Make More Money From Your Rentals Without Raising Your Rates
Rental properties often result in financial losses for investors. On Sometimes, I Do It Unconsciously.
A common renting situation looks like this:
Outgoing mortgage payment: $1,100 monthly. Revenue from rent: $1,200 monthly. A monthly positive cash flow of $100 is yours for the taking. Oh, wait, is that not the case? While it may appear profitable at first glance, when you add up all of the expenses associated with owning that rental property, you'll see that you're actually losing money. We can look at those expenses throughout a year:
Costs of holding. Assume that finding a tenant for your property takes three months and costs $3,300.
Allocate $500 for advertising in order to entice a renter.
Treatment for termites: $150.
$350; insurance for landlords.
Cost of cleaning the property following the last tenant's departure: $350.
In February, the water heater broke down and required a $400 replacement. All things considered, the annual mortgage payment was $13,200. Separate expenses: $1,750. Owning it all will set you back $14,950.
Nine months' worth of rental income: $10,800. There was a $4,150 loss for the year. Things appear drastically different now. You were still out of pocket after deducting mortgage interest and depreciation from your taxable income.
In what ways is the issue remedied?
Buying correctly is the most basic solution, of course. To achieve this goal, you may need to purchase rental properties at substantial discounts or put down 20% of the purchase price, making your mortgage significantly lower than the market rent. Of course, there's a limit to how many rental homes you can buy if you put down 20% each time. The easiest solution is to pay less for the property.
Investment Properties with a Negative Cash Flow and Their Four Most Important Causes
1. The property was purchased at an excessive price. You spent too much for the property if the mortgage is not much lower than the rent coming in. I mean, many hundred dollars less per month.
2. The rentals in your neighborhood were overstated.
The property was purchased at an excessively expensive price.
4. The asking price for the house should have been lower.
The local rentals won't be high enough to cover your costs if you overpaid for the property; if you overestimated rents on top of paying too much, you'd better have a lot of cash on hand to avoid foreclosure. You have a few options besides selling the property right away:
Make More Money From Your Rentals Without Raising Your Rates
A monthly cash flow of hundreds of dollars is within your reach with the financing method I'm about to share with you. But. The catch is the same as with any seemingly perfect solution. An Option ARM is a mortgage product that has been available for around six years, which is considered to be relatively new. There are four distinct options for making the monthly payment:
Choose a payment plan that mimics a 15-year mortgage to quickly create equity.
Choose a payment plan that's comparable to a 30-year mortgage (slowly create equity).
You can choose to pay interest solely and not build equity OR
To accumulate negative equity, choose the minimum payment.
Using the same method as a completely amortized fixed payment over 30 years, the minimum payment for option 4 can be as little as 1.5%. Assuming taxes and insurance are already deducted, your monthly payment will be $520 instead of $1,100 in this situation if you choose for the minimum payment. With the same property and tenant with a monthly rent of $1,200, you would have a positive cash flow of $680 if you had never raised the rent. I think that helps a bit, doesn't it?
While it may be satisfying, there is a catch: Compared to your interest-only payment, your minimum payment is lower. Banks will gladly accept the minimum payment even though they will still calculate the entire interest-only payment for that month because they are not in the business of losing money. So relieved, in fact, that they will just add the amount you owe on the loan to the total amount due rather than reducing it to the minimum payment. A larger sum than last month is now due to you. Oh no.
Hold on, that might not be all that terrible. Why?
While there is a vacancy, you can continue to pay it like a 30-or 15-year mortgage by just making the minimum payment. It will ease the financial strain of having to pay for marketing on top of the payment for that empty property.
Obtaining an option ARM for this reason is acceptable. Though it's not a particularly compelling one. Why? Reason being, the rate (as opposed to the annual minimum payment) usually changes monthly in accordance with the index to which it is linked. This mortgage would be unfathomable if interest rates were to fall. You can choose to pay the minimal amount each month in addition to the interest-only payment, which means you pay less each month overall. Your interest-only payment will increase monthly if rates are on the rise, even though your minimum payment will remain the same for the first twelve months. No one enjoys this when it occurs. Just so you know, the market has been going upwards since May 2006.
Given that this mortgage has the potential to significantly improve my monthly cash flow, but it also comes with some drawbacks, when would it be appropriate to utilize it?
Excellent inquiry. With every investment property mortgage you take out, this is the one question you must ask. In the following case, I would highly suggest this loan: The loan amount should not exceed 80% of the property's appraised value; however, if you intend to sell the property within one year, 90% of the value is acceptable. Your goal should be to sell the property within the following two years at the latest. This financing option is ideal for this situation. Let me explain:
Just by making the minimum payment each month, you may immediately start enjoying the maximum cash flow. You will have negative equity, but it won't have much of an impact in a year or two due to your low loan-to-value ratio. Your negative equity will amount to $5,520 after one year or $11,040 after two years, or about $460 per month. However, this is not an exact calculation because your minimum payment will increase by 7.5% of the payment, not the interest rate, once a year. However, it is near enough for the purposes of this example.
The hidden benefit is that negative equity is deferred interest, which makes it sound lower than it actually is. Since I am not an expert in taxes and do not provide tax advice, you should consult your certified public accountant (CPA) about whether or not you can deduct the accrued deferred interest when you sell the property in a year or two. If you're strategic about when you sell, you can utilize the deferred interest deduction to lower your overall tax liability in the event that you make a windfall from another deal that same year. To rephrase, you can mitigate one area's gain by utilizing the deferred interest deduction.
Keep in mind that you are under no obligation to incur negative equity if you prefer not to; you are free to pay the whole interest amount at any time. This mortgage is great because it gives you choices. Quick access to funds when you need them, with the option to pay down your balance at any time.
If your equity is high and you're selling on a lease purchase, this is the ideal scenario. In this approach, you can take advantage of the current positive cash flow while still making a tidy profit from the sale. During the lease term, many investors lose money on their lease purchases. They earn a profit solely when a sale is made. However, during that period, you'll still need money to pay the bills and fill up the petrol tank. How about we take a look at the numbers?
After putting down some serious cash to purchase a fixer-upper, you refinanced into an Option ARM. To take advantage of a 50% reduction in capital gains tax and to ensure that the property is in good standing for a mortgage, you can choose to sell on lease purchase. This will ensure that at least one year has passed since you purchased the property. While you wait for the large payday, you receive $680 per month to help with food expenses.
Using the previous example, multiply this by five characteristics. Positive cash flow of $3,400 per month is calculated by multiplying $680 by 5. Are you in need of some additional funds as you anticipate the substantial payment upon sale?
