Do you usually buy Home Warranty policies for your rentals?

General Real Estate Investing
21

Dave - thank you for the example. I guess it may make sense to do it in the short term. Not sure what would be the impact on my long term strategy - if I do this would it delay my ability to retire? Maybe yes, maybe not. In one hand I would be delaying the time to own properties free and clear (which boost the cash flow big time). In the other hand I would be able to acquire properties quicker. I will have to run the numbers to see which makes more sense for me.

One thought though - would you pay someone $1,500 to $2,000 (closing costs) to get $22,500? This comes down to 6.67% to 8.89%. And when I am thinking that I am paying someone to get my own money - not sure I would be happy with that… :O)

And on top of that I would still have to pay more in interest - without refinancing, after 10 years, I would have paid approximately $27,725 in interest. If I refinance at 5 years, I will end up paying after 10 years $34,858 in interest (another $7,000 gone…).

And the last thing is that when you refinance your mortgage will go up approximately $100.00 (assuming you can get the same term as the first one - 20 years @ 80%). Using the 50% rule, it would mean your rents would need to go up $200.00 (or 25%) in 5 years… This seems steep. If you keep refinancing, at one point you will kill your cash flow…

Hey - I am not saying this is a bad strategy… I am only trying to figure out if this would work for me…

Thank you again for the example. Helped me think with real numbers.

Have a nice day!

22

j1dias,

There are no absolutes. The 50% rule is not absolute. The refinance interval is not absolute. The prevailing interest rate when you refinance is not absolute, either. The mortgage term is not necessarily 20 years.

Once you own the property, you throw out the 50% rule. It is not relevant. The actual operating expenses you are experiencing is what matters. If you choose to refinance, you pick a number that will still let you cash flow after debt service using the operating costs you already know. If it takes you seven years, or even ten years to get your rents high enough to support refinancing at 80% then wait ten years to refinance (if you want to cash out some equity). Otherwise, refinance for less than 80% of appraised value.

What if interest rates have fallen since you took out your mortgage. There is a chance you can refinance for a higher mortgage balance and not raise your monthly payment at all. For example, a $37500 mortgage at 8% has nearly the same monthly payment as a $46K mortgage at 6% over a 30 year term.

I am not trying to convince you to adopt this strategy. You asked how it could work, and I gave you a practical example.

You have not purchased any investment properties yet, so I can understand why your focus is on free and clear property ownership. Nothing wrong with your thinking. If free and clear property is your main objective, then bluemoon06’s strategy is not for you.

I suspect that your investment plan will be to acquire somewhere between four and six rental properties, maybe apply excess cash flow to debt reduction, and own the properties free and clear by the time you are ready to retire. You are probably guessing that the rental income from a few free and clear properties is all you need to replace the take home pay from your job when you are ready to retire. You may be right, and there is nothing wrong with your plan if this is the path you want to take.

There are many different paths to the same goal. If you are interested, I can show you another variation on bluemoon06’s strategy that may “feel” better to you, will give you an extra $25K in tax free income every year, will give you all the cash flow you need in your retirement, yet won’t let you get to free and clear ownership.

23

Dave - thank you for the answer. Actually my plan is to get approximately $100k in rental income/year. To get there I will need more than 4 or 6 properties… :O( According to my 20-year plan I will need approximately 85 or 86 properties averaging $100/property/month. I have a gut feeling that I will probably be able to the get there with less properties. However I wanted to be conservative.

I am interested… :O) Owning properties free and clear is not my goal - I believe I will get there eventually. I am not opposed to refinancing as long as there is a benefit to it. In my case, if refinancing would get me to my goal of $100k of passive income quicker, then I am fine with it.

Now I am curious about this alternative strategy… Would you care to share?

Thank you.

24

Well, your earlier posts emphasized your desire to attain free and clear ownership. Ten free and clear properties will generate about the same monthly cash flow as 35 properties financed at 80%.

You imply that you need $100K annual cash flow to replace your income. If your income is $100K per year, isn’t your take home closer to $65K per year? If so, then by the time you retire, you only need 54 rental properties averaging $100 monthly cash flow per property, or 16 free and clear properties averaging $350 monthly cash flow. Remember, rental income is passive income and is not subject to the social security and medicare taxes that are withheld from your salary income.

Plan to buy buy one rental property per year for each of the next ten years. Let’s say that you buy prudently in strong rental markets and only pay about $50K for each property. Let’s say you purchase in appreciating markets and see each property double in value in ten years. At the end of ten years, the property you purchased in year one will have doubled in value from $50K to $100K, and you have paid down your mortgage balance as well so your equity exceeds $50K.

In year eleven, do a cash out refinance on the property purchased in year one. Your cash out amount is $25K and should keep the LTV on the property at or below 75%. Hopefully during the ten years of rental use, your rents have gradually increased so that you will still have a positive cash flow after the cash out refinance.

In year twelve, do a $25K cash out refinance on the property purchased in year two. And continue in succeeding years sequentially refinancing one property every ten years to take $25K per year out of your equity, tax free, and with no negative cash flows.

If an extra $25K tax free cash each year is not enough to support your lifestyle ($2K per month) or meet your investment needs, then adapt the scenario and the number of properties to the tax free cash number you need to hit.

Whether you wait until retirement to begin sequential refinancing or start in the eleventh year, this is a plan that you should be able to use to generate an extra $25K in tax free income for the rest of your life.

If the appreciation rate is lower in your investment area, just purchase an additional property for a couple more years before starting your sequential refinance.

25

That was not my intent. My goal is the cash flow - the free and clear ownership is only a means to my goal. The more free and clear properties I own the higher my cash flow. And I do get your point - if you own free and clear you will need less properties to generate the same passive income. Thank you.

Actually based on my 20-year plan I will not own any property free and clear because I am planning to have 20 year mortgages. On my 21st year, I will start having properties free and clear and that will boost my cash flow… :O)

Dave - you are absolutely right. The 100k goal was set because it is a round number. I planned for this goal. Actually as I move towards it I will evaluate it frequently. I believe I am being very conservative with my analysis. I have a feeling that if I work hard enough and make wise decisions (and learn from my mistakes so I don’t repeat them) I will get there much sooner. So I guess what I am trying to say is that I put this goal on paper and created this 20-year plan so I could put my mind around it. I will adapt and change it as I go.

One benefit I have already obtained from doing this exercise is that I realized that it is not a get rich quick scheme. I will not be a millionaire tomorrow if I start working only 10-20 minutes per day… :O) By doing the 20-year plan it is clear to me now that it will take a lot of work (and time) to build wealth and generate cash flow. The good thing is that I am in no hurry! I am as excited with the journey as I am with achieving my objectives. If it will take 20 years, so be it. :O)

And one last comment - I believe I will enjoy being a landlord. I will not get into the reasons why I feel I will enjoy it because I don’t want to get shot… :O) Having said that, the idea of managing 80+ properties is mind blogging… :O)

Hey - thank you for your idea about the 10 properties, refinancing after 10 years to generate 25+ cash flow… It may be a good option. However the good thing is that I don’t need to iron out all the details of my entire strategy now. I can be flexible and evaluate my options as I go along. I guess what I am saying is that evey year I can evaluate my portfolio, the market, and decide whether it makes sense to refinance to pull money out, to sell some properties, to pay down the mortgages, etc… I believe your bottom line message is that we need to be flexible and evaluate our opportunities. I agree. Thank you for this perspective.

I will now let you go. Sorry for the long post. This forum here is working like a therapy for me…

Have a wonderful weekend! Talk soon! :O)