I've asked this question in other areas and have yet to get 1 response, maybe here will help - before investing, financially where should I be? (I understand no one can give a clean direct answer but a ball park)
I'd like to know where should my funds be in order to apply for a home loan? Should I save up $50K first? Where should my credit be? Right now, I'm finishing up my MBA (will graduate in December, yay!) and I have practically a mortgage amount in student loans - do I pay those off first? Do I pay them down some and then apply? My financial consultant suggests that I pay off everything off first and then think about owning a home (this could take years!). Only other debt I have is my car note, but I've decided to attack that aggressively for the next 6 months, but afterwards will that be enough? I guess my question is where should one be financially in order to get started?
My answers are all coming from the perspective that you will be hunting for a mortgage for this multifamily property and not paying cash or using private funding.....
Step 1 - check your credit report and score. You can get your report for free once per year. Make sure everything is correct, and if you have any late/deliquent accounts, get those fixed. You want to know your credit report before you go to the bank and get surprised.
Step 2 - where will you be working? Do you have a job now? If you have stable employment then that is very favorable. If you don't have a job yet, focus on getting a good one first (unless you have lots of cash and or access to private funding and can buy property using "alternative" means).
Step 3 - Play with some numbers to determine how much of a mortgage you can afford. This is the step which will tell you if you need to pay down your student loan/car loan first, before attempting to buy the kind of real estate that you want...
Incomes on one side (include your job - monthly gross, 50% of the rents you would expect to get from the other units) and one the other side, your debts (monthly car payment, monthly student loan, and an estimated monthly mortgage payment ) - if your ratio of debt to income is less than ~42-44% then you won't have to pay your loans off first to start investing. If you are higher than that percentage, then you should focus on paying off your debts so that your ratio falls under that limit.
Hope this helps.
+1 to getting stable employment and good credit. If those are in order, I'd recommend you talk with a lender to see what you could qualify for. That part is free and will give you a good starting point. Maybe they say you can buy a house, maybe they'll tell you to pay stuff down because you don't qualify for anything yet. Either way, at least you'll know for sure.
If they say you qualify, then set a budget including paying for the house and paying down the debt simultaneously and then go buy a house. You can get some interesting financing options for primary residence, live in it for a while and move out and rent it. Rinse and repeat. Also, now is a great time to buy while interest rates are low. Good luck!
@Amanda Hensley Thanks so much for your feedback, I've been itching to talk to someone about this!
Yes, I will be looking for a mortgage as I'd like to try this out with financing first.
Step 1 - I check my credit monthly, there's an app called Credit Karma that updates every week based on any financial changes that have been made -I love this thing! My credit score is average, no late payments, nothing in collections or derogatory, low credit history (which is something that is hurting me), and has been on the rise over the past few years. I do have a car note, a few credit cards, and those dreadful student loans :-(. My total debt to income is 1:1 right now, so that's the part I'm trying to understand if it'll be a hindrance or will it suffice or should I attack the student loans some.
Step 2 - I've been working full time for about 6 years now (yay!) making really good money and recently got a job that is finally paying me that "MBA" that many graduates dream about so that's a plus but I don't have much history with the company yet.
Step 3 - Is something I'll have to do, I'm still trying to figure out what is a "good" deal or essentially is that up to the investor? Still learning the market and what are the areas that are good places to buy, but I will begin playing with the numbers on deals so I can get an idea of what to look for. I always wondered, essentially is the formula: Income - Expenses = Cashflow? I've seen a number of calculators and formulas but all in all it's the standard business formula, yes? (Net Income = Revenue - Expenses)
I use two things to analyse my deals: 1) the 50% rule (it's explained/debated heavily here, I recommend looking it up in the search and reading all you can about it and 2) J Scott's SFR Rental analysis spreadsheet which is available to download from here in the Files section. I think it will work OK for small multis although it's geared towards SFRs
There are numbers you'll need to plug in which you can mostly get from internet research (property taxes, insurance estimate, rents, vacancy rates) local to your area.
