Bad for a first time home buyer to start out with a big loan?

Question

Hi Everyone,

I am 25 and pre-approved with 5% down on a $499,900 two-unit multi-family unit in an increasingly popular neighborhood of Chicago--fifteen minute Uber to Wrigley Field, surrounded by tons of public transit, new restaurants popping up, etc.

Upstairs is a 3-bed 1-bath that I would live in, and downstairs is a 5-bed 2-bath including a basement. The entire mortgage would be about $3200 all-in, and if I could average just $500 per bedroom, that would cover everything. The entire building was bought in July 2016 for $250k, completely renovated, and now listed for nearly $500k.

My question is, is $500k just too daunting of a loan to get started on? In Chicago where housing is expensive, I don't have the option like a lot of other success stories on here to buy a house for under $100k, or a multi-family for under $200k, and then generate enough revenue to get other tenants to pay my mortgage. Has anyone else out there ever started out like this with a high-cost building in an expensive city?

Thank you,

- Derek

Derek Luttrell · Answer

@Ham Merritt I'm making $120k/year right now. No need to stress about my second property before even owning my first, but I'm just trying to keep my dream in mind of house hacking a new building every 3 years or so until I no longer step into an office every morning by the age of 40 :)

Derek Luttrell · Answer

HI @Sam Shueh--I am a logistics consultant, and I make $120k/year with an 805 FICO score. I have just shy of $40k in cash saved up, and I easily save $3-4,000 every month while currently paying $1000/month in housing.

If 4 of the 7 bedrooms went vacant for a while and I had to cover the remaining $1400 payment myself, it would not stretch me too thin. What other advice/questions do you have?

Sam Shueh · Answer

What do you do for living, profession or income? If you have 50% vacancy can you make it?

I am in Silicon Valley where most application developers make ~$130K+ plus lots of stock options. Those singles who live 20-30 min away from Google, Facebook headquarters have bought from me for 650-800K with 20%+ down. Most are in late 20 or in the 30s highly educated & skilled. Most receive gift money from parents to get started. A few have roomates paying like $1,000 per room.

Derek Luttrell · Answer

Thank you everyone for the input and wisdom. I actually walked the property today, and in one unit the third "bedroom" was a glorified pantry without a closet, and the laundry room was communal with the top floor tenants having to go outside to access the door leading to it. They also didn't even bother putting in garbage disposals, which I know renters look for.

Tomorrow I am going to an open house steps from Wrigley Field for a 3br unit listed at a less intimidating $375k. Rent there also easily clears $1000/bedroom (especially after the Cubs winning the World Series last year). The hunt for my first deal continues!

Shawn Ackerman · Answer

@Derek Luttrell Sounds like this deal is priced at the top of the market or fairly close. Not a good idea unless you can point to some solid indicators that it will appreciate. Not easy to do....With respect to post purchase risk. If you have 12 months reserves that will cover the debt service, taxes and insurance then I'd say proceed but if you have a penny short of that then I'd walk as a first deal. What are the landlord tenant laws on the books in that market? Here in NY tenants can squat for 6-9 months before an eviction. If the laws are anything similar to that then I'd also advise against it. That's my $0.2 without seeing the full picture/numbers on the deal.

Thomas S. · Answer

Based on the information you have provided the property is a poor choice as a rental investment. With a value of 500K and estimated total rents at only $4K the rent is far too low to make this a worth while investment.

Your approach is out of step with "best practice". You should be investing in a habitable property that you can upgrade to force appreciation not purchase one that someone else has already done.

Also keep in mind equity can vanish in a heart beat (market adjustment) so don't put your eggs in that basket.

You need cash flow that this property can not provide.

Lumi Ispas · Answer

@Derek Luttrell , it seems to me that you are looking to buy for the long haul. Let's look at this building 20 years from now and assume that whatever you buy the rental income will cover 100% the mortgage. We'll look at a 300K worth building versus 500K worth building with zero cash flow.

So the question is:

Twenty years from now, looking back would you be happy to have paid off a 500K building or a 300K building? Also, rents keep going up and a 300K building will have lower rents compared with a 500K building.

Let's see what you'll get 20 years from now:

• You get leverage: Control a half a million dollar building with 25K downpayment versus 300K
• You are paying off a half a million dollar building
• You are getting 7K/year in tax savings due to depreciation, and over 20 years that's $140,000
• High rents, will give you a large cash flow by the time the building is paid off.
• A 3 flat that's worth 300K versus a 3 flat that's worth 500K have the same 3 tenants to deal with, 3 kitchen, 3 bathrooms, one roof, etc...

Do you start seeing the big picture here? And I did not even mention Appreciation. Historically, properties have doubled in value every 10 years, let's say your property doubles in value in 20 years. Would you prefer a 300K doubling to 600K or a 500K doubling to one million?

If I was you, the only question I'll have to my lender would be: "What's the maximum loan amount I can get? :)

Derek Luttrell · Answer

@Michael Facchini that's awesome and reassuring to hear how you started expensively in Lakeview.

Assuming you lived there once you bought it, how long did you live there until moving out and onto your next property? What was your next REI move?

Sam Shueh · Answer

Possibly settle for a smaller property with less $ obligation. I would like to enjoy life more and travel if I was your age. Also 5% down is hard to get sellers interested as many sellers want higher down for a sure closing, if the market is hot. An offer FHA mortgage with 5% down just fell through. We are taking someone with 20% down conventional for less on a SFH here.

I actually lived in Chicago before. Never saved much being single living in north side -Lincoln Park-Clark. Your project seems to be ambitious.

Do you have parking for all these roomates? Do neighbor object or having code restriction renting out to individuals? As a professional I have witnessed objections having too many cars and get into shouting and gun fights by two neighbors.

Michael Facchini · Answer

Derek, I wouldn't necessarily say that's a bad thing. Depends on your income, debt-load elsewhere (auto loans, student loans, credit cards, etc.), how fiscally responsible you are....and most importantly, we're talking about a multi-unit here. Some credit needs to be given to the fact that you're buying a good investment that will reduce your monthly outlay. The first property I ever bought was a 2unit in Lakeview (Belmont and Ashland), $675k, and I was 23 years old. It kicked out a bunch of rental income and put me in a great financial position each month....and over time, to this day. 15 years later I still own it and it's one of the best investments I've made.

Many of my clients are your age and buying properties in this price range (including condos or townhomes), or even higher if a multi-unit. I don't think it's as simple to say whether it's a good or bad idea to be 25 and taking on a loan this size....there are many other factors at play which help determine if the decision is responsible. Hope that helps!

Bad for a first time home buyer to start out with a big loan?

Bad for a first time home buyer to start out with a big loan?

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