What financial situation do you recommend before buying a rental?

Question

My wife and I make about $100,000 a year total, we have ~$38,000 in student loans (total), we have no other debt, and we'd like to get started renting out properties.

We currently live in a two bedroom apt that we only rent for $760 a month because my wife works for our apartment property management co and we get a rent discount.

Though we'd like to own our own home, passive income generation is a higher priority to us at this point.

So we'd be OK with keeping our rental situation and making our first home purchase an investment property.

Do you all think we should be debt free before investing in a rental?

Shane C. · Answer

This is a completely personal decision, in my opinion, and I’d largely echo Andrew. I have a small portfolio of properties and am in no way out of personal debt. But, I have a decent W2 job and my properties cash flow pretty well. Also, I am not risk averse. When you think about rental investments, you have to think about what they represent. How much can you miss out on if you wait years to pay off those loans? I think there’s a huge opportunity cost in waiting, but that’s my personality. I’m sure there are plenty of investors that would have recommended that I not invest in real estate when I did. There are probably many others that would say I waited too long. Long answer made shorter, this is too much of a personal decision to get the “right” answer in a forum. Good luck!

Nicole A. · Answer

@Harrison Alley How much savings do the two of you have? Seeing that you have a nice low rental payment, you could potentially keep that low cost of living by purchasing a property that has 2, 3, or 4 units in it. Live in one unit and rent the others out. You can get a primary residence loan on a property that has up to 4 units in it. With a primary residence loan, you will have a lower down payment of either 3.5% or 5% of the purchase price. You'll need to show that you have cash for the down payment as well as cash for closing costs, although you can negotiate with the seller to pay some or even all of the closing costs to minimize your cost out of pocket. Also, some credit unions are offering 0% down loans but might be picky and only do it for a single-family home (vs. a multi-unit up to 4).

Quincy P. · Answer

Harrison Alley as a person that is in CC debt and have student loans you are in better shape than I was when I started. As people have pointed out make sure your getting the best interest rate on that student loan debt first. The next thing is how much cash you have to put on a property? If you are a first time home purchaser you can possibly take advantage of the 5% down or less(don’t quote me on that) FHA loan. If that is the case go big! I mean a 4 plex if you have the cash on hand for it. I have done this and it works. Not a first time buyer, but moved out of my primary and living in my 4-plex that I put only 6% down on. Without this move I would’ve not been able to afford the building. Now I have no increased my purchase power instantly without a job change or pay increase and set to recoup my down payment back in 18 months. There may be some private loans or some no money down moves that you can do, but I never understood them so they just saved cash and tapped my 401K. Checking the options I had for my retirement funds saved me and made this possible along with @brandon turner by a property in 3 months challenge. Hope this helps, good luck, and take action!

Caleb Heimsoth · Answer

Harrison Alley 5k probably isn’t enough even if you go the FHA route. Your closing costs will be higher and you need reserves. I’d keep saving or pay off your other debt

Caleb Heimsoth · Answer

Personally I’d recommend, no other debt, 6 month living expenses reserves and reserves for your property purchases.

Andrew B. · Answer

when considering student loan debt you only need to worry about 3 things: your personal risk tolerance, the interest rate on those loans, and your debt to income.if you will lie awake at night worrying because you have a vacancy and student loan payments to make, pay them off first. If you are comfortable leveraging yourself more, no need to pay them off.if you are paying 10% interest rate on your loans, and your rental property gives you 9% cash on cash return, you should pay off your loans. if your rental can give you higher returns than your loans, is the extra effort worth it. paying off loans is a risk free return and requires no extra effort. if your loans are 6%, and the rental gets you 7%, you should pay off the loans. but if your loans are 6%, and the rental gets you 15%, get the rental. I wouldn't rush to pay off anything under 4%, as this is almost free money.if you have high monthly loan payments, relative to your monthly salary you may have trouble finding financing. if your loan payments are lower it may have no effect.remember, this is all a numbers game. if someone says you always have to pay loans off, that is because they are risk averse and let fear talk. rational investors make decisions based on numbers and facts, not fear and emotion. However, remember you personal risk tolerance level is a fact just as much as an interest rate is, and should be considered in all decisions. my personal leaning is to invest in a rental, and let the rental pay your loans off for you

Harrison Alley · Answer

Thanks for the input, all! I'm aware this is very much a personal preference/risk tolerance question. But I'm definitely curious to read others' opinions on where you should be financially before starting. @Nicole A. we only have ~5 thousand saved in liquid cash - we've been pretty aggressive paying off loans and maxing out our Roth IRA contributions so far. I'm more trying to plan for a year or two down the road when we have a little more cash.