The best thing for me was to practice that analysis well before I was ready to pull the trigger on anything. I've run hundreds of potentials through those analysis steps, and it really helped me see what was a deal/what wasn't (Not to mention including the subjective criteria for school systems, location, etc, etc)
That's good insight @Amanda Hensley, I'll have to check both of those out. When I run the numbers, I guess what exactly am I looking for? (Noob question, I know I'm sorry)...like more than $200/mth, $100/mth...? What is a fair number for other seasoned investors? What minimum is acceptable?
I love that idea about practicing! This should help me feel comfortable with running the numbers before my first deal, right? Also, any recommendations as to where I can find info about taxes, insurance, rents, and vacancy rates for my area?
I can't thank you enough!
@William Murrell That's a great idea! Thanks so much for that.
Would you recommend I go to multiple lenders? Would I get different feedback w/o having to run my credit?
I'm a numbers guy, but I don't like to over analyze. If you can put $10,000 out of pocket, on a $50,000-$100,000 property that makes $800-$1000 gross rents, $400-$500 net, you'll break even in ~1.5 years. Then in year 2 you have over half of your student loans being paid by someone else, all while paying off a mortgage on an asset. In 15-30 years, you have a property worth $100-$200K that you spent $10,000 out of pocket on. If you keep paying your $800 in student loans, and apply the profit from the rental, you'll essentially cut down your repayment length by 2/3rds. Or take the profit and save up for another purchase. This is all of course speculating that you can get mortgages, but it sounds like you'd be fine.
Invest now, not later. Your "financial consultant" either wants you to invest your money with him/her, or has no idea how to actually get out of debt! Passive income gets you out of debt. One stream of income is too slow to get ahead. You need other investment vehicles to get you ahead.
You should read Frank Gallinelli's books. They're easy to digest and when you're done, your financial understanding will create a solid foundation upon which you can build a solid investing framework. You should also listen to the podcasts. They're entertaining and informative and you get to see a little bit of everything in terms of REI, including flipping, buy and hold, liens, etc.
There's a lot of "your mileage will vary" involved in this one (stable job? emergency funds? etc), but one thing to consider is the cost of financing for your student loans vs the rate of return you expect to earn or save. As an illustration, let's pretend we live in a simplified, unrealistic world. You have $100k in your pocket (lucky you!) and two choices:
A) Pay off your $100k in student loan debt, relieving you of that burden and saving the 5% interest you were being charged there, or
B) Buy a rental property for $100k, which generates $10k/year in income after all expenses are paid.
In this grossly simplified example, the rental property is the better choice. Paying off debt that has an interest rate of x% is the same as earning x% on your money, in which case I'd much rather knock down the debt. But if you find that a different choice makes or saves you 1.5x% compared to your debt, you may want to continue holding your debt and make that alternative choice.
Mark is right, you don't want to wait to invest. Your investments are like a snowball that gets bigger the longer it rolls, so the sooner you get it moving the better. And sometimes financial advisors don't always have the best advice.
As for multiple lenders, it couldn't hurt because when you lay out your financial picture, they can rather quickly tell you what you will and won't qualify for. Now, they do check your credit to give you an idea of what your credit score is but you can mitigate that as well. If you show up with all of your financial package lined up as in "this is how much I make per month, this is how much my total debt service is per month and my total expenses, and this is my FICO score. Without running my credit and giving me a ding for the check, can you give me an approximate amount of how much house I could qualify for just so I can get an idea of where I am and where I need to be?" I helped my cousin do this exact thing and though he was told he wasn't ready, they quite willingly laid out a plan that had him on track in less than six months and he was able to purchase his own house. If you do this, you can take advantage of a lot of programs available to homeowners that aren't available to investors.
@Mark Gallagher Thank you! Thank you! Thank you! That was perfectly broken down and makes sense - I too am a numbers person but tend to over analyze :-(, so this was a great way of looking at it. Like you suggested, I need to invest now not keep waiting and making excuses for why I can't. Those numbers make sense and now I see how I need the ratios to work out - you rock! Would you recommend I look for deals that'll cost me the least amount of money? (150K or under?) I was looking at 200K investments but those (based on what I've seen) don't play out in my favor as much.
I'll apply what @William Murrell recommended about chatting with the mortgage folks about what I'll qualify for and keep an eye on the things @Amanda Hensley suggested so that I'm in good shape when I'm ready to push the button.
