Rock Your Debt

Several years ago I had the opportunity to buy a rental property. It was a duplex that a friend of mine was living in. He was living in one side and renting out the other. He and his wife were about to move out of town and needed to sell his property. Long story short, we settled on a price that we both could live with and we began the process of transferring the ownership.

Financing the property
I was able to find a lender who would allow me to purchase the property with a 10% down payment. I had some money in savings but I got this brilliant idea to finance the property 100% with no cash coming out of my pocket.

Put equity to work – what some experts say to do
What I did was simply take out a home equity line of credit (heloc) and borrowed against my primary residence. I thought that this was a great idea. The equity that I have in my home is just sitting there – not providing any income at all. Why not use the equity as a down payment for something that can provide income. Made sense at the time.

Somethings are just better on TV infomercials
Buying a house with no money down puts you as the borrower at greater risk unless you are able to buy the house that is priced far under appraisal value. So, in effect what 100% financing has done is made my margins so tight that there isn’t much cash flow at the end of the month – even with a duplex. So, when the inevitable hot water heater goes out I may be forced to tap into my own savings to cover the cost.

Now, I know that this is not really a no money down situation but it was to me because I didn’t have to come up with the cash in order close on the property. Typically, when you hear no money down you’ll hear fancy finance terms like seller carry back or wrap around financing (more on these in later posts).

Lessons learned

Amount financed is key
I love real estate but I won’t buy another property until the entry point (price) is advantageous as compared to the rental market in the neighborhood. In other words, the property will easily cash flow each month. Which requires better negotiation tactics, market research, tenant selection and of course a much larger down payment. Because you are locked in for a period of time – 15 or 30 years, the financial terms of the loan are absolutely critical. All of these things were admittedly glossed over on my part this go around.

I am no expert
It showed that I was an amateur investor. It tested my ability to truly assess the property’s value as well as the ability to rent it out in order for it to cash flow each month. A bad idea for a first time rental property investor.

Borrowing against your house is crazy
What I know now is that using my primary residence as collateral substantially increases risk and expenses – and added to my debt load. I can only charge so much rent and still keep the rental occupied but due to the fact that I have pretty much financed the selling price.

Using my home’s equity was a mistake but…
I don’t regret buying the property. There is definitely something rewarding about having another property that provides income and the experience was priceless. I’m learning how to think in terms of a business owner by calculating monthly income statements and balance sheets. However, if I had to do it over again I would make sure that I had more down payment in order to reduce my expenses each month and not add additional risk by borrowing against my house.

You also may be interested in:

1. Can I Use My 401k to Buy a House?
2. Alternatives to Buying a Car with Bad Credit
3. Consider the Risks Before Taking Cash Out with 125 Second Mortgage Loan