The Real Estate Investing Podcast

with Mark Ferguson

086: How to use Debt to Make more Money

[0:00:58.9] MF: Hey everyone, it’s Mark Ferguson with InvestFourMore. Welcome to another episode of the InvestFourMore real estate podcast. I have a lot to talk about today. I want to talk about debt and how to use debt, if you should use debt, if it’s a good idea. I’ve seen some post on Facebook lately about the attitude people have towards debt.

I think so many people are scared of it and worried about it ruining their lives that they don’t see the benefits of debt and how awesome it can be if used right. But you do have to be careful with it as well. So, I’m going to talk about that and we talk about what kind of debt to use, adjustable rate mortgages, 15 versus 30 year loan terms, and then kind of how to find the right lenders. My preference is portfolio lenders, what those are and how to find them.

We’ll talk about all of that stuff very soon. Before we get going too much, just want to let you know, I do have a new rental property under contract. It’s been a while, since September of 2015 since I bought a rental property. I have another one under contract finally, I have not been buying rentals because our market is so crazy in Colorado, prices keep going up, they have not stopped, they have not slowed down but rents have not come close to staying on par with values.

So it’s really hard to cash flow, really hard to find good rentals that’s why I’ve been focusing on flips, been thinking about investing in other markets. But a couple of weeks ago, I got a commercial place under contract. So, very different from what I’ve ever done in the past. It was listed at $110,000, I’m hoping it will rent for at least $1,500 a month, possibly even more. It was a fantastic deal form what I know.

Maybe I will find out it wasn’t such a fantastic deal once I get into it and start trying to make the property perform. It has an owner occupant in it now who will be moving out so I will have to find a new tenant for it. But it’s a retail space with a shop off the back so definitely a lot of different uses that can go with it and it’s in relatively good shape. Really excited to start that process.

Speaking of lending, I have to do a different loan because that’s a true commercial property, kind of different amortizations. Most lenders don’t want to do 30 year amortizations on some commercial things. Probably won’t be able to do a none balloon payment. I’ll have a balloon payment after five years which means I have a 25 year amortization, maybe even a 30 year amortization. But in five years the lender can call the note, completely due. That’s what a balloon payment is.

So you’re really only guaranteed to have a loan for five years, but it’s based on a 30 year term for calculating your payments. So I’ll definitely have some more updates in that property. Set to close on that in a couple of weeks in the start of February, so that will be awesome and then you guys will actually be listening to this podcast while I am on vacation in Turks and Caicos. That’s an island in the Caribbean. Been there before, awesome place so I’ll be having lots of fun there relaxing, being on the beach while you guys can listen to this and hopefully learn a little bit.

All right, so let’s move on to debt. Like I said, there’s a Facebook post, someone asking, “Do you like debt, do you think debt is a good thing?” Which is always interesting. I like questions like that, it gets people talking and I would say the vast majority of people were completely against debt, how negative it is, how horrible it is, how it sucks the life out of you and then not just credit card debt, not just car debt but debt against houses as well.

I think people get caught up in how long the debt is, how much interest you’re paying, all the negatives about debt but they don’t think about the positives; what debt can do for you, how it can make you money, how it can multiply the money you make. But, you’ve got to be careful with that as well. You can’t go crazy with debt, you can’t get yourself so far into debt that you can’t make your payments, that you can’t save any money. There are many things to watch out for when you’re dealing with debt.

So, debt on houses to me is great. I think it allows you to do so much more with your money than paying cash. For one thing, interest rates are super low now still, 4% now for owner occupants, maybe a little higher for investors. If you can lock those rates in for 25, 30 years, that is a really good plan as far as I’m concerned. Because rates will probably go up a little bit, I don’t know how much, I don’t know how fast, but they’re so low right now.

I mean, we have been spoiled the last five years with how low rates are. Lowest rates in the history ever and it’s such cheap money. It really makes it hard not to want to use debt, especially for rental properties, for your house because it’s just so low. When you’re buying as an owner occupant, you do have to be careful how much debt you take on. Because as an owner occupant, when you live in that house, it’s most likely not bringing you any income, it’s not making you any money if it’s just a single family home, you’re living there with you and your family.

A lot of people will go to lenders and say, “Okay, how much money can I qualify for how much house can I buy?” And the lender will give them the maximum amount of money they can qualify for. Maybe it’s $200,000. You can qualify for $200,000, the people go out and say, “Okay, great. We can buy a $200,000 house.” But they don’t think about how much that payment’s actually going to be, if they’re going to be able to save any money after making that payment. Plus there’s a lot of cost that go with buying a house besides just sheer mortgage payment.