Thank you all so much!
@Zachary Telschow I like that approach, it makes sense. I forgot that my student loans cost (not much) but they do cost none the less...I'll have to create a spread on the cost analysis of both alternatives. The loans haven't kicked in just yet but they're definitely coming. Would you say if the interest made on the investment outweighs the interest cost of the loans then the investment should be a go? (given the stars and moon fall in line)
To speak simplistically.. if getting out of debt is the goal, you need to maximize monthly cash flow right now. As you get out of debt, your goal will likely become to maximize long-term gains. Right? Because once you're out of debt, the income from your "job" puts a whole lot more money in your pocket every month, instead of paying debtors! So right now, I would look for investments that have a high monthly return, but smaller long term return. Usually that's found in lower value properties. You can rent a $50K house for $800-$1000 but a $150K house for $1500. But that $150K house will increase in value quicker -- if they go up 10% over 5 years, the $50K house made $5K, while the $150K house made $15K.
My first few properties (6 years ago) were $20-$50K, and rented for $500-$800 a month. At the time, I had much lower income. So I used those rents to pay down student loan and dumb credit card debt I racked up. Now I'm at the point where those rentals are almost paid off (they were paid aggressively after debt paid down). I'll sell those, and buy a longer-term investment as monthly cash flow isn't as important any longer because I have very little debt.
It would be almost impossible to find real estate investments that don't generate a higher return than your student loan interest being paid out. Unless your interest rate is somehow through the roof!
Would you say if the interest made on the investment outweighs the interest cost of the loans then the investment should be a go? (given the stars and moon fall in line)
I'd say you need to weigh the ROI of each option along with the commensurate risk and decide which choice is best for you. If your student loans are at 8%, for instance, you can earn the equivalent of 8% on your money simply by paying them down aggressively. But depending on your market, you might be able to earn far more in real estate investing. For me personally, a huge spread (16% vs 8%, for instance) would make it an easy choice. But what if I could only earn 10% and the loans were 8%? That's a lot of hassle and additional risk for a 2% marginal return - I don't think I could justify that. Obviously, all deals aren't created equal, either, so if you figure out what you need to make a deal worthwhile it gives you clear criteria to eliminate deals that don't meet your needs.
@Mark Gallagher "To speak simplistically.. if getting out of debt is the goal, you need to maximize monthly cash flow right now. As you get out of debt, your goal will likely become to maximize long-term gains. Right?"
Yes, that's exactly my goal! My consultant says the same thing, he just wants me to go about it in a different way (paying everything off first, then maximize long-term gains) but I want to take get things started now. I'll check for properties in that range, but I'm sure those are those "great deals" I often hear about but have yet to see. I was thinking 100K for sure but anything lower would be a plus if everything payed out numbers wise.
@Zachary Telschow thanks for the insight, I didn't think to take that into consideration but you're right. I'll start gathering the info for my loans this week and take a crack at the numbers soon to see what analysis I can get from it.
@JoJo Diego seems like your consultant is super-duper conservative. I talk to people who tell me they have $10K in savings but a $10K credit card balance.. HELLO!? You're making .25% interest on the savings, and paying out 12-21% on the credit card. Wipe out that credit card! These people think it's great to have $10K in savings.. which sure, it is.
My somehow-related (ha) point is that you need to increase your income AND decrease your debt at the SAME time. Not keep income the same and decrease debt. Keeping income the same while trying to get out from under a pile of debt, is long and tedious. Find other ways to get income, while you work at your other job, to get out of debt. That's where real estate comes in, of course.
@Mark Gallagher now that you mention it, he does sound pretty conservative. I don't have any crazy credit card debt (less than 3K) and he wanted me to wipe my savings - placing it on the cc and focus on paying off my car then the student loans. He suggested that if any emergencies "popped up" to use my credit cards to fund that while keeping the liquid on my debt. Honestly, this suggestion made me feel very uncomfortable as I always like to have a cushion set aside but I tried it. Lately, I noticed this process isn't really getting me anywhere and the goal of owning a home just seemed further and further away. I like the idea of allowing my assets to make money while being able to use my job income on other things. Just wondering how to get started on it and if its even a possible with student loan debt.
