Published On: Thu, Jan 30th, 2014

I’m Buying Rental Property While Still In Debt

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If you listen to the news, it would make you run in the opposite direction of buying property at a time when you probably should be running directly to real estate.  Apparently, many of you do not watch the news either because, according to the U.S. Department of Housing and Urban development, December 2013’s existing home sales were the highest since 2006.

The housing affordability index is at its best, because of low housing prices and low mortgage interest rates. The average interest rate for a 30-year fixed-rate mortgage was 4.258% during the last quarter of 2012. If you’re in a stable financial position and have been waiting for the right time, now might still be a great time to buy.

Personally, I’m not looking for a home to live in.  I’m looking for a home that you or your friends would want to rent from me.  Yes, I’m shopping for rental property.  If I see the house more than four times per year it would just be for maintenance and changing the batteries on the smoke detector.  That would pretty much be it.

Since purchasing my first investment property two years ago, I’ve learned quite a bit about how to make a better selection.  It’s not that my first purchase was a bad decision, it probably just wasn’t ideal.  Going forward I would like to see the following in any home that I purchase:

  • At least two units.  Three would be ideal.
  • Outside of flood zone
  • Less than $5,000 in remodeling work/repairs needed
  • No major repairs such as roof, heater, gas lines needed
  • Close to hospital (the main employer for the area) or good school district.
  • Off street parking
  • Gas or electric heat
  • Delivered with no tenants

Of all the things that I mentioned, price was not one of them.  The price itself does not concern me, as long as when I crunch the numbers, the math ends up being where I need it to be.  To get to the income level that I’d like I’m doing the following:

[(Monthly Rental Income x 12)- 20%] – [Owner paid utilities (annualized) + real estate taxes + fire/liability insurance + lawn maintenance/snow removal] =  Potential annual income

To translate I’m calculating the total rent by twelve to get the annual rental income.  Then, I subtract about 20% for vacancies and/or unseen expenses.  I then subtract all of the expenses that I would be responsible for to get to my annual income.  I didn’t include fees for evictions, maintenance, etc.  I’m looking at the maximum return here.  For the property prices in the range that I’m buying, I hope to have a number close to $10,000 at the end.  If it’s $9,000 that’s fine too, but $10,000 would be ideal.

How do I plan on buying property while in debt?  I’m doing something completely unconventional that most personal finance experts would tell you to NOT do.  I’m borrowing 100% of the cost of the property from my 401(K).  I can hear the collective gasps right now.

Are you shaking your head thinking, “Oh, no she isn’t!”  But, oh yes, I am!

Hear me out.  My 401(K) is actually doing pretty well.  It’s has a 30% return in 2013.  I’d love to continue riding that wave for a long time, and honestly, I have more than 30 years before my official retirement age.  What I am looking at here is the potential for property to add to my income right now instead of 30 years from now.  Although, if I keep the property long enough, it can probably supply me with income well into my retirement.

But wait, you’re giving up the tax savings by not stashing money into your 401(K), you’re thinking.  No, I’m not.  I’m going to continue putting the same amount of money into my 401(K) and I am going to pay the loan back into my 401(k) as well, plus interest.  A strategy that I might employ is taking out a first mortgage on the home once I have held it for a few months and using the loan money to pay off the 401(k) loan while having a tax deductible loan for the home in my name.  I can see the light bulbs coming on now.  Genius, isn’t it?

But, as you know, the best laid plans sometimes doesn’t come to fruition.  I fully realize that I can be turned down for a loan.  I also realize that if I lose my job, the 401(k) loan would be due within 60 days.   This is less of an issue for me because my 401(k) isn’t tied to my employer but to my own business.

I don’t know if it will all work out, but I hope it will.  Just in case you think that no one else has done this successfully, reader Mildred wrote in to tell me that how she retired in her 50’s on income producing property that she purchased as a nurse.  When I grow up one day, I want to be like Mildred!

So, do you think that I’m crazy?  Is my plan nuts?!  Would you do this?

Sandy Smith

Sandy Smith

Founder at Yes, I Am Cheap
Sandy Smith is the founder of the peer acclaimed personal finance blog, Yes, I Am Cheap where she shares winning strategies for reducing debt. You can find Sandy all around the internet taking about getting you out of debt and helping others establish small businesses.She is also the founder of Colorful Money Magazine.
Sandy Smith

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About the Author

- Sandy Smith is the founder of the peer acclaimed personal finance blog, Yes, I Am Cheap where she shares winning strategies for reducing debt. You can find Sandy all around the internet taking about getting you out of debt and helping others establish small businesses. She is also the founder of Colorful Money Magazine.

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  1. Michelle says:

    Sandy, I am wondering what the price range you’re working with? I think that sometimes you have to take a risk. You know both the upside and downside. As long as you have a tenant in the property you should be ok. Am looking to more posts on this!

    • Sandy Smith says:

      It was certainly a risk and I am buying distressed homes at the very BOTTOM end of the market. I’m talking new luxury car prices. 🙂 So far, I’ve had a great tenant in who pays on time and pretty much never calls me. I will be paid off on the house in 3 years.

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Did you know?

African Americans are significantly more likely to have some type of debt (94%) compared with the general population (82%). Credit card debt, student loan debt, and personal loans are all significantly higher in the African American community.

Source: Prudential’s 2013 "African American Financial Experience" study