Thinking about buying a second home, need some advice.

[minimalistgamer]

I have a few questions regarding buying a second home in the future.

Here is my plan - Rent out this current home (which is paid off), and use the rent money to pay mortgage on our second home. The bigger goal here is to have two paid off homes as soon as possible.

When we buy a second home, I want to pay it off very aggressively. I will be putting a pretty big down payment, probably around $60k.

At the moment, 100% of my net pay check is being saved each month, which is $3400. This is after maximizing 401k.

By my calculations, in 24 months, I will be able to save $59,000

Total net pay: $81,600 ($3400 * 24)
Roth IRA: -$11,000
Property taxes and insurance for current home: -$8,000
Misc expenses: -$3600
TOTAL: $59,000

Here are my questions:

1. Should I keep saving the money in my online savings account?
2. Should I invest it in the brokerage account? If so, should I stick to VTASX or should I look into other funds?
3. From a purely wealth building perspective, would it be a good idea to buy a second home or just live in the current home (its not a bad house or anything, by the way) and invest all the money in a brokerage account?

Thanks for your advice.

[SwordGuy]

1) In the USA?
2) Lived in your current home how many years out of the last 5?
3) Intending to buy and hold 2nd house for rental, or buy and flip?

[minimalistgamer]

1) In the USA?
2) Lived in your current home how many years out of the last 5?
3) Intending to buy and hold 2nd house for rental, or buy and flip?

Thank you for your response. Here are the answers to your questions:

1. Yes, I live in the US, more specifically in the mid west.

2. I lived in our current home for 18 months now. We bought it on December 15, 2015

3. We intend to buy the second home so that we could move into it and rent out the current home we are living in.

I get the feeling that having a second home is a good wealth building strategy. What I am not really sure about is if it would be a better idea to invest everything in the stock market, and reap the rewards later. After we paid off our house, it seems as if I don't have any new goals, so I am trying to figure something out.

[boarder42]

this has been beat to death around here and you dont seem to listen much or understand it.  BUT

Mortgages are cheap right now.  If you really want to build wealth you should be leveraging this debt either thru not paying down your homes and building a real estate empire.  Or not paying down your home and investing in VTSAX. 

Seems you felt good paying down a house.  Great.  Well its a slow path to wealth to throw money at a 4% loan.  You need to learn understand and figure out how to get that same feeling throwing your money at VTSAX and watching it grow or leveraging rentals(this is faster if done properly but has more risk and knowledge required) You'll come out ahead 95%+ of the time following this strategy.  betting on the other side is similar to betting on green on a roulette wheel.  why take that chance.

Also have you even evaluated IF your home is even a good rental.  There is a lot to learn in the rental game and its not as easy as investing but when done properly you can come out ahead.  Bigger pockets is a good place to start to understand if you want to go down this path and if your house is even remotely a good rental.

[boarder42]

Think of it this way. 

you have 100k today you could go buy 1 - 100k house with all that cash and assuming it meets the 2% rule(hard to find now)  you will be bringing in 24k a year on that house

or you use the 100k to buy 5 100k houses and put 20% down on each.  now you're bringing in 120k a year across those houses minus the small mortgage payments ~29k ...

which of these seems more like wealth building

[Scortius]

Boarder makes some good points.  You've also left out the most important part of the equation, which is how much do you think you could rent out your current home for?  In general, single family homes are not great wealth building investments.  You're usually better off buying duplexes to quadplexes for investment purposes.  You should also take into account the opportunity cost of tying that money into a single house and not being able to take advantage of tax-advantaged investments in the market.  Further, even if you are hitting your IRA and 401k contributions, the market is very likely going to outperform real estate over a long time horizon.  Even further, the market is a low tax burden passive investment whereas real estate is a high tax burden incredibly active investment.  Not to say you shouldn't invest in RE, but have you sat down and seriously considered the trade-offs between the two?

[Laura33]

I agree with Boarder.  The reason real estate is an excellent path to wealth for many people is not the housing market itself -- it is leverage.  If you put $100K into stocks and the stocks go up 10%, you have a 10% return on your investment.  If you put $10K down on a $100K home and the value of the house goes up 10%, you have just doubled your money.  Meaning that that same $100K, split across 10 homes, with a 10% growth in home value, would bring you $100K in profit instead of $10K.  Buying real estate is the one area in which "normal" people get to take advantage of leverage; if you can get a tenant to cover your costs and throw off profit, at the same time that leverage is providing an excellent ROI, it's a win-win.

[All numbers for illustrative purposes only.  Necessary caveats about danger of leverage.  Etc.]

But if you focus instead on paying off the mortgage as fast as possible, you lose that boost.  At that point, your "profits" come from the overall gains in the housing market.  And if you compare those historic gains to those of the stock market, the housing market as a whole is a loser -- sure, there are hot areas and periods, just like there are hot stocks and bull markets, but over time, the housing market has historically run closer to inflation, while the stock market has historically thrown off 10% +/-.

