Wednesday, July 14, 2010

Twenty Eighth Bag Of Mail: Risk + Rentals

"If you and your husband could get $20,000 each using a personal non secured credit line at a rate of 7% interest, and put them together to make $40,000 and you had another $20,000 in a bank somewhere (so now you have $60,000) would you risk buying a sub $300,000 house that was rent ready and the rent could cover the cost of mortgage and interest on the credit line, etc. The risk being that if it isn't rented you'd have to cover your current mortgage and the investment property at the same time? I'm guessing you got where you are by taking risks like this but just would really love your perspective.


Kate, I got to where I am by taking measured risks and having weirdo good luck.

That said, to answer your question, I am going to place myself entirely in your scenario, which is SO fantastic because no one in the universe loves a bit of What If action more than me, just ask Andrew about the time I forced him play it in the car for forty five minutes and he threatened to leave me at that truck stop by the place with the BROWN EGGS sign. Which, by the way, do actually come from brown chickens, which I later discovered after one long argument, two phone calls to Allison, and a short Google search later. Who knew white eggs weren't dyed? It's amazing what you can learn from the internet.

Plus, now I'm CERTAIN that our children will be hatched as redheaded snowmen with freckles.

But anyway. Since we're playing What If, I'm going to assume that this opportunity is taking place in the current SHIT, I mean, CRAP, I mean, less than desirable economy and that there are no existing savings beyond the $20,000 that's being put towards the purchase. This means that the (very important) unknowns remaining are the household budget, income bracket, rental micro market, terms of the personal loans, type of mortgage we'd qualify for, taxes, insurance, and Homeowner's Association fees. And, most significantly, how much equity am I purchasing?

Bottom line, would I do it?

No, I would not make this move. Why?

Personal loans are bad debt. There is no tax advantage for me taking a personal loan and they don't do your credit any favors. Plus, I can beat a 7% interest rate in this market easily, especially with an FHA loan. Also, it doesn't matter to me if the house is $30,000 or $900,000. What's important is how much equity I'm purchasing and that I'm an entry to mid level property in a highly desirable neighborhood. Sub $300,000 is irrelevant if the market is only bearing around that amount. Anything is a good deal if you hold onto it long enough, you know? That doesn't help you earn money fast enough to beat inflation.

So. What would I do if I were you?

First of all, let's assume a few things. Let's pretend that you and your partner have a household budget that works and that it's in the black. Next, we're going to pretend like you have a separate retirement account, even if it's teeny tiny and stuffed under your mattress. That account never, ever, ever, ever gets touched. EVER. Last, I'd make sure that the $20,000 is earning me a little cash somewhere, probably in an Etrade account or high interest online savings plan.

If that business is in order, than I'd look at moving. But I don't want to move, you say. If you do, you'll qualify for a primary residence loan, which is light years better than that personal loan you're considering, plus you'll save tons in capital gains taxes if you stay there a couple of years. Not only would your down payment be significantly less, but your interest rate should be stellar in this market. However, if you can't sell or rent your current home, than this option is out.

Moving along.

Pretending that you decide to go forward with purchasing a property entirely as an investment, depending on your income, I'd buy something with a lower purchase price and a higher cash flow. I'd also do my very best to have a tenant lined up before I actually signed on the dotted line, or arrange a sixty or ninety day close to give myself the time to find one. Remember, in addition to holding costs during vacancies, you still have to cover general maintenance, repairs, taxes, insurance, and Homeowner's Association fees. Not to mention the possibility (which always exists!) of having to evict a nonpaying tenant. All things to keep in mind.

What would I avoid?

I would not take a personal loan. Before I'd do that, I'd throw $40,000 on a credit card and use the cash flow to pay it off before the 0% period expires. Can't qualify for a 0% credit card or the property doesn't have enough cash flow to pay off the down payment debt? Then it's probably not a good idea. It's also worth noting that I am generally against the idea of partnering financially with anyone other than your spouse. I won't expand further than that, but there are many reasons why it complicates things legally and personally.

A lot to think about, right?

After allllll of that, I want to reiterate that I think this is one of the best purchase markets that we'll see in our lifetimes, and I don't want to discourage you from buying something. I think it can be a life changing smart move. But there are lots of different ways that you can acquire a rental property, and many of these decisions can limit your risk.

And isn't that what you're asking about, anyway? Our ability to swallow risk?

Personally, I get enough kicks out of swimming with sharks and jumping out of airplanes and forcing Andrew to play What If on the highway while he threatens to leave me alongside the BROWN EGGS hatched by the the BROWN CHICKENS. So I don't need to sucker punch my retirement for a good time.

1 comment:

Kate said...

WOW Kelly! thank you so much for your advice it really means so much to me, that you take the time to really answer questions like this.

we just bought the current house we are living in about a year ago, and still working on renovations so maybe we'll concentrate on that then move into the new place and rent this one... just really eager to take advantage of this crappy market right now :)