Apr 25, 2012 102 comments

Unlocking your Home Equity for Profitable Investments

When it comes to mortgage debt, I’m a man of contradictions.

I’m a big fan of having the option of tapping your home equity to meet short-term cashflow needs, as I explained over a year ago in “Springy Debt instead of a Cash Cushion“.

On the other hand, I’m also a fan of paying off your full mortgage balance in the case of early retirement, since it provides a stable return equal to the interest rate of the mortgage you’re paying off, reducing the risk of trouble during economic storms of the future. A mortgage-free primary residence is the biggest factor that keeps the MMM family’s living expenses so low these days (around $2000 per month).

But mathematically, if you don’t mind higher risk, the odds are still in your favor if you leave your house leveraged and invest in higher-yielding assets. As noted in “Pay Down the Mortgage or Invest More?“. In that article, we learned that today’s cheap mortgage debt is a very useful tool in the hands of a skilled real estate investor.

In the area of rental houses, I have also taken the most wimpy and conservative path: I have one rental with no mortgage at all. Even though the case for keeping a mortgage on your rental property is actually much stronger than that for your primary house. The reason is taxes:

You’ll often hear people repeat the slogan “In the US, mortgage interest on your primary house is tax deductible”. But it’s actually not true for many of us, because of a concept known as “the standard deduction. Here’s a quick example to illustrate:

Imagine a couple, filing under the “married filing jointly” tax category with $100,000 in combined income and no mortgage debt. They got to claim a “standard deduction” of $11,600 on the 2011 taxes that they just filed earlier this month.

Now imagine an almost-identical couple with a $200,000/4% mortgage on their house. Their mortgage interest was about $8000 for the year, and property taxes were $1500. Both those items are tax deductible in US tax law, so they type them into Turbo Tax.. and… the program informs them that they’ll still pay less taxes by taking the Standard Deduction of $11,600.

So in fact, you could say that mortgage interest for couples is only tax-deductible on the balance of your mortgage between about $250,000 and $1 million, the upper limit for the mortgage deduction. Most people, especially those hoping to amass great wealth, try to avoid mortgages in those higher ranges. (For single tax filers the standard deduction is halved to $5800, but the impact is still significant).

But the situation is different, and better, when you start talking about investment properties. On the rental, every dollar of mortgage interest is 100% deductible off of your taxable income for the property. And you still get to keep the full standard deduction on your personal return. This is a significant benefit, especially for people in higher tax brackets.

So now we’re about to get to the point. I’ve been doing some investment property shopping in my neighborhood in recent weeks, and I think I’d like to pick up a second rental sometime soon.

In fact, I might even buy the house next door to me. It’s currently tenant-occupied, as the original owner moved away several years ago. The owner is an older lady who is clearly frustrated with the experience of being a landlord. She also lives in another city, forcing considerable commuting time onto her when she needs to tend to the house. With a shortage of cash and no carpentry skills, she keeps the place in less-than-beautiful condition, which reduces her rent income, and provides a daily eyesore for me. If I could buy it and make it beautiful, I could rent it out for $1600 per month, providing a great return on my investment. It would also increase the eventual resale value of my own house and the entire street, so any upgrades I complete will generate payback in multiple ways.

Don’t tell her I’m thinking of this, however, or she’ll raise the price on me.

My choices to pay for it would be:

1) Pay cash for the new investment property.
PROS: The ultimate in convenience and fun.
CONS: Ties up a lot of cash, and I don’t even have enough cash to do it right now.

2) Get a conventional mortgage to buy the new place.
PROS: fairly simple
CONS: slows down the home-buying process, locks you out of the best fixer-upper deals, since they are typically in a condition that will not qualify for a mortgage, and increases your costs since you need to pay lender and appraiser fees.

3) Use my existing home equity line of credit.
PROS: Same convenience as cash, since you’re just writing a check. But keeps cash free for other investments. Ultra-low 3.25% interest rate.
CONS: Interest is not tax-deductible as noted above. Decreases or eliminates my cash cushion, which is a safety margin I’d like to keep. Line of credit is not currently large enough to buy a typical investment house around here, although I could expand it, for a fee. Would need to pay back balance in full if I decide to move.

4) Get a line of credit on the existing rental house, and use it to buy a second house in “cash”.
PROS: Same convenience as cash, tax-deductible, keeps all other funds available for use. Automatically gets paid back if I ever sell the existing rental house.
CONS: Slightly higher interest rate due to it not being a primary residence. May need to pay fees to set up this line of credit.

So I’m leaning towards #4. And I want to do it pretty soon, because Mrs. Money Mustache is about to quit her cushy part-time job to pursue new adventures. If I apply for the line of credit while our family income is still higher, we’ll qualify for better loan terms.

Update! After learning more about the tax laws of this situation, I decided to go with option #3. Interest paid on a primary home line of credit is INDEED tax-deductible directly against any business income you earn with the loan. So you don’t get into the mess with the standard deduction noted above. Thanks MMM readers!

What now?

Now I’d like to turn it over to you. Who among the Wise Mustachian readers has extracted value from a rental house in the past? Where would you recommend that I look to get the best experience and a great deal? Or do you think I should go for the standard style of mortgage if the house next door qualifies?

A few ideas I’ve had so far:

My business bank, US bank, has a whiteboard out front advertising 3.25 or less% home equity lines of credit with no closing costs.
I’ve heard that lendingtree.com might get reasonable results. But I’ve never used it. Has anyone had positive or negative experiences in that area?
I know a wheeler-dealer independent mortgage broker who is very honest, competent and operates on commission. He dishes out loans from a variety of financial companies, and he’s always up-front about total costs. It probably wouldn’t hurt to give him a chance at earning the business as well.

The ideal situation would be that I go through the paperwork and end up with a nice fat $200,000 line of credit on my existing rental house, with a low interest rate and minimal closing costs. Then I will be armed and ready for business, and you’ll get to read about the total gutting and remodeling of the house next door sometime this fall!

What do you think?

Previous Post: Work Goes On… Long After the Thrill of Workin’ is Gone Next Post: Nicer Legs and Some New Carpentry Skills – for Only 15 Bucks

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Shawn April 25, 2012, 6:11 am

Another idea that may fit into the brainstorming above is using the private banking arm of a bank. If the higher rate that they would likely lend you money at cancels out “standard closing fees” associated with a primary mortgage or a HELOC type loan, it may be beneficial.

I did this when I bought my farm as a short term bridge between sale and intra-family financing.

It seemed private banking at this institution had the ability to do basically anything they wanted.

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Lc April 25, 2012, 6:42 am

I have mixed feelings about lendingtree. We used it and we did end up getting a decent rate (6% in 2006, not so good today but we have since paid it off.) However, we kept getting calls asking us if we still needed a loan for several months afterward. So if that’s something that doesn’t bother you, it’s worth a try to see what rate you can get.

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Michelle April 25, 2012, 6:44 am

You might want to check out interest tracing rules, IRS Pub 535. Even if you borrow against your primary residence, but can keep records to show that all loan proceeds were used to buy the rental you should be able to deduct the HELOC interest expense on Schedule E.

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- James April 25, 2012, 8:25 am
  
  Michelle is dead on here. Read the pub or (gasp!) talk to a CPA. Tracing rules work nicely in situations like this one.
  
  Reply
  - Mr. Money Mustache April 25, 2012, 9:12 am
    
    Great tip regarding the interest tracing – thanks! I figured there SHOULD be a way to do it, but I incorrectly assumed that since the interest is already sort of tax-deductible, there wouldn’t be a way to re-assign it to be deductible against an investment property. I’ll read those guides on the IRS page. I also have no problem with talking to real accountants. In fact, I get to talk to them every week, both through this blog and in real life. But the learning continues, which is a great thing.
    
