Investing with High DTI, When to Refi

David:
What’s going on everyone? This is David Greene, your host of the BiggerPockets Real Estate podcast. Joined today with my good buddy, Rob Abasolo for an episode of Seeing Green, where we take your questions from the BiggerPockets growing and thriving community and answer them so everyone can learn how to make money investing in real estate. Rob, how are you today?

Rob:
I’m good man. I am becoming a regular at Home Depot all over again. I’m doing a remodel. It feels like I know everybody there. They’re greeting me at the door by my name and I forget how expensive things are. It all adds up.

David:
Are you checking the thermostat before you leave the house and being angry because it’s set too low?

Rob:
I was, but we just got a new AC at my house, which I’m happy about because my house is cold, but I’m sad about because it’s very expensive to replace an AC and honestly, it is good to be home again for a little bit there things were tense because it’d be a hundred degrees outside, but 80 degrees in our house, so all is well in the Abello household. How are you, buddy?

David:
That’s great to hear. And if you’re like Rob, you can kick the sawdust off your new balance tennis shoes that you picked up at Home Depot. Tuck your polo shirt into your Docker’s pants and strap yourself in because we have a banger of a show for you today. Rob and I are going to talk about using the sneaky rental strategy, even when your debt to income ratio is having a hard time keeping up, much like Rob’s ac, how to handle bookkeeping as you scale your business but cannot afford a full-time bookkeeper, much like Rob cannot afford Home Depot, consolidating your debt and going through home refinances so that you can purchase more real estate of which you might need to rehab like Rob at Home Depot. All that and more in today’s awesome show that is not sponsored by Home Depot, but probably should have been.

Rob:
Oh, and most importantly, while we’re here, if you want a chance to ask your question, please go to biggerpockets.com/david. The link is into description in the show notes. Pause this, send us your question and I can tell you I got some inside knowledge that if you ask a question, you have a very high percentage of us answering it, so go do that real fast.

David:
Great point, Rob. Let’s get to our first question of the day. Alright, our first question of the show comes from Benjamin Sergeant in Utah. Benjamin is currently wanting to invest in the area where he lives, which is Ogden, Utah and surrounding areas. He bought his first house, which is a house act and is looking to buy a second property. I love the advice that you give of buying a new property every year and moving into the new property and making the old one a rental. My question is how do you qualify for financing to do this? The house I bought four years ago was 250,000 and now is worth 415,000. The median home price is now four 90 k. I got a promotion at work with a pay raise and I put in more hours but can’t qualify for a new loan. Do you turn the house into a rental before you can use the rent as income? So the first property won’t count as debt anymore. Thanks for all you do. Benny,

Rob:
Sir? Yes sir.

David:
Yeah, that was a sergeant joke, wasn’t it? Rob? I see what you’re doing there.

Rob:
It was Benjamin Sergeant sir? Yes sir. We’ll answer that question. Okay, sorry. Carry on.

David:
Let’s talk about sneaky rental tactics in real estate for Benny Sergeant here. First off, what do you think about the strategy of you buy a house, you live in it and then you move out of it when you buy your next house, turning it into a rental that you only put 5% down on instead of 20?

Rob:
Fantastic. I actually think it’s the, I’ve done some version of this. I didn’t carry it on for every single year, but I’ve tried it. I love it. I think the interesting thing is that it kind of works for anybody. I think it’s honestly great for people that don’t necessarily want to go all in with real estate. They don’t want to just scale to a hundred units. They could just buy one every single year and just kind of build up a portfolio of five 10 houses over the course of their career, and I think that’s a very easy way to retire as a millionaire in my opinion. Now what he’s asking is you turn the house into a rental before you use the rent as income, so the first property won’t count as debt anymore. It’s my understanding that you’re going to be working with your loan officer to inform them that this will be turned into a rental and then they will then take 75% of that rental income and apply it towards your DTI. Is there a seasoning period in which you do have to have that rental income coming into the bank account?

