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My situation is that I'm 23 and have about $4k a month of spare income after everything. I'm considering buying a house in the area I come from, a relatively cheap area where I have friends who bought decent 2-bed 2-bath houses for down payments of $5k-$10k with monthly mortgages of about $1500.

My thinking is that if I can get a house that way and rent it out and have it break even, then it's just an asset that slowly pays itself off. Of course there's maintenance costs and shifts in market value, but even so.

However, I don't know the further implications of this. For instance, if I get a loan to buy the house, does that limit my ability to take out further loans for other things? Or does having the house give me an asset I can use as collateral and actually increase my ability to purchase other things?

If there's anyone who has done this, I appreciate any pointers to the aspects I'm sure I haven't thought of.

  • Using a house you are renting as collateral for another loan? What happens to the tenant if you default? Does the bank assume the lease? – WetlabStudent Apr 10 '15 at 18:18
  • I don't know but I do know it's a very common practice. – temporary_user_name Apr 10 '15 at 18:34
  • There have been past questions here about the business of being a landlord, absentee or not, which have coveted many of the practical aspects from financial to finding and dealing with tenants. I'd highly recommend reading those first, then coming back to us if you have specific questions those didn't address. Note that rental is a business, not just an investment. It's also questionably on-topic as a personal finance question but I'm not sure where else it belongs. Entrepreneurs? – keshlam Apr 10 '15 at 19:03
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    Any correct answer to this will be highly influenced by geography. You should probably include your metro area. – Mr. Mascaro Apr 10 '15 at 21:51
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    How could this possibly be answered without you telling us at the very least what country you live in?!? – curiousdannii Apr 11 '15 at 11:14
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Lets consider what would happen if you invested $1500/mo plus $10k down in a property, or did the same in a low-cost index fund over the 30 year term that most mortgages take.

The returns of either scenarios cannot be guaranteed, but there are long term analyses that shows the stock market can be expected to return about 7%, compounded yearly. This doesn't mean each year will return 7%, some years will be negative, and some will be much higher, but that over a long span, the average will reach 7%.

Using a Time-Value-of-Money calculator, that down payment, monthly additions of $1,500, and a 7% annual return would be worth about $1.8M in 30 years. If 1.8M were invested, you could safely withdraw $6000/mo for the rest of your life. Do consider 30years of inflation makes this less than today's dollar.

There are long term analyses that show real estate more-or-less keeps track with inflation at 2-4% annual returns. This doesn't consider real estate taxes, maintenance, insurance and the very individual and localized issues with your market and your particular house. Is land limited where you are, increasing your price? Will new development drive down your price?

In 30 years, you'll own the house outright. You'll still need to pay property tax and insurance on it, and you'll be getting rental income. Over those 30 years, you can expect to replace a roof, 2-3 hot water heaters, concrete work, several trees, decades of snow shoveling, mowing grass and weeding, your HVAC system, windows and doors, and probably a kitchen and bathroom overhauls. You will have paid about 1.5x the initial price of the mortgage in interest along the way.

So you'll have whatever the rental price for your house, monthly (probably almost impossible to predict for a single-family home) plus the market price of your house. (again, very difficult to predict, but could safely say it keeps pace with inflation) minus your expenses.

There are scenarios where you could beat the stock market. There are ways to reduce the lifestyle burden of being a landlord.

Along the way, should you want to purchase a house for yourself to live in, you'll have to prove the rental income is steady, to qualify for a loan. Having equity in a mortgage gives you something to borrow against, in a HELOC. Of course, you could easily end up owing more than your house is worth in that situation.

Personally, I'd stick to investing that money in low-fee index funds.

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    Do you do any real estate investing? The rental rate you will get AND the value of the house are NOT complex to predict. How do you think it's done every single day and so consistently? A solid mixture of looking at the condition of the property and also looking at the comparables in the area. – Anthony Russell Apr 11 '15 at 0:14
  • @AnthonyRussell I had the impression that any market is vulnerable to bubbles, crashes and other such effects. Is real estate an exception? – Superbest Apr 11 '15 at 6:03
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    It is not an exception but that doesn't mean you are incapable of identifying the value of the house and the proper rental rate.... We're not all out here guessing. There is a method to the madness – Anthony Russell Apr 11 '15 at 15:58
  • I don't deny there is a way to do this for the immediate and short term markets, but 30 years from now it would be very hard to predict indeed. Especially when we are talking about one specific rural or suburban single family home. Multi-family in city centers will have more comp properties, a more tested rental market and a more defined land value. – fontophilic Apr 13 '15 at 16:57
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There are actually a few questions you are asking here. I will try and address each individually.

Down Payment

What you put down can't really be quantified in a dollar amount here. $5k-$10k means nothing. If the house costs $20k then you're putting 50% down. What is relevant is the percent of the purchase price you're putting down.

That being said, if you go to purchase a property as an investment property (something you wont be moving into) then you are much more likely to be putting a down payment much closer to 20-25% of the purchase price. However, if you are capable of living in the property for a year (usually the limitation on federal loans) then you can pay much less. Around 3.5% has been my experience.