    UPDATE: I think I see where it says the deduction is allowed. Here’s the publication: http://www.irs.gov/pub/irs-pdf/p535.pdf
    
    On Page 12, I see this paragraph: “You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your business. Interest relates to your business if you use the proceeds of the loan for a business expense. It does not matter what type of property secures the loan. ”
    
    That sounds great. The only contradiction is on page 10, where it says:
    “TIP: If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. The interest is usually deductible as qualified home mortgage interest, regardless of how proceeds are used”
    
    To me, it sounds like they are saying your are ALLOWED to deduct the interest as a business expense, but it would be unnecessary since you can already claim it as a personal deduction. However, for people well within the “Standard Deduction” limits, this is not the case, so you’d choose to use it as a business expense.
    
    I think I should update the article with this new information and it might even change my plans regarding the line of credit.
    
    Reply
    - James April 25, 2012, 9:18 am
      
      I didn’t mean to sound quite so snarky. A little bit, but not so much. Much respect.
      
      Reply
    - I am Reyes March 7, 2020, 3:09 pm
      
      Just wondering if using a HELOC to pay off home early is a scheme, or something that people really do? Curious if you have any articles on that?
      
      Reply
Gypsy Geek April 25, 2012, 6:52 am

I have a question. Last year we paid off our house so we have no mortgage. Do I have to go through a long process again with a bank (appraisal, costs, etc) to start a HELOC?

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- Arbor33 April 25, 2012, 12:14 pm
  
  All depends on the bank/credit union. When I went in last week to fill out the application for a HELOC, the lady in charge told me they were slow on customers and have been kicking out LOCs in as little as 2.5-3 weeks! It really depends on how busy the appraisers are and whether they do drive-bys or walk-throughs.
  
  Not really an expert on this but that’s what my experiences have taught me. Make some phone calls to places in your area and ask around.
  
  Reply
Susan @ Afford Your Passions April 25, 2012, 6:55 am

I wish I had $1,500 in property taxes on my $200k home. My property taxes are $6,500 on my home with with a value (according to property tax records) of $150k.

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- GregK April 25, 2012, 7:38 am
  
  http://www.mrmoneymustache.com/2011/09/28/get-rich-with-moving-to-a-better-place/
  
  Reply
- Stashette April 25, 2012, 8:16 am
  
  You live in Texas correct? That means you don’t have state income taxes, so living in a moderate home you are probably doing better than people from other states.
  As a former Texas resident, I was surprised the impact my paycheck took when I moved to a state (Indiana) with income taxes. I think that Texas has one of the lower tax burdens of all the states.
  
  Reply
- smedleyb April 25, 2012, 9:01 am
  
  And we here in NY state get to pay high prop taxes ($9200 on 270K home) and high income taxes. Yippee!
  
  Reply
  - Mr. Money Mustache April 25, 2012, 9:18 am
    
    Thanks, GregK for linking to that “moving to a better place” article, I was going to do the same thing!
    
    I definitely think people should consider the tax burden (compared to the value of the services the local government provides) when choosing where to live.
    
    For example, Michelle is paying $6500 in tax on a $150k house. Here, the taxes would be under $1000 on that value, and the state income tax is about 5% of income above a certain level. To make up the $5500 difference, you’d have to earn well over $100,000 per year.
    
    In other words, Texas or New York might be horrible places for early retirement. Unless the taxes are buying you something useful – perhaps subsidized health care, better public transportation, better schools, or something else you happen to care about.
    
    The US has so many beautiful places with great climate and wonderfully low costs of living. Particularly in the Mountain West, but also many other spots. Find them!
    
    Reply
  - Des April 25, 2012, 10:25 am
    
    Aren’t property taxes more local than state-level? In my area, folks choose the neighborhood they buy in partially based on property taxes there, as some are significantly higher than others. Maybe it is different in other states, but in areas like mine it is possible to live *near* a big city (for its proximity to a great hospital, sports team, and cultural events) but still outside it where taxes are lower.
    
    Also, this is super anal and nit-picky of me, but from what I can tell New York does not have high income taxes. They look average to me. The problem is that you have high property taxes AND avg. income taxes AND avg. sales taxes. I think most states ease up on one of those three…
    
    Reply
    - Kathy P. April 25, 2012, 11:10 am
      
      I live in NY and my county + school taxes total about $2400 annually on a property assessed at $100K (which includes 1.8 acres of land). Sales tax varies by county, where I live (in central NY) it’s 8.75% and I think 4% of that is for the state. I’m not sure our income taxes are all that high either; I did some checking on other northeastern states (like Vermont) awhile back and NY’s income taxes seemed to be right in line with those places.
      
      Of course the way around the sales tax is just to buy less stuff. And at least in NY, food is not taxed though I know it is in some other states. The state sometimes does temporary suspensions of sales tax on clothing purchases below a certain amount for a month or so around back-to-school time as well.
      
      Reply
      - Arbor33 April 25, 2012, 12:22 pm
        
        I second that. Sales taxes are definitely a county thing and based off of your comment, I’m guessing we both live in Oneida county? Property are more localized and vary based on towns, villages, and cities.
        
        Reply
    - Joe M. April 26, 2012, 1:36 am
      
      I know that here in NJ it is very dependent on the local towns. For example, in my town 3%-3.5% is the standard household tax. The next town over, which borders us and is a 5 minute drive away from the center of our town at most has ~2% of the home’s value as property taxes. I guess you could say the town bordering us is a little more undesirable, but it’s not a bad place to live at all. I would even argue that is has a better High School than our town.
      
      Reply
  - Jamie April 25, 2012, 12:44 pm
    
    WOW! We live in a small town 20 miles north of Milwaukee, WI and our property taxes on our 1950’s ranch are $3400 a year. Our house on a good day would sell for $195000. We do pay state income tax and have a 5.6% sales tax though.
    
    Reply
- ErikZ April 25, 2012, 1:24 pm
  
  Hi, I work at a company that makes software for local Assessor and Treasurer offices.
  
  6500$ seems high. Have you tried contacting your assessor’s office and lodging a protest? A protest means you think they’re charging you too high and you want them to review your property. You might want to get involved at the local level of politics and see what’s causing this.
  
  Normally when I see property taxes this high, the owner brought some undeveloped land, and the county installed municipal services (electricity, water, sewer, roads) and is charging the effected parcels for the work.
  
  One more note, we don’t have a presence in all states, but so far all the ones we do, property taxes are county-level, not State.
  
  Reply
Another Reader April 25, 2012, 7:01 am

Lending Tree is a lead generator. The offers are generally uncompetitive and they are not set up to do atypical loans. You will get better rates and terms from a good broker.

The HELOC on the rental is likely to have a significant rate penalty over an owner-occupied house. I’m curious about what you find.

I buy for cash when I’m dealing with a bank, whether it’s an REO or a short sale. Banks generally want certainty over a few extra dollars. When I’m buying directly from an owner, it depends on the situation. If the situation is not competitive, I would get a pre-approval for a traditional mortgage and make that part of the offer, along with an earnest money deposit that shows I’m a serious buyer. You are going to pay more for the rental property mortgage but you get predictability in return.