David:
So for most loans you’re going to have to show that you then collecting rental income on it. Many lenders will give you an exception if you have a lease in hand from a tenant saying how much they’re going to be paying. Correct, and they will usually let you take 75% of that income. They’re assuming that 25% of it is going to go to pay for repairs and vacancy and all the other stuff that you’ve got, and they’ll take 75% of that income and use it to off balance the debt that you took on the mortgage like the taxes, like the insurance. It’s already there, but it’s not a guarantee. So this is one of the reasons that the advice I often give is that people need to live beneath their means because if you’re cutting it really close with your debt to income ratio and then you take on another mortgage and you can’t buy your next property, this can be a problem. Sure. However, if you’re saving more of your money and you’re not taking on debt, you don’t have to worry about needing to show the income from the house before you can get the second one. The other thing is if you use a debt service coverage ratio loan to buy an investment property that doesn’t apply. It just doesn’t work that good because usually you’re trying to buy another sneaky rental, so you’re going to have to use a conventional loan to put three to 5% down.

Rob:
Yeah. So let me just break this down a bit because I think the specific question is that gap in between renting the property that you own now and I guess buying the new property, and I think what Benjamin here wants to know is exactly what you said. How fast do I have to have a lease? Is having a lease good enough or do I actually have to take rental income and if I have to take rental income, how can I possibly do that if I’m living in the house? That’s what I think is sort of the issue here. Or I guess that’s the big question.

David:
Yeah, you’d have to show I have a lease that’s going to take place dated for next month or two months out and they’re going to pay me X amount of money for rent. It starts on this date. At that point they would let you do it, but he might have to find somewhere else to live for a short period of time. You might have to move into a short term rental, a medium term rental, a family member while they’re shopping for that house. That first one is tricky. If you’re cutting it really close with your DTIA hundred percent true, but then once you’ve got this first property as a rental and you’re showing the income for it and then you buy your next primary residence, you’ve already got the rental income, then you do this again, you’ve got more rental income with every property you buy, you’re picking up more rental income, but it can be hard to get it started kind of like getting a kite off the ground.

Rob:
Sure. It does seem pretty interesting because you basically have to work for it at super speed A, you have to get someone to agree to move into it like a month later, which is probably a little bit harder than having it be available a little bit sooner. And then the second part that makes this really tricky, especially if you’re married, especially if you have kids, is having to find somewhere to live for a month moving in with your parents, moving in with a friend, Airbnb a house, it’s sneaky. It’s sneaky and it’s tricky, but good things come to those that put in the work, I suppose. Right?

David:
Yeah. I wish there was an easy answer for the people that have a family and this is intrusive or they have a spouse that is hesitant. I just don’t think there’s a way around that obstacle. You got to figure out how to make it the least intrusive way possible and know that it is a short-term sacrifice for a long-term gain. But if you want the benefits of a 3% down mortgage, a 5% down mortgage instead of a 20% down mortgage and the better interest rate, it’s going to cost you something. It’s probably going to cost you some comfort for sure.

Rob:
But that’s why it’s so great.

David:
Yes, it’s What’s that Dave Ramsey line live like no one now, so you can live like no one later.

Rob:
Yeah. Did he say that? That’s not his phrase, is it?

David:
Yeah, he says it all the time, but he says it better than I say it. He says it with that. Where’s he from? Tennessee probably. Tennessee accent.

Rob:
Yes. I think he says live life now so that you can live life like no one can later. Stupid.

David:
You just rushed your way through that to get to the stupid. I saw what you did and I’m here for it.

Rob:
Exactly.

David:
Thank you Rob and thank you Mr. Sergeant. Hang in there, man. We want to hear how that goes. All right. We’re going to take a quick second to get to a show sponsor so that we can bring you these shows for free, but hang tight, we’ll be right back.
Welcome back. Alright, our next question comes from Austin. Austin says, I’m looking to expand, but I’m being overwhelmed by the amount of work required to keep it all organized. Oh, I love where this one’s going. I have seven doors personally and another four with a partner in a two member LLC. I had one accountant give a quote that was quite high for a small number of properties and QuickBooks eliminated their desktop platform. Yeah, that’s been a bit of a pain for me too. We like the QuickBooks desk option. Does anyone have any QuickBooks alternatives that work for class tracking and or can recommend an accountant ideally in the San Diego area that would be able to get us going in the right direction? Alright, before we get into this, if you’re looking for an accountant in the San Diego area, don’t be surprised if you get a really expensive quote.
I think rent on houses in SD right now, they’re like $6,000 a month for a three bedroom type of property. It is very expensive to live in that area. People are going to charge more. I am sure if you go to Ohio or Kansas or something, you’re going to find a bookkeeper that will work a lot cheaper. So quick tip there. Look for places with a lower cost of living to hire remote workers. But before we do, Rob, you and I have had the bookkeeping discussion. Your books are clean, mine are dirty, yours are simple, mine are chaotic. I think we got really good response from the last time we went into bank accounts and LLCs and bookkeeping. What’s your thoughts on Austin’s dilemma?

