Does It Really Make Sense to Buy instead of Finance?

[GrayGhost]

Hi guys, new Mustachian here. I've been reading up on a lot of MMM's articles on his blog, and a recurring theme I've noticed is his aversion to mortgages for housing for himself and his family. Instead, he seems to prefer to buy homes for himself in cash whenever possible. My question was addressed a bit in this post: http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/

But I have a few more questions that I hope you guys would be willing to clear up.

To start off with, allow me to introduce myself. I am a pretty young guy with my Roth IRA for the past two years maxed out, and even though I have another year left in college, I'm going to try to make and max out my contributions to a Roth TSP this fiscal year. (A TSP is the military's equivalent of a 401k.) I don't know very much about becoming a landlord, but I looked at a few places where I'm likely to work and saw that fixer-upper homes were quite cheap, and I have realized that it's quite possible for me to buy them, live in them for however long my job requires me to, and then sell or rent them out when it's time for me to move. Some of these houses are just $20k-$30k, so even though I might not be able to buy them outright, I'd be able to put down 60+% and then aggressively pay down the mortgage going forward.

But doesn't it make more sense for me to get maximum leverage by putting as little money down as possible and taking advantage of VA benefits in order to minimize monthly payments? Here's a summary of VA home loan benefits, BTW: http://www.benefits.va.gov/HOMELOANS/purchasecashout.asp

There isn't a risk of me spending money frivolous, because I'm not that kind of a person, I've never been that kind of a person, and I wasn't raised to be that kind of a person. I pretty much spend money on food, rent, necessities, and that's it, with about 10%-20% of my income allocated towards entertainment and shopping, the latter of which I feel is justified since, as a young guy, I just don't have much of the stuff that I'll need going forward into life yet.

With that said, I'm pretty sure that it would be best for me to maximize my leverage, minimize my monthly payments, and invest whatever money is left over after bills and money spent improving and renovating whatever homes I buy. Naturally, I still assume the risk of botching renovation projects, buying a place in a bad area, and things like that, but these are things that would happen even if I bought a house with 100% cash. I figure that by instead of taking a huge bite out of my savings, it would be best for me to keep these in the stock market (various Vanguard index funds all the way) and increase my 'stash rather than putting all of my eggs into a house that I'll have to figure out how to fix up as I go along.

The numbers are definitely on my side as far as I can tell, given that I don't end up being an idiot and spending the money I'm "saving" by making minimum monthly payments. Given the pay and benefits that I'm going to receive upon graduation, I figure that even after maxing a Roth TSP, Roth IRA, paying for a mortgage and improvements and putting extra cash away into a brokerage account, I'll have more than enough to entertain myself in my own ways.

What do you guys think? Any advice is highly appreciated.

[nktokyo]

Fixer-upper homes were quite cheap, and I have realized that it's quite possible for me to buy them, live in them for however long my job requires me to, and then sell or rent them out when it's time for me to move. Some of these houses are just $20k-$30k, so even though I might not be able to buy them outright, I'd be able to put down 60+% and then aggressively pay down the mortgage going forward.

Hi there,

What would you theoretically be able to sell a place for after fixing it up?
What would your total cost to be to fix the place up to a rentable/sellable standard?
What would the income be on one of these places after all expenses?

With a fixer-upper, especially in the price range you're talking about, you'll probably be decently profitable to the point where it would make more sense leveraging and doing more than one property (or putting your money into a fund if you so desire).

If you can renovate and sell at a profit my strategy would be to buy homes that you wouldn't mind having as a rental, clean them up, sell off 3 in 4 and every 12-18 months leave yourself with a "free" house.

It's simplistic, but I used it to be financially free in 7 years and it might work for you.

Good luck.

[GrayGhost]

What would you theoretically be able to sell a place for after fixing it up?

Yes, I would be able to sell or rent them out. Areas around military bases seem to have pretty strong economies, even in terms of long term prospects, since there's a constant source of employment there.

What would your total cost to be to fix the place up to a rentable/sellable standard?