Banks are notorious for pulling lines of credit whenever the credit markets tighten. Lots of folks got their equity lines cut or closed in 2008. Their “emergency funds” disappeared just as the emergency started. Banks will also check your credit periodically and may ask for employment verification if you carry a sizeable HELOC. Your HELOC could get turned into the equivalent of a mortgage on the payback terms stated in your agreement at any time. If this happens, conditions will likely not be ideal to put a regular first or second on the property.

Your retail bank is almost never the place to get a mortgage. The retail side of their mortgage business is more expensive than letting the broker deal with the correspondent/wholesale side.

In your shoes I would take the wheeler dealer broker to lunch, and ask him to pencil out your options.

Having tenants next door is something else you might want to give some thought to. Can you live and let live when it’s your property?

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- GregK April 25, 2012, 7:53 am
  
  “Having tenants next door is something else you might want to give some thought to. Can you live and let live when it’s your property?”
  
  Actually, I own and live in a two-unit property, and rent out the second apartment. It’s really not that big of a deal. In fact, since my tenants know their landlord lives upstairs, they probably behave better than they otherwise would. I’m sure that dynamic would play out with next door tenants as well.
  
  There’s no reason to “live and let live” — if they’re doing something you don’t like to the property, you tell them to stop!
  
  Reply
  - KMB April 25, 2012, 9:46 am
    
    I started the same way you did, with a 2 family, then bought the single family next door.
    
    Owning the home next to you is BADASS! If anything, it seems that tenants self regulate. The people who don’t plan on respecting the home they are renting generally do not want to have their landlord next door.
    
    Reply
- Mr. Money Mustache April 25, 2012, 9:31 am
  
  I’m curious about these reports of lines of credits drying up just when you need them. My lines have never budged, through recessions and booms. Do any other readers have first-hand stories to share?
  
  I could see how you’d be at risk if you had a high loan-to-value ratio. In the boom years, many people bought houses with 80-100% financing, then took out additional lines of credit based on imaginary home appreciation or overly optimistic appraisals.
  
  When property values dropped and foreclosures started happening, it is natural that banks would want to shut down all of these lines of credit with no collateral. Those lines never should have been issued in the first place. (When I look at the outstanding balance on some of the “short sales” around me, I see situations like $330,000 outstanding on crappy little houses that were never worth more than $210k!!)
  
  The LOC that I’m proposing opening, on the other hand, would be under 50% of the current (post-housing-crash) value of the collateral property. So even if a second housing crash cut property prices down by a further 30%, they’d STILL have their loan fully backed.
  
  Just as a note: I’d probably pay back this loan over the next five years anyway. I don’t plan to stay leveraged indefinitely.. just was thinking of getting one of the few remaining properties in my area on sale before they are all gone. (Houses started selling very quickly this spring, at what I consider to be elevated prices. I hope this isn’t a long-term trend since I want them to stay CHEAP!).
  
  Reply
  - Another Reader April 25, 2012, 9:42 am
    
    I know at least six people to whom this happened. In two cases they were overleveraged and account reviews because of the changing market triggered closures. The other four were the result of bank policy changes. Two were reduced 75 and 90 percent respectively and the other two were cancelled with zero balances. Equity lines are subject to change or closure at the discretion of the lender, which is why I always thought using them as emergency funds was risky.
    
    Reply
  - Des April 25, 2012, 10:37 am
    
    This happened to me, though not on a HELOC.
    
    I had a $20k visa card and my bank offered a really great balance transfer offer. My student loans were at 6.8%, so I called and applied to have my credit limit raised to $30k so that I could balance transfer them all over. They asked why I wanted a higher limit, and I told them I wanted to xfer $30k of student loans to them. I was approved, and completed the transfer. I threw all my extra money at the account, and paid it down about $5k before getting a letter saying that they were lowering my limit to $25k. Based on information on my CB, my balance to limit was too high. It was my ONLY debt, and they had approved that balance to limit just 3 months earlier! Oh, and I also WORK for that bank! So, they have my income information right there, my total debt had decreased, and I have no negative information on my CB other than that card being at the limit.
    
    All that to say: yes, it can happen even if you aren’t a bad credit risk. I had an 800+ score, and I hadn’t done anything other than what they had already recently approved and they still reduced it. It is all automated. And yes, it will happen right when you need it. It all happened in 2008, everything tightened up for everybody, banks and regular folks alike.
    
    That isn’t to say leverage isn’t a good thing, just don’t bet the farm that it will be there. If I had been using that as my e-fund, I still could have sold stocks in an emergency (albeit, at a huge loss). I’m a big proponent of a diversified e-fund.
    
    Reply
    - AFF April 28, 2012, 5:04 pm
      
      DES –
      
      Very interested to hear about your student loan and balance transfer gambit. I have two student loans, 15K at 7.8% and 45K at 6.8%. I get credit card offers with zero percent balance transfers and zero percent transaction costs fairly regularly, but most are for 12-15 months and a max of 10K. I have never seen one for a 30K line of credit. Based on what you’re saying, if I could get a 0% balance transfer and 0% fees for the 15K loan, I could really make a dent in my repayment. When did you get this loan? How did you evaluate it? What was your plan if you hadn’t paid off the balance by the time the loan reset? I think knowing that I had 12 months to pay it all off or I would get dinged with a huge interest rate would be an interesting commitment device. It sounds like it worked out for you, so kudos. Interested to hear more.
      
      Reply
  - Rob L. February 3, 2017, 9:24 am
    
    This happened to me on a personal line of credit. When I deployed for military duty, my civilian paycheck stopped auto-depositing (my military paycheck was going into a different account). I never defaulted on anything and had stellar credit, but within weeks my bank decided I was unemployed and my “springy debt cushion” vanished. I found out when my wife called me at Fort Benning from a grocery to tell me her debit card was declined!
    
    Big-time violation of trust by a certain Big Corporate Bank I’d had an account with since I was 7!
    
    Not a big deal as I didn’t truly need the money – but had I ACTUALLY lost my job, I would’ve been SOL .
    
    Reply
Erin April 25, 2012, 7:04 am

The tax deduction is never a good reason to keep the mortgage though… say you pay $1000 in interest, and you’re in the 20% bracket, for example. You avoid paying $200 in taxes with the deduction. But you paid the bank $1000… I’d rather just pay the $200 to the government, and have no mortgage interest! If you MUST have a mortgage, I guess having the deduction is better than not, but not a good reason to keep a mortgage around for fun.

As for the answer, I’m in the camp of having no debt of any kind, ever…

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- Mr. Money Mustache April 25, 2012, 9:43 am
  
  I do understand that. I don’t want to borrow money because of the tax deduction.
  
  I want to borrow it because the interest rate (4% or so) is lower than the return I get by investing the money (about 10% annually by taking gross rental income minus expenses).
  
  Money I don’t have right now. In other words, I’m interested in the value of leverage!
  
  Your point would be well-taken if I had $200k of cash in the bank, uninvested and earning 0.8%, yet I still wanted to borrow another 200k for the tax deduction.
  
  Reply
AspiringYogini April 25, 2012, 7:10 am

Option #5?: Would the nice out of town owner of the home next door hold the note for the mortgage and the two of you could negotiate terms that suit both your situations so that when you had the ability you could cash out of the held mortgage? Then you both have more control and all the interest, improvements, etc. would be tax-deductible. She might be able to get a better deal than what she would do with the money and you could most likely get better terms than with a financial institution! Could be a win/win!?!

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Steve April 25, 2012, 7:14 am

Yeah, everyone always points to how you get to deduct your mortgage interest. However, if you are the sort that lives within your means like me, you won’t be able to deduct jack because of the standard deduction.