Rob:
Okay, couple of thoughts. So he’s at enough doors and enough properties, in my opinion, to justify a bookkeeper. The hard part about bookkeeping is that typically bookkeepers charge like $500 per entity sometimes per property, and for a lot of people, 500 bucks per month is their profit on a property, whether it’s long term or short term. What I’ve always heard is when you have one to three properties, you can kind of track all of your expenses in an Excel sheet. Once you move past three properties, it’s pretty hard to do that. So a couple of things in terms of finding a tax pro, you can hit on over to biggerpockets.com/tax pros to find tax and financial planning professionals. So a little plug for us there. Secondly, as a BiggerPockets Pro member, you actually have access to ESSA and it’s included in your membership, which helps investors manage and optimize their portfolios.
You can use sessa for things like accounting, tenant screening, financial reporting, all that good stuff. Now, in terms of what I’m using these days, I actually just found this new bank that I like and it’s called Base Lane. Have you ever heard of this? No. Okay, so Base Lane is like a online, one of the new online banks out there, and basically they integrate a super simple bookkeeping software into the banking. It’s kind of crazy. It’s very intuitive. You can actually start a bank account per property and assign expenses at the end of pretty much every day if you want to, but you can categorize every single expense per property and it’s actually making by bookkeeping pretty simple. And David get this, this is a new one for me. They have a PY on their checking account anywhere from one to 4% at the moment. It depends on what the treasury is doing, but depending on how much money you have deposited in there, you can have up to 4% a PY. So it’s kind of like one of those things. I just started using them and I’m like, hmm, this seems too good to be true. But so far they’re actually pretty

David:
Good. API stands for annual percentage yield. I’m going to

Rob:
Assume Yes, and you could use that really I think at his scale at Seven Doors and do a lot of it. I’ve talked to my bookkeeper, Matt at True Books and he was basically saying, Hey, with these softwares, they’re always great, but your tax people still have to go and reconcile some of the expenses. So I don’t know if it’s a hundred percent perfect quite yet, but from my experience it’s actually been pretty simple. I’ve just switched over all my real estate stuff to that. So I’ll report back in a couple episodes if it’s still working out.

David:
That’s an amazing answer. Thank you for that. I was going to say just look for an area with a cheaper bookkeeper and say, I want limited service. How cheap can you do it?

Rob:
Yeah, yeah, yeah. I guess that’s a better, a much shorter answer than I just gave, but this is really topical, especially for short-term rental hosts and long-term rental hosts that do their own bookkeeping. But it’s like bookkeeping is such a horrible, horrible, horrible expense for the mom and pop person, and I think it’s a huge gap in the market. I think it’s a huge issue for people like Austin here. So I’ve been doing a lot of research into it, so that’s why I’m like, all right, hey, this is working. I’m going to keep trying it, so I’ll let y’all know if it works well, but for me, so far so good. Now, David, if I remember correctly, you actually, you hire a bookkeeper, right? Full-time,

David:
Have my own bookkeeper. That works for me. Yeah, so she handles it for me, but for most of my career I had to outsource that or just not have it done at all. So here’s something I was thinking when you were talking there, Rob. If I was in Austin’s position here, I would reach out to me or someone like me and say, Hey, I need this specific bookkeeping service. How many hours do you think it would take of your time to do this? And can I pay you to use your bookkeeper for my thing? Because someone like me might be like, all right, I don’t know that I need my bookkeeper to work 40 hours a week. She’s probably not working all that long. So if Austin needs two hours of work or three hours of work, we can do that for X amount of money and it’s going to be cheaper than going to a bookkeeping firm and trying to hire someone who’s going to find a way to extend three hours of work into 20 hours.
So they can justify charging you for that, and it’s going to be cheaper than hiring your own full-time person that you don’t need, but it’s probably going to take a little more work. You’re going to have to ask around quite a bit before you find someone that’s willing to take their staff member and pull them off of what they’re working on or has a full-time staff member like me that doesn’t necessarily have full-time work. So what my plan is, is I want to hire a couple VA bookkeepers to support my main bookkeeper and then start taking on additional bookkeeping services for small business owners with those people to eventually earn enough income to pay the salaries of that staff and get that expenses off my books.

