How to determine a budget

28 Replies

My husband and I may be moving back home to Chicago in the near future. This time around, we would like to house hack. The idea is to buy a 3 or 4 flat in a neighborhood that we like (we like a lot of them!)

I think I've found myself in "analysis paralysis" very early on, because I'm stuck on the process of how to determine my budget. For our first house (currently our home in Nashville,) I simply used the 28% rule, more or less. 

I now am understanding that with investing, A. you can get creative with borrowing money, B. you don't need to put down 20%, and C. there are so many other factors to add to the equation. That being said, does anyone have suggestions on where to start? I know this is a big question with lots of variables, but I'd love any advice on how to set a budget. I think the idea that you can get creative with borrowing money is sort of throwing me for a loop.

If I can come up with a ballpark price point, I can then start to move forward with analyzing potential deals. I hope with some advice here, I can get the ball rolling. Thank you!

Hello Rachel, Glad see people are moving back to the Chicagoland for a change, when everyone else is moving out. My wife and I are also tossing in the idea of house hacking for our first deal but nothing is set in stone yet. We both are new to REI and looking at many creative angles to get out first deal done.

So the first thing are doing to see what our budget might be in all the creative ways to start is: Going to lender/bank and get a pre-approval letter. Print out past 2 years tax returns, 3 months bank statements and pay stubs/ income generating assets. Just to see where we stand. Hope this helps you on your husband on y'all journey back home to Good Ol' Chicago. Also, it would be great if you can post back up the ways and steps you took to help future novice investors. 

See how much you are pre-qualified for and bounce that off the rents. That should give you a ballpark price point and somewhere to start. Then explore different neighborhoods that fit that criteria.

Find a detailed calculator (Check out BP's) and plug away. Use an interest rate a smidgen higher than the one your lender says is the current rate to account for an increase prior to closing. Make sure to budget in for maintenance, capital reserves, vacancy. After all monthly projected expenses, make sure you are still cash flowing.

If paying less than 20% down, you will likely need an FHA loan. FHA has a lot of safety requirements be met, for example, you can't have a closet pull chain light that doesn't have a globe cover and there must be no chipping paint inside or outside the home. If the seller will not fix them before closing, you need to do a renovation loan at a higher interest rate. You will have an easier time looking at recent rehabs or newer properties (most of Chicago has older inventory).

If you are using the income from the property to qualify for the loan, check the zoning before you put in an offer to make sure that it is proper. For example, if you have a 3-unit property on a lot that is zoned for single family or duplex, you can't count the income from the extra unit and that will lead to qualification issues down the line. 

Chicago is a very tenant friendly city. Make sure to read over the landlord tenant ordinance and if using an agent, use one that has his own rental properties to assist with orientation, advice, and resources to help you succeed.

@Rachel Hertel - House hacking is definitely the right way to go!  The easiest way to find out your max purchase price is to talk with a local lender like @Michael Barbari or @Michael Facchini . Definitely, look into a low down payment loan program like FHA or Home Possible.

I completely know where you are coming from with the analysis paralysis so more than anything, I'd recommend worrying a little less about the numbers and more about getting a deal done.  

@Joseph Cameron  Thank you for your input! It is beneficial to hear from someone who is in a similar position as us. So are you still renting? I ask because right now we own, and I imagine that income from selling will add another factor to the equation.

@Frank Geiger  Thanks for your advice! I appreciate the simplicity of your advice; sometimes I overthink things or consider too many possible scenarios, which results in me getting stuck. 

@Joseph Konney I appreciate your thorough response! Ultimately, we are hoping to break even with cash flow. From what I've read, the areas we are considering buying are hard pressed to have positive cash flow. Would you agree with others that it would be important to see how much I can qualify for, before calculating my cash flow?

@Theresa Harris  Thank you for your help!

@Jonathan Klemm I appreciate your input! It's nice to be given a different perspective that helps me step out of these cycling thoughts, and take the first step. And thank you for helping me network, and supplying me with local professionals.

I hope to apply all the guidance this community supplies to our decision-making process! 

@Rachel Hertel - A lot of people get into "analysis paralysis" because there are just so many dang numbers to analyze: rent, principal, interest, taxes, insurance, capex, maintenance, vacancy, property management ahhh!! Let's see if we can simplify here.

First, I would talk to your lender and see what your low down payment options are. I am guessing there will be a 3.5% down (FHA loan) and perhaps a 5% down (conventional loan) option. Ask them to estimate what your monthly payment will be including Principal, Interest, Taxes, Insurance, and PMI (PITI + PMI). Once you have this number you have your fixed monthly expenses.

Next, look at market rents in the areas you are looking. Make the appropriate adjustments as it relates to your place. For example, if you see that a 2 bed, 2 bath rents out for $1,500 and one of your units is a 3 bed, 2 bath. You can likely assume $1,700 as a good estimate. Add up all of the units on your prospective properties and compare that to your fixed payment in the previous paragraph. 

Personally, I like to see $750 to $1,000 over the PITI, but that will differ based on area. Obviously, the larger that gap, the better. I am in Denver and that's what I like to see.

For all of the other expenses you have your "reserves" number. This accounts for vacancy, capital expenditures, maintenance, property management, and everything else. This number is discretionary and totally up to you. However, for my singel family homes I usually start at a base of about $300 per month and then increase or decrease that based on: location, age of the property, size of the property, and any known large expense coming up.

This way you have three numbers you are looking at: Rent, PITI + PMI, and Reserves. Take your Rent and subtract the PITI + PMI and the reserves and you get your monthly cash flow.

Hope this helps and simplifies things a bit! 
 