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- Emmers April 26, 2012, 1:48 pm
  
  Well, that depends a lot on where you live. I live in an expensive area (DC), and our modest home has a $230k mortgage on it. Our itemized deduction is greater than the standard deduction, and yet we are living well within our means. (We deliberately bought something we could afford on one salary, to give ourselves more job flexibility.)
  
  That doesn’t mean I’m not hoping to refinance to get a lower rate, though! :-D
  
  Reply
Travis April 25, 2012, 7:19 am

First the idea of getting a loan for tax purposes in general is a flawed way of thinking. Why would I ever want to give Uncle Sam $1 for him to give back $0.25. Yes, tax planning is a vital part of any business venture and of personal finance but it should not be a major determining factor.

As for your options. I used lending tree on my first home purchase. I used the three brokers that contacted me along with a local broker to negotiate a lower rate and a free refinance. Since we did a 100% finance at the time the refinance allowed us to drop PMI a year later since the home value increased enough to do an 80/20.

When purchasing the second home I did not use lending tree but did negotiate again with several local brokers and got ~$1,300 in closing costs waived.

My point is get quotes from three sources (1) your broker friend, (2) your local bank, & (3) a third source. Then compare the offers and begin working with them to reduce your overall cost.

I would caution against leveraging your primary residence since you have the other rental and why risk your home when you don’t have to. I think a combination of cash, HELOC from rental and possibly a traditional loan is your best bet. Doing it all on a HELOC is risky from the standpoint that these typically have a 10 year payback and a variable interest rate. However combining these options can eliminate PMI, make it cash flow positive, and reduce the overall risk.

Oh and that 3.25% HELOC will likely be ~1% higher since it is on a rental and not the primary.

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Weston April 25, 2012, 7:35 am

“mortgage broker who is very honest, competent and operates on commission”

I’ve never heard of a mortgage broker who works on anything other than commission. Where/how would you find one?

Like most people on commission the worse the deal is for you, the better it is for the mortgage broker. The higher the interest rate the broker can sell you the more he makes. The more junk fees he can convince you to swallow the more he makes. The more you borrow the more he makes.

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GregK April 25, 2012, 7:46 am

MMM, one thing you really need to think about; how long are you planning on keeping the balance on your HELOC? 3.25% (or more like 4%+ on a non-primary residence) is a great rate, but it’s not going to stay there. As interest rates climb (probably starting in 2014), your HELOC will look like less and less of a good deal.

If you’re only holding the line for, say, five years or less, the lower, variable rate is probably your best bet. If it’s going to be longer than that, you’ll almost certainly be better off with a fixed rate offering (this could include a home equity LOAN, rather than LOC. Some banks offer fixed-rate HELos).

Whatever you choose, you’re going to be better off with the property than without!

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saudisimon April 25, 2012, 7:54 am

Offer to look after the rental and repairs for the owner and pocket 10% a month, plus what you make on repairs. You get a better looking house next door, a small income with no risk or mortgage hassle, and the nice old lady doesn’t have to drive over to check on things because she knows you’ve got everything under control. Is getting into debt on a speculative venture a good idea? Do you really want to have to meet those payments every month? It is one thing to have a free and clear rental, another to have one on credit. I know I don’t enjoy it, and am frantically paying my loan down so that I can go back to feeling rich and debt free. Greed is bad!

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- riley April 25, 2012, 8:54 am
  
  Second that.
  
  Reply
  - Brotherbryan April 25, 2012, 9:27 am
    
    That’s where I am right now. But more so because I believe in singular focus and massive action.
    
    Reply
- cdub April 25, 2012, 12:40 pm
  
  This is good advice considering how much MMM likes to fix up houses. Being a property manager is a job however.
  
  Personally I went with out of state (Memphis) turnkey properties bought with traditional mortgages. My rents are twice the amount of the loan, insurance and property management. The cap rate is at around 14% with a 41.2% ROI.
  
  Reply
  - Bryan in Tahoe April 25, 2012, 1:09 pm
    
    cdub, who is your broker in Memphis? That sounds like an attractive investment. You don’t mind owning property where you can’t see it, check on it, etc?
    
    Reply
    - cdub April 25, 2012, 3:47 pm
      
      I went through two different brokers, one property from each. Memphiscashflow and buymemphisnow. I flew down there to vet the quality of their rehabs and to see some of the properties. The two I purchased I was able to walk through and feel comfortable with their property management operations and maintenance staff. I chose traditional financing as these are mortgages 2 and 3 in my name.
      
      Unlike most real estate investors, I don’t feel my proximity to the investment brings anything to the table. I can make a disaster out of the simplest repairs and do not want to landlord or deal with repairs. I will take the 8% property management hit and leave that to the professionals while I work on reducing expenses in my personal life.
      
      Reply
    - Keith April 25, 2012, 9:31 pm
      
      Also check out http://www.memphisinvest.com/ and do your Due Diligence… Chris Clothier gave a nice presentation at BiggerPockets summit… Here it is if you want it, along with some other great presentations.
      
      http://www.biggerpockets.com/conference/presentations-from-the-2012-biggerpockets-real-estate-investing-summit/
      
      Reply
      - cdub April 26, 2012, 10:24 am
        
        Yep, Chris is the big dog in Memphis but I decided not to go with him for various reasons, most of them are just simple numbers. It is my understanding that his prices are higher because he has to kick back cash to one of those “flip this house” dudes that pushes people to his properties. Basically, shop around, do the math, vet your partnerships.
        
        Reply
- vwDavid April 25, 2012, 1:50 pm
  
  This is a fantastic compromise.
  
  I also considered the junk heap next door as a potential rental and decided my psyche could not handle watching what may or may not go on.
  
  Reply
riggerjack April 25, 2012, 9:02 am

I used key bank in 2008, no problems, no hassles as I built my current house. They have a nifty feature allowing you to lock the rate on you heloc balance. But since you have the equity, I’d get the heloc on your primary home, then fix up the place, then refinance for the better long term locked rate. Should work out the best ratewise.

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T April 25, 2012, 9:30 am

Hey MMM,
From what I’ve read:
– You own your current property…
– You own a rental property close by
– You now want to buy ANOTHER rental property next door

I am the only one that’s seeing that you are putting almost ALL your eggs in the one basket?

You’re not only investing the vast majority of your wealth in “property” but you’re doing so in virtually the one area AND with the same type of properties.

I understand that property is likely one of the safer things to put all your eggs into and that the US has house prices that are definitely a “buyers market” right now… but to me it just seems too risky betting on so many similar horses.

Reply
- Mr. Money Mustache April 25, 2012, 9:50 am
  
  Hmm.. I like your contrarian perspective there, T! Always good to have a cautious word thrown in.
  
  I guess the risk would be in an economic collapse affecting the rental market in my area more than in other parts of the country, or the stock market. I can’t foresee such a thing, but that’s what risk is – stuff you can’t predict.
  
  I think that so far, the majority of my wealth is actually in my skills and personal relationships rather than in monetary assets, since I could earn the savings back within a few years if they were lost. But that’s also a risky thing, since skills are dependent on health. And personal relationships are based on people not deciding that they think I am a jerk and ceasing to talk to me :-)
  
  The MOST risky economic plan is the one that most Americans use: living a lifestyle that depends on continued employment income to pay the bills. If you lose your brain or body power, or your industry goes obsolete, you have no backup plan.
  
  The “safest” economic backup plan I could achieve right now, according to crash theorists, is a portfolio of non-US-based dividend paying stocks.
  
