My dad would probably kill me for saying this, but debt can be a good thing and paying cash can be a bad thing. There it is, I said it. Why is that such a big deal for me to say that you ask? Because growing up, I was taught that you don’t spend more than you make, and if you do have debt, you pay it off as soon as possible.
I don’t disagree with my dad for saying that, because being debt free can be a tremendous feeling. My wife and I are currently trying to eliminate all of our debt, but we are doing it slowly and wisely. If you try to eliminate all of your debt as soon as possible though (draining your savings), you could run into an even bigger problem: not having liquidity / reserves. This can and should be a scary feeling. If you don’t have an emergency fund or liquidity, one larger unforeseen expense could wipe you out.
Setting Aside An Emergency Fund
Having an emergency fund should be a very important part of everyone’s financial plan and budget, but it is especially important for investors. Let me dive a little deeper into why.
As investors, our goal should be to use as little of our money as possible. Many people may have the same thought process I grew up with. If I can pay cash, why wouldn’t I? I wouldn’t, because there are plenty of avenues out there to finance your investments and still keep you liquid. Yes, you will have to pay for this money, but for flips it is usually on a short term basis. The biggest reason is that if you put a large chunk of your funds into a property, it is locked up in that property until you get rid of it or refinance it.
- What if the market cools off and it takes longer to sell?
- What if you go over budget and all of your money is already tied up in the project? How will you finish the repairs?
- Or, my personal favorite: What if another great deal comes along and you don’t have any money? Yes, you could finance that second property but you may have a hard time doing that now, because all of your money is tied up in that first deal. No liquidity…
Paying For Your Money
Paying for money can work to your advantage in many ways. Let’s say you have $100,000 to work with. You could probably buy a smaller house in the inner city and have the funds to repair it. What happens if you find another deal like that? Or 2, 3, 4 more deals like that? If you used financing to purchase that first one and get the repair funds, you could have potentially put little to no money down (contact me to find out how). Yes, you are paying interest on the money you borrowed, but you still have most if not all of your liquidity. Now when those other great deals come along, you can easily get them financed like the first one. Having liquidity is a very important piece to any lender (conventional or hard money). It shows them that you have the ability to make your payments, take care of overages and still live your life without having to make a decision on which bill to pay.
Another big part of liquidity as an investor can be if you want to own rental property. Traditional thinking would be to save up money to put 25% or more down on a turn-key rental. Then you have a loan with a traditional lender and currently have 25% equity in that property (on paper). Equity in a property is not liquidity. As a good friend of mine says “you can’t buy a beer with equity”. What if there was a way to buy rentals without having to put 25% down, have equity in the property and still be as liquid as before. If you are willing to buy a distressed property and put some work into it, you can buy rentals for little to no money out of pocket. Below are the basics of it:
- Purchase a distressed property and borrow the repair funds as well. (I know a good lender)
- Repair property to get it rental ready. Doesn’t have to be the nicest house on the block, but take care of issues.
- Once rehab is done, refinance out of rehab lender to a traditional low interest long term loan (I know a good refi lender as well).
Liquidity Helps Build A Portfolio
All of this has been done without having to put a large amount down. You are still liquid and can do this process over and over again to build up a portfolio that cash flows. Sounds easy, doesn’t it? If you would like to learn more about this process, make sure to register for any of our upcoming classes on Building a Rental Portfolio.
The reason liquidity plays a large roll in this scenario, is you will need it to qualify for two loans. The rehab lender (Pine) is going to want to see that you are liquid, but the refinance lender is also going to want to see that you are liquid to make the mortgage payment. Typically they want to see a percentage of your UPB (unpaid balance) on all of the properties you own. The good part about the refinance lender, is they will consider a portion of retirement accounts towards that requirement.
Back to the debt free part of the conversation. I am not saying ALL debt is good. High interest credit cards should be paid off sooner than later, but debt on investment property is not as bad as you might think. Keep making your monthly payments, but instead of taking a bulk of your savings to pay it down faster, keep yourself liquid so you can let your money work for you.