You’ll have taxes, insurance, you’ll have to maintain the house while you live there. You might have some repairs on the house while you live there, you’ll have utilities while you live there. There’s all types of things to consider when you’re buying a house as an owner occupant. My rule of thumb has always been, do not buy the most expensive house you can. It makes it really hard to save money, and if you want to invest in real estate, it makes it really hard to buy other properties as well. Because when you’re buying rentals, even when you’re flipping, if you’re maxed out with your debt to income ratio on your personal house, really hard to get any other loans.

My rule of thumb, I’ve always tried to live by is to make my mortgage payment on my house be 10% of my income. A lot of banks will go way higher than that. Much, much higher. If you can go 10% of your income, which is not easy, it’s tough, it leaves you money to save up, it leaves you money to invest in other things and you should be able to qualify for another loan for rental, maybe even get a shorter term loan for a flip.

So be careful when you’re buying a personal house. I think a lot of people is kind of blindly follow their real estate agent, blindly follow their lender, and they don’t think about how much that payment costs them, that they’re going to be able to save money, what it’s going to do to their lives. Speaking of that, I do have a new book that I’m working on, hopefully it will be out soon on the basics of buying and selling houses, which goes into a lot of that, just how smart it is to finance houses but taking your time to actually make sure you get a good deal. Don’t just blindly follow people who tell you, you should buy a house and just do whatever they say. Take control of the process yourself.

All right, now with rental properties, debt is a completely different tool. You ware using that mortgage to make you money. So on a good rental property, your rent should cover the mortgage, the taxes, the insurance, maintenance, vacancies, utilities, all of the expenses that come up and have some money left over. So you should be able to use that debt to make you money every month. Along with that, you’re paying off the debt slowly over many, many years. So, yes, it’s going to take you a long time to pay off that debt if you make the minimum payments but you’re going to be making money with that debt.

Yes, you’re paying a lot of interest to the bank but you shouldn’t be concerned with the interest you’re paying to the bank. You should be concerned with how much money you are making in your pocket, you should be concerned with the profit you’re making. How much money are you making compared to after all the income comes in, all the expenses go out. If you’re paying a lot of expenses and interest, that’s okay if you’re still making money. Kind of like people who get tied up in paying too many taxes because they make a lot of money.

Some people will think, “I don’t want to make very much money so I’ll have to pay so much taxes on it.” You don’t need to worry about how much in taxes you’re paying, you need to worry about how much money is staying in your pocket. Taxes are a really good thing, if you’re paying a lot of taxes, that means you’re making a lot of money and a lot more money is staying in your pocket. Always try anything about the profit, not how much money you’re paying to other people, not how much the expenses are and trying to reduce the expenses, think about the profit coming back to you.

Now, if reducing those expenses increases the profit, great. But a lot of times just blindly reducing those expenses without thinking about the consequences can reduce your profit and that is not what you want. So debt on rental properties can be an amazing tool, an awesome tool and it will make you more money if you buy the right properties. You can buy multiple properties with multiple loans and the benefits of rentals with their tax advantages with paying down the debt, cash flow coming in, possible appreciation and getting a great deal by buying below market value and that is really hard to do in almost any investment, any industry and to be able to do that with houses is just a huge advantage.

The more houses you can do that on, the better off you’ll be. So buying more rentals the right way with financing is almost always better than using cash to finance those properties. Something else to think about when you use cash to buy even your personal residence or renal property, it is not easy to get that cash back out. It is not liquid, you cannot just go to the bank and say, “Hey, I want to get a loan today to take some money out of my house.” You’re probably going to have to refinance it, you may have to sell it. Maybe you can get a home equity line of credit but those are not long term loans.

A home equity line of credit may only be a couple of years long, maybe five. The rate can go up or down usually with those and there will be fees to take that money out. If you refinance the property, you’re going to have to qualify for that refinance just like you would any other loan. You’re going to have good credit, you have to have a steady job for the last two years most likely, good debt to income ratio. You can’t just go refinance a house because you don’t have anything against it and expect the bank not to have the same qualifications as someone buying a new house.

