Author Topic: Best idea ever or pure lunacy?  (Read 7000 times)

brandino29

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Best idea ever or pure lunacy?
« on: October 22, 2013, 12:59:10 PM »
I had a major epiphany yesterday that will likely come as little surprise to folks as yourself. 

(Brief background: Wife and I just recently became first time landlords in a low cost of living area. The rent covers the mortgage plus about $400 extra per month.)

I was walking through a part of town yesterday that we'd like to move back to when I saw a couple of for rent signs.  In that moment, it occurred to me that if we moved out of our current home and rented it out, we would be able to pay the mortgage and then pocket an additional ~$450/month.  Between the two monthly rent checks, we'd have more than enough to cover the mortgage on a third house which could become our primary residence, essentially allowing us to live mortgage free as other people pay down the principal on all three houses for us. 

Granted, I recognize that there are aspects to consider like potential vacancies and repairs, however, if we could take the $750/month we pay toward our mortgage today and instead put that directly into savings, I think that over the long term (hell, even over the short term) we'd actually be better off financially (barring some sort of disaster, unexpected job loss, etc). 

The numbers even seem to work out if we were to move out and rent an apartment for ourselves instead, creating a quite odd situation where we own two homes yet live in a rented apartment.  Which would make a lot less sense than putting it toward equity in a home of course but would still allow us to save more money. 

I ran this idea by family who of course said it couldn't be done and wasn't worth the trouble---which makes me even more eager to try it out and prove them wrong!

Kipp

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Re: Best idea ever or pure lunacy?
« Reply #1 on: October 22, 2013, 01:05:12 PM »
I think it can be done.  My former boss purchased 20 acres continuous with his property with two lots (rented to mobile homes).  He continued to rent and uses that money to pay for all of his land.  Not a bad deal.

Peony

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Re: Best idea ever or pure lunacy?
« Reply #2 on: October 22, 2013, 01:28:44 PM »
I have at least one tenant who I know owns a building in the same neighborhood that he is renting out to others. He's taking advantage (in a good way) of the good deal he has with me! I could -- and probably should -- raise his rent (I suspect his net worth is well above mine, thanks to my stupid choices in the past), but he's been completely reliable for 10+ years and I'm still making money, so he gets to keep his sweet deal for the time being.

willn

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Re: Best idea ever or pure lunacy?
« Reply #3 on: October 22, 2013, 02:45:54 PM »
(barring some sort of disaster, unexpected job loss, etc). 

Yeah because those things never happen.  (Sorry, that was sarcasm). My point is that you're ramping up the risk bigtime here.  Lots of people do this type of thing, and lots of people end up broke because they lose a job because of a health event, then because they can't devote attention to a rental at the same time of these stresses, they end up with a bad rental situation.  Or any of another dozen scenarios that suddenly make three mortgages tough to cover. 

I say, slow down a bit, you're a first time landlord, give yourself a few years to pound down some mortgage debt and discover how much you enjoy landlording, then buy another.

Quote
I ran this idea by family who of course said it couldn't be done and wasn't worth the trouble---which makes me even more eager to try it out and prove them wrong!

Everything worth doing is trouble, but that's not a reason to do it of course.

Lots of real estate investors do this type of cash flow building, but for me that's not a good enough reason to get three mortgages.  Your idea of moving to an apartment is ok, the additional risk is low.  Although if you like your primary residence I'm not sure its worth it for a few hundred a month.  Between carving the budget and a part time job that would earn that.  Again, its ok to go slow, have a bit of patience, and think about how these deals will work if things go bad---it's easy to find real estate deals which win when everything goes right--but in the long run, they need to work even when things go bad, like the economy, your employment, your health, the weather.


KingCoin

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Re: Best idea ever or pure lunacy?
« Reply #4 on: October 22, 2013, 04:00:11 PM »
This might be a good idea, but it's no free lunch. Essentially you're borrowing money at, say, 5%, and investing in assets that are yielding, say, 9%. This is awesome until your asset stops yielding 9%, and you're just bleeding 5%. Imagine a scenario where an economic downturn hits. You could quickly find yourself paying two or even three mortgages. If you lose your job too, it could be a financial disaster, not to mention the months of frustration and sleepless nights.

Granted, I recognize that there are aspects to consider like potential vacancies and repairs

This is the crux of the issue. The fact that properties spit off $400 more than the mortgage is sort of meaningless in itself. If the property rents for $800, and the ongoing expenses run $400, you have quite a bit of cushion. If those numbers are $2400 and $2000 respectively, you're playing with fire. I'd read up on the 50% rule to develop your thoughts on the issue, and be sure to stress test a range a scenarios before jumping in.

