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A
Single’s Game of Real Estate
(Getting started in your twenties)
By Dan Auito
This discussion leans
toward answering questions asked most often by our youthful men and women in
there early twenties. They often begin to ask themselves the question, “Should
I consider buying a home, condo/town-home or some other type of real estate
that I can call my own?” Due to the fact that housing has up to this point
always been provided for or lived in on a rented basis we tend to find that our
newest contributing members of society find themselves at a loss for the most
beneficial and advantageous way to enter this next phase of self-sufficiency.
Due to the fact that most
of us grow up in either a rented apartment or our parent’s single family home,
it stands to reason that most people, when beginning to ask themselves the
question of purchasing their own dwelling, will come to the conclusion that a
condo or small house is probably the way to go. That’s a result of conditioning
and it’s a hard mindset to break! After taking the time to talk to or
personally guide a respectable number of people in their twenties, I have come
to find that firm, direct and accurate information can really adjust the
reality of how real estate can be acquired and used to their best advantage
starting with property that sets the tone for a much more profitable and
rewarding future.
Everyone understands the
concept of paying rent, so to begin with a great opening question to our real
estate student is, “How would you like to collect that rent as opposed to pay
it!” Naturally this question gets their attention and we can begin to open the
door of enlightenment. I like to use the duplex example to illustrate the two
homes under one roof concept. Some people are unfamiliar with what exactly a duplex
is and how it works, so I simply state that quite often you find duplexes
composed of one building that has two bedrooms and one bath on each side, all
under one roof, some larger, some smaller.
These are as easy to
finance as a single family home and in many cases allow you to qualify for a
larger loan amount which leads to using leverage and more of other people’s
money to get ahead faster in life. Using an example lets say you find a duplex
for $150,000 (California is higher), your loans interest rate is 6% that would
cost $899.33 a month to pay
principle and interest back on a 30 year loan. They would have to insure it, so
we use an average of $5 per $1000 of home value to average insurance costs. So
$5.00 x $150.00 = $750.00 a year for insurance. We divide that by 12 months to
get a figure of $62.50 a month for
insurance. We also have annual taxes that are based on what the home is worth
multiplied by a millage, or mill rate. Let’s use a tax rate of $11.00 per
$1,000 of the homes assessed value: $11.00 x 150 = $1,650.00 a year. Now divide
that by 12 months to get a monthly tax of $137.50
and by adding principle, interest, taxes and insurance (P.I.T.I), we get a total monthly mortgage payment of $1099.33.
Now when
you rent one side out for (in many cases, approximately $750.00 a month) you
are left to pay only $349.33 out of your own pocket every month. When I get
this point firmly affixed to the gray matter of their brain, it becomes clear
that this amount is much lower than the amount of rent they are now paying to
live under someone else’s roof and rules. Now the questions start coming in the
following order. Well? How do I buy something like this? The answer most often begins with, “By
getting pre-qualified for a loan,”
and I go on to say you will need to gather and bring the following things to
the bank loan officer to get started:
1.
Copies of three years of tax returns for first time
buyers + schedules and W2 forms
2.
Copies of most recent pay stubs within the last 30 days
3.
Copies of your most recent three months of bank
statements
4.
A list of all creditors with name, address and account
numbers
With
these initial documents the lender can begin to process your application for a
loan. They will determine your assets and liabilities (net worth) as well as
verify where you live now, your credit history and a host of other information
that begins to validate your existence and ability to borrow money now and in
the future.
Once
they’ve had a chance to review and verify your information they can pre-approve
you for a certain loan amount. Once your approved you can begin your search for
a home of your own, typically as a first time home buyer you will find that
there are programs that let you put as little as 3-5% percent down in order to
buy a home that satisfies the lender’s guidelines according to its value and
conformity. Now on a $150,000 loan the
down payment can be anywhere from $4500.00 - $7500.00.
There
are ways to lower these costs and a great place to start is by attending a first time home buyer’s class. These classes introduce you to
the basics and give you further information on programs that are currently
available that may offer you the opportunity to buy with nothing down! So with
that said, the next step is to get to a free class and get familiar with the
process. Often I recommend going to the class before going to see a lender so
you don’t appear so green and unprepared upon your initial introduction.
Since I
usually find these poor souls wondering and wandering in the land of the lost, the
next frown I see come over them is the realization that they just don’t have
the money required to start. So the question comes up as to where to get it. I
usually ask about savings, whether parents or grandparents can help, if they
can sell valuable possessions or take second jobs, get grants, gifts, use trust
funds, personal loans or co-signers, or a combination of these alternatives
with a complimentary loan program usually gets the ball rolling. Options and
hard money lenders usually come later as alternative funding and acquisition
sources, so I won’t confuse any one with those now.