I believe I could do it for $10k-$20k in general.

What would the income be on one of these places after all expenses?

Honestly, to start out with, my margins are not going to be very big as I have a lot to learn and I'll be working a 9-5 at the same time. That's why I'm not yet sure if it's best to rent or sell, and that's why I think it's best to maximize leverage and put the rest of my money into the market.

With a fixer-upper, especially in the price range you're talking about, you'll probably be decently profitable to the point where it would make more sense leveraging and doing more than one property (or putting your money into a fund if you so desire).

If you can renovate and sell at a profit my strategy would be to buy homes that you wouldn't mind having as a rental, clean them up, sell off 3 in 4 and every 12-18 months leave yourself with a "free" house.

It's simplistic, but I used it to be financially free in 7 years and it might work for you.

Good luck.

Thanks for the advice, I really do appreciate it.

[chicagomeg]

Maybe VA mortgages are an exception, but I've heard that it's challenging to get a mortgage for less than $100k and damn near impossible under $50k. The profits just aren't there for the banks.

[Johnny Aloha]

Congrats on your saving and spending.  Contributing to a Roth while in college is impressive.

Most banks and mortgage brokers have a $50k loan minimum, with 20% down. for conventional loans.  I've talked with some banks that will loan $30k, but they are smaller, community banks.

The VA loan can be a gift or a curse.  Right now the rates are significantly lower than conventional ... I locked a 3.25% 30 yr fixed (over $700k).  It's unbelievable.  Just don't overspend the house - but sounds like you won't.

There are some drawbacks of a VA loan though.  There is a funding fee (~2.15% I believe), but it can be financed.  Also, the guidelines are more strict - no properties with unpermitted additions, must be in good shape, etc.  Basically they are protecting theiI had to replace a bathroom mirror because there was a slight crack in it.  Really?  Ok, whatever it takes for 3.25% for 30 years!

As MMM and others have said - if you are comfortable with leverage, it can/will provide significantly better returns than buying in cash.  But if you are risk averse, buying with cash is ok too!

[Villanelle]

VA loans have somewhat strict conditions about the condition of the property, so buying a fixer can be rough.  If it has stained carpet and an awful 70s kitchen, then it will be fine, but if there are issues, even seemingly minor ones, it can be a disqualifier for a VA loan.

Also, the thing about the military is that you can end up needing to move on very short notice. I've seen many, many of our friends buy houses with plans similar to yours, only to get screwed because they *must* move on 2 months notice (or even with more notice, but still a set time they must leave), and they can't sell or even rent for enough to cover the mortgage and other costs (and you'll almost certainly need a property manager in that scenario, since you'll have moved out of the area).  It is far, far more risky than you seem to be acknowledging in your OP.  When you can stay in the home until it sells, you have a great deal more security because if it takes a year to sell, you are still only paying for one home, and if you can't sell it at all or rent it for what you need, you can just stay put.  When you are almost certainly going to be moving frequently, this strategy can go bad quickly because you create situations where you end up with a property in San Diego while you are in Florida, and suddenly you are paying a mortgage on a home you don't live in.

[GrayGhost]

Maybe VA mortgages are an exception, but I've heard that it's challenging to get a mortgage for less than $100k and damn near impossible under $50k. The profits just aren't there for the banks.

If that's true, then I guess I'll have to get a more expensive place. That's probably not a bad thing, it's just that I want to minimize my commitment as much as possible.

Congrats on your saving and spending.  Contributing to a Roth while in college is impressive.

Most banks and mortgage brokers have a $50k loan minimum, with 20% down. for conventional loans.  I've talked with some banks that will loan $30k, but they are smaller, community banks.

The VA loan can be a gift or a curse.  Right now the rates are significantly lower than conventional ... I locked a 3.25% 30 yr fixed (over $700k).  It's unbelievable.  Just don't overspend the house - but sounds like you won't.

I'll definitely be shopping around for good deals whenever I get stationed somewhere. I have no intentions of making a rash decision, and even if I do have to buy a house at nearly market value, I'll be sure to add something to it in order to improve the resell rate.