Another Reader

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Re: Best idea ever or pure lunacy?
« Reply #5 on: October 22, 2013, 07:39:01 PM »
Depending on the numbers in your area, this is actually a very common and successful way to build a rental portfolio.  Buy a home at owner occupied interest rates, live there a year, buy another home, rent out the first home.  Rinse and repeat, until you have four financed properties.  Since almost all conventional financing today is Fannie/Freddie backed, the process becomes more difficult for 5 to 10.

You do need to read up on investing and allow for the anticipated expenses above the mortgage.  Over time, including capital improvements, the rule of thumb is operating expenses usually add up to 50 percent of the rent.  That includes the taxes and insurance, which may be in that mortgage payment.

brandino29

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Re: Best idea ever or pure lunacy?
« Reply #6 on: October 23, 2013, 09:56:17 AM »
This is the crux of the issue. The fact that properties spit off $400 more than the mortgage is sort of meaningless in itself. If the property rents for $800, and the ongoing expenses run $800, you have quite a bit of cushion. If those numbers are $2400 and $2000 respectively, you're playing with fire. I'd read up on the 50% rule to develop your thoughts on the issue, and be sure to stress test a range a scenarios before jumping in.

This is a good point that I didn't clarify.  The mortgage on our rental is $397/month which we are renting for $800.  The mortgage on our personal home (30 years at fixed 3.25%) is $515/month, and we could rent the home for $1,000/month. 

This idea for us is very much in its infancy but it seems like it might be doable.  We both have steady jobs and stable salaries with no reason to suspect that would change.  Part of the appeal is that even a bad situation could be manageable.  For example, we'd be able to cover the other mortgages indefinitely if both rentals sat vacant.  In a real cash crunch, such as some sort of health issue resulting in long term job loss, we could sell one or both homes without a fear of losing money.  We got very lucky and ended up getting both homes well below market value and have a good bit of equity built up on top of that. 

I say, slow down a bit, you're a first time landlord, give yourself a few years to pound down some mortgage debt and discover how much you enjoy landlording, then buy another.

Indeed.  It's been smooth sailing to date but it's also only been 2 months.
« Last Edit: October 23, 2013, 02:50:13 PM by brandino29 »

totoro

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Re: Best idea ever or pure lunacy?
« Reply #7 on: October 23, 2013, 10:09:42 AM »
Well if the numbers work and you are okay with landlording I don't see why not.  This is how we obtained our rental properties.  Each was bought as a primary residence first and then later converted to a rental.  Our mortgages were granted with better terms to an owner-occupier than they would have been for rental properties. 

willn

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Re: Best idea ever or pure lunacy?
« Reply #8 on: October 23, 2013, 10:43:59 AM »
Oh, read your mortgage loan contract carefully with respect to occupancy requirements. It is not unheard of to find it to be subject to extenuating circumstances or even prohibited. 

totoro

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Re: Best idea ever or pure lunacy?
« Reply #9 on: October 23, 2013, 11:30:21 AM »
Happens all the time in Canada - people move in, move out, rent it out. Typical mortgages here state that you intend to occupy the house.  If that was your intent when you signed the mortgage, but your plans changed after, you are not in breach of contract.

I would not sign a mortgage that requires you to occupy the house during the mortgage term. That would be too restricting. Shop around when your renewal comes up.

A bigger issues is insurance.  You need to change your insurance when you change the use.

arebelspy

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Re: Best idea ever or pure lunacy?
« Reply #10 on: October 23, 2013, 12:41:15 PM »
You've hit the first step in the realization of how neat rental income is.  After you're successful at that and the rents are paying all 3 mortgage for you, you'll realize that picking up even more soon pays for your other expenses, and then you're just living off cash flow.

It takes a certain type of person, but if that's you, it's a great way to build wealth and become FI very quickly (much faster than a standard 4% SWR method).
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
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MKinVA

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Re: Best idea ever or pure lunacy?
« Reply #11 on: October 23, 2013, 01:17:55 PM »
Ouch. You need to get these numbers straight. Your mortgage is 397 and you rent it for 400? I guess that was a mistype and you actually rent for 800. Also, ignore what the Canadian guy said about lying to the mortgage company in the states. Shopping for mortgages down here is not easy. As a matter of fact, it is darn tough to get a mortgage and even harder to get one for rentals. You won't just go to the bank with a deal and tell them to take it or leave it. You are going with your hat in your hand and beg. And you better have a substantial down payment or you are going to pay through the nose on interest.