They’re going to be almost exactly the same and that loan is going to cost you two, three, 4% in closing costs of the amount of the loan, which means if you got a $100,000 loan, it might cost you three or $4,000 to get that loan, to pay the bank, their origination fee, prepaid interest, prepaid taxes, prepaid insurance, closing fee, title insurance, there’s all types of cost that go into that and it can take 30, 45 days to complete that refinance. It is not a fast process. A lot of people have paid cash for houses, changed jobs, retired, thinking they could refinance it very easily, come to find out, they could not refinance it. They had to sell the property, get the cash out and when you sell, there’s costs as well.

You’re going to have to pay six to 10% for all the costs when you sell it, real estate agents, closing fees, repairs, maintenance, anything you need to do before it’s sold. There’s a lot of cost that come with selling a house. So it’s not easy to get that cash out if you need it when you pay cash for rental property when you pay cash for even your personal house. So if you’re saving up all your money, hoping to pay cash for property and you’re using most of your cash you have to buy that property, you need to rethink that.

Maybe it’s a better idea to get a loan, put much less money into the property, save that cash, either invest in something else, emergency fund. Whatever it is, use that money to make you more money, not just to pay cash because remember, with interest rates at four, 5% and you’re paying all cash per properties, that means you’re saving or that money’s making you about four, 5% return, which is not very good. You can do much better especially if you’re investing in real estate.

All right, so, assuming you want to get loans on houses, you see the value, you see that debt is not always bad, what are the types of debt out there? So I guess before we get into that, we should talk about there can be bad debt as well. If you’re using debt to buy furniture, if you’re running up your credit card debt like crazy for extravagant living, yes, obviously I think that is bad. That is not a good use of debt. But I don’t want you to think car loans can be bad debt if you had to buy that car anyway and you can then use that money you saved to invest in properties.

I don’t think credit cards can be bad debt if maybe you’re using that credit card to flip a house, you use it to buy materials, you used it for the down payment, whatever it is. You know you’re going to make much more money than the interest that debt cost you when you flip the house. That’s kind of how you have to look at debt. If you get that debt, what are you going to use the cash for, how is it going to make you more money and it’s going to make you more money than the interest, fees, closing costs of that debt?

Now, if you’re using that debt to go on vacation and do silly things that are not going to make you any money, it might not be wise to get that debt. But if you’re using it to invest, buy more cash producing assets, debt can be awesome. Whether it’s credit cards, houses, cars, but really analyze how you’re using that money you’re saving, what you’re going to do with it.

All right. Now most loans on houses are 30 year mortgages. There’s also 25 year amortizations, 20 year amortizations, 15 year amortizations and what that is, is basically how long it takes to pay off the loan. If you get a 30 year loan, that means you make the minimum payments every month, that loan will be paid off in 30 years. If you get a 15 year loan, you make the minimum payments every month, that loan will be paid off in 15 years, pretty simple stuff.

A lot of people think 15 year loans are the best, a lot of lenders will push 15 year loans as a best bet as safer because they say it saved you so much money and interest. Yes it does save you some money and interest, however your payments will be much higher every month on a 15 year loan. While you're saving money in interest over the years, you’re paying almost as much money extra in payments every month and you will pay a slightly lower interest rate on a 15 year loan.

But to me, it is not worth the extra payments and one reason is the debt to income ratio, if you’re trying to buy rentals, if you’re trying to buy properties, banks will look at your debt to income ration, which is how much income you have coming in every month versus how many debt payments you have going out every month. If your debt to income ratio is too high, they will not lend to you. A 15 year mortgage will make your debt to income ratio much higher, make it much harder to get new loans. So while you may pay slightly less in interest, I think the financial flexibility of a 30 year loan is much better.

If you want to pay off a loan earlier, you can pay extra payments into that loan. You don’t have to, but you can. If you have a run to financial problems where you’re not making as much money, you get laid off, the payments on a 30 year loan will be lower, it’s going to be safer, it’s going to be easier to make those payments in the future than the 15 year loan.

Again, accessing the equity in your house is not easy. So if you have a 15 year loan, you’ve been paying it down for a couple of years and you have all this money saved up in that loan but you need it for some reason, you’re going to have to refinance, get a home equity line of credit, sell the house to access that money.

So my thoughts have always been a 30 year loan is more flexible, has lower minimum payments which help in case of emergencies, help your debt to income ratio, make it easier to invest in more properties. If you really want to pay off your loan faster, you can make extra payments in that 30 year loan. But if something changes, you can stop, which is really nice. I’ve always liked the 30 year loans for that reason. A lot of banks kind of push to 15 year loans but I don’t think it’s a great choice for a lot of people.

