For many, here’s how the story goes. They have one small investment property, maybe two. Total value is around $250,000 or so. They own ‘em free ‘n clear. They’re racin’ to finish payin’ off their home mortgage so that when retirement hits, maybe in about 10 years, they’ll not have that to pay every month. In fact, they don’t like thinkin’ about it much. Social Security says they’ll get around $25-30,000 yearly, assuming they call it quits around 65ish. The rental, a triplex they’ve owned for quite some time, has proven reliable. But it nets ‘em only around $20,000 a year, and that’s before taxes. They’ve looked at every possible way they could improve their likely post retirement income, but it always ends up with the same answer. They need more income to help pay off any new property they might buy, in time for retirement. They certainly can’t afford to buy for cash. They don’t wanna work into their 70s either. The way they see it, they’re dead if they do, and dead if they don’t.
They’re resigned themselves to an income, give or take, of $50,000 — all of it completely taxable. Without a house payment, plus a good budget, it should work. But it’s not what they bargained for when they began investing. A feeling of disappointment and resignation begins to take over. Here’s a way they can create another income stream, while still arriving at retirement with a free ‘n clear home and rental, AND at 65. It’s nothin’ new under the sun. Most folks just haven’t had it presented before.
Here’s the gist.
They might consider puttin’ a new loan against their rental, which is worth around $250,000. Doin’ so isn’t even a taxable event. The loan would be for roughly 70% of that value, around $175,000. Today’s terms means they’d be payin’ around 4.5% interest (30 yrs., fully amortized), which comes out to a monthly payment of about $887. So far, so good.
Let’s then have them go out and acquire a note (or notes), secured by real estate, that they buy at a discount. Now, discounts are all over the map, from over 50% to just 10%. Let’s say they find something they can buy for around 65% of the notes’ face value. At a $175,000 purchase price, that means they can buy notes totaling $270,000. (Yeah, I rounded up a few hundred.) The payments/terms are as follows:
10% interest, amortized for 30 years — no balloon. Monthly payments total around $2,370. (a few pennies less)
They’ll pay taxes on the part of the payments that is interest. Let’s say they net about 70% or so — roughly $1,660.
The strategy calls for them to then apply the after tax note payments — $1,660 — to the new triplex loan. Do this for about 80 months or so, less than seven years, and they’ll have paid off the triplex again. ‘Course, it’s a bit more likely than not, that the notes they bought will have paid off before seven years passed. It’s also completely possible they wouldn’t have. The last several years have shown, however, that the typical life span of these notes tends to be less than seven years, sometimes far less. It’s completely random. Predicting note payoffs is a fool’s errand to say the least. There’s a huge difference between ‘tends to be’ and what actually happens to any individual note. NEVER make investment plans predicated on a note(s) being paid off early, unless disappointment is your friend.
It’s 10 years later and time for them to retire.
At this point they know what they have for income. There are three separate and completely independent sources. Social Security, the triplex, and the notes. SS gives them $25,000 a year. Their triplex spits out about another $20,000. Their notes, assuming none have paid off early, are good for a tad under $28.500. Add ‘em all together and they’re retired on approximately $73,500 annually — every penny of it completely taxable. But, on the bright side, that’s a smidgeon over 63% more than they’d of had without the note income. ‘Course, if the notes had paid off during the 10 year period between purchase and retirement, they’d of paid the taxes on their profit, and bought more notes totaling higher face value, and yielding bigger monthly payments.
Built in raises
What’s so attractive about this approach is that once retired, life goes on for the notes. They get paid off, some sooner, some later. Each time a note gets paid off, our happy retirees take the after tax proceeds and buy a bigger note(s). In other words, every now and then they get raises. In fact, let’s take a brief look at a credible potential scenario.
Though their original note acquisitions didn’t adhere to the 2-5 year payoff trend, they did pay off in around nine years. After payin’ taxes on the profits, their net was roughly $235,000 or so. They immediately rinsed ‘n repeated, buyin’ around $350,000 in more notes. Their note income then rose immediately from $28,500 to, give or take, just over $36,000 annually — a raise in note income of over 26%. That would’ve meant their initial retirement income would’ve surpassed $80,000 a year. Either way, they’re much better off having turned their trusty triplex into their own personal bank, even if only for a short while. Again, and please, burn this into your memory. Notes pay off randomly, not predictably. This is especially true if they’re fully amortized.
This option is nearly universally available to those who find themselves nearing retirement with less than acceptable income. The more free ‘n clear equity you have available, the more income you’ll be able to generate. What appeals most to folks, at least in my experience, is that it allows them to return their income property to loan free status, and in a reasonable time span. In other words, it’s not ultimately a zero sum game. What really attracts ‘em though is the future raises that will randomly occur over time.
Turning your small income properties into temporary banks can make the difference between a disappointing retirement, and one with hope.Too Little Time & Not Enough Capital: Turnin' Your Property Into A Bank by Jeff Brown