[minimalistgamer]

Think of it this way. 

you have 100k today you could go buy 1 - 100k house with all that cash and assuming it meets the 2% rule(hard to find now)  you will be bringing in 24k a year on that house

or you use the 100k to buy 5 100k houses and put 20% down on each.  now you're bringing in 120k a year across those houses minus the small mortgage payments ~29k ...

which of these seems more like wealth building

Thank you for your response.

I understand what you are saying, and from a purely mathematical perspective, you are right. I have a greater chance of building wealth when I leverage OPM (other people's money). I am not entirely sure I want to put myself in that kind of a situation though. I know I will be making less money in the long term, and I missing out on all the gains, but I will sleep better at night knowing I don't have to worry about house payments.

Here is my strategy:

1. Save enough money to have a very large down payment
2. Buy a new house at the end of this year or early next year
3. Rent this place out (I live in a college town, so I am assuming it won't be too much of a problem)
4. Aggressively pay off the mortgage on the new house (my income + rent income)
5. End up with 2 paid off houses within the next 10 years.

All of this while I continue to max out my 401k and Roth IRA each year.

Boarder makes some good points.  You've also left out the most important part of the equation, which is how much do you think you could rent out your current home for?  In general, single family homes are not great wealth building investments.  You're usually better off buying duplexes to quadplexes for investment purposes.  You should also take into account the opportunity cost of tying that money into a single house and not being able to take advantage of tax-advantaged investments in the market.  Further, even if you are hitting your IRA and 401k contributions, the market is very likely going to outperform real estate over a long time horizon.  Even further, the market is a low tax burden passive investment whereas real estate is a high tax burden incredibly active investment.  Not to say you shouldn't invest in RE, but have you sat down and seriously considered the trade-offs between the two?

Thank you for your advice.

At the moment, I am not thinking about becoming a "real estate investor". I am wanting to take advantage of the fact that I have a paid off home, so that I can move into a better home, and eventually end up with two homes.

I live in a college town, therefore I am fairly confident that I should be able to find renters. A 4 bedroom house is renting for around $1400 here, and considering I am very close to the university, I am assuming that I shouldn't have a lot of problem finding renters.

I agree with Boarder.  The reason real estate is an excellent path to wealth for many people is not the housing market itself -- it is leverage.  If you put $100K into stocks and the stocks go up 10%, you have a 10% return on your investment.  If you put $10K down on a $100K home and the value of the house goes up 10%, you have just doubled your money.  Meaning that that same $100K, split across 10 homes, with a 10% growth in home value, would bring you $100K in profit instead of $10K.  Buying real estate is the one area in which "normal" people get to take advantage of leverage; if you can get a tenant to cover your costs and throw off profit, at the same time that leverage is providing an excellent ROI, it's a win-win.

[All numbers for illustrative purposes only.  Necessary caveats about danger of leverage.  Etc.]

But if you focus instead on paying off the mortgage as fast as possible, you lose that boost.  At that point, your "profits" come from the overall gains in the housing market.  And if you compare those historic gains to those of the stock market, the housing market as a whole is a loser -- sure, there are hot areas and periods, just like there are hot stocks and bull markets, but over time, the housing market has historically run closer to inflation, while the stock market has historically thrown off 10% +/-.

You bring up some excellent points. I will definitely give this some thought.

However, my current home paid off, and the plan is buy another home, and rent out this one so that eventually I will have a second paid off home.

[chasesfish]

Minamiliastgamer:

Congrats on your strategy, it works really well because you get to buy your new house with an owner-occupied mortgage at a great rate.

Whether you use leverage or aggressively pay down your house is up to you.  If you can get to four paid off houses, you're about guaranteed early retirement.   The amount of leverage you put on the properties is your personal choice.

Congrats on the success

[minimalistgamer]

Thank you very much. I appreciate it.

My current plan is to save enough money for a 20% down payment on a $220,000 house, with a $10000 buffer, and then start looking for houses. This means, given my current reserves I am going to have to save a total of $28,000. This will give me the $44,000 needed for the down payment to avoid PMI. By my calculations, I should hit this mark in 8 months. Hopefully, this will work out!

[boarder42]

This makes no sense.

Ok don't use leverage. Let's just assume that's not an option

You still have shown no knowledge of IF the property you plan to rent is even a good property to rent. Just bc "it rents" doesn't mean it's a good return on the amount of money you have tied up.

You asked advice. Took none of the advice telling you the best way to do it. And then hung on one random persons statement that justified what you wanted to do. That's not learning or knowledge growth if that the way you're approaching life.

Chases fish please share how you came to the conclusion this strategy was sound with incomplete information about the property he plans to rent.

