm not advocating using a TSP loan to buy more house than you can afford.

Comments 2 through 7: See response 1.

I think you are interested in a completely different calculator than I proposed.

[Aviator_Guy]

I would never recommend taking money out of TSP for any type of loan, especially for Real Estate. My current home mortgage fixed interest is 5.75%. By leaving your TSP alone, that money can work a lot harder for you in TSP vice out.

I withdrew money from my TSP in the early 90’s for a Real Estate down payment, but if I hadn’t done it, I wouldn’t have been able to make the deal. At the time, it seemed like a good idea. But once the dust settles, you think, man, what did I just do? Anyway, that’s my thought on it. Good luck with your TSP investments!

[VirginiaBob]

I would never recommend taking money out of TSP for any type of loan, especially for Real Estate. My current home mortgage fixed interest is 5.75%.

Sure, at 5.75% mortgage rate, you are sitting pretty, buy what if rates rise near 17% like in 1981?

[ChemEng]

Sure, at 5.75% mortgage rate, you are sitting pretty, buy what if rates rise near 17% like in 1981?

I still think that thats looking at it backwards. The opportunity cost is the missed growth in your TSP and *not* the potential difference in mortgage rates. Theres a big difference between the 2.

[VirginiaBob]

True, but the difference could be invested elsewhere.

[pyriel]

I would never recommend taking money out of TSP for any type of loan, especially for Real Estate.

[QUOTE]Can any of you do a spreadsheet for me since i'm so impressed on how you guys did that. Here are the condition.

50k in TSP. Borrowed 20k to purchase a rental property.
Property was bought for 110k, 6.75% apr, 30 years mortgage, 4k closing, 16k renovation, monthly payment of $713 monthly mortgage, $100 monthly insurance, $87 monthly property tax. Rental monthly is $1500. Vacancy rate of 1 month for every 24 months rented. Appreciation factor of 2% per year. Maintenance rate of $100 per month.

Which is better? Pls dont forget the 4.5% interest for TSP Loan payment that is going back to the lendee. Tnx [QUOTE]

I did it this year. Can you calculate pls if I am losing out or gaining. TY..

P

[ChemEng]

I did it this year. Can you calculate pls if I am losing out or gaining. TY..

P

I put together the basic framework on my spreadsheet on the first page of the thread. The idea is to compare the value in your TSP with no loan to the value of your mixed investment. If the difference is positive, then it doesnt make financial sense to make the investment. If its negative, then it does. That simple.

[pyriel]

I put together the basic framework on my spreadsheet on the first page of the thread. The idea is to compare the value in your TSP with no loan to the value of your mixed investment. If the difference is positive, then it doesnt make financial sense to make the investment. If its negative, then it does. That simple.

Based on your statement that you will not borrow anything to finance a real estate deal, I wanted to show that some RE investments will be better or far superior than keeping it within TSP. I'm providing an excel worksheet to show proof that it can be done and I will continue to keep doing it whenever I see deals like this.;-)

P

[Ed]

Can any of you do a spreadsheet for me since i'm so impressed on how you guys did that. Here are the condition.

50k in TSP. Borrowed 20k to purchase a rental property.
Property was bought for 110k, 6.75% apr, 30 years mortgage, 4k closing, 16k renovation, monthly payment of $713 monthly mortgage, $100 monthly insurance, $87 monthly property tax. Rental monthly is $1500. Vacancy rate of 1 month for every 24 months rented. Appreciation factor of 2% per year. Maintenance rate of $100 per month.

Which is better? Pls dont forget the 4.5% interest for TSP Loan payment that is going back to the lendee. Tnx

P
This may help which is the cost of TSP loans.

http://www.tsp.gov/cgi-bin/byteserver.cgi/forms/oc96-16.pdf

Ed

[ChemEng]

Based on your statement that you will not borrow anything to finance a real estate deal, I wanted to show that some RE investments will be better or far superior than keeping it within TSP. I'm providing an excel worksheet to show proof that it can be done and I will continue to keep doing it whenever I see deals like this.;-)

P

The spreadsheet looks sound. Just another case showing the power of leverage and profits. When the investment goes up, leverage amplifies the increases. When the investment goes down, very bad things happen.