  Oh, what a risky world we live in :-)
  
  Reply
  - GregK April 25, 2012, 10:21 am
    
    You’re probably also perfectly capable of getting a job in tech again if you had to… it seems unlikely that your health, your mind, your relationships, the stock market, and the rental market would all collapse at the same time…
    
    It seems to me that investing heavily in rental real estate puts you at a small risk of having to fall back on your existing skills to replace the wealth and streams of income you would lose in the event of a rental collapse (and like you, I’m really having a hard time picturing what that would look like… you might loose most of the property values in another epic housing crash, but not the rent. Your area specifically would have to be decimated economically, causing people to move out). Worst case scenario, you have to move and go back to being not early-retired like the rest of us!
    
    Reply
    - TmcD April 25, 2012, 5:12 pm
      
      Heh, in the words of the immortal Jack Handy:
      
      If you lose your job, your marriage and your mind all in one week, try to lose your mind first, because then the other stuff won’t matter that much.
      
      Reply
  - Brian April 25, 2012, 12:27 pm
    
    Right on, there is risk in any investment. You just need to make sure you cover your margin of safety. As long as your location is fairly stable, like it won’t become Detroit, non-leveraged real estate seems like it would have a good margin of safety. Over time, the government is incentivized to inflate currency, so they will lean towards that, and your investment will grow. As long as you can ride out the in betweens.
    
    Reply
- Rich Schmidt April 25, 2012, 12:02 pm
  
  My wife and I currently own our house plus two rentals less than a block away, right next door to each other. It makes lawn maintenance a breeze. :) I just mowed all three lawns yesterday in 2 hours.
  
  I suppose one could say we have too many eggs in one basket. But those aren’t our only eggs– er, investments. We’re also invested in stocks, bonds, state pension, etc. Plus our skills/careers/etc (from which we don’t plan to fully retire for another 18-25 years). I imagine the same is true for MMM.
  
  All three of our properties have mortgages on them, but those mortgages are being paid by the tenants. (Did I mention that our house also has two apartments in it?) Rental demand and rates would have to fall dramatically for us to find ourselves in trouble. House prices don’t matter as long as we’re not selling.
  
  There are pros and cons to being a landlord, and pros and cons to owning investment property close to home. For us, right now, the pros far outweigh the cons.
  
  Reply
- ultrarunner April 25, 2012, 2:18 pm
  
  If you’re an egg farmer, putting all the eggs in one basket isn’t that risky. Do what you know instead of randomly throwing money around in the name of “diversification”.
  
  Most people who get really rich do it by having a singular focus in an area they know extremely well.
  
  And, while there is always risk, the Colorado Front Range housing market isn’t likely to crash catastrophically anytime soon. My house appreciated from 282k to 380k from 2005 to 2011… right through the worst housing crash in US history. People really want to live here, for many reasons that aren’t likely to change soon.
  
  Reply
  - Another Reader April 25, 2012, 9:22 pm
    
    I’m a huge fan of diversifying over a long time by picking up assets when they are on sale. Right now we are coming to the end of a really great sale on residential real estate. Buy what makes sense now, because the sale is about over. It will be a long time before the deals are this good again. The next sale might be on dividend paying stocks or some other asset class you want to own, so save up any extra incoming cash after this purchase to shop the next sale.
    
    Because money is so cheap right now, I would try to leverage something to make this purchase, With your anticipated rate of return and the low interest rates, your leverage will be very positive. However, I would want to lock in the low interest rate and not float it with a HELOC. You will likely be very happy with this approach five years from now, whether or not you pay the loan off.
    
    Reply
- Diane April 26, 2012, 9:31 am
  
  John Madden lives in my area and owns a boatload of real estate. He is quoted as saying something to the effect of “I don’t own anything I can’t walk to”. True or not, I can’t say, but it is a wise strategy. There are huge advantages in owning property that you can get to easily. MMM’s proposal speaks to efficiency and building on (!) what he knows, not putting his eggs in one basket. A quick way to ruin is to invest in things you know nothing about and don’t understand.
  
  Reply
Praxis April 25, 2012, 9:32 am

The timing on this is pretty amazing, because I’m looking at starting a real estate snowball here. I’m pretty young and don’t have a family to worry about, so I might push the leverage.

Here’s a really fun idea I’m going to look to try:

* Buy a distressed house below market value and fix it up. Funding can be cash, hard money loan, home equity, or a special loan arranged with a lender, whatever.

* Immediately refinance with a portfolio lender the full appraised value of the house- after repair. Usually you can pull 75-80% cash out. You need to use a portfolio lender so they’re not subject to FMA’s normal 120-day-no-refinance-period after a sale.

If you get the right properties, you can walk out of it with zero down, or close to it.

I was formerly trying to pay off my house, but now I’ve got a dilemma. I only owe a small amount on my house at 5.25%, but have 40k home equity available. I can cash-out refinance to get that 40k less origination fees of 2.5k, and move the whole loan to 3.8%, or I can keep paying the small remaining loan at 5.25% and have the 40k home equity line of credit available. (My credit union charges 6.5% on home equity line of credits though! Maybe I need to shop around)

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Nathan April 25, 2012, 9:37 am

I’m sure you’ve already looked into it, but I looked into a HELOC for my rental about a year ago, and they had disappeared in the credit crunch. The agent told me to check back in a year or two.

As to whether to take a HELOC on your primary residence or your rental, seems to me that it’s six of one, half dozen of the other. You’re going to be decreasing your cushion regardless.

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Jeff April 25, 2012, 10:09 am

I don’t see the point in taking out any type of loan other than a 30-year fixed, given today’s low rates and the expectation that this property will continue to pay you for the next 30 years. I realize this goes against your principals of doing everything yourself, but your best financial move would be to finance 80% out of your house and 80% out of the other rental property you own and buy as many properties as you can and let other people manage them.

I bought a house with cash and am in the process of fixing it up to rent. I’m going to take out a mortgage on it once it’s completed and worth a lot more money. I should get a loan for pretty much everything I’ve invested into the property, which means the house was essentially free. That loan goes toward the next house I buy where I’ll do the same thing. If I were you I would at least do this with the rental property you already have fixed up. You essentially get the benefit of flipping a house with the benefit of a steady income of rent.

Reply
- Jimbo April 25, 2012, 10:58 am
  
  This is just another take on the fisherman metaphor, isn’t it? I knew it…
  
  Reply
BobInDenver April 25, 2012, 10:21 am

Well, in your hypothetical, the couple making $100k is is also paying 5% state income tax if they’re here in Colorado, and if they are at all mustachian, putting money into IRAs or 401ks that are also deductible, so they are going to be well over the standard deduction.

Loans on investment properties generally have a significantly higher interest rate than the rate on a primary residence.

These should also weigh into the decision. As should the question of what happens if there is a real meltdown? There is something to be said for only having to pay property taxes to hang onto your primary residence.

Reply
- Ken June 20, 2013, 2:30 pm
  
  Minor correction to your post. IRA and 401k deductions have absolutely nothing to do with whether or not you use the standard deduction. Take a look at your tax forms – IRA/401k are not part of Schedule A. They occur above line 40 (IRA) or on W-2 (401k). So they are knocked off before you ever get to the Schedule A vs. standard deduction choice.
  
  So for your example of $100K income at 5% their Schedule A will only show $5K leaving another $6K of other deductions to be found before mortgage interest is truly affecting you marginal tax rate even if they were maxing out their IRA/401k.
  
  Of course the best Mustachians are already FI, living on $25K and in a state with low property taxes. So for those folks a whole lot of “deductible” interest is actually effectively not deductible at all as they will probably have very little on schedule A and will use the standard deduction. In fact, at current interest rates they would have to have a fairly huge and un-Mustachian mortgage debt to even get part of their interest payments deductible.
  
