Debt Free Investing

[Lance Cummins]

Hi BP! I am new to BP and I am loving it! I listen to all the podcasts and love reading these posts. My wife and I are not fans of debt (good or bad). We worked very hard to graduate from college debt free. We are both working now and making a combined income of $85k. We just bought a house a couple blocks from a university that has 2 bed and 1 bath down stairs and a efficiency rental unit upstairs with a separate entrance from the back. We purchased the house for $83k and it was appraised at $84k. So we did not get a great deal. We plan to have the house paid off in 2 years then move to another house and rent the top and bottom of this house out. We should be able to get around $1,000 rental income/month and we will have no mortgage payment. Any advice for a beginner? Does this sound like a solid game plan?

[Brian Mathews]

Originally posted by Adam Johns:

Lance Cummins Assuming 50% of your rent goes to expenses, you'll make about 6K/yr off of your 83000 without financing, or about 7%. If you financed with 20% down, you'd pay about $360 a month to P&I, so you'd make about $1680/yr on $16,600 invested, or about 10%. On top of that, your tenants are paying your equity in, so your ROI is going to be much higher in the end (let's pretend you keep the house for 30 yrs and it doubles in value) Cash: 6000 * 30 = 180,000 + 166,000 (value at sale) = 346k - 83k = 263k / 83k = 316% ROI Financed: 1680 * 30 = 50,400 + 166k = 216,400 - 16,600 = 199,800 / 16,600 = 1204% That's doing a lot of assuming and it sort of keeps everything "in a vacuum", but I think it demonstrates the power of leverage. And if it's a question of risk, shifts in value are going to have a bigger impact when you're all-cash, also.

I'm not sure about you. But I'll take $6K a year with little risk vs. $1680 a year with higher risk, such as default. What happens when the $4000 hvac system goes out. With $6K, you still have $2K left. With $1680, you're $2320 in the hole. Then lets say the tenant does a midnight move-out and leave you with a $2000 cleanup. You just broke even, unless you use leverage and you're now $4320 in the hole for the year and you become one of those landlords wanting out and you sell for less than you paid just to get out of the trap. By my calculations, you're approximately 30% down for the year now. And we all know this scenario will happen at some point. Remember the tortoise always wins the race.