086: How to use Debt to Make more Money
On this episode of the InvestFourMore Real Estate Podcast I talk about debt. I hear how bad debt is all the time. How debt ruins lives, how it ties down people, and how the banks are the only ones that benefit from debt. I have a completely different view about debt. I love debt! You have to be careful how you use debt, but if used right it can make you much more money than paying cash for everything. I have debt on my personal house, 13 of my 14 rental properties, 15 of my 16 flips, and on a couple of my cars. I do not consider any of that debt bad, because I can use the cash from that debt to make much more money than the debt costs me. On this podcast I talk about why debt is not scary or bad, what type of debt is the best to use (Arms, 15 or 30 year mortgages), and how to find a lender that will lend you money.
Why are so many people scared of debt?
I think the idea of debt scares a lot of people because debt can cause problems. If you use debt the wrong way or get in over your head it can destroy people financially. Most people who get buried in debt are not using that debt to invest in things like real estate, they are using it to fund their lifestyle. You have to be very careful how you choose to spend the money that debt gives you.
Many people decide to spend as much money as they possibly can on a personal house. They talk to a lender who tells them how much they can qualify for, they go find a house for that much and buy it. I think people should spend much less money on houses than what the lender says you can. It makes it really tough to save money or invest in real estate if you are maxing out what you can qualify for on the house you live in. The same goes for cars and other goods. If you spend the maximum amount the bank will let you, you will have a very hard time saving or investing any money.
How can debt increase your returns on real estate?
Whether you are flipping houses or buying rentals, debt increases your returns. I can flip three times as many houses at one time using debt than I could using cash. While the debt costs me money, I make much more money on each flip than the debt costs me. My rentals make me $500 a month after I pay the mortgage and other expenses on them. If I did not have debt, I would make $800 to $900 on each property, but again I can buy three times as many with debt. Not only do I make more money per month with debt, but I have more rentals which means more tax advantages, more equity pay down, more appreciation, and more diversification.
How dangerous are adjustable rate mortgages?
Adjustable rate mortgages or ARMs got a very bad name during the housing crisis. I love ARMs for a number of reasons and I do not think they are as risky as many people make them out to be. During the housing crisis, ARMS were abused to help people buy more expensive homes. Lenders were offering 6 month or 1 year fixed interest rate periods, but the payment would shoot up after that fixed period was over. The buyers were only qualified to make payments on the initial payment and many houses went into foreclosure when the payments increased.
Most ARMs have a five or seven year fixed rate period today. That means the interest is guaranteed not to change for the first five or seven years of the loan. The initial rate on an ARM is actually lower than rates on 30 year fixed loans. While the rate can go up after five or seven year, the ARM actually saves money over a 30 year fixed loan in the beginning. On a five year ARM, the loan does not become more expensive than a 30 year fixed rate loan until about year 8 assuming the interest rates goes up the most it possibly can on the ARM. If rates do not go up, the rate on the ARM will not go up either. If you plan to sell the house or refinance it in 8 years or less, an ARM will probably save you money over a fixed rate loan.
Are 15 or 30 year loans better?
I also see many people get 15 year loans instead of a 30 year loan, because they save money on interest. It is true that a 15 year loan usually has a lower interest rate than a 30 year loan, but the payments on a 15 year loan are much higher than they are on a 30 year loan. You will save some money on interest, but you are also paying much more money upfront. The higher payment increases your debt to income ratios and makes it tougher to qualify for more loans. I am a fan of making your minimum monthly payments as low as possible, but paying extra if you want to pay them off early.
How can you find the right lender?
I use a portfolio lender for all of my loans. The lender is more flexible with their qualifications, but have fewer loan options. I can finance my flips, and rentals with local lenders when the big banks will not.