  This highlights the perversity of the sacrosanct mortgage interest deduction and property tax deduction. We are told it will help the middle class boost themselves into home ownership. This is complete and total BS of the smelliest type.
  
  The reality is that only a schmuck like me that is raking in far too much income such that my state income tax alone takes me above the standard deduction will truly benefit fully from mortgage interest and property tax deductions. The people who really need the help (median income lets say) actually hardly get any benefit at all. Their state income tax will barely get them a third of the way to the standard deduction. Since they can’t afford stupidly large properties most of their property tax and mortgage interest will barely get them to much less above the standard deduction. So the reality is they see little to no benefit at all.
  
  Reply
Art April 25, 2012, 10:54 am

What about owner financing? Seems like the woman is already used to getting a rent check, she might be open to receiving a payment from you without the hassle of landlording? Seems like you would be able to negotiate some cool deals too since you only need one person to agree and not a bank. Like 0% interest with some profit-sharing in your rental venture…Something I would definitely think about.

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mike crosby April 25, 2012, 10:55 am

MMM, I’ll never forget when I started to buy property years ago and asked others on the burgeoning internet what they thought.

I got back a bunch of over-analytical comments on why it wasn’t a good idea. Luckily, I followed my gut and not their posts.

BTW, I got the welder from Harbor Freight yesterday, now I just need to find some scraps of metal.

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jlcollinsnh April 25, 2012, 11:08 am

with your preference to be a cash buyer, perhaps a hybrid of #1 & #2 makes sense.

use the cash you have and a conventional mortgage for the balance. If you are borrowing say 50% your rate should be rock bottom.

you can then pay it off quickly, or not, as your needs and desires dictate.

Reply
Geek April 25, 2012, 11:34 am

(I am not a tax expert)
“Now imagine an almost-identical couple with a $200,000/4% mortgage on their house. Their mortgage interest was about $8000 for the year, and property taxes were $1500. Both those items are tax deductible in US tax law, so they type them into Turbo Tax.. and… the program informs them that they’ll still pay less taxes by taking the Standard Deduction of $11,600.”

There is also “sales tax/state income tax” which is deductable at the federal level, kids/education deductions, and a number of other deductions that may kick you above the standard decution, so perhaps the mortgage amount is 200-1mil instead of 250-1 mil.

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greg April 25, 2012, 12:56 pm

Don’t know if this was already mentioned but what about a refi on the rental house and use the cash if enough to pay cash on the other. Major pro is you could lock in the financing over x years unlike the loc.

Reply
George April 25, 2012, 1:51 pm

MMM, One thing you are not factoring in with either the home equity loan or a conventional mortgage is all the fees you are going to have to pay the bank just for the privilege of taking out the loan.

Anyway, you sound too emotionally attached to this house next to you. Think about it, do you really want to see your tenants every time you step outside? What if they fall behind on the rent or turn out to be a-holes?

Since you are going to be your own property manager, I can see why you want your rentals to be close to you, however this is too close. The ideal would be within 1-2 miles distance from your primary residence or say a few blocks over from your main house.

Anyway, don’t buy the house, instead purchase a real junker for a cheap enough price that you don’t have to tie up serious amounts of cash. Stay away from the loans, they are a huge hassle. Pay all cash for a cheap crappy house and use your carpentry skills to add value to that junker property in order so that you can rent it out and later sell it for a big profit.

This is the area of the market with the fewest competitors and with the fewest number of people who will be able to handle the workload; use your unique situation of good carpentry with lots of free time to your advantage, very few if any other investors will be able to do this like you can;

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Hugh April 25, 2012, 1:58 pm

I like this post, I’m dealing with a similar predicament myself. I have two houses paid off but feel like my money could be put to a better use with a little extra debt, whether its in another house or some other investment. I’m partial to the 30yr mortgage just because I feel like rates a artificially low right now and taking advantage of a sub 4% loan for the next 20+ years seems like a once in a life time kind of opportunity. Having such a fixed capital base has to be worth something unlike the credit line which would be convenient but like others have mentioned having it called away at absolutely the worst time could be a real disaster. All the great investors talk about having access to capital on an as needed basis when the times look the worst and prices are the best. Can’t be greedy when others are fearful if their is doubts about the availability of money.

Just my two cents and keep us posted on how everything works out.

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Naomi April 25, 2012, 2:10 pm

Zillow is a great source for mortgage leads. We’re considering a re-fi with one of the lenders, but haven’t pulled the trigger yet.

Reply
- Nice joy August 26, 2017, 3:44 pm
  
  I have used Zillow mortgage to find a lender . I got 3.25 APR . No appraisal fee, No buying points or closing costs
  
  Reply
RiskyStartup.com April 25, 2012, 3:02 pm

How about option 5) – Have few beers, and then pick one of the other 4?

It helps speed up decision making and you can blame alcohol if decision turns for the worse… ;)

Reply
Warped April 25, 2012, 4:34 pm

I own some commercial property with a loan from the prior owner.

He had paid it off, and was getting a nice monthly check.

I send the checks to a title company; it was like $500 to set up the account and $4 each month to handle the billing/tax statements/interest calculations.

Now, he gets a nice monthly check without tenants calling him!

Worth asking the current owner about, if the others don’t pan out.

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MacGyverIt April 25, 2012, 5:05 pm

“In fact, I might even buy the house next door to me. It’s currently tenant-occupied, as the original owner moved away several years ago.”

Word of warning (OT from the loan) – you may not want to let the renter/ neighbors know you’re the LL. They could end up on your door step every time there’s a bump in the night….

Reply
- Diane April 26, 2012, 9:49 am
  
  Good warning, MacGyverIt. A friend of mine owns several apartment buildings in a prime area. All his tenants think he’s the scruffy handyman who does repairs and collects the rent for the owner. He jokes that his wife’s going to get everything when he dies, so she’s the true owner anyway. A real millionaire next door kind of guy.
  
  Another point: Landlords have more control over their tenants than they realize. One way not to get cheap, crappy tenants is not to own a cheap, crappy house in a cheap, crappy neighborhood. Always interview prospective tenants as though you were interviewing them for a job, because that’s exactly what it is. Never buy a house that you’d be unwilling to live in yourself. It is a great tax-saving exit strategy to serially convert each rental into your personal residence and then sell it off.
  
  My vote is to go for it, especially if the current owner will carry. If she can’t/won’t, get the cheapest money available. If possible, fix it up with an eye on eventually living in it. You can sell yours, take the up to 500K exemption, move into the one next door and do it all over again. This is a tax loophole that I expect will eventually be tightened or closed, so you may want to take advantage of it while it’s still so generous.
  
  Reply
Nurse Frugal April 25, 2012, 5:50 pm

Hmmm…..This is a tough one to weigh in on. It seems like you have made your mind about the second rental property. I don’t know if you have your heart SET on that house with the little old lady, but I have heard of another interesting way to buy houses. You can go for a drive in the neighborhood and pick out a few dumpy houses, where it looks like the people who live in them can barely afford to keep it up and pay rent. Then knock on their door and offer them your price. From what I have heard, it sounds like this has over a 50% success rate. This would provide MMM with some good projects in the house, but if you offered them a good deal you will still be coming out ahead even with the total price of the projects inside. Also, if this house or rental property were to have two separate places for renters you can make a great profit every month. For example, detached garage that can turn into another living space, or create a separate entrance for the first and second floors to turn the place into a mini apartment! Score!