Your deal can absolutely work, but you need to do more than numbers on a cocktail napkin to make sure. Look at real mortgage rates, real insurance rates, closing costs, maximum rents, property taxes, all of it.  And the best of luck. I really hope it works cause it sounds awesome. More people should think of renting instead of tying up so much capital in just a place to live.

totoro

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Re: Best idea ever or pure lunacy?
« Reply #12 on: October 23, 2013, 02:30:45 PM »
What Canadian guy told anyone to lie to a mortgage company in the States?

If you are referring to me I'm not a guy.

If you are referring to me I never advised anyone to lie on anything. Fraud is a reason to vitiate a contract.  However, owing a home and later changing it to a rental is permitted and is not fraud or lying.

willn

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Re: Best idea ever or pure lunacy?
« Reply #13 on: October 23, 2013, 02:45:58 PM »
owing a home and later changing it to a rental is permitted and is not fraud or lying.

Totally depends on the loan contract. It's a must read doc, as they vary wildly in the US market.

brandino29

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Re: Best idea ever or pure lunacy?
« Reply #14 on: October 23, 2013, 02:59:54 PM »
Ouch. You need to get these numbers straight. Your mortgage is 397 and you rent it for 400? I guess that was a mistype and you actually rent for 800.

Haha, yeah, I thought I had changed that to $800.  Should be fixed now.

Shopping for mortgages down here is not easy. As a matter of fact, it is darn tough to get a mortgage and even harder to get one for rentals.

We just went through this process a few months ago to get our first rental and it was pretty smooth.  I emailed our loan officer yesterday to ask about this new idea I had and she said we'd likely qualify for a new conventional loan even at only 3% down.  Of course, that's another issue as with so little down we'd be taking on a good bit more risk. 

You've hit the first step in the realization of how neat rental income is.  After you're successful at that and the rents are paying all 3 mortgage for you, you'll realize that picking up even more soon pays for your other expenses, and then you're just living off cash flow.

It takes a certain type of person, but if that's you, it's a great way to build wealth and become FI very quickly (much faster than a standard 4% SWR method).

This is the long-term game plan for sure.  Our real estate empire is very much in its infancy with one SFH rental.  But I'm not yet 30 (for a couple more months at least) so I feel like we're off to a good start.

Happens all the time in Canada - people move in, move out, rent it out. Typical mortgages here state that you intend to occupy the house.  If that was your intent when you signed the mortgage, but your plans changed after, you are not in breach of contract.

I would not sign a mortgage that requires you to occupy the house during the mortgage term. That would be too restricting. Shop around when your renewal comes up.

A bigger issues is insurance.  You need to change your insurance when you change the use.

This is a good point.  We actually bought our first house on an FHA loan that does have some restrictions---I'll have to go back and read the specifics.  Our realtor at the time though said he knew plenty of people who began renting their houses out before the mortgage was paid off without anyone coming after them about it.  And our intent was definitely to live there and we have for over 3 years now. 

MKinVA

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Re: Best idea ever or pure lunacy?
« Reply #15 on: October 23, 2013, 03:16:52 PM »
Sorry, tortoro. Didn't mean to offend, but it's obvious they don't intend to purchase a primary residence. I have never heard of getting a mortgage rate as low as a primary residence when purchasing a rental (including points in that). And there are a number of mortgage products that do not allow you to convert to a rental. FHA being one of those. People might do it and get away with it, but I would hate to be on the bad end of a pay back provision or, worse, cancellation.

totoro

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Re: Best idea ever or pure lunacy?
« Reply #16 on: October 23, 2013, 03:36:35 PM »
Sorry, tortoro. Didn't mean to offend, but it's obvious they don't intend to purchase a primary residence. I have never heard of getting a mortgage rate as low as a primary residence when purchasing a rental (including points in that). And there are a number of mortgage products that do not allow you to convert to a rental. FHA being one of those. People might do it and get away with it, but I would hate to be on the bad end of a pay back provision or, worse, cancellation.

It is not obvious they don't intend to purchase a primary residence.  They do, in fact, live in a home that they are potentially intending to turn into a rental and state:

"Between the two monthly rent checks, we'd have more than enough to cover the mortgage on a third house which could become our primary residence, essentially allowing us to live mortgage free as other people pay down the principal on all three houses for us.