Im surprised that you can get a deal like this to work though. Why would someone rent a place at 2x what the monthly mortgage would be? And if thats the case, why arent there more real estate prospectors in your area doing the same.

(As an aside, I thought that interest paid on a mortgage is only deductible if its the home you live in. I was surprised to see mortgage interest *AND* depreciation tallied.)

[Scout333]

Mortgage interest related to rental property is deductible (considered business interest). Rental Income is taxable. Ain't tax fun?:)

[Bullishreturn]

Based on your statement that you will not borrow anything to finance a real estate deal, I wanted to show that some RE investments will be better or far superior than keeping it within TSP. I'm providing an excel worksheet to show proof that it can be done and I will continue to keep doing it whenever I see deals like this.;-)

P

A couple things about your assumptions:

First, I think you didn't take into account in your profit line the fact that you had cash outlay in the beginning to fix the place up:

"total closing cost & downpayment from investor pocket
$20,000.00"


That "out of pocket" cost, if I read your spreadsheet correctly, should have been deducted from your five year profit line. You also should show the opportunity cost lost from not having that 20K available for investment, if you wanted to get a true picture.

Several other comments- just in general. Your assumption is that you are renting it every month and receiving income every month for the five year period. How sure are you that you can get a good tenant that will pay, on time, with checks that don't bounce? I ask because I've seen some bad tenants in my time, and chasing them for the rent is not easy. And i've seen vacant space for at least a month between teneants on more than one occasion. I don't know what the rental market is like near you, but you should make sure you are counting on valid assumptions for vacancy times between tenants as well.

Finally, I didn't see any of the items I mentioned before about utility costs or special assesments rolled in, as they would be your responsiblity as owner during any time the home was vacant. Are you counting those costs as well?

Real estate CAN be a good investment, particularly multi-family homes where even if you have one unit vacant, you can still count on income from the others while you are looking for the right tenant. My parents did some three and four unit multi-family homes when I was younger. I can tell you that I did a lot of the maintenance to keep the places going, so I know you have to keep that in mind as well.

[pyriel]

Ed, Chemem, Scout, and James,
Tnx for the replies and thoughts about this. This kind of deal doesn't come often and requires much research and patience. It also requires that an individual is ready to move in to the deal anytime which means that all of his/her financial requirement are in order. It is also not for newbies and that is something that I would like to emphasize here. I don't want our readers to think that this kind of deal is easy to get. I also have and RE agent that is working himself to death (hehehe).

There are alot of competition here and many of them have money. This is really a small time operation. I differentiate myself from them because I look for fixer upper while many of them are going for new constructions. Not sure if you read my other posts but we have the marines coming to Guam from Japan and they are expecting a 16billion dollars being pumped in to Guam's economy within the next 6-10 years. My estimate is five years of good RE here.

As for James comments, I know that I will get paid evey month because my tenant based renters are section 8. This means that you and the rest of the US is financing my rental income through electronic fund transfer. Our houses here are made of reinforced concrete cement blocks so they really cant destroy that. Our section division here have no qualms in terminating the tenant if they don't follow the rules. Let me tell you something about these section 8 tenants, they tend to stay 3-5 years staying in beautiful house that i provide them ;-). Not sure if you notice that i factored in maintenance cost every month just in case;-)

I also don't understand what you are talking about the 20k. I was able to show that I will get all the 20k back within 5 years + more. After under three years I am actually playing with "Other People's Money" OPM since I am able to recoup the 20k I invested. One thing I didn't show in my spreadsheet and you failed to realize is that is the percentage amount that I could get if I decide to reinvest those monthly profit I am getting on a monthly basis;-)

RE like this is not for newbies and I would like to reiterate that. I make it sound easy because I've done several of these in the past. Please don't follow unless you know what you are doing. Thank you...