[boarder42]

If you have a house worth sub 140k it may make sense. Add to the fact it's a college town and I'd increase my costs associated with maintaining the house. House really should be worth 70k or less to be a good investment.

[minimalistgamer]

If you have a house worth sub 140k it may make sense. Add to the fact it's a college town and I'd increase my costs associated with maintaining the house. House really should be worth 70k or less to be a good investment.

boarder42:

Thank you for your feedback. I definitely appreciate it. It is not that I didn't take the advice. I understand what you are saying is mathematically correct, but I cannot get myself to go into debt to build wealth. I am afraid I am far too conservative to go that route. That being said, I am definitely going to give this some more thought tonight. None of this is set in stone. I am absolutely in a situation where I can change the plan.

If you have a house worth sub 140k it may make sense. Add to the fact it's a college town and I'd increase my costs associated with maintaining the house. House really should be worth 70k or less to be a good investment.

Could you please explain what this means? I am not sure why my house needs to be worth less than $140k to rent it out. At the moment, I have no mortgage payment. Therefore I do not know why the value of the house matters.

You are right that renting the house to students might mean more maintenance, but I do have the option of renting it out to families.

The whole reason I started thinking about buying a second house is because I've had an incredible opportunity of having a paid off mortgage, and I wanted to put that good use. I am still going to take out a mortgage, so I am technically leveraging debt...

[boarder42]

The fact that you don't understand why the house needs to be worth over 140k to possibly make sense means you do not understand enough to be in the rental game. Go read bigger pockets

There is a 2% rule  This rule is hard to find and follow but still findable today. Some settle for a 1% rule in some markets this rule makes sense.

You need to educate yourself before you go down this path. That is glaringly obvious.

The value matters bc you could sell the house and invest in a better rental or the stock market.

There is also a 50% rule

I don't know how these work or how to apply them so I stay away from real estate investing. Which you said you're not doing but you are if you're renting.

[chasesfish]

I'll add one other thing to the reading list:  Robert Irwin, buy-rent-sell.

My comment was really meant to say "At a high level, getting up to four free and clear rental houses is a path to financial independence".   In my experience, college towns are generally great rental markets.  I've twice worked in cities that housed the largest university in the respective state.  This meant you had a consistent transient population creating rental demands and the cities also end up with the anti-development crowd controlling town politics, so the supply of rental properties within walking distance to the university was limited.   I had a number of customers in both markets that were financially independent and did it all with single family rentals.

The limited land availability tended to drive prices up and cap rates down, but you can still do okay as long as the cap rates are consistently low.

The poster needs to research and understand price verses rental value and understand home quality and maintenance.  With what he's doing, that classic book is a good read.

[boarder42]

as i understand the 2% rule its that the rent should be 2% of the value of the house monthly.  meaning at 1400 your house would need to be worth 70k to make it a great rental.  Some areas allow for 1% rentals but not all and its not very common but that would mean your house must have a value of 140k or less if you arent meeting this rule you arent using your money wisely.  Single family homes that makes sense to live in more often than not do not make good rentals. 

You said above "i dont want to be a real estate investor"  well guess what, you're proposing the exact opposite of that and if you dont want to learn you probably should just buy some REITs and call it a day. 

the 50% rule as i understand it applies to what you should expect as a return after taxes vacancies and everything else that cost money on your rent value, meaning at 1400 a month you actually would only pull in 700, this obviously varies some but these "rules" like the 4% rule exist for reasons.

learn and understand before you jump into this.  on the face of it, it sounds like your rental is a poor one.  since reading into your comments its worth more than 140k.

sounds to me like you want to move and are trying to justify it and not pay real estate fees by renting out a poor rental. 

[minimalistgamer]

Thank you. I am going to do that right now.

There seems to be a lot more to this than I had anticipated. It all started out with the simple notion that considering I have no monthly payments  towards a house, I could rent out this place, and just pay what I was paying towards this house to another house. I still think there is some merit to the idea. I will however educate myself more on the rental market.

[boarder42]

Thank you. I am going to do that right now.

There seems to be a lot more to this than I had anticipated. It all started out with the simple notion that considering I have no monthly payments  towards a house, I could rent out this place, and just pay what I was paying towards this house to another house. I still think there is some merit to the idea. I will however educate myself more on the rental market.

you have to consider what your real return is on the money tied up in the property.  you could invest money in any number of ways and cover your house payments on the new house. 

Your OP was about wealth building... if thats what you want to do you should be optimizing to the degree possible your dollars you invest, be it property or the markets.

if your house is worth 200k, after inflation you could expect the same 1400/month return from the stock market.  and in this scenario you dont have vacancies or other home costs to worry about that erode that money, As well as the fact that its not as tax efficient as LTCGs or QDs. even based on a 75% rule where you got to pocket 75% of the rental price b/c you were always occupied and super efficient with everything ... you'd still have to have a house valued at 180k or less to make sense and i dont think you can get to that great a return.