Another thing to look at are adjustable rate mortgages. On my rental properties, I have 14 rentals now, all of them except one that’s paid off, have an adjustable rate mortgage on them. An adjustable rate mortgage, that means the interest rate can be fixed for a certain amount of time, say five years, seven years, 10 years. But the loan term is still 30 years, maybe 25 years. So the payment, won’t be paid off for 30 years, but your interest rate is only fixed for five years.

Say my interest rates four and a half percent the first five years on the sixth year, that rate can jump up. Now, it’s not guaranteed that rate will jump up. If rates have not gone up in the future, if they’re still steady, your rate’s probably going to stay the same, that same 4.5% in that sixth year. It only goes up if rates have jumped up as well. Another thing to consider is the rate will not jump up 10% in one year. There are limits to how fast the rate can go up.

So I think with my lender, it’s either can jump up 1% for four years or five years to a maximum of like 8%. So it can jump from 4.5 to 8.5% but it can’t do it all in one year. It takes four, five years for it to go up in that entire amount and rates would have to go up at least 4% from where they are now for it to go up that maximum.

That seems very risky to a lot of people. Like, “Oh my gosh, rates are going up like crazy, my ARM’s going to go up, my payment’s going to go up.” However, I still don’t think ARMs are that risky for a couple of reasons and one of those is, your payment is going to be much lower in the beginning than the 30 year fixed rate loan. Your interest rate will actually be lower than a 30 year fixed loan, which means your payments will be lower, which means you’ll be saving money for that first five years with that low interest rate.

You can use that money, build up your emergency fund, invest it in something else, build up reserves on your properties. So if your payment does go up, you aren’t out of luck because you have no money to saved, you can’t afford those payments. Another thing is, when your payment does go up, it’s re-calibrated on your new loan balance, what your loan balance is in the future, not on what your original loan balance was.

So if you paid a little extra towards it or maybe other factors come to play, your payment might not be that much higher than your current payment when the rate adjusts. So if you take into consideration the lower interest rate for the first five years, seven years, whatever. The ARM fixed rate period is compared to the rate jumping up the maximum amount it can every year.

You’re saving so much money in those first five years, you usually won’t start paying more on an ARM until two or three years after the fixed rate ends. For example, on my five year ARMs, you know, if I paid the minimum amount, the rates jumped up as high as they possibly could on the sixth, seventh, eighth year, I think I start paying more on that adjustable rate loan mid-way through the eighth year than if I would have had a 30 year fixed loan with the same higher rate the entire time.

So if you’re planning to keep that property, more than eight years, more than 10 years, maybe a fixed rate loan makes sense. But if you’re planning to sell it or refinance it faster than eight years, you’re going to save money with the ARM, which is another reason to think about the adjustable rate mortgage. I have been refinancing my properties quite a bit because I buy them below market value, get awesome deals on them, the loans are being reduced every year by my payments and rents have been going up.

So I can refinance them, keep the same cash flow, take cash out, buy more rental properties with them and that kind of starts over my loan term where I have another five years, maybe seven years of fixed rate loans, I don’t have to worry about my rate going up.

Another thing I always think about too is I’m not super tight financially to make payments. I have reserves, I have money saved up. I know I can make those payments if they go up, I can’t refinance, I don’t sell the properties for some reason. If my payments go up, I am going to be okay with making the extra payments even from the cash flow, from the rent I have. I have enough cash flow to cover those extra payments. Think about that as well, if you are using an ARM because you can qualify for a more expensive house, I think that is extremely risky.

I don’t think ARMs are a good tool to use to buy more expensive house because the payments are lower. I think it’s a good tool to use to save money, make extra money on houses you can easily afford. A lot of times with your personal house, that’s what happened during the housing crisis that’s why ARMs got a bad name was Shysters were giving people really short term arms, one year, six months, fixed payments and the payments would double after a year and people didn’t know that, they don’t know what’s going on and they made such short term ARMs because the payments are really low to begin with.

That allowed them to qualify for much more house than they could otherwise. Once the payments jumped up, there’s no way they can make those payments, houses went into foreclosure. Those ARMs don’t even really exist anymore, it’s actually a much safer loan that a lot of people give it credit for, so it’s something to consider. Another reason why I use ARMs, like I said, I have a lot of mortgages I my name right now and for those who are investing in a lot of rental properties, once you get four mortgages in your name, it becomes much harder to finance properties.