I agree I don't know what the rules are for specific US mortgages but the information for FHA mortgages, which the OP has, is online and permits rentals after a one-year occupancy: http://homeguides.sfgate.com/can-rent-fha-loan-3231.html

It appears in the US this is a common clause: "Occupancy. Borrower shall occupy, establish, and use the Property as Borrower's principal residence within 60 days after the execution of this Security Instrument and shall continue to occupy the Property as Borrower's principal residence for at least one year after the date of occupancy, unless Lender otherwise agrees in writing, which consent shall not be unreasonably withheld, or unless extenuating circumstances exist which are beyond Borrower's control."

My understanding would be that this is dissuade individuals from getting lower rate financing for rental properties that are considered higher risk.   

pl28

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Re: Best idea ever or pure lunacy?
« Reply #17 on: October 24, 2013, 04:45:19 PM »
The 20% down payment that is required by most lender now days will come in to play at some point. Assuming that with a couple of houses, that can be a hefty sum that is tie up if you pay 20% down each time.

But I do agree that real estate is probably a pretty solid investment so might be a good idea to give a try

meadow lark

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Re: Best idea ever or pure lunacy?
« Reply #18 on: October 25, 2013, 12:30:20 PM »
Some of you guys are so negative.  Ie, hat in hand, begging, paying through the nose?  20% is required by most lenders?  Umm, no.  As someone who has bought 4 houses and sold 1 in the last 3 years, no.  I didn't beg.  On my 2 owner occupied ones I put down 3% and 5%.  On my rentals I put down 20% and 25%.  There was no paying through the nose.  They are all in the 4-low 5% APR's.
 

zinethstache

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Re: Best idea ever or pure lunacy?
« Reply #19 on: October 25, 2013, 10:36:46 PM »
brandino29, I have the same idea as you, so if it is Lunacy, we both are afflicted. First my thoughts on primary mortgage requirements. When we re-fi'ed last year we carefully read that we have to live in our home for a minimum of 12 months, it was very clearly spelled out on one of our signing documents. So you should be able to find a mortgage with similar terms.

Since that Refi, we've become new landlords, but we had already researched and committed to that particular FI path and are under contract for property #3. So far with the first two (duplexes so 4 doors) the total cashflow pays for ALL of our basic housing expenses and that's a great feeling. #3 will pay for (cars and food) and down the road #4 is our fun money and medical.

We might end up in a pickle if landlording is not our thing, but our skill set is in everything home maintenance/repair so it made sense in our situation to commit to it 100%. At first I was thinking of turning our residence into a rental, but we love it here so likely we will continue with duplexes until we have 4. That will be our FI jumping off point.

Like Meadowlark, I also found getting a mortgage painless and quick using the same local lender (3 mortgages in 8 months), so now I feel I have a relationship with them in the event we want to go for 5-10 mortgages. If our circumstances were different I would prefer to acquire more slowly and live in each unit along the way. Unfortunately age and medical issues altered that plan.

If you go the "live in it for a time" route, you get better rates, can put much less down, but your cash flow will be lower as well. It will also have a fixed timeline. I suggest you fiscally map out your game plan both ways. It will be a trade off of time vs. money. We are impatient and are looking at ways to shortcut our acquisition time.

Because of the mustachian education this site has provided, I have changed things up for #3 and am going for a cash deal. I found low interest cash options lurking about that took me time to sort out/find/become comfortable with using. Once the ball is rolling you will be amazed at the new paths that open up to you. It is akin to finding money under a rock. What a surprise it is to find out that decisions made long ago have ended up providing money now when we need it.

I agree with Meadow Lark, stay positive, this should be a fun journey, but definitely research, research, research and then research some more! I might be singing a different tune in a year, but so far have enjoyed the ride!

totoro

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Re: Best idea ever or pure lunacy?
« Reply #20 on: October 26, 2013, 10:17:12 AM »
We own three properties with seven rental units plus the carriage house we live in.

We went the primary residence to rental route starting in 2009.  First property was 10% down, second was 15% and third was 20%. At this point, our cost of living for mortgage/utilities/taxes/insurance are paid for by rental income.

We are in Canada so our ROI is much less than many places in the US.  If I was in the US I would definitely be investing in RE.