The
bottom line is this: If someone wants something bad enough there is always a
way!
The nice
thing about duplexes is that the lender will take into account the fact that
75% of the rental income from the other side of the property can be used to
offset your qualifying ratios, so in this case they can use 75% of the rentals
$750.00 income to reduce the amount you must earn to qualify for what appears
to be an unaffordable loan. Seventy-five percent of $750.00 equals $562.50. Now
subtracting that amount from the original mortgage payment of $1099.33 leaves
you with a payment of $536.83 which the bank says you must be able to repay
every month out of your own pocket. You can do this!
Can you
begin to see how with a little information, effort and belief you can actually
own something and pay less than what you are currently paying in rent?
Let’s
continue on with the way things begin to unfold once you begin the journey. Starting
with the day you close the deal and become the new owner you will see that you
now have just created a passive income stream that gives you an extra $750.00 a
month without you having to punch a clock or trade a certain amount of hours to
earn the money. Your new asset works for you day in and day out constantly
generating income for you while you go and do other things. This is leveraging
your time and money in a very beneficial way!
You also
will notice that at the closing of your purchase that the old owners who sold
you this property had to prorate or give you a share of the rents due and any
security deposits that the tenants had given to them. Now add to that the
likelihood that your first house payment won’t come due until about a month and
a half after you move in and you find yourself with, low and behold, extra money, probably for the first time
in quite a while!
Let’s
calculate it using simple math. Assuming
you close on the 15th of the month, you will have 45 days before
your first payment comes due, you will be credited with 15 days of rent, you
will receive all security deposits of the tenant and you will receive another
month’s rent on the first of the month from your tenant and you yourself will
have no rent or house payment of your own to make for another whole month. What
does all that add up to? Let’s break it down:
1.
Fifteen days of rent equal to $375.00
2.
A half month’s rent as a security deposit equal to
$375.00
3.
A full month’s rent in another 15 days equal to $750.00
4.
No payment to the bank for another 30 days and you’re
not paying rent to anyone any longer, so you keep whatever you normally would
have had to give to someone else as rent that month (let’s say that was
$500.00).
5.
Another payment to you for $750.00 from your tenant as
well as you having to make your first mortgage payment of $1099.33 on the 1st
of the month which comes 45 days later.
Side
note: If you decided to rent your second bedroom to a roommate, they would
pay
$500.00 a month and half your
utilities as well, thus your basically living and
owning this property for free.
Say goodbye to all those student loans as you
divert all these freed up
funds to pay off loans instead of a landlord!
Adding
these up, we get $375.00 + $375.00 + $750.00 + $750.00 + 500.00 not paid to
your old landlord. That equals $2,750.00 that you will now have as a result of
your first month and a half of ownership. Now subtract your mortgage payment of
$1099.33 and you are left with a reserve fund of $1,650.67 in your account.
Take your parents out to a steak dinner and celebrate - you’ve earned it!
Let’s
review: You decided to buy your own home, you made the choice early to offset
expenses by looking at a multiple income property, you went to the homebuyer’s
class, you went to see a lender and got pre-approved for a loan, you saved or
arranged to have the necessary amount required to buy and you hunted, searched
and analyzed more than a few properties in order to find a good one that would
satisfy your criteria.
Your
next phase is to begin to realize that you are now responsible for the welfare of another family or person due to your
willingness to become a landlord. Your tenants pay rent and expect you to take
care of their housing needs. If you chose a good property by carefully looking
at plumbing, heating & A/C, electrical, foundation, structure, roof,
location and price, then you should be well positioned to be able to
successfully manage these duties. Often, you as the new owner will begin to
make improvements to the property such as painting, installing new carpet and
doing some inexpensive landscaping and repairs. These are the things that add
value to your property and keep your tenants happy while at the same time not
breaking the bank!
With
$1,650.67 in your bank account, you’re not exactly Donald Trump just yet, but
you’re getting there! Smart landlords establish
6 month reserve accounts and/or contingency
funds, which protect them in times of vacancies
or when expensive unforeseen repair bills
pop up in addition to regular planned-for maintenance items. What I’m saying is
don’t spend your reserves frivolously. In my case, a steak dinner is a
tradition but the major portion of your funds should only be used to build,
protect and enhance your asset’s ability to produce and sustain income
generation.
By
taking on responsibility in the housing market at such a young age, you will
have some added benefits and opportunities coming to you. Let’s look at what
starts happening: the first thing is you have overcome fear and lack of
understanding by acquiring your first property. In addition, you have begun to
offset expenses while saving more money, you are establishing excellent credit
while building assets, and you’re gaining tax advantages while getting
management, home buying and repair education at an early age. These are
outstanding life skills that you can employ for the rest of your life and the
longer the period of time that you have to use them, the further the
compounding effects will help you to go.
