22. BUYING A VACATION HOME WITH EQUITY

SUMMARY KEYWORDS

home, short-term rental, buy, year, loan, mortgage insurance, payment, down payment, equity, numbers, house, balance, long, rent, property, rate, Adrian, monthly payment, money, cover

SPEAKERS

Rob, Intro, Adrian

Intro  00:02

Welcome to the get rich, slow podcast. This is the stuff we and our expert guests wish we knew a decade ago to get the most out of our financial life will provide you with insight into wealth building activities and practices that can expand your net worth exponentially. get insight from top professionals who will reveal how to build wealth the long way, work smarter, not harder and identify your financial blind spots. With over 25 plus years of experience as licensed real estate professionals and a long track record of winning for their clients. Robin Adrian will teach you what it takes to be an everyday real estate millionaire.

Adrian  00:42

Hello, future millionaires and welcome back to the get rich slow Podcast. I’m Adrian Shermer here with my co-host, Rob Delevan.

Rob  00:48

Good morning,

Adrian  00:49

everybody. Good morning. But today, I want to chew into a subject near and dear to my heart. We’re talking about a property purchasing property a lot here. And we talked about the gain in equity and how that is value. But let’s talk today a little bit about how you can put that to work and how quickly you can put that to work because it is called the get rich, slow podcast. But I feel like this timeline is faster than a lot of people realize. So, let’s chew into that. And my concept here is going to be how long would it take you to use the equity in your home to buy a second home. And when I say second home, I mean that as a term. Second home is a term that’s used in the industry, we have primary second home and investment properties. So, second, homes are kind of unique, they often have great interest rates that are very close to or equal to first loan rates. And their core concept was exactly like it sounds, it’s for someone’s beach house, it’s for someone’s vacation home. You know, this is a home that you don’t live in primarily. It’s the second. But it’s a house that you utilize yourself, typically. And that’s exactly what you can do if you buy a vacation home. And we’re going to more into the economics of having a property that in a rentable space where you can do more of a short-term rental thing. That’s a whole subject that we’re going to take an episode to spread all the way out. But this is just about the economics of getting access to that kind of equity, and what you can expect from equity gaining your house.

Rob  02:17

Right? And the beauty of this is it really is the core of this the concept of the get rich, slow podcast, right? Yeah. Yes, it’s quicker than you think. I mean, I’m telling you, like five years goes by in no time. But the cool thing is Andrew, and I were just playing with numbers here. And it’s kind of a five-year plan, and you’re probably doing it maybe a little quicker than that. And you’re rapidly going from minimal down payment, 5%. And out to okay, you’re at 80%, and addressing those issues with better loan rates, reifying, you know, all these different options, big picture, but also, you’re building wealth here. And you’re doing it through leverage, and, frankly, discipline of making that monthly payment and building equity every single month versus renting and doing exactly that for building wealth slowly for someone else. Yeah. So yeah, for yourself. You No, dammit, do it for yourself and pay rent. So, let’s dig into what will actually first Yeah, this second home mortgage, it generally requires 10% down versus the 5% down, right. And that’s a big hurdle for most people who want to buy the second house, you know, you can always buy the second house, move into it and do it as a primary if you’ve owned the first house for a year, or longer. And you can do it but there’s this one kind of get out of jail free card with 10% down, you can buy a second house and you don’t have to move because we do get that like, I got to save up a bunch of money at the same time for a down payment. But I like my house that I live in I’ve done it up how I want it, you know, good schools good for you. You know, whatever it is people love their homes. Right? Yeah. So, the question becomes is how do you build wealth without moving? Well, you get one Get Out of Jail Free card, buy a second house with 10% down, which is better than 25%, which is kind of the traditional number four, you know, buying a home and investment home that you’re not going to move into. So yeah, unless

