30. ALLOWING OTHER PEOPLE’S MONEY TO WORK FOR YOU WITH LANCE JOHNSON

SUMMARY KEYWORDS

leverage, equity, home, home equity line, property, downpayment, payment, paying, people, credit, net worth, clients, mortgage, utilizing, buy, market, cash flow

SPEAKERS

Rob, Intro, Adrian

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.

Welcome back, future millionaires to the get rich, slow Podcast. I am your host, one of your hosts Adrian SHERMER. I’m here with Lance Johnson and Rob delavan. How you guys doing this morning?

Good morning. Fabulous morning, everybody. Great day to be building wealth.

Absolutely. Today, we got a bit of a title here. And that is allow other people’s money to work for you. core concept here is utilizing leverage to build assets. And I’m gonna pass it over to rob here to fire us up on this idea.

So the goals of this podcast would be to teach the audience what utilizing leverage means, and then different ways to actually use utilize leverage in different sectors that’ll be fun. And who should be using which types of leverage lots of big concepts, we’ll try to break it down and chew this up and spit it out?

Absolutely. And this is really the first layer of that idea, right? We talked about this a lot where it’s, you know, if you don’t know any better, you think that that building wealth means just taking a slice of what you earn and throwing into a pile and eventually that pile gets really big. That’s like old school. First, you know, just open a savings account. This is the next tier in that concept is how do you what do you? How do you force that asset to make to work harder for you? Right,

so let’s just kick this off with so Lance, I’m going to drill you here. For someone who does not know what leverage utilizing leverage means just describe it in the simplest terms possible and pretend like Adrian and I are the idiots in the room. Alright.

So from its basic form, let’s just you guys know that I am very real estate, pro real estate. So the biggest hurdle for real estate is honestly coming up with a down payment, if you use leverage. So the basic concept that most people know is I come up with a 510 20%. Yeah, down payment, and then I take leverage, and I buy house a vacation home a vacation rental, a rental. If we didn’t have that leverage, then you know, and you were buying a $400,000. Home, how long? Adrian Rob, would it take you to come up with the full amount to buy that house?

years in years? Right,

right? A lifetime lifetime, sliding away from you.

Wonderful mechanism called mortgages that we can use to get to a 510 20% 25% down, whatever you qualify for, to get leverage. And why do we do that? Why would you recommend that? Rob, why would you recommend to take leverage to buy a real estate?

Well, I mean, just one of those concepts is if you buy now you’re capturing whatever value it is today, because it’s an appreciating asset. And you know, if I wait 10 years to buy cash or 20 years, whatever, it’s going to what do you use? What what term did you use? Adrian? I think you said it slips away because it keeps appreciating.

Yeah, well, yeah, I have this conversation with clients all the time. Well, maybe I should wait. I should wait until I have 20%. down 50% down whatever rule of thumb. I heard, you know, grandma’s say, two decades ago, and especially in an environment where rates have fallen to. I mean, absurdly historic lows. Yeah, it makes sense to leverage the value of that property. One of my favorite things to say is I would rather own 20% of five homes then 100% of one home.

Yeah, so a good concept. So the hardest part, Adrian being a mortgage broker is what is the hardest part of getting somebody into that vacation rental or second home or whatever is usually what?

It’s downpayment. downpayment is typically the largest initial barrier, followed by fitting everything into your debt to income ratio, having that payment be a portion of your income. Although As we’ll talk about, we’ll expand into this, you can end up using the rental income from your departing, to count against that mortgage and kind of roll and roll and roll. That’s how people end up with four or five properties. It’s not that they on paper can afford four mortgages at once, they can afford four mortgages, minus in many cases 75% of the rent on those properties, which makes it you know, hopefully, if you’ve phased it out, right, and you, you know, picked good properties, then that’s going to be at least breakeven for you.

So what we want to do is get back to that not the four person, but the person that has that home is appreciated, and they’re ready to make the next venture. So let’s let’s focus on that individual. So that individual probably has equity in their house, it’s grown, they’ve paid down their debt. I know, I’m a big proponent of 15 year mortgages. So I think 85% of my clients will try to work towards doing a 15 year loan or a 30. But we’re making payments, like we’re paying it off in 15. Right, and flexibility and equity. And there’s pros and cons to it in a rising market versus a down market. So now we’re at that stage where that person’s ready for the next home making their current home or rental, they’re waiting for a vacation home, a vacation, rental, a rental and and so now we can access that money, that equity that has been built in in that home, we get access money in their 401k, we can access money in their espp stocks or investments. And so that’s what this this episode’s about is how do we come up with that new downpayment for that next home? So let’s explore the first one, which would be home equity line of credit. So most of our recommendations, when we do financial planning is, you know, go establish a home equity line of credit, get a capture for anybody to utilize that equity in the right time. So the right time for me is either emergencies. Okay, you know, you’re you need to help out some somebody lost some jobs, you got to bridge a gap, and you need reserves or cash flow to help you or opportunities, which is the next rental vacation rental. So home equity line of credits are a great aspect where you can access that money to apply for a down payment on the equity built for rental. Yeah. Have you guys ever had some experience with that with your clients?

