Is car debt bad debt? First time mortgage applicant, tips needed

[Jesse Olsen]

Howdy, Hope the detail proves to be helpful, I would appreciate all the helpful feedback I can get. 

Will be applying for my first mortgage loan in the next 5 months and want to ensure I am in the best position I can possibly put myself in. My highest hope is to land in a multi family property with a FHA loan 3.5% down, and use the renters income as a portion of the total income expected on the property, therefore allowing me to qualify for a bit higher priced property.

Bit about my situation

-Currently pay $1,450 for 2 bedroom apartment.  After electricity all 3 of us pay $500 a month. 

- Excluding the cost of rent, my total expenses are only $750 a month currently (Including Car pmt).

-Income: $2,200-3,000 depending on commission. $2,200 is base pay & guaranteed.  Been at job for 2+ years at this point and plan on staying for some time. 

-Current credit score: 650 Anticipated score in 5 months:710  (Just paid off last of my CC debt, Also my credit will no longer be a "thin file" in 5 months according to the bank)

-Total cash available for purchase of a property: $15,000-20,000

-Credit cards available to me if needed for repairs/misc: $20,000 

-Only debt to my name is a $3,900 car loan.   $140 a month. 

- Will have my Real Estate license by December.  In school now. 

My ideal outcome with multi family property.

-$1,900 Expenses/ Cost to maintain property/ Mortgage payment

-2+ bedrooms in all units.

-Rent out 1 side completely = $1,000 a month

-Side 2 will presumably have 2 rooms (Where I will be living).  I currently live with my long time girlfriend, someday to be wife, who will also be paying rent.  We will also rent out the spare room in our unit, maybe to her brother who lives with us now or a friend.  Either way expected income from this side is $1,200 if we are all paying $400 ($100 LESS! than we pay now).

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Keep in mind  my income will be right around $2,500 a month.  Minus the $750 equals $1,750 available.  If I only need to contribute $400.00 a month then yes, it is absolutely reasonable for me to get into a property where I am building equity and enjoying the benefits of being a homeowner.   Right?

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Questions

1.  Does where I'm going with this make financial sense in your mind?  I feel anything is better than dumping money down the endless rent hole.   I need to have a plan in action by December.  A cheap condo is my last resort. 

2.  I have the cash to pay off my car now. Do I pay it off thus freeing up $140 a month of cash flow, or do I keep the loan and continue building credit? 

3.  Do you have any suggestions for first time home buyers and building credit?

4. Do you have any other recommendations for a first time home buyer who is looking to build a part time- long lasting career in the Real Estate Investor world.  

5.  Any do's or do not's when speaking with a mortgage broker and applying for your first time?

Thanks for taking the time to read. 

[Jibran Najmi]

Jesse,

I’m guessing that the reason you have a 5 month timeline is that your lease ends right around there?

I am a newly licensed agent as well whose expectations started out very much aligned with your current expectations but have since aligned with reality. I originally started out wanting to buy a duplex where I lived in one side and the other side covered all expenses including the mortgage, interest, taxes, insurance, capex, repairs, maintenance etc., and STILL cash flowed $100. Unfortunately for me, I live in DFW, and that deal doesn’t exist. Realizing that I adjusted my expectations to simply wanting to breakeven………..and now I’m willing to accept -$250/month of cashflow in the worst case scenario.

While the numbers are important I would argue that the first two things that are more necessary to understand is your personal understanding/education & your criterion for investment.

I would say that more then 75% of the battle is figuring out what you truly are looking for, and from there you can easily determine whether that is realistic or not. For example, what class of property are you satisfied with? A? B? C? …..D..? What are your goals in the short & medium term and how do those align with this purchase? Do you have intentions of getting married and raising a family? Do you have kids? What types of properties are you just not willing to tackle? For example, prior to 1978 there were no regulations on lead based paint……are properties where you have to remediate that fair game?

Once this is determined, what do you personally know? BP is a great start. I’d check out biggerpocket.com/books and read every single on listed there. More importantly, what is your methodology for analyzing a property? There are plenty of gurus out there with their own magic rules. There is no silver bullet. Instead, my opinion of the best approach is that you take multiple metrics from the 2% rule, the 50% rule, Gross Rent multiplier, cap rate, financing terms, NOI etc. and overlay them side by side to get a true picture of how each property stacks up against each other.

If you have completed all of this then lets take a look at your numbers:

In the eyes of a lender, they will generally take your income from the past 2 years and average it. Lets assume its 2200 for right now. I would say that 720-750 is a good goal prior to obtaining a mortgage. The reason I say that is that while you are right - you are burning money on rent, a bad deal is NEVER better then no deal. In the long run, I would say it is better to spend an additional 6-12 months making sure your credit is perfect to ensure that you get not only the price you want but the terms you want. It does you no good to crush it on purchase price but then have a 30 year fixed mortgage at 5-7%.

While you mentioned numerous metrics for your ideal property, there is no purchase price defined. The bottom line is always defined by the top line. Further, if your girlfriend is about to be your wife, you may need a mindset shift and stop charging her rent, and instead pool your resources. If you feel paying off your car is smart, do so if and only if you feel its reliable enough to carry you through closing on this property. You also mentioned you're getting your real estate license by December - while I congratulate you on that decision as it will educate you immensely, unfortunately its going to add some money to your monthly expenses. You will pay a broker for carrying errors & omissions insurance, you will pay for centralized showing, depending on the broker you may for training, affiliating with the NAR and many other expenses. I would estimate (I'm in TX) around $400-500/month.

Building credit is a simple function of education. Understand what composes your score and work on the big ticket items: Pay your bills on time & lower your utilization ratio.

I can’t really speak to your situation without more details, but from afar I feel there are numerous things you need to define and address prior to buying a house. I feel like I may have come off as blunt or harsh, but it was not intended that way. I hope you will forgive me, and not hesitate to reach out if I can be a resource or of help in anyway. Congratulations on realizing early the power of real estate and good luck to you!

Jibran Najmi