How much of funds to use with private investor

Question

Hello - I have a bit of a spin on the age old question: To use all of your savings on your first property or not.

I have 10k I have saved in 6 months to put towards a property.

I have planned to use 5k of my own funds and a private money lender for the remaining 14k at 5% over 10 years.

My question is this: Should I use all 10k of my own funds and only borrow 9k (at 5%) so I don't have to pay as much interest to the private money lender as I would on the 14k?

My thinking has always been that if I have 10k to put 5k into one unit and then continue to save my net monthly cash flow from this unit (see below) + job savings on top of the other 5k I have left to buy a 2nd property by the beginning of summer '17.

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Property:

Listed at $105,000, PP: $95,000 (plus 4k seller credit), Rent history: $1,100 past 3 years. 20% down (19k) puts the loan amount at $76,000.

Monthly Income (rent): $1,100

Monthly expenses (including taxes, insurance, HOA, P&I): $810.15

Positive Cash Flow: $289.85

Monthly Private Money Lender expense: $148

Net Monthly Cash Flow: $141.85 (to go towards next unit)

Key words: rhode island, providence, savings, down payment, private money

Anthony Thompson · Answer

I would wait until you can afford the full down payment for three reasons.First, in the application process of most residential mortgages they are going to scrutinize your finances, paying particular attention to where you get the money for the down payment.They will be looking for exactly the situation you're describing, where you're getting a loan from someone else because you can't pay the down payment yourself, and unless the source of funds is willing to give you a "gift letter" saying it's not a loan (and you sign something saying the same thing), they will turn you down for the loan.And as I wrote in another BP thread today, if there are Federal funds involved (almost always the case with mortgages as I understand it), I believe it's a felony to lie on those forms. Serious stuff, mortgage fraud - people can and have gone to jail for it, even in RI.Second, I almost always recommend against a new investor buying a condo for their first investment property, unless s/he already has an existing relationship to that particular condominium association/complex (owning another unit in there, being on the board, etc.).There are just too many issues that seem to come up with other condo units, the condo association rules, ratio of owners to renters, condo association board politics, special assessments coming down the road, how professionally (or unprofessionally) the condo board manages the building and its finances, and - importantly - the fact that you have no control over the HOA fees but are required to pay them.New investors are almost by definition unable to grasp the complexities of the condo association they would be joining and unable to understand that they are tying their financial fate to a group of people who may or may not be managing the property and its finances well. Also if a number of other condos stop paying their fees (as happened 6-8 years ago), it will be up to the remaining condo owners to make up the difference.In many ways condos have all the burdens of owning a house but all the limitations of an apartment. Except for certain limited circumstances I usually recommend against them, at least for long term buy and hold. (Non-beginner investors can do OK with condos on a short-term basis at the right point in the market cycle but care must be taken not to be without a chair when the music stops.)Third, in this particular case the #s are not only tight, by my calculations they'd actually put you into slightly negative cash flow.Using the same format as the original, my numbers are:Property:Purchase price: $95,000Down payment: $19,000Private $ down payment loan: $14,000Real down payment: $5,000Monthly income: $1,100Yearly income: $13,200Operating expenses using the "50% rule": ($6,600)this would include taxes, insurance and HOA feeYearly mortgage pmts (main mortgage): ($4,896)(76,000 loan for 30 years at 5%)Yearly private loan pmts: ($1,782)(14,000 loan for 10 years at 5%)Yearly free cash flow: ($78)For all the reasons above, I would recommend you continue saving until you have the entire down payment. Then I would look for a 2F located within 15 minutes of where you work, buy that (possibly living in one side if you need to), learn some property management from that, then after some digestion time move on to your next deal.

Brandon Ingegneri · Answer

I personally don't see a deal with the cash flow that you have presented. There may be some value add ons to improve cash flow. If that is the case, my opinion may change. It seems like it may be advantageous on your part to build funds. Also, private lenders tend to have more limited time frames than what you have presented. Have you gotten hard specific terms from the lender regarding this deal?

Elizabeth Newcombe · Answer

I don't know the particular unit or area, but yes, I would say that for an income property, you want your purchase price to be low enough compared to rent that you are at least in the positive digits after accounting for everything. I would recommend plugging everything into the rental calculator again, look up vacancy rates in the neighborhood using neighborhood scout, or as a general rule of thumb plan to set aside 10% of rent for maintenance/vacancy and repair budget. I'm not going to discourage you from going for it if u see upward rent potential and property values going up there, but I personally wouldn't do it. If it was a multi-unit and you were planning to live pretty much rent free and have the other unit cover most of the rent, that would be a good investment. Or if there is demand in the neighborhood for nicer more expensive apartments, see if there are some affordable updates you can do to increase the rent a couple hundred per month. If you want help, message me the address and I will take a look at it for u.

Alexander Zurn · Answer

@Elizabeth Newcombe is it because my purchase price is too high? The unit itself is move in ready, everything "appears" to be updated and in working order. Home inspection is this Monday though so they can tell me the repairs needed, if too much I can back out. But you're saying in general, not enough cash flow? What number should I be looking for in my first purchase?

Elizabeth Newcombe · Answer

Yea I don't see any cash flow there, unless rent could go up. You haven't accounted for repairs, maintenance or vacancy. I'd suggest finding a property with better cash flow potential.

Alexander Zurn · Answer

I have 2.5k in IRA that I add to every week, family if necessary. The expenses also include vacancy rates, forgot to include. I could use net monthly cash flow to put towards cap x fund for the unit. It's a condo, however, so HOA dues will cover majority amount of potential big problems, no?

Joseph Birbiglia · Answer

I think those numbers are too tight. I don't think you can count on that cash flow. Where's the repair budget? I'd avoid private lending if at all possible. The question is, do you have an emergency backup, like $5k in a Roth IRA, or family who could bail you out of a jam? Good luck!