Adrian  04:38

there are some pretty tough terms for those loans when you get down to like even 15% down. There are options out there, but they can be pretty expensive because they’re, they’re gonna be at a higher rate. They’re higher risk, right? If you have a life event that causes you to not be able to pay your three mortgages. What’s the what’s the one you’re gonna pay the one you’re living in, so exactly, you know on the craps table, that is the statistics they read into in the background here. Trying to figure out, you know, interest rates are based on calculation of risk, basically, you know, so bunch of big math goes on, they figure out what are the average default rates? And how much money do we need to make to be profitable and still, you know, cover all the houses that were lending money for him. So, here’s a way to access that. And when we have that question, how do you get that pile of money aside for a down payment? How to get 10%, down on a half million-dollar house? That’s $50,000? That’s a very difficult amount of money to put aside for most people, so how do we, how do we get that after we put a down payment into our own primary residence, and so I’m gonna be running all these numbers, that a half million dollars, because it’s a nice round number, but this all scales, so it’s going to be a one to one, if you bought a $300,000 house, this same concept applies, it’s just scaled down. And then the theory here is that, as we’ll see, at the three and the five-year mark, there’s a couple different ways that you can access equity and buy a vacation home that is of equal value to the property that you bought. Now at that present time, so including appreciation,

Rob  06:08

right? So, let’s just go through the assumptions really quick as far as the numbers that we’re going to use, and this is for our national audience, right? All three of you. This is the Portland metro area market. And this is pretty typical of the Portland metro area, Portland, Oregon, metro area market. So, let’s assume $500,000 first house, and let’s assume $500,000 second home. And let’s also assume that the down payment on your first house was 25 25,000, which was 5%. Let’s also make the assumption that you have a kick ass real estate broker that works very closely with a lender who is going to with that 5% down, you’re going to mortgage insurance. For the purpose of this, let’s assume that that realtor is able to negotiate some down payment coverage, not closing costs, closing a facility to cover buying out of that mortgage insurance, which is usually the equivalent of a few years at a couple 100 bucks a month. So, three to $6,000. Right in closing costs coverage, then, let’s assume that the second home is going to be that 50,000 to 10%. And also $500,000 purchase. And let’s assume that interest rates are at Well, currently, they’re at what about three and a quarter, that’s where we read a quarter

Adrian  07:41

is yeah, pretty average. Right now, I’m gonna throw it at a three and a half percent rate. I always have to disclose this stuff, especially being industry interest rates, you know, they’re influenced by a lot of different things, not the least of which is you know, your down payment, your credit score, you’re gonna have to run this at your own numbers, I think three and a half is fairly conservative. For right now, these numbers will shift though, over time. But the way that you chip into the equity in your home shouldn’t change. hyper drastically, we can scale these numbers for anything, this is kind of just for some rough work here. So, I’m starting with a three and a half percent, which I’ve gotten plenty of people well below this in the past few months anyway. And that’s a $500,000 purchase price, that means your loan is going to start at 95% of the home’s value, right so and at that echelon, you can’t do anything when you first buy that house, I know you’ve got equity there, but there’s not really a product that I’ve seen out there where you know, I’m gonna use what I’m seeing as industry averages, most home equity lines, or cash out refinances are going to cap but 90% of the home’s value, maybe 80%, depending on how you’re using the property. So, for now, we’re going to use nice conservative numbers and the more typical programs that you’re very likely to find all over the country, in any bank that you might walk into, or talking to a loan officer. So, and then I’m also the other assumption I’m gonna make is a 4% per year appreciation rate, which is pretty much about what the average has been over the past few decades, we can make an aside and talk about 2009. I really think that that’s kind of a that’s a whole conversation to unpack. We’ve touched on it before. But the key thing I tell people is, you know, that was there was a lot of fraud at that time. There are some great movies about that The Big Short is an awesome entertaining movie that actually tells that story very surprisingly accurately and well. And not to say that fraud can happen again. But there are a lot of checks and balances that were introduced to prevent that. So, if we do see another market crash where values fall, it’s going to have to be something weirder. I mean, we just lived through a pandemic, or we’re still living through it. And yet values have continued to spike. So, right, it’s supply and demand. They’re still making people, they’re still making houses, they’re not printing lands, you know, the odds are that on grand average, we’re gonna see values continue to rise and as Rob and I have touched on right now Would you say like metro areas probably higher than 4%? On average? Yeah, to close towards city centers where, you know, the popularity

Rob  10:06

is growing? Typically, but let’s, let’s just be very conservative entry average for. Exactly.

Adrian  10:13

So, I’m gonna throw some data here. If you’re on the video, you can see this, but let’s get the numbers out there. For the listeners 475 Is your balance at your zero, right? Do you make a dip before you make your first payment, by the time you’ve made a dozen payments, that balance goes down by nearly $10,000, you do chip into it slower at the beginning than at the end. But it’s still a pretty good hike there. The principal and interest payment on this by the way, we’re using this rate and using this initial balance is 2001 3296. So, you’re gonna have taxes and insurance. On top of that, that’s not your total payment, you’re gonna have mortgage insurance potentially in there of usually, I would say in this range about a couple 100 bucks a month. But that’s going to vary depending on your credit score and some other stuff. But that kind of gives you a ballpark of what kind of money is being shelled out for this. And then again, this all scales, press it down for $300,000 loan about the same, but we’re gonna use this as our baseline. So, 475 goes down to 466 and change, and then year two, you’re getting down to 457. And then year two to three, we’re getting closer to that 10,000 a year. So, you can see this growing, the balance goes down more and more because more of your payment is going towards principal and interest. And by the end of year three, and these are the numbers that are important to me more than anything, we’re at 447 and a half 1000 for a balance. But the property has gained value. Now it’s worth in theory 562 and a half $1,000. And the important thing about these two numbers, and the reason that year three is so important to me is that now your balance is less than 80% of the home’s value, right, you can get a home equity line up to 90% of your home’s value. So, you can get a home equity loan that is 10% of that new value that 562 You could in theory, get a $56,000 home equity line, or to be a little more than that, actually, if we run these numbers, but you know, let’s round off for simplicity. And then even if that home that you wanted was half a million dollars when you bought this house, and now it’s worth 560, that’s okay, you’re gonna take 10% of your house. Or if you buy a half million-dollar rental property, you’re gonna have a bit of overspill there to maybe take care of some maintenance, or maybe buy some furniture if you’re doing and do short term rental type stuff, right. So, there it is, right there is access to about $56,000 that you can pull equity out of the house, your mortgage payments gonna stay the same on the primary, you’re gonna have this new small payment here. So, you got to be able to afford all three of these payments, don’t get me wrong, this has got to be you know, within the affordability index for you. This, this avatar is a person who’s making definitely getting into at least the low six figures to do this. But remember, this is also scale. So, what I’m talking about is the three years in theory, this person’s buying a vacation home, that’s worth half a million dollars, and now owns over a million dollars’ worth of real estate within a three-year span. They’re starting lending only $25,000 as they’re down.

Rob  13:03

Now, let me jump in. And let’s just make sure that we know we’re making this assumption that you could at least rent the house out the second home, the vacation home or investment home, as we call it. With that 10% down the 56k or so that you got from that equity line. You’re going to be able to cover the new payment and the new and the equity line based on the rent that that new home would bring in. Yeah, and the note and that’s not weird. A $500,000 home today in the Portland metro area is typically gonna get you know, probably not a brand-new home it might. Adrian that’s a good case study like actually your home. But I mean, I have a home listed right now. You know, audience, don’t worry about it, because this will come out a few weeks later, but and it’ll be long gone, of course. But we have a homeless right now single level 16 1700 square feet, four bedroom, two baths. That would rent for about 24 $2,500 a month all day long, nice big lot older home, but it’s been updated and in in great shape. It would be a perfect short-term rental but also a perfect long-term rental. It would cover roughly what we’re looking at on a short-term rental basis here. It would also it would definitely cover if you were doing short term rentals which earn roughly double gross what a long-term rent rate would be so 25 to 2700, something like that, that this would rent for pretty easily. You know, on a one-year lease, it’s going to be pushing 5000 or so a month on a short-term rental. Now short-term rental Airbnb, those sorts of things have a lot more maintenance and moving parts and it’s a management issue. fences and so on. So, we’ll dig into that in the future on another episode. But yeah, there’s a lot to unpack there, this is doable, in that you can buy that second home and cover your expenses, which is the goal here?