As for troubles, I have recently had a couple of tenants who were unreasonable.  Make sure you know the landlord tenant rules and follow them promptly.  My skill set includes no repair work whatsoever but, as a lawyer, I can handle difficult tenants professionally and that has saved us time and money. 

anniebelle

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Re: Best idea ever or pure lunacy?
« Reply #21 on: October 26, 2013, 11:33:28 PM »
It is not remotely close to lunacy, it's a creative and lateral-thinking way to increase your property portfolio. Do it. If you can cover costs (be very generous with your projected expenses), you'll be just fine. Make sure - absolutely - your rental properties are in growth areas.

Landlording (as you probably already know) exposes you to the best and worst of human behaviour, but it's all good stuff for strengthening your resilience muscles.

Good luck! :-)

Daleth

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Re: Best idea ever or pure lunacy?
« Reply #22 on: October 27, 2013, 10:51:50 AM »
It can totally be done. My husband and I just hit that point (of having effectively no mortgage on our house because our rentals cover all the mortgages) this year. And it only took us about two years to reach that point. Two years from when we bought our first rental property, that is.

THAT BEING SAID, we also had to sink about $25,000 into renovations, repairs and maintenance to get to the point where we were renting all the properties for a total of several hundred more than they and our home cost. And there's some more roof work coming up. So you do either need a good savings cushion and/or a high-paying job to have the security that a disaster won't make it all blow up in your face.

I don't agree with the "fear factor" that an economic downturn could make it all come to naught, though. Assuming you have fixed-rate mortgages, which is the only sensible way to go IMHO (unless you're house flipping, which doesn't seem to be your plan), the only impact that an economic downturn should have on you is that MORE people need a place to rent, because in downturns fewer people can afford to buy.

Oh, read your mortgage loan contract carefully with respect to occupancy requirements. It is not unheard of to find it to be subject to extenuating circumstances or even prohibited.

Unless you're in a different country with laws unlike those in the US, I would disagree with you on that. When you buy a house as a primary residence you have to intend to live there yourself. The bank can't require you to actually live there; what if, for instance, your job transfers you across the country two weeks after you close on the house? The bank can't stop you from moving for your job, and they can't renege on the mortgage just because something came up AFTER closing. As long as you INTENDED to live there when you closed, you're okay. In practical terms that means that (assuming you don't have a post-closing job transfer or family crisis that requires you to leave the area) you need to move into the house for at least 6 months, preferably 12--if you do that there's pretty much no way the bank could prove you did NOT intend to live there when you closed.


Daleth

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Re: Best idea ever or pure lunacy?
« Reply #23 on: October 27, 2013, 11:00:38 AM »
owing a home and later changing it to a rental is permitted and is not fraud or lying.

Totally depends on the loan contract. It's a must read doc, as they vary wildly in the US market.

I think you're misinformed, there. A bank cannot dictate how you use the house, at least not as long as what you're doing is legal. The decision tree goes like this:

1. When you apply for the mortgage, do you intend to move into the house yourself?
- If yes, go to (3).
- If no, go to (2).

2. Fill out the application forms for an "investor" type of mortgage [personal loan if you're buying in your own name, business loan if you're buying in the name of an LLC or corporation].

3. Fill out the application forms for an "owner-occupied" type of mortgage. Assuming you still intend to move in when the day comes to close on the mortgage, you're golden--there's no fraud because when you signed the application and the closing docs, you intended to move in.
....3(a). You have to move into the new house within X days after closing (many loan docs say within 60 or 90 days). That said, I've never heard of a bank going after someone for not moving in within the required time.
....3(b). If, after you move in, you change your mind and decide to move back out, that's your business. You can leave it empty or rent it--the bank doesn't care what you do, as long as you keep it insured and keep paying the mortgage. The FHA has more requirements on residency (they have more requirements on pretty much everything than normal banks do), but as another poster pointed out, even they only require you to live there for 12 months.

So the rule of thumb is, if you buy a place as owner-occupied and live there for 12 months, you can do whatever the heck you want afterwards--and if you don't have an FHA loan you may not even need to live there for that long. That said, if your plan is not to hold the house indefinitely but to sell it within 5 years, think about the capital gains tax exclusion--that requires you to live there for two years.
« Last Edit: October 27, 2013, 11:04:59 AM by Daleth »

Another Reader

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Re: Best idea ever or pure lunacy?
« Reply #24 on: October 27, 2013, 11:02:27 AM »
From a practical point of view, Fannie/Freddie require you to wait a year to buy another owner-occupied property that they finance.  Since they buy pretty much all of the single family paper, it's tough to get another loan for an owner-occupied property until the 12 months have elapsed.