Reply
- Mr. Money Mustache April 25, 2012, 10:05 pm
  
  Great idea! I should really seek out junkers. As someone else pointed out, I am a bit attached to the idea of fixing up the house next door, because it affects my daily life so much. But the price has to be right.
  
  I guess I just can’t stand to see un-maintained houses! Everything must be tidy and nicely built! Vinyl and piss-stained carpet floors need to be banished from Earth, forever!
  
  You just need to watch your use of the D-word. Why would I “go for a drive” somewhere within my own city? I’m not looking to travel to Kansas or Colorado Springs to look at these houses.. there’s no need to get radical and break out the CAR!! :-)
  
  Reply
  - Margaret @ LLNOE June 9, 2013, 5:07 pm
    
    This exact same thing happened in our neighborhood a few years back. The junkiest houses would start at $299K. A contractor started to come around and knock on doors of houses that were not currently up for sale and picked one up from an elderly couple for $139K!!! He didn’t flip it though, gutted it and it’s now his primary. This technique seems to work! :)
    
    Reply
Redeyedtreefr0g April 25, 2012, 6:11 pm

Oh god, how are we ever going to move there?

If I read right, you live in Longmont, which is where our friend lives and is the next place we’d like to try living to see if it is the place we want for our “forever” home. $1600/mo for rent? I searched craigslist and didn’t see anything under $900 for only 1 bedroom! I’m a school bus driver which means no income over the summer, we have no savings, and a bunch of near-max credit cards, I’m panicking over here.

Do you have a projects in Longmont?

Reply
- Mr. Money Mustache April 25, 2012, 10:01 pm
  
  Yeah.. although my town is cheap relative to the quality of life and the high-paying jobs around here, it’s still relatively expensive compared to most non-coastal cities. There aren’t loads of $50,000 houses on the auction block like there are in some of the worst-hit areas of the housing crash, for example.
  
  Longmont houses seem to start around $100k in the less desirable areas. $220k gets you a good solid big’n’cheap (a 2200SF suburban house with 2 car garage, big lot, and basement). $170k buys a tiny house in the historic district, and $450k buys a beautiful one on any of the very nicest streets. Because of these not-overly-cheap prices, there aren’t many landlords interested in renting out a house for only $900/month.
  
  The prices are supported by the fact that it’s only 10 miles from Boulder, where scrape-off shack houses start in the 400s, nice houses close to downtown are $1-2M, and the fanciest places occasionally sell in the tens.
  
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Ben April 25, 2012, 8:07 pm

Hello MMM…

I literally just did what you are contemplating; took out a HELOC against one of my rental houses that I own free and clear (for purposes of purchasing another rental, combined with some of my own cash).

Here’s what you will run into:

Most banks quit doing HELOCS against investment properties after the financial collapse of 2008. The only large bank I found that would do it was Wells Fargo (they are the home equity kings). They’ll give you 65% LTV. Zero closing costs or other fees. The HELOC itself has a $75 annual fee that is waived the first year. And if you close the account in less than five years you get charged a $500 fee.

IMO this is a great strategy for acquiring rental properties, but only if you plan on paying down the credit line quickly. It is very handy. I was thrilled to finally find a bank that would do this. You also may try some local banks or credit unions.

Feel free to email me if you have any other questions or would like more info. Great timing on this article…I close on my investment property in less than two weeks. Nothing like a “cash” offer!

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Keith April 25, 2012, 8:57 pm

You want to learn some creative real estate, I recommend you invest $10 to charity on Rich Weese book, he loves avoiding the tax man, and will probably open up your eyes on real estate. http://fromjanitortomultimillionaire.com/

Reply
George April 25, 2012, 10:50 pm

MMM, I don’t see how you are going to make much money here with your loan ideas.

Suppose, first, you did a conventional loan:
I don’t know what the market price of that house is, but lets assume its 200k and your putting 20k down (to avoid PMI), In general, the 3% range mortgages are only for 15 year mortgages. The 4% range is for 30 year mortgages on a primary residence Your probably looking at high 4% or 5% for a 30 year on an investment property.

According to the calculator (http://www.mortgagecalculator.org/
) at 4.5% interest, the loan has a payment of $1,120 for mortgage and property insurance combined. You said you can prob get $1600 a month rent, however you are also going to have insurance, repairs, vacancies. Furthermore, you are looking at about 5-10k in closing costs, thus if you are lucky and even manage $350 a month profit, it will take a year and half of your $350 profits just to pay back 6k in closest costs.

Instead suppose you choose the HELOC,
According to http://www.bankrate.com/home-equity.aspx
A 75K HELOC currently has an interest rates of 5.45% posted and the interest rate just goes higher for larger amounts, most landlords try to get an 7-8% return on their properties, thus here you are talking what maybe a measly 2% return on your idea (7.45% – 5.45%) (plus you are getting a lot of head aches and hassle). You did mention a whiteboard offering 3.25%, did you look at the fine print? is this some kind of teaser rate to draw attention, does it apply all the way up to 200k?

The scenarios above show that this deal probably will not yield above and beyond the 4.5% or 5.5% interest rate you will be paying for this loan to make it worthwhile. Instead, your taking on the risk without much reward.

This is why I said the best deal is to purchase a run-down foreclosure at fire-sale prices with all cash. Cash is king. This is because a 0% interest rate always trumps low interest rate.

The road to wealth is through hard work, discipline, skills, and knowledge, not by playing interest rate games.

The best deal is to purchase a decaying foreclosure and make it livable to the point where you can get $800 a month or more rent from it. Then this money is just about all pure profit since there are no loans (you don’t have to feed the beast). I know that in my area, there are way more foreclosures sitting around than there are people in their 30s with lots of free time and money to fix them up! Be a picky buyer, play hardball with the sellers or banks, use them against each other to bid their properties down til you get a really great price.

Lastly you mentioned taxes, why is this even an issue at all for you? With your family in early retirement, you are only making like 30-40K a year? Your already in such a low tax bracket, tax strategy is not going to matter much at all. Tax does become much more important for people working full-time pulling in 6 figure incomes because they are actually starting to get really high in the tax brackets! But for you, taxes probably are not going to be much of an issue. After all the mortgage deduction on your taxes is so that you can give the bank a $1 to avoid paying 25 cents to the government, a net loss of 75 cents. Thus, so what if you can deduct rental property interest even with the standard deduction, your still losing 75 cents on every dollar.

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- Mr. Money Mustache April 26, 2012, 8:15 am
  
  I hear you George – your points are all spot-on, it’s just in the details of your number assumptions where you go wrong. You gotta trust Mr. Money Mustache when it comes to doing the math for his own rental houses :-)
  
  For example, around here when you buy a house with cash, there are NO closing costs. (A few hundred go to the title company, which the seller pays out of their proceeds. This was briefly mentioned in the last article of the foreclosure series). Similarly, I can get a line of credit with no closing costs, my interest rate quotes are lower, vacancy and maintenance is lower than average, etc.
  
  Also, when counting mortgage “payment”, remember to count the principal payoff amount as part of the profit. It’s not part of the cashflow, which is also important, but that money is going to your bottom line eventually. With a surplus of cashflow these days, I’m most concerned about 1) Fun, and 2) longer-term results.
  
  The biggest score, however, is that in the case of the house next door, I can clear a $50,000 profit on fixing it up, even after paying for materials and paying myself $40/hour for renovation labor. So the rental plan would probably be short-term, and eventually I’d sell it. I’m also eventually selling my primary house, which might ALSO appreciate by at least $10k just by having a nicer house next door.
  