@Rachel Hertel , please let me know what questions you might have.  Here to help!  As @Jonathan Klemm stated, it's easy to get stuck in analysis paralysis but the first step is getting together with people that can shed light on the various questions you have - particularly the numbers and then how to source the right property from there.   It will all come together....little puddles of info will soon form a pond as I say.  Just start intel gathering and get some help piecing it all together from those that do this daily :-)

@Rachel Hertel - I definitely recommend seeing what you can get pre-approved. There is a good chance you will not be able to see a property if you are not already pre-approved. Furthermore, you want to be in a position to make an offer when the right property comes along. Talk to your lender to see how income and expenses of the property and your gross income will weigh in on your pre-approval.

If you put enough money down, you will cash flow. If you lost your primary source of income, will you be able to cover the expenses of your property and for how long? The risk of break even cash flow is that you might underestimate your expenses so it is a good idea to budget positive cash flow to make sure you are not running at a loss. To be sure we are on the same page, if you are buying a 4plex and the income from three units gives you a break even, you are likely in good shape. If you are counting potential income from the 4th unit, my opinion would be to put more money down to have some breathing room in case of income issues. 

@Craig Curelop your breakdown is wonderful, thank you so much for spelling it out! The way you have laid it out is very helpful. I think the best thing for me to do is calculate a few options in each location, just to get some practice, and an idea of what I can expect in each city.

@Michael Facchini I love the puddle analogy! It's great to hear encouragement from folks like you that know the business. It is motivating, and I'll surely be reaching out with plenty more questions.

@Joseph Konney that makes a lot of sense! I truly appreciate the input, and understand how it helps to manage expectations. 

These tips are all so great! I personally am leaning towards Chicago, because it's my home, but I'll have to see where jobs take us.

@Brie Schmidt , since we don't know exactly where we will be moving, or even when (although my husband is actively searching jobs) I haven't been doing very serious searching. I'm from Skokie, so wouldn't be totally opposed to living there, but Evanston would be preferable if living in the "burbs." In terms of neighborhoods in Chicago, I'd love to explore options in Andersonville/Edgewater, Ravenswood, and Lincoln Square, or further South in Logan Square, Humboldt Park, Bucktown, Wicker Park. However, my initial reaction is most of these locations are too expensive. 

For the city locations, you need a budget of at least $700k but more realistically closer to $900k and those areas will not qualify for FHA or 5% down so you will need at least 20% down

@Rachel Hertel - Regarding potentially "not" qualifying, you need to understand FHA's "Self Sustainability" or "Self Sufficiency" test. Also, the 2020 FHA loan limit is $765,600 in expensive markets (note: that is the loan limit, not the purchase price limit). Find out more details from your lender or do a quick Google. Unfortunately, it might count as advertising to link you to some good articles from here.

Originally posted by @Rachel Hertel :

My husband and I may be moving back home to Chicago in the near future. This time around, we would like to house hack. The idea is to buy a 3 or 4 flat in a neighborhood that we like (we like a lot of them!)

I think I've found myself in "analysis paralysis" very early on, because I'm stuck on the process of how to determine my budget. For our first house (currently our home in Nashville,) I simply used the 28% rule, more or less. 

I now am understanding that with investing, A. you can get creative with borrowing money, B. you don't need to put down 20%, and C. there are so many other factors to add to the equation. That being said, does anyone have suggestions on where to start? I know this is a big question with lots of variables, but I'd love any advice on how to set a budget. I think the idea that you can get creative with borrowing money is sort of throwing me for a loop.

If I can come up with a ballpark price point, I can then start to move forward with analyzing potential deals. I hope with some advice here, I can get the ball rolling. Thank you!

Since you'll be considering multifamily with less than 5 units, you should use the same rule for budgeting as if it was a single-family. (28%) Your lender will be using that rule. The bottom line, make sure you can afford to make the payments to hold the property without any tenants. Once you understand what you can afford without any tenants, then you can start running numbers to see what the impact of having tenants does to your monthly cash flow.  If you were looking for 5 units and up I'd provide a different recommendation.

@Brie Schmidt I had a feeling that our "dream" neighborhoods would be over budget. Though I haven't determined an exact budget yet, I know these numbers sound higher than we can afford. That being said, we know we have to be flexible and compromise in order to start on this journey. I will reach back out once we know for sure where/when we are moving!

@Crystal Smith I appreciate the advice; I will start running numbers for practice once I know if we will be coming to Chicago. I would love to come back home!

@Rachel Hertel - Check out west suburbs just outside Chicago along the highway that have similar commute times by car or CTA train lines to the city center like Forest Park, Oak Park, Berwyn, and Cicero. Prices are more moderate in those locations. Additionally, if you or your partner ends up needing frequent suburb access, you are positioned well for easy access to both the city center and suburbs with the highway access. 

@Joseph Konney  I'll definitely keep an open mind with the suburbs. I'm from Skokie, so I could see myself coming back home to them at some point.

@Brie Schmidt When you talk about a loan limit increase, are you referencing that max limit for an FHA loan that Joseph mentioned? Does this mean that once you need to borrow more than that, you have to put 20% down?

@Rachel Hertel I have a property calculator that I use (combination of a few different ones out there) that i would be happy to share. Let's you compare different scenarios side by side to see the difference a change in each component will make (price, loan amount, interest, rent, insurance, etc.)

Let me know and I'll shoot it over in a google sheet link. 

@Rachel Hertel - you can see current FHA loan limits by county here: https://entp.hud.gov/idapp/htm...

If, for example, the loan limit for a 2-flat is $471,100 and you want to purchase a $500,000 property at 5% down. You would need to put down at little more than 5% as 95% of $495,894 is $471,100 is the maximum loan limit. 5% plus ~$4K may work. I'd recommend talking to a loan officer about your specific situation.