The big banks don’t want to finance more than four mortgages, some of the smaller banks will go up to 10 but your down payments go up, your credit scores have to be higher, much more strict on giving loans when you have more than four mortgages. Because of that, I started using local banks, which I call portfolio lenders, to finance my rentals. They still allow me to do 20% down weren’t as strict on a lending guidelines, really easy to work with. Super easy to work with.

They’ll finance more than 10 loans and there’s lots of local banks, credit unions, all across the country who love to finance investors. My portfolio lender also finances my fix and flips on one year term loans, really great to work with but there’s some drawbacks to using those local portfolio lenders. One of those is, on rental property loans, they won’t do a 30 year fixed loan. They will only do a 15 year or ARMs. Five year fixed rate ARM on a 30 year amortization or seven year fixed rate on a 30 year amortization.

So I don’t even have the choice of doing a 30 year fixed rate loan. That’s another reason why I do them. But again, it doesn’t bother me using an ARM because it’s cheaper, it makes me more money in the beginning, and it doesn’t get more expensive until like that seventh or eighth year I’ve owned the property and almost all of my properties I will have refinanced to change the financing on, even sold a couple, by the time I get that far into it. So it doesn’t bother me; seven or eight years, the rents are going up as well, they should be able to cover that increased payment if it does come around.

So portfolio lenders are awesome but they have their drawbacks. Another problem too is not all portfolio lenders will do the 30 year amortization, some will only do 25, some will do 20. It takes some time to find them, takes some time to figure out who to use for your financing. I’ll give a few quick tips here on how to find a portfolio lender, I’ve got articles that go over all of these things we’ve talked about; debt, adjustable rate mortgages, 15 versus 30 year mortgages, portfolio lenders, how to find them.

So I’ll link to some of those in the show notes as well. I cover them in my book, Build a Rental Property Empire in depth, really go through that a lot. Finding a portfolio lender, first thing I always do, ask references, you know? Friends, family, other investors, real estate agents, even lenders. You know, some lenders will tell you they can’t loan on houses, don’t be afraid to ask them well, do you know how can? Do you know a local banks who are more friendly?

Title companies, anybody in the real estate industry, you can ask them if they know local lenders who like to loan to investors. That should give you a few names if you can’t find any in that way, you can search online, portfolio lenders, for local banks, try and find banks that are local to certain communities to at least local to the states. The smaller they are, usually the more flexible they are, you can go to REI meetings, real estate meetups, try and find other investors, talk to them about who lenders are, they may have lenders come talk to those meetings. So many ways to figure out who is lending on properties.

Another way is if you see people buying rental properties, you know investors who are buying rentals, even buying flips, a lot of times you can check public records to see if they’re getting loans in the properties and who their lender is. So if a lender is loaning on flips, there’s probably a good chance they might have their own rental property programs, vice versa, and if you know very active investors in your area who are buying a lot of properties, some of them might be paying all cash but many of them also might be getting loans and you can look up who they’re getting their loan from, contact them, go from there.

It’s important to know when you talk to a portfolio lender, they want to make sure you’re serious, hopefully you’ve bought some investment properties in the past. That’s the first way to get in the door, let them know you have experience, you’ve done it and really, that’s the best way to let them know you’re serious, have examples of properties you want to buy, examples of cash flow, they want to make sure that property is a good property and that you’re a good person to lend to as well. So if you can show them you’ve got cash flow, getting really good deals, they’ll be much more likely to lend to you than just saying I’ve got good credit and a good job.

All right, that is all I’ve got for the financing aspect, hope that helps. Again, don’t be afraid of debt, just be careful with how you use it, be careful that the money you’re making with that debt is more than a debt cost. Try to make sure that you’re cash flowing on your rentals. Don’t be afraid of Arms. Again, look at the situation, write out the numbers, figure out how much they’ll cost you versus a regular loan if it’s worth it or not.

Again, I think the flexibility of a 30 year mortgage is so much more beneficial than a 15 year mortgage. I like to do the longer term debt as I can. The longer the debt is, the better for me, on cars, on houses, all of that. Just because the payments are lower, it helps cash flow better, just a better situation for me. If you can find a portfolio lenders that will lend on rentals or flips, amazing partners to be involved with.

So even if you have some good lenders now or you’re not in a position where you need a portfolio lender, keep your ears out, keep your eyes out, begin looking for them in case you need them in the future.

All right, thank you all for listening, hope you enjoyed this episode. If you have any questions, please comment below. You can always send me an email as well, [email protected] and I hope everyone has a great rest of the week.