Adrian  15:16

Yep. Yeah, absolutely. And that second loan, you know, there’s a, there’s a range of rates out there, it would be tough for me to kind of pin down most of those are usually interest only for the first 10 years, they’re amortized over 20 years. You know, so they’re, they’re a funkier type of loan, you’re gonna have to chew into that a little bit shorter to figure out where you want to be, you know, that can be more like five to 7%. You know, if you’re at say, 6%, you borrow that 56,000, that’s gonna be another 400 bucks a month out of your pocket, that you’re borrowing as a down payment. Now, effectively, sure, the second home, but and you got to make the mortgage payment on the second home. But that second home, in theory, whether it’s short term rental, we’re talking about or long term rental should at least cover its cost of existing, and then you’re really starting at that point, you’re opening a business that rents this property, you’re a business owner, when you own especially short term rental, you know, you’re going to be putting that into your tax returns, you’re gonna have profits, you’re gonna have to declare, you know, this is something you want to run it really run the math out on. But what we’re showing here is that in three years after owning a house, you can access 10% of the equity of that home, in theory using industry averages. And then we take it another couple of years, if you don’t want to do you don’t want to add the $400 payment, right? The balance goes from that 447 and a half down to just under 427. And the theoretical value at a 4% gain per year goes up to 608. And now we’re a lot closer to the loan being about 70% of the home’s value, which means you could do a refinance of that whole loan itself back out to 30 years, you could have a new loan that’s at 80% of the home’s value, a cash out loan. So, if you got 608, for a value, that means your new loan is going to be about 486, which isn’t that much more than you borrowed in the first place. So, if rates are good, when you make that move, or as good, at least of the one that you had before, you could refi at that five-year mark, and in theory, get a payment, that’s pretty close. Probably lower, actually, too, because, as we mentioned, even at the three-year mark, you’re going to get to that, that 80% loan to value. So that three year mark, you should also be able to if you had monthly mortgage insurance of a couple 100 bucks, drop it off, you can get rid of it exactly drop off a couple 100 bucks worth of mortgage insurance, you take on a $400 second loan payment, where are you at net, I’m paying $200 more a month, but now I’ve got 50 grand to put down on that vacation home, right, and then have a 10% down situation, which is also a lower payment here.

Rob  17:53

The key is what you’re looking at is time is on your side. So, if three years it was probably like, you know, barely breakeven, and five years, you’re sitting pretty. Now, let’s take it to the next level. Right? So, let’s say every month from the get-go, instead of making that you know, 2132 monthly payment for on your primary house. Let’s say you throw an extra $200 a month.

Adrian  18:21

Oh, brilliant. I like that. Because that’s that difference there between mortgage insurance savings. And so, if you got used to that just paying $200 More, you could get the second and they would know each other out you have the same amount, right. But yeah, go ahead.

Rob  18:34

So, throw those numbers in there. And you know, the Year Zero, you’re just for 75. But year, one after one year of doing that. So, you’re basically out what 2400 bucks. You’re looking at 40 Let’s see 46 out. Well, it’s let’s see, let me run the numbers. Yeah, I got to scale this out here at the end of year one. So, start or end of year two, I’m sorry, you’re at 40 452,000 that you owe instead of 457. Year three, you’re at 444 40. And your four years for 27. year five year at 414. And your cost was if we did our math right there is what like 12 grand 12 grand. Yeah. So, you spent $12,000 And you’re really in a much better spot. The concept is you work usually you have a significant other that also works. You’re in a spot where usually when you’re buying your first home, your income is increasing. You don’t want to necessarily purchase every basically be at a monthly payment that every single dollar that you possibly have is squeaking out to get into this loan. So, make a little extra, you know, monthly payment, look at it as a savings account, and you’ll be able to unpack that on the back end, you’re gonna have huge, I mean, after five years, you’re, let’s see, jump in here, Adrian until after five years, what was your loan to value.