  Tax considerations are also a good point – if I really have to pay a full percentage point higher for an investment loan versus a primary house one (4% instead of 3%, meaning 33%), I’d still want to use the primary house loan, since my tax bracket is far below 33%. BUT, it looks like I can deduct the interest expense anyway (see other comments). So the decision needs to be made on safety and flexibility rather than plain dollars.
  
  Reply
  - cdub April 26, 2012, 10:32 am
    
    You are going to be doing well getting 5.1% on an investment loan even with rates as low as they are right now. It doesn’t hurt to shop around and ask someone that deals with real estate investors. I am working with guild mortgage and they are used to dealing with the self employed, the heavily leveraged etc.
    
    Reply
  - George April 26, 2012, 12:42 pm
    
    Yes, you are right about the mortgage payments in your comment.
    
    In the scenario above with 200k loan at 4.5%, you get a monthly payment of $912 (mortgage only, not including property tax).
    
    According to http://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx, if you look at the Amortization table, these monthly mortgage payments of $912 for the first year breaks down to about $249 for principal/month and $663 per month in interest.
    
    So yes, this addition $249 per month is also being added onto your wealth. This would in addition to any regular profits you make.
    
    So yeah I see your point, I guess in my scenario, I was looking at more from a cash-flow generation perspective rather than selling the house or houses for capital gain profits.
    
    Also, you might be able to get a better interest rate with the HELOC on your primary residence. I am not as familiar with HELOCs as mortgages and I don’t really shop around for HELOCs to know. Best of luck.
    
    Reply
    - blindsquirrel April 26, 2012, 8:02 pm
      
      Well, unfortunately, tax losses on rental property for passive investors phase out if your personal income is over 150k. Paid off investment property is the way to go. Sweet spot is make cash but allow depreciation put you at a loss that you can deduct but you are making a great return.
      
      Reply
  - Another Reader May 1, 2012, 1:44 pm
    
    Looks like it would be a good time to pick up a rental in Boulder County.
    
    http://www.housingwire.com/news/denver-area-rents-hit-10-year-high-low-apartment-supply
    
    Reply
izakwould April 27, 2012, 10:26 am

I’ve been thinking about buying a second house in our neighborhood to fix up and rent out. Any recommendations/resources/advice for first-time landlords?

Reply
Susan April 27, 2012, 11:32 am

We are in the process of doing the same thing and don’t really want to add more money to our mortgage on our primary home even though we have over $100,000 equity we could use. We have found an investment loan rate of 3.5% for 10 years. We are putting down 30% of the purchase price and after the loan payment, we should net about 500 per month on this house. The house is located near an army base and is in the same area as our first rental home that we own free and clear. Both houses are and were foreclosures and we were lucky enough to act quickly enough to get them. Both only needed some paint and minor repairs. These are not complete fixeruppers. We have had great success with our first rental house and we are hoping that we will soon be growing our own mustaches here in N.C.

Reply
FreeUrChains April 27, 2012, 12:55 pm

I say buy the neighborhood with a $2Million Non-recourse loan from a bank, with a plan of action. Because you know you want your very own MMM Monopoly Board :)

Reply
- Mr. Money Mustache April 28, 2012, 7:23 am
  
  Yeah! It would be nice to rename my road to ‘Stash Street, make it all into well-tended rental houses that run on renewable energy and get free access to a community tools and supplies library and even a community garden. It would be like a commune, except run according to the highest ideals of ethical Capitalism :-)
  
  Reply
Cindy June 27, 2012, 11:19 pm

Another thing to consider about using HELOC’s is that some of the credit reporting agencies (like Experian) consider HELOC’s revolving credit, similar to credit cards, and so if you are utilizing more than 30% or so of your home equity credit line, your credit score will take a hit.
I recently used a HELOC against my paid off primary residence to purchase a rental property, and was surprised to see my credit score go down by 50 points or so (since I used 97% of the credit limit against my HELOC). I suspect that if I had taken out a conventional mortgage against my primary residence, my credit score wouldn’t have taken as much of a hit…but for me the hit was worth it because I avoided closing costs and got a lower rate than I would have on a conventional mortgage.

Reply
Kate January 4, 2013, 12:31 pm

We are considering a home equity line of credit or a home equity loan to finish renovating our home. We would need to use about $75 K to finish the work. What type of home equity line would you suggest having? Fixed rate? Adjustable rate? Any suggestions? We currently have only a fixed rate home loan of around $350K at 3.25% We are considering a fixed or adjustable rate line for about 10 years.

What would be the pros and cons of adjustable or fixed rate equity line? I figure we should open it up just for the sake of fiscal flexibility. What type of line do you currently have?

I’m glad you are able to continue enjoying you Hawaiian “vacation” despite furnace issues.

Reply
bob July 31, 2013, 10:03 am

I live in 3000 sq ft house, lake of Ozarks MO. Taxes 750 a year. Sweet.

Reply
tommy v March 16, 2014, 2:53 pm

Hi,

I am in a little dilemma and was wanting some advice.

I purchase a rental property 5 years ago at 6.375% in sugar land texas. Loan balance currently is $97000. pmt is $674 per month and $512 is going to interest.

I am wondering if i should get a heloc on my primary residence since the rate is 4% currently and I owe nothing on my house. Use the proceeds and payoff the investment property, then writing the interest off on my schedule E.

My other though was to pay it off with the 100k i have in a savings account, saving myself $6144 in interest every year.

I am currently married, income is 50k per year, using standard deduction bc i have no more home interest decduction.

Which option is the most advantageous ?

Reply
- SEVY March 23, 2014, 11:04 pm
  
  Why do you have $100k just sitting in the bank earning less than 1% while paying over 6%. Your going backwards. There are a lot smarter people coming to this site than me but here is what I would do. Pay off the rental. This will give you addl income to invest in another property or to put in your investment fund. Second I would still open a Heloc to have as your emergency fund if ever needed or buy another rental if rentals are your focus. Good luck!
  
  Reply
Loren November 5, 2014, 9:54 pm

Instead of investing in rental properties with my HELOC, I invested with a private lending firm. I’ve been averaging 11% on a 3.75% HELOC. No landlording hassle necessary.

FYI MMM, I’m down the road from you in Louisville and Elevations CU has offered me two HELOC closings with zero closing costs.

Reply
Kate February 15, 2015, 11:34 am

What would be the difference between a HELOC and simply refinancing the loan?

Because of the low interest rates right now (around 3 percent), would it make sense to refinance a home (worth around 1 million) and keep the cash out in pocket ($200K)?

I would be interested to know the benefits of a HELOC vs. just simply refinancing. Would a HELOC be cheaper loan to obtain–so that is why it is considered a better investment? Thanks for your thoughts!

Reply
John October 16, 2015, 9:38 am

Hey MMM, i am thinking about using option 3 (HELOC on my primary residence) to buy a rental. Do you move forward on that option and have you further confirmed that the interest on the HELOC is deductible if you use the standard deduction? Any special rules to follow?
Thanks,
John

Reply
Mr. Real Estate July 9, 2016, 4:15 am

I occasionally use lending tree to shop rates, but the trick is to never use your real phone number or they will call you like a crazy ex… Lately I have been giving them the number to the IRS whenever I want to see the advertised rates.

Reply
EarningAndLearning May 13, 2017, 2:45 pm

Wow I learned so much from reading this post & all the comments! What a great community of Mustachians!

Reply
Kevin Johnson November 8, 2018, 1:26 pm

So, who has the best HELOC with the cheapest interest, and no closing fees?

Reply

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