Defending Dave Ramsey (Part I)

     If you search Dave Ramsey on BiggerPockets, you will come across several articles. Most of the articles are critical of him. I’ve read several of Ramsey’s books and regularly listen to his radio show as I drive to work. I like him. I like his message. I think some of the articles on BiggerPockets regarding Mr. Ramsey are misleading.

     Specifically, I’d like to address criticisms of the Dave Ramsey method of real estate investing. Dave Ramsey preaches that you should pay cash for rental properties and not take out a mortgage. He would have you avoid debt. This article is going to look exclusively at rental income/risk.

     Hypothetically, you have $100,000 to invest in real estate. Following the Dave Ramsey method, you could pay cash for a single $100,000 property. Alternatively, you could put twenty percent down payments on five properties that are worth $100,000 each. Let’s put a few more details into this hypothetical and compare the two methodologies. I am using numbers from an actual house, located in Central Illinois, that I almost invested in. And yes, I used the BiggerPockets calculator in reaching these figures.

Total Purchase Price: $100,000
Monthly Property Taxes: $258.33*
Monthly Insurance: $45.00
Monthly Mortgage Payment (30 year, 4.75%): $417.32
Monthly Rent (income): $1,100

Cashflow: Following the Dave Ramsey method, your cashflow is going to be $796.67/month. [Rental Income $1,100 – Expenses of property taxes and insurance $303.33 = $796.67 monthly cashflow]. The Cash on Cash ROI is 9.56%.

     Let’s compare that to buying five houses with 20% down…

     Your monthly cashflow is going to be $379.35 per house. That is $1,896.75/month for all five units. [Rental income $5,500 – Expenses of mortgage, property taxes and insurance $3,603.25 = $1,896.75]. The Cash on Cash ROI is 22.76%.

     In terms of potential cashflow, using leverage can get you more than twice the potential cashflow. But the wisdom of the Ramsey method is not in maximizing cashflow, it is in minimizing risk.

Risk: Following the Dave Ramsey method, your monthly expenses are $303.33/month. That’s the monthly portion of property taxes and insurance for the house. In Central Illinois, property taxes only come twice a year (Spring and Fall). So, your actual monthly bill is the $45.00 insurance. And biannually
you will be billed roughly $1,549.98**.

     If you bought the five houses, your monthly expenses are $3,603.25/month. That figure includes your mortgage, property taxes, and insurance. Property taxes are still billed biannually, but you have two payments of $7,749.90**. The actual
monthly bills are the insurance and mortgage, which come to $2,311.60/month.

     Now, here is why I’m defending the Dave Ramsey method. It is not anything I read in a book. It is from advice from a mentor of mine. Prior to buying my first investment property, I had a friend who already owned multiple units. He and I chatted about a lot of things I was learning on BiggerPockets. The most important advice he gave me was “if your (rental) house is sitting empty, you better be able to cover the payments on it!” It is a piece of advice that has guided my investment
journey. Looking at the potential profits is great but respect the risk that comes with it.

     If you buy rental properties, I hope you have good renters. I hope you have no damage to your property. I hope you have no vacancies. I always hope for the best, but I prepare for the worst. Your rental property will be empty at some point. There are factors in rentals that are outside your control, so it will happen. So, let’s look at those hypothetical numbers again factoring in some vacancies.

     Following the Dave Ramsey method, your expenses of property taxes and insurance for the full year are $3,639.96. By paying full cash for the property, you have minimized risk. So, let’s see how much risk/reward you will have if you have income for:

Months Rented           Rental Income            Total Cashflow
11 months                    $12,100.00                 $8,460.04
9 months                      $9,900.00                   $6,260.04
7 months                      $7,700.00                   $4,060.04

     Further, if you are following the Dave Ramsey baby-steps program, you did not invest in real estate on day 1 of the program. You already have a budget in place, paid off your debt (except your home mortgage), and have months of emergency
funds in place. You are in a financially good spot when you purchase the investment house. If the house was empty the whole year, you’re probably in a spot to cover the full $3,639.96. You are seeing less cashflow, but you have
substantially less risk. Less risk means less stress for the investor.

     Now, let’s look at the investor with 5 houses. The yearly expenses on the five properties is $43,239!

Months Rented                    Rental Income                       Total Cashflow
11 months                            $60,500.00                              $17,261.00
9 months                              $49,500.00                              $6,261.00
7 months                              $38,500                                   ($4,739.00)

     The investor in this situation may or may not be on solid financial ground. They may still have other debt that they are paying on. If the five units sit empty for a year, that $43,239 yearly expense looks pretty steep. That expense is
going to cause significantly more stress on the investor. 

     Here is why I am defending the Dave Ramsey method. I’ve read the other article on BiggerPockets. There are plenty of people who will only see the above numbers comparing the 11 months – total cashflow numbers. No doubt, there is greater potential cashflow. I’m trying to get you to look at the risk. I want
you to remember what my mentor taught me. If the house is empty, can you cover it financially? 

     If you saved $100,000, investing in real estate can help you grow that into even more money. It can help you build wealth. Look at your situation first. Look at the reward AND the risk. If things went wrong, how much can you cover? If you can cover $3,639/year – pay cash for the one house. If you can cover $43,239/year – leverage the five houses. Neither method is inherently right or wrong. Don’t be too quick to dismiss one over the other.

*If this tax number seems high to you, remember this is an
ACTUAL property calculation from Illinois.

**Property taxes are not actually billed 6 months each in
Illinois, but for purposes of this example, it’s easier to do
it this way.