P

[pyriel]

A couple things about your assumptions:
.

BTW, in here when I move my funds I am making an assumptions. With RE, I don't. I don't buy a property unless, I know that I will make money. In fact, many RE agents have talked to me, telling me that an investment is sound and that it is a good investment. However, when I do the number just like what i've shown, it always turns out to be a dud investment.

The difference between TSP//IRA/Mutual funds vs. RE is that for me, I can affect the outcome of my RE investment. When tenant moves out, I go out and look for tenants. With stocks, we all make an ASSUMPTIONS that it will either go up or down at a certain period of time.

RE also is cyclical. It means that like stocks, it will go up and down. However, RE cyclical event doesn't happen overnight. It takes time and a good lead way to prepare for an event. The moves I am making now is based on cyclical upward trend (guaranteed by Uncle Sam) that RE here will increase because our Marines are getting kicked out of Japan;-)

P

[Show-me]

The moves I am making now is based on cyclical upward trend (guaranteed by Uncle Sam) that RE here will increase because our Marines are getting kicked out of Japan;-)

P

Off topic: If you conquer a country that attacks you, you should never ever get kicked out of it. :suspicious: Just a personal quirk. Sorry.

[pyriel]

AFirst, I think you didn't take into account in your profit line the fact that you had cash outlay in the beginning to fix the place up:

"total closing cost & downpayment from investor pocket
$20,000.00"


That "out of pocket" cost, if I read your spreadsheet correctly, should have been deducted from your five year profit line. You also should show the opportunity cost lost from not having that 20K available for investment, if you wanted to get a true picture.
.

The assumption that this out of pocket cost went down the drain is a false assumption and can only be construed by inexperienced RE investors. If we decide to put our money in TSP that money remains in TSP. The money placed in RE is the same concept of putting the money in TSP. The money didn't go anywhere but to the investment. In fact, putting money down to upgrade a fixer upper provides the individual an immediate return on investment. I'll give you a real RE example based on the last purchase i made... I purchased the property for 105k and plunked down 20k (repair and closing cost). What you don't see here is that the property was appraised for 115k prior to the purchase and in dilapitated standard. By putting in 20k the property was re-appraised for 140k within less than 2 months. Now, I have a property that I owe 105k with appreciation value of 35k from the 20k I invested. That alone is a return of 15k or 75% return in two months.
Now, I can do two three things here; Refinance to get some money back from my 20k initial investment or sell the property for 140k and run away with 15k profit. The last option is to keep the property, continue to wait for further appreciation, then refinance to get 100% of the money investment and still rent the property to continue to receive passive cash flow.
Try doing that with your TSP. I guess my point here is that we really need to keep our options open when it comes to investing. And there are some RE investments that are superior than TSP.
I would like to point out that any individual that would like to venture into RE must have reasonable knowledge about it. Again, what i'm doing is not for amateurs. Please don't follow unless you become more proficient with dealing with RE investments...

P

[ChemEng]

I'll give you a real RE example based on the last purchase i made... I purchased the property for 105k and plunked down 20k (repair and closing cost). What you don't see here is that the property was appraised for 115k prior to the purchase and in dilapitated standard. By putting in 20k the property was re-appraised for 140k within less than 2 months.

If the market is as strong as you say it is, why not just pay the closing cost and flip the property for $115k? Better yet, why isnt your real estate agent make this move?

Im still having a hard time believing that there is a real estate market that is that far out of equilibrium that deals like this are possible. Its nigh unheard of stateside--even in beautiful Kentucky.

If you are making it work, congratulations. But I still believe you are underestimating your risk exposure. James hit on it partly with your probability of occupancy being 1. But you are also completely ignoring the risk associated with having so much debt open.