This
type of initial home-buying strategy can and does lead to further opportunities
to grow and achieve further benefits besides those already mentioned.
Individuals who learn to accept responsibility early will by nature grow more
mature throughout the process and in effect create for themselves a higher
status in the minds of others by being looked upon as a current homeowner and
landlord. Once established, you will become known for what you can do. If you
were single when you undertook these challenges, then you will appear and
become more self-sufficient to the opposite sex.
What do
I mean by that? What I’m saying is when you meet someone who may become your
spouse in the future, they will recognize your ability to provide for their
safety and protection and they won’t question or complain about your fooling
around with wild ideas of becoming educated in real estate now. They will
accept that this is something you do and will respect your ability to manage
this part of your life.
As time
passes on and you find this love of your life and the eventual marriage
proposal ensues, the time will come when you’re going to want to separate
business from pleasure. As a young couple the time will come when you
may want to start a family or at least separate yourself from your tenants
while moving up to a nicer single family home that suits your changing needs
more appropriately. Perfect, because now is the time to consider renting out
both sides of the duplex while you begin to investigate your new single family
home.
How does
this phase work? Hold on, I’m getting there! Okay, let’s assume its two years
later and you have been living in and improving your duplex all along. Now
taking into account that you bought a decent property in a good neighborhood
and inflation and appreciation has been adding value in addition to your
improvements, your $150,000 duplex should command a new appraised value of
$175,000. Let me explain how the value grows: 3% annual inflation multiplied by
$150,000 equals $4500.00 the first year. Let’s also say that appreciation due
to demand also adds 5%, so 5% x $150,000 equals $7500.00. Now $150,000 + $7500
+ $4500 = $162,000, which represents the new value for year one. The second
year we do the same math on $162,000 and we get $12,960 for year two. Adding
that to $162,000 equals $174,960. Okay, I was off by $40.00. Don’t forget any
improvements and that you may have bought it at a discount because the old
owners where motivated and you might find its worth even more.
Now over
those two years you have also been paying that old mortgage of $1099.33 each
month and the principle amount that you owe on your loan has been reduced by an
additional $3,965.96, leaving you with a loan balance of $146,034.04. The
difference between the new appraised value of $175,000 and the current amount
of $146,034.04 which you owe equals $28,965.96. This number represents the
equity, or value, that you currently own in the home. Knowing this, it is
entirely possible to apply for and receive a home equity line of credit up to
the full value of the new appraisal! If you haven’t gone overboard on buying
cars, boats and running up other revolving debt while at the same time your
significant other or spouse-to-be has a job and good credit with manageable
debt, than the bank is going to approve this line of owner-occupied credit.
Now what
you have done is set up a line of credit which can be used to buy a $145,000
single family home with a 20% down payment. This allows you to avoid paying
private mortgage insurance (PMI), thereby creating a very affordable new
mortgage on your new family residence.
NOTE: Do
not confuse homeowner’s insurance with private mortgage insurance. PMI protects
the lender while homeowner’s insurance protects you. When you put down 20% of
value on a home’s purchase in the form of a down payment, you are in effect
protecting the lender from yourself because if they foreclosed on you for
non-payment, they could sell the home fast for less than full value and still
be paid in full.
Don’t pay for private mortgage
insurance if you can avoid it!
Let’s not forget that as
the value of your duplex has risen the rents should also be increasing along
the same lines. Now instead of $750.00, you should reasonably expect to get
$800.00 per month, per side, which now delivers $1600.00 a month to your bank
account. Unfortunately you still have to pay for 28 more years on the original
loan amount, so you will make that good old $1099.33 payment as usual. That
leaves you with $500.67 left over to pay that new equity line back with. Your new $29,000 equity line which you used
as a down payment on your new home costs you $336.71 @ 7% for 10 years. Now
$500.36 minus $336.71 leaves you with $163.96 left over to maintain a nice
little reserve account for vacancies and maintenance/repairs. This is a good
example of how to transition to a secure lifestyle while using your existing
asset base to buy more.
Review:
1. Break
the mold and look at multiple income property to start.
2. Go
to a first time home buyer class to get ready.
3. Go
to a lender prepared to qualify for an affordable loan amount.
4. Focus
your effort on learning how real estate works.
5. Realize
the sooner you start, the better off you will be.
6. Offset
expenses by renting to others.
7. Manage
tenants, deposits and property responsibly.
8. Plan
for the future using assets and equity lines to start.
9. Keep
reading and learning how to do new things with real estate.
10. Find
mentors and use knowledgeable people to help you along the way.
I hope this little plan of entering into homeownership has
given you some ideas in your quest for independence. Wishing you all the best! Your investment pal, Dan
Please visit with the family at www.magicbullets.com we look forward to
seeing you!
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