That’s right. I said it. Use your credit card.
I’m sure most of you have heard the explanation of bad debt versus good debt. Bad debt is when you finance purchases like flat screen TVs, cars, vacations, or…look out, I’m about to say it… your own home. Good debt is when you finance purchases that will give you a return. Education is a big one. Another big one? Real estate! (The right real estate, of course)
It’s simple. If the interest rate on a loan or debt service is lower than the return you are making on whatever you buy, you’re making a profit!
When and How to Use Your Credit Card
Using a credit card will obviously only get you so far in real estate because most likely you have a credit limit. Say $15,000. So you won’t be paying all cash for a $100,000 property anytime soon, but there is a lot in real estate you can do with $15,000. You can buy a $50,000 rental property using a mortgage with 20% down. $10,000 for the down payment and $5,000 should cover closing costs. Bam! You just bought a rental property with a credit card!
Is using a credit card a smart move in every case? No way. Let’s say you buy said rental property and said rental property is bringing in a 10% ROI. Your credit card is charging you 17% interest. That won’t work. I mean, it will work, but you’ll be losing money so don’t do it. But what if you are really well established with a credit card company and you can pull off paying only 7% interest and the property is bringing in 10%? That works! Well, maybe. Don’t’ forget the amount of interest you are paying on that mortgage too.
Eek! Things are getting confusing! Don’t worry, it’s easy. If you read my article on how to calculate rental property numbers on a napkin, you can do exactly that here. Follow the same process and add up the same numbers I list there, but then add in the extra debt service payment for the credit card. If you are still positive on the cash flow, it’s a good deal! If that extra debt service payment puts you only at breakeven or negative on the cash flow, it’s no longer a deal.
As far as how to use your credit card, the best way is to take a cash advance against the card. You will likely get a much lower interest rate and the cash becomes available in your bank account almost instantly. There are usually fees for doing this, but just add those into your calculations to be sure it doesn’t mess with your numbers, but the fees usually aren’t all that high so it shouldn’t affect them much if at all.
What if You Don’t Have a Credit Card?
That’s fine. You can do the same thing with other types of loans. Do you have a car that is paid off? You can secure a loan with your car, essentially get a full car loan based on the worth of your car, and use that money to put towards real estate. Lines of credit work. You can even use an unsecured loan if the interest rate isn’t too atrocious. My favorite loan source is my 401K. Some 401K/IRAs will let you self-direct so you can buy real estate directly with the funds, but if you don’t have that option you can borrow against your 401K/IRA. The advantage to doing this is the interest you pay on that loan goes back to your own account! So in this case you may not even want to add in your debt service to your calculations (unless you are worried about monthly cash flow specifically) because that money is just going back to you. It’s going to you in a form where you can’t touch it until retirement, but it’s still going back to you.
I’m nearly certain I’ll have people comment saying using a credit card is extremely dangerous and risky. My response? It’s completely dependent on your personal comfort level. I’m totally fine leveraging as much as I can, when I can, and from where I can and to the max limits that I can do it. How else would I buy real estate? I don’t have my own money to do it, so I have to use other people’s. I do fully understand why someone may not be comfortable using maximum amounts of leverage and credit cards, so I’m totally okay with that being your stance if that be the case. Only do what makes you comfortable.
If you are comfortable using credit cards and other sources of financing however, my only warning is to make sure you are being smart about it. I talked about numbers and making sure that taking out the additional financing isn’t going to flush your profit down the toilet. Another thought is to make sure you understand all of the payback terms of the loan. Are there any penalties for anything? Is there any fine print you need to be aware of? Most importantly, I think the biggest protection you can have when you use leverage is to make sure to keep extra ‘emergency funds’ available. Don’t spend every penny you make off your investment. Save most of it, if not all of it, until you have a nice nest egg to cover any unforeseeables. Have an action plan set up to handle payments, emergencies, and worst-case scenarios.
Can anyone recommend any other clever ways of financing a little extra cash?