Heres a real for instance (and not a Kiyosaki-esque ideal paper case)--I worked with a soldier who lived in Pensacola while he went to dive school and invested in a property there. He was saving 10% of the rental fees in repair and maintenance costs. Then the air conditioner and roof needed *replacing* in the same month. He had to come out of pocket to get them back up.

Then Hurricane Katrina happened. And surprisingly, no one wanted to rent a house that didnt have a roof. He did have insurance, but after 3 month of blue plastic shingles, it still wasnt replaced. Not to mention the potential structural damage that may have been caused.as well. He ended up having to pay for 8 months of the mortgage payments. Then when he was finally able to get someone back into it, it was for 75% of this original asking price. He still had to continually foot the difference.

If he didnt have the mortgage over his head, then everything would have been fine. But to not include the risk associated with having so much of your investments purchased on leverage just doesn't make sense to me.

It just like having a 2-1 (or 3-1, 4-1 et al) margin account. Do you immediately invest the margin because of the potential upside? Of course not because using leverage increases the risk profile of the investment. Why is your real estate investment any different than this?

(Long winded I know-product of late night and ample lubrication.)

[pyriel]

It seemed that you missed my other posts on the RE market stability. As i mentioned in the past we have been seeing a downward movement in RE starting from the east cost and at this time has hit the west coast. I also mentioned that it will start migrating farther to Hawaii and will eventually hit Guam as well. The only thing that is saving us for now is the movement of the military here from Japan but Hawaii is already seeing a slow downward movement in RE.

Now, the problem with the example you mentioned is that soldier was not ready for calamity. This is always a problem when people buy RE and not understanding the numbers behind it. I've had so many offer from an RE agent telling me that an investment is good but when I did the number its really a lousy deal. Same goes for insurance. I pay for good insurance and since I am dealing with one insurance company with my multiple RE, I get better treatment. Its a relationship that started when I only had one property. Additionally, RE in US never learned when it comes to calamity. Here on Guam, we have nowhere to go so we made all our houses out of solid reinforced solid cement blocks. Our roof is also made of the same materials. This is why we kind of laugh when the US gets hit with a baby hurricane with winds of about 150mph.
As far as reinvesting the margins is concern, well the appreciation allows me to reinvest them by refinancing. I get my money back so now im playing with OPM. As far as the passive income from rental is concern, those are reinvested back by buying more RE. The problem I have now is that I have to continue to buy RE so that I don't pay taxes. But that is another thread all together.

P

[pyriel]

If the market is as strong as you say it is, why not just pay the closing cost and flip the property for $115k? Better yet, why isnt your real estate agent make this move?
Im still having a hard time believing that there is a real estate market that is that far out of equilibrium that deals like this are possible. Its nigh unheard of stateside--even in beautiful Kentucky.
(Long winded I know-product of late night and ample lubrication.)

I forgot to answer this... knowing the market means networking and being able to move into a deal faster than the other guy. This means that your financial must be in order and all documents ready to go when a good deal materializes. Additionally, I specialize in fixer upper while many here are going after new houses. My rental market is also for Section 8 while others are targeting the military. Additionally, RE deals like this doesn't come often and it is usually grabbed before it comes out of the market or LMS. My RE just recently bought a 200k brand new house that he is renting for $2500 to a military guy. You do the math with 30 yrs to pay and he put a 20% down payment;-) There are times that good deals will pass me by and i can't do anything about it coz of fear being overextended. That is also another thread to talk about and possibly what happened to your soldier friend...

[rokid]

You've probably seen Cramer's recent FED meltdown and his advice to "walk away from your home if it's down 20%." However he was singing the "it's no problem" tune in mid-July.

http://www.youtube.com/watch?v=BVl9SQ-KVmE&mode=related&search=

I guess his wisdom only has a half life of about three days. He's entertaining but....:laugh: