It's been over two years since I bought my first building, and since the very beginning my goal has been to accumulate as much real estate as possible. The phrase I've been using to describe this aspiration is to become a Reverse-Millionaire: to owe as much money to the banks, in the form of secured real-estate mortgages, as possible. The thought is, that the more money I owe the bank, the more properties I'll own and the more money I'll make, not necessarily in the short term, but by holding for the long term. If I can become a reverse millionaire while I'm young, in 15-20 years I'll most likely have "boatloads of money". There are lots of other advantages, for example, any rent inflation, becomes more money that I can pocket each month.
In order for this tactic make sense, I have a few important rules.
- Only buy a place when you definitely have the monthly cashflow to support it. I only want to buy a place if I know that I have the money to pay for it. I assume a 33% vacancy rate, meaning that if I receives $1,000 a month rent, count it as only +$666.67 toward cashflow to cover maintenance and vacancy costs (banks conservatively use 25% when calculating your income before giving you a mortgage).
- Only use 30-year fixed mortgages. Although you will have to pay a higher interest rate, this will keep the mortgage costs from spiraling out of control. After I buy a place, I know that my principle and interest payments will stay the same for the next 30 years, which is very comforting (although insurance and taxes go up).
- Do not lie on the applications. This should be obvious, but it isn't always as you'll see shortly. When a bank gives you a mortgage, they're betting based on the information that you gave them that you are going to pay the loan back. They use the information on the application to determine how likely it is that you will default. If they are willing to give you a loan based on an honest application, then they believe that they won't, within a tolerable level of risk, lose money. There are reasons for the checks and balances that the bank uses, when you lie you're much more likely to get yourself in over your head.
Now, using this method I've purchased four properties in the last two years. I am not quite the reverse millionaire that I want to be, but I'm about two-thirds of the way there. Because I followed the rules listed above, I am in fine financial shape. If interest rates go to 500% tomorrow, that's fine for me because I will be paying the same amount for the next 30 years. If a tenant doesn't pay rent for a few months (as regular Landlord Shmandlord readers are aware does occasionally happen), then I can handle it.
The key point that I want to make is that, if I didn't follow something similar to the above guidelines, it would have been very easy for me to achieve my goal of becoming a reverse millionaire by now. For example, I could have selected much riskier loans, like the infamous interest-only ones. Or I could buy more places from sellers that are in kahoots with shady mortgage brokers, which appear to be able to offer loans regardless of credit scores. The problem is, if I did these things the entire house of cards would be much more unstable than it is now.
Not everybody has been as careful. Case in point: Casey at I am Facing Forclosure dot com. This guy racked up 2.2 mil in debt (including 140k in unsecured credit card debt). Now, as you'll see very quickly on his blog, he's in trouble. I stumbled upon his blog on I Will Teach You To Be Rich, where oddly enough Ramit knew Casey from high school and gives some insight into Casey's character:
Casey had tried to sucker people into a scam real-estate deal less than a week before he admitted he was going through foreclosure. I was fortunate enough to recognize his pitch as bulls**t, but what if someone had gotten conned into it? Financial scams on unsuspecting people make me furious. So I read through his site. It turns out that he had bought multiple houses in different states (hoping to flip them quickly), lied on his applications to get his loans approved, and had grossly miscalculated how much it would cost to renovate and flip them. Bad move. His debt is now over $2 million.
Now I don't feel quite as bad about not being a Reverse Millionaire yet. However, I'm still confident that if I continue the course that I'm on, I'll eventually get there in a reasonably safe way.