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For those of you who do property management - Financing?
I had a conversation with my BIL this weekend, who is getting into property management. For now, this means he owns two homes, rents them out, and lives in his parents' basement with his girlfriend and their baby. His choice for now, but he believes this will pay off. He is hoping to eventually make a living out of it.
Let me start by saying that I was a loan specialist for two years. Not nearly enough to make me an expert, but I do have some pretty good knowledge about mortgages and loans. Also we're in Canada, so our banking system is different than in the states. Below I'll explain what BIL is doing to finance his properties. When he explained it to me, I told him it was a terrible idea but he was told by his banker that this is the norm. Please tell me what Money Matters thinks!
Each of his properties is financed with a HLOC - Homeowners Line of Credit. The limit of these LOCs is 80% of the home's value. Example, each house is worth 200k, so he has two LOCs with limits of 160k each. He keeps these maxed out at all times. The minimum payment on these types of loans is the interest only.
BIL is collecting rent, but paying only the minimums on these LOCs. He is not touching the principal at all. He collects $1200 in rent per month for each house; puts $600 from each house per month on each LOC to cover the minimum payment, and the other $600 from each house he puts into a savings account. He plans to do this until he has enough cash for a down payment on another home, and keep doing the same thing over and over. Bascially, he never plans to touch the principal until he sells the property when he retires. He will keep carrying the loan balances.
Has anyone ever heard of this method or buying properties? It sounds insane to me. His debt ratio would be through the roof. What if he couldn't rent the houses out? What if the interest rates spike to 10, 12, 15%?
Re: For those of you who do property management - Financing?
What your BIL is doing is risky because you are right, if the properties couldn't be rented or interest rates spiked or if there was a major repair needed or any number of other cash depleting scenarios, there might not be enough to cover the minimum HELOC payments. At the end of the day, this is part of why we are in this housing mess! People leveraged their homes with the back stop being they could flip and sell at a gain to cover losses. I am very familiar with this strategy and several success stories but equally as many failures.
If this is your BIL is your sister working? If this is their only source of income and their only assets, I would be worried. If she is working and/or they have other assets then I'd worry less. Most of the "successful" scenarios work out where there is a salaried partner. Someone who works in a "day job" and receives a W-2, living within their means on the one partner's wages and essentially "investing" the other partner's income for the future.
If your sister isn't working, I'd encourage them to seek some financial advice. I like the book Making Sense on the Dollar (www.makingsenseonthedollar.com) it is an easy read to consider some of the pitfalls and potholes of what they may face in the future.
I have a hard time believing he'll be able to take on too many homes with this method. People who are in real estate and landlording for a full-time income typically buy their properties in cash, the people who finance are those who only manage one or a handful of properties. With more than a few his debt-to-income ratio is going to become high enough that no reputable lender is going to give him more money. They're also going to want to start seeing higher and higher cash reserves.
I don't think the idea of carrying the balance on the loan is inherently evil, but he's doing himself a disservice. Yes, his payments are lower, but his payments will be even lower if he pays off these properties (ie, zero, then all his money is profit). He'd have to be getting a heck of a return on the money he's saving to make that worthwhile.
Thanks so much for your input!
Bray, it's my DH's brother, not my sister's DH. SIL does work but from what I understand they're still in financial trouble.
ArcadianDreams, your last paragraph is pretty much exactly what I was trying to portay to him when we spoke about it last weekend. His savings are in a TFSA yielding 1.25%. Not worth it at all.
Thanks again for your opinions.