Rob:
Man, that’s crazy. So you have a full-time. Yeah, I’m probably not super far from there, but man, it is expensive. I hired a, a virtual assistant in the Philippines that was relatively inexpensive that did my books, but inexpensive oftentimes ends up being the opposite of that. So I quickly switched over to True Books and yeah, it’s been better. It’s been more seamless. There

David:
You go. So we covered it from every single angle that we possibly could to everyone listening hopefully. Yeah, I think

Rob:
So.

David:
Actually one of those four different trails that we offered, we’ll offer you the scenic view that you were looking for for your own books. All right. Our next question comes from Billy in Detroit. Why don’t you take this one? Robbie? Oh,

Rob:
Billy, yeah. Okay. Question three, consolidating credit card debt, best options. Billy says, my wife and I currently own three doors and move to a new larger city in hopes to continue our real estate investing journey. Over the past year, we have dealt with death in the family, three totaled cars, medical bills, moving expenses, job change. It has been turbulent, but things are finally settled. We finally renovated our home and are stable, but we have amassed around $40,000 of credit card debt that we need to pay back. We make combined around $150,000 a year and would like to consolidate. I looked into 0% interest credit cards to balance transfer, but with my self-employment income and my wife’s name change, it’s proving to be a nightmare. Is there any private or better option for debt consolidation? Once we get that credit card balance taken care of and on a stable payment, we want to aggressively pay it off while saving for our next brrrr.
Okay, so basically he wants to know what is the best consolidation practice for all of my debt? I would say top of my head, I would often say the 0% interest credit card sounds like he’s having a tough time getting a credit card, so that’s unfortunate. I don’t know. He says he owns three doors. So my first question would be do you have any equity in those three doors and could you possibly get a home equity line of credit to consolidate all of your credit cards? Now you’re still using basically a credit line to consolidate credit cards, but at least it’s one payment, and if you can save money on that monthly payment, then you can basically just aggressively attack principal and hopefully it’s at a lower interest rate in most cases, like a home equity line of credit than a typical 25 to 30% interest credit card.

David:
Well said. Now, in addition to your comment about 0% interest credit cards, I have found the cheapest rate in general is going to be secured debt, usually secured by real estate. So a mortgage ends up being the lowest interest rate that a person can get to consolidate debt. Now, you can’t just go get one unless you have a solid debt to income ratio or debt service coverage ratio on properties. You’re taking on debt to pay off debt. You got to remember that this isn’t like free money, but you’re usually going to get a much better rate on secured debt than on unsecured debt like a credit card. So I would consider, especially because you’re getting usually a tax incentive here, a tax write off if you’re going to take unsecured debt, it’s an expense in a business as opposed to just unsecured debt, which is used to buy personal items. So take on that debt on a mortgage, use it to pay off your personal debt, and then please, for the love of everything good, don’t go run up that credit card again because now you’re stuck with mortgage debt and more unsecured debt with a high rate, and that’s where you get yourself in a big trouble.

Rob:
If you can’t get ahold of a home equity line of credit, pay off that lowest credit card that they have, and if that’s a $200 monthly payment that they get rid of, take that extra 200 bucks that they would’ve paid and apply it towards that next highest balance and keep doing that over and over again until you have no more credit card debt. That’s going to be probably the, I don’t know, the more traditional way of doing this.

David:
I think that’s really good advice. The key here is you get out of debt and you don’t get back into debt and you put your focus on something positive like acquiring new assets instead of something negative, like spending money for fun and acquiring more debt. I found that the people that have a goal like buying real estate tend to get much more serious about their finances and where their money is going than when you don’t have a goal and you just have this overall sense of I should be saving money, but it’s hard to be motivated. Kind of like when you took that fitness journey, Rob, when you had, Hey, my goal is to hit this weight or to hit this body fat percentage, you were eating very specific food every single day and working out a very specific way versus Yeah, I know I’m not supposed to eat sugar, I’m not supposed to eat carbs, but you’re much more likely to do it.

Rob:
Totally. I actually am not anti Dave Ramsey methods at all. As much as I like to have fun here, I actually think it makes sense for people in this situation when you have lots of credit card debt to do whatever it takes to get out of credit card debt. I’ve known a lot of people that were super religious, Dave Ramsey followers, they did it. What’s funny is that it’s kind of that overcorrection where they go so hard to eliminate debt that I’ve seen a funny amount of people go the opposite direction immediately after and get a new car or a pool or whatever. So I have seen that. So I would say attack the credit cards as hard as you can and try to just practice simple financial habits afterwards. It’s not sustainable to diet super hard and work out six times a week and be super, super crazy. Eventually you’re going to burn out, but what happens is you work super hard towards a goal. Once you hit that goal, then you can kind of not necessarily completely let up, but you can institute more sustainable habits. But I think being aggressive and getting rid of credit card debt like this is never a bad idea.

David:
Great advice there. Coming up after this quick break, we are going to be discussing what markets are best for investors to pursue and where Rob and I might be investing in the future. But before we get into that, let’s take a quick break to hear from our show sponsors and welcome back coming up, we have a refinance question and what the best use for a property with two houses on a big lot is. But first, Rob, where should I invest next?

Rob:
Well, one cool announcement from BiggerPockets on the journey to help investors reach financial independence is that the market finder is now live on biggerpockets.com/markets with various heat maps to help show things like affordability, rent to price ratio, appreciation, and if you’re a pro member, you get extra benefits like the top 25 best markets to invest in. So definitely check that out if you have it, my friend. But outside of that, what do you have going on in your world?

David:
Well, I got a couple properties in contract. They’re both brrrrs noy, so I found a couple properties getting ’em fixed up. They’re going to be rentals. I think I’m going to be making a new recording studio in one of them, and I’m probably going to move into it. So I don’t know how long be out of California, but I think I’m leaving California and I’m going to be moving to the south.

Rob:
So what’s the city then? Where are you moving? Have you revealed to population earth where you’re going?

David:
I haven’t revealed the city yet. I have revealed that it’s in the south and I don’t know how permanents going to be. I’m kind of going to be bouncing around some different areas in the south. I’m going to go check out the Carolinas, check out Alabama. Henry Washington has been telling me all about northwest Arkansas. He thinks I should visit it. I used to live there. I wanted to check out a couple other places in Florida, Tennessee. I was in Knoxville not too long ago like that. And I hear Houston, Texas has a very handsome man. That’s right. If you’re into that kind of thing,

Rob:
Dude, man, I’m building a podcast studio in Houston, Texas. Imagine if we did BiggerPockets live, man. It’d be crazy.

David:
Yeah, so that’s what’s kind of going on in my world. I’m back in the B seat, I suppose. How about you? What’s new? You got another short term rental under contract, right?

Rob:
Yeah. What isn’t new is probably a better question to ask, but okay, so I talked about this on the last Seeing Green. I had to stop my house from getting demoed by the city of Houston. That was a shake up. I was set to close, make 105 K. Then we found out, oh hey, city’s demolishing your house. I have to go and say stop. So that was an unfortunate because I was going to sell that house and do other things with that 105 K, but I choose to see the silver lining here, and I actually am starting to turn over some stones and I’m looking into building a 10 property on their four pad split, which is a co-living and basically the rent by the room model. And then I am renovating a house down the road from here and launching that as an Airbnb here in Houston.
Very excited. I’ve taken on most of the project management and remodel management and actually have done a lot of the work myself. I feel like I’m past this, but every so often I like to make my life harder so that I can talk about this stuff and remember the glory days. And honestly, it’s been a lot of work. It’s been really frustrating, but I am really happy to sort of be back in the saddle and kind of launching my own Airbnbs again. So excited about that. That’ll be launching in the next couple of weeks, and that will be, I think, the most designed forward property in Houston. That’s my goal,

David:
The most designed forward. Can you share anything about what this design forward term means?

Rob:
Yeah, it just means that a lot of the short-term rentals in Houston aren’t really that great. They don’t look that great. The design is like four to five out of 10. I just don’t think that there are a lot of super tiptop operators. I’m not saying that there’s not. I just think that there’s sort of a wide open market here for people that want to come in and do what we do at Funk it and kind of just goes super, super crazy with the design and unique experience. So there’s wallpaper on the ceilings, the colors everywhere. It’s going to be pretty cool. You’ll have to come check it out when you move Houston. And last thing, David, you know that I’ve been talking about reinvesting back into my properties. Well, I have a property in Bryan, Texas that was so-so Airbnb, and we just put about $30,000 into the backyard to basically there was a shed back there. We put a ton of money into opening that shed up putting new drywall, making it like a game day style home. It’s home of a and m. And I put a pickleball court, I put a mini mini putt there, a cornhole. I mean, it’s the whole nine yards. And a lot of people often say, well, you went to ut, how dare you buy a house in College Station? But the way I like to see it is I’m taking Aggie’s money and that’s okay with me.

