Financing a Second Property: Part One of a Quick Guide

 

IMG_8874Although most financial experts will advise you not to cash out your retirement funds to purchase real estate, it was the right choice for me. I’m going to walk you through the steps I took to make it happen. There are at least two special circumstances that stacked the deck in my favor, but some of the practical advice I give below is worth considering regardless of what your case may be.

Some Background 

When the ex and I split, in 2011, the United States was still recovering from the recession. Although we had more money saved for retirement than the average couple, I had invested everything in equity funds, which were still down considerably, as was the value of our modest house in Austin. The lawyers with whom I consulted about asset division did not believe that I’d be able to remain a homeowner, let alone purchase a second home.

“What will you do? Move in with your parents?” one of them asked.

Among other things, these gloomy speculations made me realize that if I retained an attorney, I could stand to lose a great deal of money, especially if my ex and I got embroiled in a court case. I resolved to employ attorneys on a consultation only basis, hiring one to write up the final divorce paperwork for a flat fee. The whole thing, which included advice from two of the top family lawyers in Austin, cost about $4,000.

In order to keep the house — pretty much the only way I could remain a property owner, given my lack of a stable work history and the stringent mortgage qualifications at the time — I did a cash out refinance while we were still legally married, tapping into our existing equity. My ex got most of that so he could purchase a house for himself; I reserved a small amount as an emergency fund.

This turned out to be a wise move. Austin recovered more quickly from the economic downturn than the rest of the country, and the value of my home rose 26 percent in the next four years. Early last spring, I checked the account balance of the 203b funds I’d been awarded in the form of a Qualified Domestic Relations Order (QDRO). I didn’t log into the account very often; the whole thing reminded me of the difficult days right after the separation. This time, however, I was pleasantly surprised to find that my stocks were up almost 100 thousand dollars as well.

Assessment

I sat down with a pencil and paper and made a complete accounting of my financial situation under various scenarios. I estimated approximately how much I would receive in Social Security and how much the Federal Government would offset the modest pension I’d receive from the community college if I stuck in the plan long enough for it to vest. I also had some Roth and regular IRA funds that were not marital property — not a lot, but not nothing, either.

I realized that I would not be in bad shape even without the QDRO funds. There was not a lot of money, but my needs are modest, and even if I became seriously ill, I was never going to be wealthy enough to afford top-notch assisted care, which these days exceeds even the cost of attending a liberal arts college per year. I would have to be proactive about my health — watch my weight, reduce stress, keep up regular exercise — and hope for the best.

I had been searching MLS listings in coastal Maine for months; now I contacted Realtors and narrowed the field of choice. My best friend and her husband had connections with the Blue Hill Peninsula, so I focused my real estate search there. Good restaurants and a strong artist community were definitely bonuses.

Gathering the Funds

I decided how much money I would need at minimum to afford a house that fit my requirements. Ideally, I wanted a place that would continue to bring in rental income even after I moved up to Maine for good, and properties like that were slightly more expensive. Although QDROs are exempt from the 10 percent penalty that one ordinarily has to pay on an early distribution, I would still be taxed heavily on the retirement funds — more on that in Part Two — so I decided to supplement this amount with another cash out refinance.

For what it’s worth, I love cash out refinances. For an initial $15,000 downpayment on the house in Austin, my ex and I have purchased well over a million dollars worth of real estate. If I had to guess, I’d say we have about $400,000 in equity stemming directly from that initial investment. Subtract the mortgage payments, and that still leaves $150,000. That’s about 17 percent interest over 15 years. Not bad. If we had bought on the west side of town, like our Realtor recommended, we’d be millionaires.

I had my excellent mortgage broker, Jim Loughborough, dig deep to try and get me the maximum amount he could manage out of the refinance. Since I freelance part time and work at the community college part time, the paper chase was excruciating; the lender wanted to know everything about me, and after we ran into problems with the IRS that pushed the closing date back into June, they wanted to know it all over again.

That was nothing, however, compared to my last minute realization that the tax burden from the QDRO distribution would be tens of thousands of dollars more than I initially thought.

Parts Two and Three of this guide discuss some of the ways in which I will be able to cushion the tax blow. I’ll also impart some of the wisdom I learned about the importance of cash flow from one of my freelance clients, a successful Realtor in the Bay area.

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