Yeah, but

Yeah, sounds good and bad.

I mean, there’s some people that that got in trouble with that, you know, way back when the market crashed, but at the same time, the idea is, you’re the best home equity loans are only going up to 80%. Also was, you know, somebody might own have a 50% first, and then you know, they might have $150,000 in that equity loan, which is pretty typical, up to 80%. And rolling that into that next purchase is a huge thing. And they’re still under 80% loan to value and you game out. Okay, if you’re 45 years old, like you said, you probably want a 15 year mortgage, not a 30, right, because I don’t want to be 75 when I’m paying this thing off, versus, you know, different places based on their individual situation. But it gives you the power of leverage, which was actually my my second question to you, Lance was the power of leverage and applying that to net worth.

What does that look like? Yeah, so let’s, let’s continue on with that. Let’s break down the situation you were going down. And so what really is happening is somebody buys that house and it’s a $250,000 home, that is now is now worth 500,000 in the Portland metro area. value is going up, balances dropping, right that when you first purchase it, let’s say you did a 30 year mortgage, now your balance, you know, you put 20% down, so that’s 50,000. So you had a $200,000 mortgage, that’s probably now 165 and you have a $500,000 house, you have quite a bit equity. So now you establish a $250,000 line of credit. Right? Real simply done 250. And last, it’s there’s not a huge hiccup. You still have equity in the house if you were to tap into it temporarily. And we’ll get into the risk associated with that. But now I have that 250 and I’m ready to buy that $750,000 home now. And 20% down is 150,000. So now I have that equity. Now I don’t have to disrupt my past loan. Okay. I’ve just had that line of credit, I can put a down payment. That’s 600,000. Now on that house, so now we have to deal with jumbo loans versus non jumbo loans. And you get into that new house and work with you, Adrian have that line of credit or establish you’re looking for a house, very simple transaction for downpayment, you have the equity, that’s one option. The other idea is, the other option is a client could have half a million dollars in employee stock, and mutual funds and stuff like that. And they can use margin loans, which are like a home equity line of credit, it’s called a line of credit against an asset base, which we talked a little bit about, and they can use that as well. Then the other thing, they can do a 401k that most companies have, you can leverage up to 50% of that, and you’re really paying yourself back, which is a whole different topic, we’ll get into long term, but you can do up to 100,000, you can take 50,000. So if you have two people working, you can access and and there’s another way you’re you’re becoming your own bank, because you’re paying yourself back the interest of the growth. So what happens is, most clients don’t realize they do have three really simple options of using leverage. And why would you use leverage versus sell? Well, you can’t sell the 401 Ks, you’d have to use leverage. If I sold the stock, I’d have to pay taxes. And in order to access the equity in the house, you’d have to refinance the primary, or you have to sell the house, which that’s not what the objective is. So the average, we have this really good way to get that bit that first big hurdle on the next property is these three levels of leverage, allow you to get that property without too much, you know, anxiety or hoops to go over taxes the day.

Absolutely. And, you know, each situation should be analyzed separately should talk to your own set of professionals, when you’re ready to do this, this is a whet your whistle kind of conversation. But I will say that what you’re describing is, I think fascinating, because in my world, at least, you know, the the home equity lines for one thing, those are right now, I haven’t really seen anything out there for investment properties, it is primarily a primary home product, they want that to be the home that you’re living in, if you’re going to create a home equity line of credit, we talked about doing it early. Part of that is because if you go to the bank, and you say hey, I want a home equity line of credit, to use as a down payment to buy something else, they consider that maybe a little bit riskier, and they don’t want to prove that product. Whereas if you say I want a line of credit for future investments, potential improvements, or whatever may befall me in the future, that makes sense to them, they’ll sign off on that. And then you can pull that equity out. If you’ve got an older loan, you may be at a higher interest rate, if that make more sense, do a cash out refinance. But Rob, we run into this a lot with clients where they do that. And they do it as a primary residence. And right in the paperwork, you sign a piece of paper that says I intend to live in this property for the next 12 months, that’s a problem. If you think you’re going to turn around and buy a primary residence A month later, using that money as your down payment. It is not a problem. If you’re going to treat it as an investment property, you’re gonna do a bigger downpayment on investment property, and it could be that three 5% down, you know, craziness. But yeah, you can really tap into that.