@JoJo Diego I do agree with his credit card assessment. There's no reason to have money in savings yet carry a credit card debt.
But he wants you to pay everything else off before making investments, that I totally disagree with. That's how you get stuck never getting ahead.
Depends largely on your risk tolerance. Financial consultants typically give conservative advise. It's not wrong to be conservative, but it's not always optimal. If you're willing to take more risk and can qualify for a loan to buy a rental, that would probably give you a better return.
There's no right answer, but I'd personally take care of things in this order.
1. Pay off high interest rate loans.
2. Invest in real estate if a good deal is available.
3. Pay of low interest rate loans.
@JoJo Diego In certain respects, I'm in a very similar situation to you. Finishing my MBA in two weeks, and have quite a bit of loans associated with the program (though I've begun chipping away at it). Rates vary from 5.4% to 6.8% (I paid off those gaudy 7.9%s). I think the folks above gave you plenty of good technical stuff... Let give you the emotional side: I would rather blow my head off than wait for all of my MBA loans to be repaid to purchase my first investment property! Don't want to forgo today's opportunities! Congrats on being almost done.
I am in a very similar boat. Over $100k in student loan debt. I'm working on paying down my credit card and installment loan debt first, then I'm jumping straight into my first investment property as soon as my debt:income ratio is in shape. I'm fairly close, but I just pay too much for "all" of my bills every month to be considered for a mortgage of any type.
Like others have said, if you find a good deal with positive cash flow, allow someone else to pay your student loan debt or you! =)
@Mark Gallagher I can't thank you enough for your insight! I think I'll take the route of paying off the cc and the car while saving up a down payment. I meet with my consultant in a couple weeks and will let him know my thoughts as I'm eager to try this real estate game out and see how it goes.
@Adam Moehn I like your layout as well, it at least leves some glimmer of hope for me to try out investing while still tackling the items that need to be handled. Like Mark was saying, why not let my investments pay for that education especially since it's definitely possible. Thank you!
@Jonathan K. Thank you and congrats to you as well - major accomplishment I know you're happy it's the final stretch! I couldn't have said it better myself, waiting just seems like the end of the world and I'm not one that enjoys being stagnant for so long. Although I wish someone had educated me on the true burden of financial loans when i was younger, but that's a topic for another discussion lol.
@Shawn Daniel It seems like thats the consensus among the investors on here and it does make sense, I think this is the route I'm going to take while looking at the cost of my loans vs the cost of deals that I've been looking at. Thanks so much for the insight, owning property just seems close to impossible with these loans in hand but I knew there had to be others out there that have purchased homes with student loan debt as well, I just always wondered where did they get started.
@JoJo Diego , how are things progressing for you? I've enjoyed reading your questions as well as the (awesome) advice others here have given you.
I had about $15K in loans for my MBA and had a similar internal debate. The loans were subsidized Stafford loans at 6.8% interest. I was just getting into the analysis of REI at the time and was considering whether or not to pay them off, short myself on cash a little bit, and have peace of mind before starting my REI, or keeping them intact and getting my REI off the ground simultaneously.
Contrary to the advice you've received here, I just went ahead and wrote a check for the $15K and wiped them out. Obviously if it was $115K, that'd be a different story. For me, knowing that if REI went south and I'd (almost certainly) be stuck with these loans even in the event of bankruptcy, it was worth the ("only") $15K to knock them out of the way. Needless to say, that definitely affected my cash position and (mildly affected) the size of the deals I could consider, but it had an impact nonetheless.
If I had to go back and do it again would I change anything? I honestly don't know. Some days I think yes; others, I think no. I had a weird run of employment/unemployment which helped me to qualify for the subsidized loans at the time, however, now since I "make too much" and can't deduct the student loan interest, the 6.8% was closer to a "true" interest rate.
The good news is that with my only outstanding debt being my home mortgage (at 3.375%, 30 year fixed - for which I only put 5% down, conventional loan!), I can continue to aggressively put funds aside for REI - buy-and-hold rentals.
Looking forward to hearing about your progress. Much success!
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