Borrow from First Property as a Downpayment on Second?

[inquisitive]

Appreciate any advice on my situation.

I live in the suburb of a big city, own real estate, and will be moving about 10 miles from where I am currently to be closer to work. It will make a big difference due to moving out of a currently bad living situation, in addition I will save time commuting to work due to the amount of traffic and geographic considerations, will be closer to social life, and have access to some public transportation options. I've noticed that rental prices are very similar to what the cost of a mortgage payment would be. Given this, I'm leaning toward buying. I've also lived here several years and am pretty familiar with the neighborhoods. I've run some calculations and am not sure that buying a second property would make financial sense due to the cost of the downpayment. If I put that in the stock market or another investment and made 9% nominal return/year it would add up to quite a lot.

I have about 40% equity in my current property and can rent it out to cover its cost completely. What I am thinking about doing is taking a loan on this property for the downpayment on a second property I will purchase. I will become a landlord and rent out property 1. I don't know how long I am planning on living in the area but even if I only lived in property 2 for a couple of years I could rent it out afterward at close to its monthly cost as well.

Is this a reasonable strategy?

Other questions: My credit score is good but not great. It's been increasing a few points for each of the last 9 months. Should I wait until it's excellent and maybe make some student loan payments to try to get it even better?

2. Should I wait for the next stock market/real estate crash? I don't know when this will be but I've noticed MUCH better real estate deals when something like this happens, plus more selection. I am going to move out from my current place regardless, so the alternative would be to rent at very expensive rental prices until I would buy, also I would probably have to commit to a one-year rental although I could potentially sublet if I wanted to buy, depending on what the rules are.

Thanks!

 

[FIGuy]

Hey inquisitive,

I'm going to recommend you read through some posts on "biggerpockets.com" and learn about the 50% rule, the 2% rule, and the legal risks involved in both owning rental properties in your own name (vs. in a legal entity) and in particular being a landlord vs. having a professional rental manager.

Short answer is no, don't do this until you research a lot more. Stocks are a lot more certain (over time) and a lot less hassle, but not necessarily more profitable.

Who knows when the next crash is coming and what it will look like? No real free markets exist so it's all tulip crazes and bailouts anymore. I say invest when you're happy with the effort and returns after doing your homework.

Good luck!

 

[inquisitive]

Thanks for your message, incredibly helpful. I didn't realize how much I didn't know but have spent the last week reading articles on the Internet and posts/blogs on biggerpockets about all the topics you have mentioned, which has led me to other topics, and so on. I'm starting to get a good understanding on real estate.

 

[FIGuy]

Thanks for your message, incredibly helpful. I didn't realize how much I didn't know but have spent the last week reading articles on the Internet and posts/blogs on biggerpockets about all the topics you have mentioned, which has led me to other topics, and so on. I'm starting to get a good understanding on real estate.

My pleasure. Biggerpockets probably saved my financial backside. I got all wrapped up in one of the rich dad guy's books and was ready to go all in on the "sure thing" of RE investing. I still kinda messed up the first one, but ended up happy with it in the end. It was pure luck though.

One thing I'll add is that buying in cash (my approach), while looking worse in the math vs. leverage, makes you slow down and lets the knowledge grow along with the net worth. Many people can prove the logic of financing in a low interest environment, but it's all about who's better off after 30 years. It's somewhat hard to mess up cash purchases in the end (Detroit?), but buying the wrong property with a big pile of debt brings risk of bankruptcy. We bought our first one with a mortgage, then paid it off and have been going only with cash since. We're still small potato investors, but are happy with the outcome and are meeting our goals. I'd be comfortable with about our combined annual income in fixed interest debt if it made sense to do that and would probably refinance if a killer deal came along and I didn't have the cash.

For me, it came down to a question of means and goals. We have the means to save about 75% of our work income and we invest in cash in the RE game. When I looked at our modest goals for passive income and how much quicker we'd get there with mortgages vs cash deals, the timeline was only about 3 months difference. Mortgage path assumed buy with financing, then pay off as quickly as possible once we hit the total target NOI. I certainly get better deals with all cash anyway so I bet cash is actually quicker for us. If one can only save 25% of work income and / or the passive income goal is bigger, then mortgages probably make sense. Using a mortgage is basically having tenants pay off the principle and thus is kind of like adding their savings rates to your own. At least, that's how I view it.

I have a buddy leveraging RE to the max as he has a different scenario. He and his wife have significant student loans + a higher COL and didn't see a way to save cash fast enough for that route. So, instead he's buying lots of RE units below market, fixing and refinancing out the cash, and buying more with the same cash over and over. After 15 years, he'll (hopefully) own all those units and they'll pay off his student loans over time. Higher risk, but makes sense for his scenario. He'll probably end up wealthier than me.

A nice complicated excel sheet can answer this question for your personal case. I'm a conservative investor and believe I'll end up financially happy going slow and steady and don't want the chance of messing it all up at 45 with too much risk. I know I'm giving up my chance to be crazy rich in taking this path too.

Good luck,

Chris

 

[Senator]

I actually post on BiggerPockets once in a while.

You may not qualify for a mortgage on the second home if you have two payments. You will not be able to use the rental income unless it is on your taxes for at least two years.

You should be able buy a second home, with a minimal down payment with FHA.

Rental property is a great investment. And can make or break you. If you get great tenants, it's easy. And it's easy to get great tenants of you know what to look for.

 

[inquisitive]

I have the rental income on my taxes for 5 years but every year it shows up as a loss due to depreciation. Financially, this isn't a loss because depreciation doesn't cost me anything, so hopefully they will see it that way. If I hold on to it, I won't have to pay back the depreciation.

 

[Senator]

The banks will add the depreciation back in.