Good Debt: Yes, There IS Such a Thing!

Until now, I’ve always written about real estate for homeowners. I’m going to depart from that area for a change and talk a bit about real estate investment basics. This one is written for your average Joe who is richer than they think.

I would venture to say that most people don’t outright own their homes. In fact, I’m sure of it because I look at a lot of title searches in my job and they usually say that such and such bank or lender has mortgage rights to the property. It doesn’t say how much, but I sometimes wonder if the equity in a home is going to waste. (If you’re new to the real estate world, the simple definition of equity is the value of a property minus the outstanding balance. More on this important term below.)

You see, the equity you have in your existing home can be used to buy you an investment property which could easily make you quite a bit of cash if you play your cards right. I am typically aware of a handful of properties that are being rented out for more than it costs to pay the mortgage, so if you get the right tenants, and the right property, it’s pretty low risk compared to other kinds of investment and offers a good return.

As the value real estate has dropped a bit of late, sometime around now or the not too distant future is going to be the best time to buy investment properties.  Savvy investors have been sniffing around for the past few months looking for those sellers who NEED to sell. Such sellers have subsequently priced their home very low to beat all the competition out there.

Of course, both buyers and sellers and people who are only pondering these matters want to know when the mystical bottom of the market will reveal itself so that they can get just the right timing. Truth is no one can know when this is until a few months after the fact, so don’t let anyone tell you they know with certainty what the market will do next. We know it will go up and it will go down, we just don’t know when, but there is something to be said for keeping your finger on the pulse. Certain general short term predictions tend to be in the right ball park but long term ones are more speculative. One of the good things though about real estate vs. stocks and the like is that stocks can have big changes in a day, and real estate takes months or years to have big changes in value and in the case of the type of investment we are exploring here, you can make revenue in the meantime. This is not your flipping houses or assignment of sale on an unbuilt condo make a ton of cash in a couple of months kind of scheme. Those kind of investments are not for this kind of market, and they’re not for people who don’t know a lot about real estate. This is a safer more gentle method of investing in real estate for people who have normal steady jobs and want to get more out of their assets.

It’s time in this post for a little case study. Keep in mind that although I’m doing my best to use typical numbers and real examples here, what is available to each person WILL VARY and therefore so will the numbers.

Let’s say you bought Nanaimo’s most statistically average house in 2000. You paid $150,410 for that house. Actually, for the sake of simplicity let’s round that off to $150,000. You put down a solid 10% down payment of $15,000 and got a mortgage for the remaining $135,000. You’ve been a good boy/girl and made all your payments on time. You still owe $125,000 on your home (The payments for first few years in most mortgages are mostly interest.) but as your statistically average home has increased to $364,163, (or let’s say $364,000) as of November ’08, the equity in your home is worth $202,600. (The Banks calculate your equity as being 90% of the home’s value minus what you owe on it.) This is your leverage that can be used to make you some serious cash in the long run if you have the patience to do a little homework and go through with doing some investing. Of course, there are also those who own their homes outright, and in that case the equity would be 90% of the total market value of that home.

Let’s look at what this equity of $202,600 can do for you rather than just sitting there collecting dust so to speak.

I know of a listing in Nanaimo right now that is being advertised as having an upstairs and a downstairs, each of which are rented out at $750/mo for a total revenue of $1500. Of course in addition to mortgage there are things to consider like taxes (about $150/mo. in this case) and upkeep which will vary from month to month. If you decide that utilities are to be included in the rent, this will also have to be factored in.

The property is currently listed at $239,900 but let’s be conservative with how much you can negotiate it down for, say you get it for $235,000. As you are using your home as security to purchase another property,  in this (example) case you are eligible for a 35 year variable rate mortgage at the current rate of 4.5%. (Ask your lender about variable rates and when to “lock in” and when not to.)

This works out to a payment of $1076 per month.

With a revenue of $1500/mo this leaves lots of leeway for paying taxes and what have you after you’ve paid the mortgage payment. I do recommend though that the extra few hundred dollars you have left over each month be saved/invested in a way that lets you access it if you need it. This is so that you have some savings put away in case they are needed to pay for maintenance on either property. As with any investment you want to make sure you can afford it. Make sure you’re in a position to make payments for a couple of months if and when the place is briefly vacant and be able to pay for up keep once in a while like new windows or new paint etc. At least until you feel you have enough saved. You may have all this already though ad not even know it. Talk to your financial advisor. If you don’t already have one, get one. They are sometimes the same person who can set you up with a mortgage by the way.

Here’s where it starts to get fun and all this dry reading (my apologies) you’ve done so far is starting to pay off. Someone else is paying your mortgage for you while they are living there. That’s a sweet deal!

But here’s my favourite part:

Property values increase over time.

Yeah yeah yeah… I know what they’re saying in the news. Better than they do in fact. But here’s the thing, the prices go up and down in the short term and go up in the long term. Don’t believe me? Look it up. You can start with the local info here.

So, I’ll say it again. Property prices increase over time, so however much the property value increases over the next however many years is bonus cash for you. And remember, someone else is paying for your investment. AND as the market is in a down shift right now, there are more bargains to be found. Like I said before, you can try to wait for the mystical bottom of the market, but no one knows exactly when it is until a few months after the fact. But there are deals like this out there right now, and if you put it off too long waiting for the ultimate bargains you will realize you missed the boat when they start to disappear.

But despite all this info, if I know most people I know that they’re still uncomfortable with what future markets hold. fter all, we’re constantly hit over the head with bad news about it from the media that just makes us afraid of it but doesn’t help us understand it one bit.

So, just for fun, let’s  say that you get the 35 year amortization, and during that time the very nature of real estate values and inflation enter some strange dark eternal winter. You rent the place out for 35 years, never increasing the rent because there’s no inflation in this strange time and the value of the property remains the same the whole time! (Oooooh…. it’s like an X file! Cue the eerie music.) Financially speaking, the property turns out to barely break even because you have 35 years of bad tenants and there’s all sorts of problems with the place. Oh no!!!

But guess what…

You now have a free house that is worth $235,000, and you got it for free.

Now, just what kind of retirement do you think you could have with that kind of money?

I could think of a few things I’d do with it…

Do you think it might be worth talking to your mortgage broker about this?

I don’t think anyone is so busy that they can’t at least look into something like this to see if it’s feasible for them.

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