There are some drawbacks of a VA loan though.  There is a funding fee (~2.15% I believe), but it can be financed.  Also, the guidelines are more strict - no properties with unpermitted additions, must be in good shape, etc.  Basically they are protecting theiI had to replace a bathroom mirror because there was a slight crack in it.  Really?  Ok, whatever it takes for 3.25% for 30 years!

As MMM and others have said - if you are comfortable with leverage, it can/will provide significantly better returns than buying in cash.  But if you are risk averse, buying with cash is ok too!

Since I'm so young, I think it makes sense for me to make relatively risky financial choices. I won't be rash, hasty, or unwise, but the fact is that I have enough time to do things that may succeed and give me a great ROI, or may fail and cause me to lose money. I definitely need to do a lot more homework, especially when I start to get stationed places, but I came here to make sure that my general strategic mindset is sound.

Thanks for all the advice.

VA loans have somewhat strict conditions about the condition of the property, so buying a fixer can be rough.  If it has stained carpet and an awful 70s kitchen, then it will be fine, but if there are issues, even seemingly minor ones, it can be a disqualifier for a VA loan.

I will definitely be aware of this... and if I can't get a VA loan for a cheap fixer, I'll just get one in a better shape. I don't want to take too much risk in buying a fixer, since I will have to learn all about repairing it from square one by myself.

Also, the thing about the military is that you can end up needing to move on very short notice. I've seen many, many of our friends buy houses with plans similar to yours, only to get screwed because they *must* move on 2 months notice (or even with more notice, but still a set time they must leave), and they can't sell or even rent for enough to cover the mortgage and other costs (and you'll almost certainly need a property manager in that scenario, since you'll have moved out of the area).  It is far, far more risky than you seem to be acknowledging in your OP.  When you can stay in the home until it sells, you have a great deal more security because if it takes a year to sell, you are still only paying for one home, and if you can't sell it at all or rent it for what you need, you can just stay put.  When you are almost certainly going to be moving frequently, this strategy can go bad quickly because you create situations where you end up with a property in San Diego while you are in Florida, and suddenly you are paying a mortgage on a home you don't live in.

That's the reason I want to get a mortgage, in order to reduce my risk as much as possible. Sure, I'll probably be stuck paying for a house that's vacant for some time, but as long as it sells or I can find a renter for it eventually, I don't think it's that big of a deal.

Being a military guy, I don't really have any alternatives, except for renting wherever I get stationed (naturally, this is something I'd like to avoid). I'd like to get some real estate in my portfolio, or failing that, at least get the experience to be able to fix, flip, and rent houses in the future.

[LinCO]

GrayGhost, some of your comments make me think of that Brilliant postcard, "I've learned so much from my mistakes, I'm thinking of making some more!" Ha ha.

I have financed with Pentagon Federal Credit Union. Their 30 year fixed is 3.75% right now.

One thing I'll mention in your situation is the difference between owner-occupied financing and "acceleration clauses" in many mortgages. I have 3 loans for owner-occupied and am now renting out the houses. Technically, if the bank wanted to, they could tell me to pay off the loans since I'm not living in the houses. My 2 properties I have financed as rentals are at 6 and 5.375%. Much more expensive. If the banks accelerated me, I'd be in a pickle.

I was raised with rental properties so there's been a lot that's hard but I'm used to it. I'd say in your situation, keep a big stash you can draw on if you have unanticipated expenses. Banks count like 20% of your rental income for repairs - don't leave yourself scrounging that up if you can help it. Enjoy your first extended vacancy, they're the downside. Also try to get some kind of blanket insurance - we got screwed by our landlord policy and learned the hard way.

Regarding maximizing your leverage, we went there before the real estate crash and have been cash poor for too long now. With things looking up, we are talking about NOT going there again. This means most of what I've read and have on my bookshelf is not helpful now. But I don't trust there won't be another meltdown in our economy.

My favorite real estate blog is calculated risk.