My Plan to Finance my First Deal; realistic or fantasy?

10 Replies

Hi BP,

I have been following the podcast for a while now, reading books, informing myself. I would like to get into real estate investing, but I have had never more than $2.000 in my bank account in my life. I now came up with a strategy and I would like to have some feedback, whether it is a realistic scenario or total bogus. Two years ago I bought a house via FHA ($2.000 down,lol, actually I only paid $500 and the agents used some of their cut to make the deal happen. I wasn't even aware of that at the time) for $160.000. The mortgage amount is $159.500. After 2 years I still owe $157.000. According to various websites thanks to appreciation the home is valued now between $195.000 and $221.000. The plan/idea is to take out a home equity loan (according to a Bank Of America online calculator I qualify for a loan of $25.000) and use it as a down payment for investment property. The monthly payment for the HEL would be $260 (again according to an online calculator). If I buy a property for $100.000 with a down payment of $25.000 my monthly mortgage payment would be approximately $400. My combined monthly payments are then $660. If I can rent the property for $1.000, wouldn't that be awesome?

The problems I see are:

1. Finding a $100.000 property that will rent for $1.000. (Well, it will have to be a good deal, of course, maybe a foreclosure. Let's just assume it will be possible to find that deal. If finding the deal is the only hindrance, I'll happily search for it for as long as it takes. 

2. Additional costs such as closing costs (investment property and home equity loan, vacancy in the beginning, repairs)

My main question is: Is a home equity loan a reasonable way to generate money for your first deal? 

Where does my calculation not add up? What am I not considering? Where am I wrong? 

Thank you for your insight.

P.S. I do have a real estate license, but do not work as a full time agent. In case that makes a difference somehow

@Tim Hocker Many people use HELOCs to fund their real estate. The nice thing about these is that you don't pay closing costs. The "bad" thing is they are tied to market rates. So just keep in mind the HELOC rate today may not be the rate tomorrow. Still, it's cheaper than hard money. The $100,000/$1,000 is a popular metric to qualify a property. Keep in mind your numbers aren't taking into account insurance, taxes, capital expenditures, or property management. So personally I'd want a 1.5% or 2% deal if I'm paying off both a HELOC and mortgage.
Hi @Tim Hocker , what you have laid out is a reasonable, and popular, plan to get into real estate. Your $100,000 / $1000 goal is a good start, but you'll probably need a little more than $1000 in rent to make it a worthwhile rental property. The only criticism I have for you is this.... please dont take offense to it, but the fact that you say that you've never had more than $2000 in your bank account is a giant red flag. Why is that the case? I only ask because you are going to be spreading yourself very thin with a rental. If one unexpected thing goes wrong, and you are in big trouble. I would suggest figuring out how to get your personal finances cash flow positive before going all in on a rental property.
Also, keep in mind you need to account for closing costs and taxes in your analysis. I am in process of buying an $87k property with 15% down; closing cost plus prepaid taxes and insurance will mean my OOP cash is about $18k.

I would look at seeing if you could get qualified for a rental property before taking out the HELOC. Explain to the lender exactly what your plan is and see what they suggest. If you don't have some extra cash left over after the end of the month you might want to wait until your cash flow situation is a little better and you have saved up some money. I'd work on having more than an extra $2,000 saved up. Also, realize that IF you are able to find and close on a $100,000 house you will have repairs and other expenses, plus the perfect tenant will not show up the day after closing. One small bump in the road and with the lack of extra cash flow you might end up loosing your home and the rental house. Keep learning and get your income up and expenses down.

I love the HELOC strategy, but you should be buying with the intention of refinancing to completely pay off the HELOC in no more than a year. The last thing I want is hundreds of thousands of dollars sitting at a variable rate loan indefinitely that I have no means of paying off. If the deal you negotiate doesn't allow for this, it's not a deal. Good luck!

@Tim Hocker That can be a solid strategy. I think your mortgage of $400/mos is missing taxes, insurance etc., maybe it would be in the 600 range. But the general premise would work. If you do it, I would look at refinancing the heloc sooner than later and might also work on trying to get a little more money saved up cause you will need a cushion for the rental property.
@Tim Hocker I agree with the comments saying you need a bigger cash cushion. Could you get more hours at work or a second part time gig? If so, do it to build reserves. Also read up on how others have slashed spending to build up reserves. Once you see your savings rate consistently increasing, go for your Heloc idea to buy a property.

@Tim Hocker I am very new to all this as well. One thing that I read/hear again and again is that going into buy and hold, you really do want a larger financial cushion. What if you get this property, only have, at most, $2,000 set aside for any expenses and then there is a massive pipe burst issue and you have to do some major repairs? Or suddenly it turns out the roof wasn't in as good of condition as it seems and starts leaking badly and needs large repairs or replacement and you only have $2,000? You will lose your shirt! Or, go further into debt trying to take care of these issues... which doesn't help either because then you are now paying down that debt (credit card or what have you) and your mortgage/other expenses. Be VERY careful. It has taken me almost two years to have my first flip on the market. 1.5 years of that was just me reading, listening, and watching to make sure I had the deepest understanding I could sans-experience. I almost bought two small side-by-side SFH to rent out a year ago and am SO glad I didn't. I went the flip route instead and now will have a much larger base capital to work with.

Whatever route you pick, go slowly at first. Be very, very cautious. Be overly cautious while getting your toes wet.  We can be more aggressive and open to greater risk as we accumulate more capital AND experience.

@Tim Hocker Keep in mind that your HELOC may very well be an interest-only loan - so make sure your monthly payment is covering the actual debt and not just an interest payment. Also, a home equity line of credit is a different product than a home equity loan.

@Tim Hocker Ditto on what others have stated. I would suggest considering flips to generate more cash flow. The rental SFR game requires reserves. Also openIng a HELOC does Impact your DTI. And comes wIth fees.