I'm TERRIFIED to over-leverage

8 Replies

I'm worried about over-leveraging myself on my properties. My wife and I have our primary residence and a rental property (that we have owned for about 4 months). I'm thinking about using $20K of the $80k equity in my primary residence to buy another buy and hold SFR rental. I'm also about 2 months away from being able to use the equity of our current rental house for a down payment on another SFR rental.

My wife and I make enough from our W-2 employment to make the mortgage payments if the rentals go vacant.  What are the dangers of using the equity for down payments on other properties? Can we just keep doing this?

most will tell you leverage to the max and its all about number of doors ... and or refi till you die.

end of the day you have to be comfortable .. if vocation throws off enough cash flow to debt service all your units if they were vacant for a year or so or indefinitely then I personally feel your not taking a huge risk.. unless job security is an issue.  As you mature as an investor IE get older  like me.. then you will start to feel the need to pay things off like I have been doing last few years.. for me I want ZERO debt and am working my way there.. to me that is the only way your truly financially free.. ( I have seen to many markets crater in my years to think that it could not happen) and the only people that make it through those are usually those with limited to zero debt.. But I will be in the vast majority.

Like you I make money in other places than rental income. So rental income is way down the list for me personally on something I need or want.

@Jordan Coates what you are feeling is perfectly normal.  And I would also add that it's better for you to feel this than no concern at all!  But there are some basic parameters in place when you receive a "conventional" loan that are designed to protect you (and the bank too).  What I mean is that with each conventional loan you receive you will be required to have "reserves".  This is money that you will be required to have set aside for each property you own.  Somewhere from 2-3 months of the total mortgage payment for each property.  As you gain more properties the more reserves you will be required to have.  And while the loan approval is based on this nearly every financial expert will reinforce that you always need to have 3-6 months of ALL your bills set aside for "just in case" purposes. As long as you follow those rules you should have a significantly better chance of success if things were to go sideways.  Feel free to ask more questions if you need.  Thanks!  

The danger of using the equity for down payments is you are destined to make more money. That will of course translate into more taxes. Sad but true.

If you are not comfortable with leverage you may not be cut out to be a investor.

The stance on this varies from Dave Ramsey- pay cash for everything - to a debt to your eyeballs, refi and strip all equity possible no matter what, forever.

I wish people that weigh on on this had to reveal where they are.  Newb/equity poor with a million payments and a theory?  Or have been doing it a while and have both leveraged and paid off assets?  

My opinion, having more than half of my rentals paid off is - not all leverage is the same. I got rid of higher rate and commercial debt. I am comfortable with long term, fixed residential mortgages that don't bother you at 80% or less LTV because I hate PMI. Even I have 75-80% debt in the 4s. Just got another one matter of fact, although the refi process was pretty horrible.

I say 80%- LTV on fixed rate residential debt below 5% is a-ok @Jordan Coates   

If you have reserves for CapEx, and can weather vacant units for some time, by all means borrow more. Remember that markets WILL cycle and values WILL go down at some point. I thought I had a lot of money for reserves and then got a nasty surprise. TWO new roofs needed. One vacancy for three months. Another STILL vacant. Am I making my debt service payments? On time every month...but I also have other sources..and you have your W2 job. So is leverage a BAD thing? Can be--especially if you are leveraged to the hilt and have nothing to fall back on. Would ONE major problem cause you major financial issues? If so, hold off. If not, continue to build. I am taking on more debt next week...OPM...because that is the key to building an empire.

Originally posted by @Steve Vaughan :

The stance on this varies from Dave Ramsey- pay cash for everything - to a debt to your eyeballs, refi and strip all equity possible no matter what, forever.

I wish people that weigh on on this had to reveal where they are.  Newb/equity poor with a million payments and a theory?  Or have been doing it a while and have both leveraged and paid off assets?  

 

As a RE investor, we really need to forget about Dave Ramsey for now.

I own several duplexes, and plan to do brrrr strategy to get into the bigger game. I have free & clear property but would like to do cash-out refi to free up more funds. But again, I am comfortable with the kind of debt I have, they are long-term, fixed, low-rate debt, and I know that I am not over-leveraged.

@Jordan Coates You should be terrified.  It's natural.  It's expected.  And to a certain degree, it's prudent.  You've own a rental for 4 months so you likely haven't felt the hit of a downcycle, a major cap-ex expense, and potentially you've yet to deal with a vacancy.  Using the ol' W2 to make mortgage payment isn't a bad backstop but boy will it be an emotional gut-punch if that happens.

So, okay, that's not really productive as far as giving perspective on what to do.  

1.) Being terrified of being over leveraged is a secondary concern. Be terrified of being undercapitalized for reserves. You could be 80/20 LTV for 5 properties but if you have $1MM sitting in the bank, you can ride out any issues. That's a little hyperbolic but hopefully it at least illustrates the point. If you have substantial reserves a vacancy will only deplete those reserves, not impact your W2 lifestyle.

2.) You will want a good chunk of leverage so you get the mortgage interest tax deduction.  That doesn't mean you have to have 80/20 leverage but you'll want something there.  In all likelihood depreciation won't offset all of your income.  The only thing more painful that debt is paying the government a percentage of your income.

3.) You really, really, REALLY need to talk to your spouse about leverage your primary residence. It's a non-starter for some significant others. If the REI world implodes you can always walk away from your no-recourse loans. Your credit will be destroyed but if you still have your jobs, you can still pay your mortgage. If you start messing around with increasing your mortgage payment (i.e. increasing the balance by refinancing to extract equity) you really put that in jeopardy.

This is a very anti-BP sentiment but: "You've owned a property for 4 months and that's too short of a window to validate or invalidate your investing thesis".  You could have bought a gem or bought a dog.  You don't know and you won't know for a while.  You can read the fun stories here about the $5K costs to a unit turnover for a bad tenant.  

Anyway, all of this is a moot point if your spouse isn't on board.  And when I say "on board" I mean she's the one driving the "what's next" discussion.

@Jay Hinrichs , I keep trying to vote twice for your post but I just net out at "zero every time"!!!  Yes Yes Yes.

@Steve Vaughan , I'm with you philosophies are all good and well.  But wouldn't it give a little legitimacy (or the opposite) to get to see the fruits from the application of that philosophy in the posters lives?  Or those who advocate courage while staying in the fox hole.  Spending someone else's dollar is always easier!

@Jordan Coates , Life is to be lived today.  Don't do anything that makes you lose sleep.  I'm not anti leverage.  As a matter of fact one of the strongest reasons to refi now is that while it might be nice to wait for a down turn, the only people who benefit from a down turn are those with cash.  Because in a downturn any equity you have will be affected as well.  So it may not be available.

But if you take little manageable steps until you've got a safety cushion of a few months, and no consumer credit at all, and a paid for primary residence (I admit it I do bear a resemblance to another Dave..) then you can feel absolutely comfortable going all in and leveraging to your hearts content (it's only a passing resemblance to that other Dave).  

Patience will be rewarded more than aggression almost every time. It just takes a little longer. 

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