Adrian  20:18

So, after five years, it’s 70.18. If you don’t make that extra payment, it’s 68.07, if you do, and one of the key things to me too, was that by year three, you actually were, you know, this loan devalues quite a bit lower. So somewhere in the middle here, I mean, this could be even just two and a half years, if you make that extra $200 payment in this scenario, right, somewhere right about the two-and-a-half-year mark, you’re going to hit 80% loan to value you’re going to drop your mortgage insurance from the monthly payment. And you’re going to have the ability to go back to a bank and say, hey, I want a home equity line of credit, or I want a home equity loan. Let me get the figures for that and make a decision if you want to borrow out that extra 50 grand or so and then turn that money directly right away into the other property definitely want to let it sit in your account. And there’s other things you can do with this right that we’re going to talk about, you know, you could use it to start a business you could the second home is just an example I’m throwing on the table, because this is a way, I know to build wealth. And I know that if you buy that second home, that’s half a million, now you’re at a million dollars of owned real estate, which at a 4% appreciation is going to get you an equity gain of about $40,000 a year. Right, which is more than I need in some years in my life. It’s going to stretch. Yes, right? You’re doing it does take a lot of capital do you have to make good money in order to do this, this is not simple. It’s not for everybody. I’m not saying that. It’s, it’s scalable, though. So, you know, in an area where $300,000 like in the nation, where $3,000 is more of an average, and there are still plenty of homes in what would be considered vacation areas that you can buy in that range as well. It’s going to scale the income that you get off of it, but it’s accessible to someone who makes a lot less money than the hypothetical I’m built on here.

Rob  22:02

On that note, remember, you know, we’ve done a podcast on you know, dual incomes working at McDonald’s, right? Yeah, you work for a couple years at McDonald’s, you’re managing the place, you’re gonna make 60 $70,000 a year, yeah, you’re working your butt off, you know, doing all sorts of different things. But if you’re into it, do it, you know, dual incomes 60 $70,000 a year, there’s 120, grand, five years out, you’re here, you know,

Adrian  22:28

you own a million you in the bank, don’t get me wrong, I own a million dollars plus worth with real estate,

Rob  22:34

and 25 years later, it’s all paid off. And that’s a good spot. And I’ve got lots of difference between you know, retiring and eating cat food, on Social Security, good luck, or, you know, having some assets that you’re out doing things you know, and minimal overhead, because you own your house outright, and probably a rental or two or three, you know that you’re also doing the same thing. So

Adrian  22:59

and once you’ve got this second home, and you’re reporting income, especially when you’re reporting on your taxes, once you’ve done that for a couple of years, that is now part of your adjusted gross income, you own a rental business, and you do whatever your current job is. And this is where the multi multiplicative effect comes in. You can use that to buy more properties that you can invest because you’ve gotten access to these funds. Now your cash flow is different. Or you can just let that be like you’re saying you can just let the balance keep falling. And that alone is enough to really accelerate where your life is gonna end up. Right.

Rob  23:31

So, let’s leave it at that. This is just fascinating. We will for future episodes, we’ll talk about more of the short-term rental Airbnb model and how it would be coming back and pulling into you know what that would look like in this scenario, as well as you know, there’s a number of other different directions we can go with it, but this stuff is doable. And that’s the beauty of it. So, I love it.

Adrian  24:02

Absolutely. You got it, man. Thanks a lot for your time, everybody. We’ll catch you next time on the get rich slow podcast.

Rob  24:08

All right. Thanks, Adrian. Take care.

Intro  24:11

Thank you for listening to the get rich, slow podcast. If you like what you learned, please subscribe, rate and review so we can grow wealth for even more families.