But what’s cool about that is and Lance is a big proponent of this is the vacation rental, right? So you have the second home, yes, and there are lending products for a second home, where you only have to put 10%, down not 20. And still can your conforming and all that sort of thing. And then there’s also opportunity to, to, to be able to basically put yourself in a situation where you’re refiling ahead of time, and then looking at where you’re where you’re going to land strategically. Yeah, so it’s, it’s just a

Monday is gonna be

a bunch of different products that we can use to do this. And it all feeds back to Lance’s trying to encourage this client to say, hey, if you vacation in, let’s say, Oregon wine country, right? Yeah, just as an example. You know, you could put 10% down, use that home equity line of credit. It’s minimal, and you sock away at paying down debt as that first versus the fixed rate mortgage, which is at a lower rate. So I don’t want to get too far off on that. Yeah, this is exactly what Lance is, is describing of, hey, a vacation home can also be a rental. So do that business asset, essentially and go from there and do it on your margin account, if that’s appropriate, if it’s appropriate, or, you know, whatever else, your 401k you know, those sorts of things.

And then I’d love to jump to some of the risk associated, because it’s very real time. You know, these are all strategies leveraging off of something. So when you’re leveraging there’s a cash flow component, there’s a tax component that you have to address. Because not, you know, if you’re taking equity at a house that’s not used for the growth, you know, there’s a tax issue, what his ability to write off and so forth. But one thing we want to note is those home equity lines of credit and those margin loans. When you just use them, and write the checks on them, and put the down payment, they are adjustable. And we are at a very low interest rate. And so what ends up happening is, you know, we’ve experienced the last, you know, 30 years that interest rates have been going down, well, eventually, they’re going to hit a low point. And we saw that in 18, where they started rising upwards, and the market didn’t do as well. And I think we’re going to experience that going forward. So you know, when I look at that leverage, you can get that leverage in in a more adjustable rate, but you got to really look at the long term and figure out how to manage your debt in a in a rising interest rate environment. So that’s one risk, you have to worry about the what’s the exit strategy,

and what is what is the cap, because these, these products have caps typically 5% over your starting rate. And there’s a limit to how much they can invest each year.

Let’s use the margin account as an example, your accounts worth, you know, 300,000, and you can leverage up to 50%. That’s awesome, you take the 50%, but then the market goes down 20%. And that margin cow, your underlying stock goes down to 240,000. And now you only have 120,000, that you’re able to leverage. So if you push it up to the max, and you don’t allow any flexibility to the market changes, all sudden, you have what they call those margin calls that you heard about in the 80s, where you had to come up with $30,000. So you definitely do have to manage your risk, you don’t want to max and what you alluded to rob was, you know, some people, you know, real estate’s an illiquid investment, and you have all these options. But if you tap into all these options, and they’re adjustable in the market turns on you, we definitely have to have a backup plan, you don’t want to go to the nth degree on all these accounts, you need to leave some reserves and some opportunity, or for emergency. And so there’s, there are some things that we definitely when people utilize these on a long term basis, we really got to focus on what the downside could be.

So let me end with this final question for you, Lance. So what would you say are just the basic principles to utilizing leverage as safely as possible?

You know, I think having an idea of where your cash flow, I’ll bring it back, I am very cautious about advising anybody when I don’t know their net worth, and I don’t know their cash flow. So my first thing is, before you start taking a lot of cash flow, you need to take stock of where you are today, and figure out where your your tipping point is where you get into a danger zone where your cash flow goes negative or your net worth is being to leverage so I would say seek a financial advisor professional to help you get your net worth and cash flow in place, then from there, take on leverage you can afford to pay and know that you have multiple backup plans. So I wouldn’t want to leverage against my house leverage against my stocks leverage against my 401k is and you’re maxed out and all sudden one of you are the main income earner loses their job in a down market. So like you need to know what those worst case scenarios are. But then, using those get those things in place, like Adrian said, get them in place well in advance. So when you are going for a property or you have the home equity line of credit in place, they’re not going to ask you about it. They’re just going to ask you where you’re going to come up with the downpayment, you know, and sometimes people will put that downpayment in their checking account way ahead of even qualifying because then that’s what it looks like, here’s what it is, right? So there’s just, there’s just strategies that put you in a better viewing spot with the lenders that for the new property that we can put you in by planning ahead for the event. Um, and then, you know, make sure you have backup plans and understand when things go Bad interest rates rise market gets very volatile. jobs could be on the hook, you need to know that you can afford this thing without those things. And then that way you don’t, you’re not forced to sell like we had no 809 where people were forced to sell when they didn’t really they should be buying in that particular time,

right. Which is, which is a huge Oh, that that is a fun topic. We’ll have to do a little little bit of a history lesson there for a future. Love it. This is this is broken down. I think with enough bytes that we can we can chew on this granola. And I just I’ve enjoyed this topic. This is this is a fun series that we’re doing here. And I’m looking forward to the next one. Thank you all for listening.

Yeah, yep, we’ll catch you next time on the podcast guys. Thank you.

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