David:
This is something I’m going to have to learn if I move to the south, this whole college football thing. Not a culture that I understand whatsoever, but I know it’s intense.

Rob:
Yeah, it’s all good though. My best friends are Aggies. I forgive them. Alright,

David:
Our next question comes from Tony in Texas.

Tomee:
Hey David and Rob, this is Tony in San Antonio. It’s been a minute. I have another question for you guys as the house hack turns. So again, I’m a veteran. I bought a duplex living in one side, working on renting out the other side as a vital room, medium term rental for military personnel. I’ve been getting phone calls lately to do A-V-A-I-R-R-L, supposedly an easier way for us veterans to refinance and get into a lower rate. When I initially purchased the duplex, I did the two one buydown. So my first year I’m at a 5.15% interest, second year, 6.15, and then it evens out at 7.15. I figured I need to get down to at least in the fives to actually make this a feasible decision. My big thing though is I’ve heard that when you refinance, it’s almost like you start the clock over because your amortization schedule is going to be at the beginning making more payments on interest even though the interest rate is lower. So I wanted to know when you guys were in your acquisition stages or in the beginning of investing, how often did you actually refi or did you only refi if you could get another property? How do I think about it? And is rate as important or should I, even if I do, should I refi the rate and keep the terms the same? Just a lot of stuff going in my head trying to build something special in San Antonio. Definitely. Again, thank you guys so much for your help.

David:
All right, Rob, the why behind the refi, what’s your thoughts?

Rob:
Yeah, so he asked when I was getting started, how often did I refi? Well, the thing is when you’re getting started, most of the time you don’t have a lot of money and we’re starting small and kind of scaling up accordingly. Now, some people are of course more aggressive than others. I ran out of money very quickly and I had big dreams and aspirations and literally the only way I could execute on those dreams and aspirations was one of two ways. Go partner and raise the money, which I did, or build equity force equity in my property, refi and use that money to go out and do new things. And I remember I got a loan and I paid all this money on the closing costs and everything like that, and a year later I had to refi to go out and basically get a home equity line of credit, build a new construction.
I felt really dumb to be honest, because I think it was well over $5,000 in fees that I was paying to refi and I didn’t have it. That was a lot of money back then for me. I mean, it still is, but I was just like, man, I can’t believe I’m making this really silly decision to close again and pay all these closing costs and basically get myself in more debt at the end of the day. But if it wasn’t for that decision, I would not have gone on to basically build a new property, new construction, cash out, refi, get all of that money back and scale up my portfolio. So I think at the beginning, if it’s a tool that you can use and you can afford the payments and you have a good financial foundation, I think it’s okay to refi so long as what you’re getting out of it is something greater than what you’re getting right now. So he said, is the rate super important? No, the rate is not particularly important. What’s important is the return and how much more cashflow you’re getting as a result. I’m not saying it’s unimportant, but what matters to me is ROI and cash on cash. And so if he can get, I dunno a better investment out of it, I don’t mind refining.