The Process

Your plan is sound but I would HIGHLY suggest looking into what it means to be a landlord. This is not a decision to be taken lightly. You need to know the tenant landlord laws in your city AND state. You need to call a tax consultant and speak to them about what you will be charging for rent, and how much you should withhold for taxes. You also should talk to them about what write offs are available for rental properties. "Breaking Even" with rent and a mortgage can also mean loss when tax time comes if you don't account for repairs made.

Financing

Your first rental property is the hardest to get going (if you don't have experience as a landlord). Most lenders will allow you to use the potential income of a property to qualify for a loan once you have established yourself as a landlord. Prior to that though you need to have enough income to afford the mortgage on your own.

So, what that means is that qualifying for a loan is highly related to your debt to income ratio. If your properties are self sustaining and you still work 40 hours a week then your ability to qualify in the future shouldn't be all that impacted. If anything it shows that you are a responsible credit manager.

Conclusion

I can't stress enough to do YOUR OWN research. Don't go off of what your friends are telling you. People exaggerate to make them seem like they are higher on the socioeconomic ladder then they really are. They also might have chicken little syndrome and try to discourage you from making a really great choice. I run into this all the time. People feel like they can't do something or they're to afraid so you shouldn't be able to either. If you need advice go to a professional or read a book. Good luck!

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    They never count 100% of expected rent, they assume that you will have gaps between renters. They may use 75% or 67% coverage. – mhoran_psprep Apr 10 '15 at 17:16
  • I've never heard of a percentage so I can't comment on that. Sounds like a thing a lender would do though so +1 – Anthony Russell Apr 10 '15 at 17:20
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    @mhoran_psprep, you are absolutely right! Each bank will have a figure specific for your area and it's a good number to know both for applying for a loan and to do your preliminary calculations for being a landlord. Most banks, especially portfolio lenders, will be more than happy to share their expected occupancy ratio with you. – Mr. Mascaro Apr 10 '15 at 22:05
  • "If the house costs $20k then you're putting 50% down." - He's making enough to have $4k spare every month, so I'm guessing his friends aren't buying $20k houses (huts? dog kennels?). The $5-10k is probably the lowest % possible, so 5-15%. – Superbest Apr 10 '15 at 23:55
  • @Superbest its called an exaggerated example.You don't honestly think I wrote that entire well thought out answer yet assumed that do you? Common.... – Anthony Russell Apr 11 '15 at 0:09
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I would suggest the use of a management company to handle a rental property. They will take care of things like collecting rent, coordinating repairs and all the little things that come up when dealing with a renters.

They typically charge a percentage of the rent or a flat fee, so make sure you include that in your rent calculation. You take a little bit of a financial hit, but save a lot of head aches - especially if you decide to acquire multiple properties in the future.

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From personal experience:

Loan Impact

It does impact your ability to take out other loans (to an extent) Your first investment property is going to go against your debt to income levels, so if you take out a loan, you've essentially decreased the amount you can borrow before you hit a lender's debt to income ceiling.

Two things about that: 1) I'm assuming you have a primary mortgage - if that's the case they will factor what you are already paying for your primary house + any car loans + any student loans, etc. Once you've successfully taken out a mortgage for your investment property, you're probably close to your debt to income ceiling for any other loans.

2) There is usually a 2 year time period where this will matter the most. Once you've rented out this property for 2 years, most financial institutions will consider a percentage of the rent as income. At this point you can then take on more debt if you choose.

Other (Possibly Negative) Impacts and Considerations Maintenance Costs Renovations Turnovers Taxes and Insurance Downpayments and interest Income tax Advertising costs Property Management costs Closing costs and Legal fees Vacancies HOA fees

Other (Possibly Positive) Impacts and Considerations Passive Income as long as the numbers are right and you have a good property manager Tax deductions (And depreciation) Rent has low correlation to the market

Other investment alternatives: Stocks Reits (not directly comparable to investment properties)

Long story short- can be a hassle but if the numbers are right, it can be a good investment. There's a series of articles further explaining these above listed components in detail.

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You should absolutely go for it, and I encourage you to look for multi-unit (up to 4) properties if there are any in your area. With nulti-unit properties it is far more common than not that the other units pay the mortgage.

To comment on your point about slowly building an asset if the renter covers the payment; that's true, but you're also missing the fact that you get to write off the interest on your income taxes, that's another great benefit.

If you intend to make a habit out of being a landlord, I highly encourage you to use a property management company. Most charge less than 10% and will handle all of the tough stuff for you, like: fielding sob stories from tenants, evicting tenants, finding new tenants, checking to make sure the property is maintained... It's worth it. There fees are also tax-deductible...

It makes a boat load of sense. Just look at the world around you. How many wealthy people rent??? I've met one, but they own investment properties though...

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protected by Chris W. Rea Sep 3 '16 at 17:58

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