Robert Kiyosaki is Smarter Than ME

By
Mortgage and Lending with Jacob Dean Mortgage



Ok, so yes Mr. Kiyosaki is smarter than me (just a touch richer, too). Watching CNBC this weekend, he discussed wealth through real estate, among other things, along with a panel of 4 other people. During the show, he mentioned that he is looking for tenants to pay at least 150% of his mortgage (or full mortgage payment plus 1/2 payment as profit) in monthly rent. As a continuation of my Mortgage Math blog series, I want to actually take a look at this and, of course, run some numbers.

So let's look at a home in my area of Northern Virginia. These townhomes run around $350,000 and lease for around $1700 to $1800 per month. So, in order to have a 30 year fixed mortgage payment of less than $1800 based on a 6.5% interest rate, you would need to finance about $280,000. That means to BREAK EVEN, you need to roll equity from another investment or place a down payment of $70,000 to have your monthly rent cover your monthly mortgage payment. That is principal and interest only, so it doesn't include your taxes or insurance, but with a 20% downpayment, your lender will probably give you the option to pay your own escrows. In order to get to the target 150% of the mortgage payment (keeping market rent) you need a downpayment of 45% of the purchase price, or $160,000.

The most important thing to understand is that this is based on a traditional 30 year fixed rate mortgage. Since the math doesn't fit the mortgage, investors have tried to make the mortgage fit the math, and now you see one of the reasons we are experiencing the real estate difficulties today. Investors turned to less-traditional products to squeeze more home into the balance sheet. These products range from interest only options on mortgages and Adjustable Rate Mortgages (ARMs) to the dreaded Option ARM mortgages, where borrowers had the option to make 1 of several payment choices, including payments which DID NOT EVEN PAY THE INTEREST on the mortgage. These negative amortization mortgage products add the unpaid interest onto the balance of the loan. For buyers who are completely payment driven, it is much easier to get a mortgage payment that will be covered by the rental income. The 3.5% start rates (not interest rate) on this same property could get you a $1200 mortgage payment with only 25% down, or $87,500. *see disclosures below*

So now that we squeezed a $350,000 house into the magic 150% target, is this a good loan? For most investors, it is not. To review Adjustable Rate Mortage math, the interest rate you pay on your outstanding balance is determined by an index, which can adjust, and a margin, fixed in your loan documents. Even with a fixed "payment" of 3.5%, your interest rate on your mortage could be 7 or 8% depending on the index and margin selected when you originated your loan. Yes, you guessed it, the extra interest is added back to your principle, and now we have the (black) magic of compund interest working against us. As long as homes appreciated in the double digits, investors could sell out at a profit even if they had to bite the bullet a bit for a year or so. Unfortunately, not only have homes not appreciated (as much, if at all in some areas), but interest rates have risen as well.

So is now a bad time to buy an investment property? Probably not, since it seems there will be an abundance of distressed properties on the market waiting for capitalized investors to salvage, hold for a bit, and make a nice profit. My advice? Work with a loan officer who COMPLETELY understands the math, and even more important, can explain it to you!

*couple quick disclosures on the option arm products. most lenders limited these products to 70% loan to value for non-owner-occupied properties, and (unknown to most individuals) margins could be bought down similar to discount points on your interest rate. Buying down a margin might have cost a little up front, but could have saved quite a bit on the true interest you paid on your mortgage. *

About the Author: Brian Piper is a Senior Loan Officer with East West Mortgage in Vienna Virginia, one of the largest brokers in the country. Also online at http://www.virginialoanpro.com/

Comments (1)

John smith
SmartRate Mortgage - Tampa, FL

I didn't see the original show and have only been in this group for a short time.  Yeah, it would be great to be able to collect 150% of what you are paying.  It would be like Christmas every month.  If it were that easy everyone would be a landlord.

The simple fact is that the larger and more expensive the house, the harder it is to cover the note with a renter.  I think the idea of 150% is great on maybe an older home or a smaller home that you purchase or own in a good financial setting.  But new construction or even recent construction, you need to find the right home in the right circumstance.

I'm no expert, and I don't proclaim to be. 

It's easy for these experts to say what you should charge but much less practical to implement it.

But if you can.  More power to you.

Sep 04, 2007 06:34 AM