David:
Alright, my thoughts on when to refinance in general, I say don’t refinance unless you need the money. I know that sounds obvious, but part of Tommy’s question there was, should I wait till I need the money or should I refi just to refi? And I think that’s because when we describe the brrr method or a refinance in general, we always just talk about it ends with a refinance. But we are not saying that obvious reason why is because you’re going to buy more property. So if you have nothing to buy, you might not need to refinance. There’s nothing wrong with letting your equity sit in your properties if you don’t need the money for something else, because when you refinance, you do increase the debt that you’re taking on and the amount of debt service that you’re going to have to pay out for that.
Now in your case, Rob, you were trying to scale, you were trying to expand, so that’s why you ran out of money fast. There was more stuff that you wanted to buy In a market where prices are going up, rents are going up, values are going up, you’re probably going to be taking action quicker and more consistently. So you’re going to be running out of money faster. So naturally the refinance process is going to happen quicker. But in today’s market, there’s deals out there, but they’re not as plentiful. They’re not everywhere. You’re going to have to look a lot longer for ’em. So you’re going to move slower, which means you don’t have to refinance as quickly. And Tony also brought up some of the downsides for refinance. You set back your amortization schedule, so a higher portion of your payment goes to interest and set a principle.
If you do refinance a property, you’re also having closing costs that are added to the balance. So you’re losing a little bit of equity every time you do this because you’re taking on more debt and you’re getting back in cash. Now, overall, the healthiest way is if you’re making and saving money through a business or your job, so you don’t have to rely on equity in previous properties to buy future properties. You can do that, but I think it’s preferable if you can make the money some other way and then you don’t have to refinance at all. You can just keep reinvesting the funds that you’ve been making or some combination of it. So I like the idea of only refinancing when you need the money and maybe you keep enough money in your savings for the down payment of one property, right? So if you find a property, you’re like, all right, I’m spending the money I have in savings on this new property. I will also start the refinance of a second property to replenish that savings. So you always have one down payment ready to go.

Rob:
I agree. I think it’s one of those things where don’t take a refi lightly. You should be very strategic, and that’s what I’ve done every single time that I’ve ever done it. So remember, rate, interest rate is this big scary number, but if you’re getting a much better real estate deal as a result, then I think it’s certainly worth considering. I’ve got a property, by the way in LA that has a 3.25% interest rate, and I’ve got about five, $600,000 of equity in it. And boy, let me tell you, there have been a lot of times where I’ve started the refi process and I’m like, I don’t want to. I keep going back and forth, but beautiful thing is that property has a great HELOC on it, and I just use that for the same thing. And I was able to actually do a lot of stuff with that HELOC as of late. So you don’t always have to refi. Maybe sometimes there’s a HELOC solution out there for you.

David:
Is this why you got that tattoo that says 3.25 until I die?

Rob:
That’s right.

David:
All right. Our next question comes from Bora Moon in the East Bay of California, which is the same place that I currently live. Bora says, I bought two houses on one lot a few months ago. One of them is a 1600 square foot house. The other a 550 square foot small house, but it’s not an A DU. My initial plan was to update both homes live in the main house and rent out the downstairs of the main house and the smaller home, I would pay less than what I would’ve been coming out of pocket renting. And if I refinanced to a lower rate, I would save even more. Now here’s the thing, the small house has a backyard bigger than the building. It sits on the same size lot of the other 1800 square foot houses around here. So I thought, what if I do an addition and turn it into a small single family house instead of a super small 550 square foot house?
I could add hundreds of thousands of dollars of equity, and if I split the lot, I could sell one of them for a nice profit. The question is, how do I fund the construction? I’m currently using cash to renovate the main house whose RV is 1.3 million. One option would be to do a cash out refi and use the cash towards the rehab edition of the smaller house. But then can I split the lot and sell the small house after? Does it require another refinance? I have no idea how this would work. I’m also worried about rates going up through a cash out refinance. Another option would be liquidating stocks I already own and using that money to do the rehab. It feels a little risky to tap into my reserves, and I would prefer not to. Is there another option or am I going to overboard with this and should I just stick to my original plan? Am I missing something here? Please advise. Thanks so much. All right, Rob, we’ve got a lot of moving pieces. We’ve got a lot of upside. What do you think?

Rob:
So this perfect example from the last question that we were just talking about. Will getting you a refi really generate more wealth? Will it generate a better return? They just said here that if they do this addition on the property, they’ll get hundreds of thousands of dollars of equity and build a lot of equity in their house doing that. So yeah, if they refi, they’ll have a higher rate. But if they’re adding two, $300,000 to their net worth and adding two $300,000 to equity, that to me is a perfectly acceptable reason to drop a low interest rate. So long as they’re not sacrificing a ton of cashflow or anything like that, but I don’t think he is, seems like he’ll come out net positive across the board with the cash out refi.

David:
Couple things that are concerning here before we even discuss splitting a lot and selling one of the units, you need to call the city or the county first and say, Hey, how is this going to work? Do not spend any money. Do not put any plans into place until, if they’re going to honor that, a lot of the time they’re not going to do it.

Rob:
That would never fly in la. I mean, maybe there’s a way to do it, but I had that same idea at a little 300 square foot a DU, and I remember thinking, man, I’ll just split it off and sell it for 400 K. And the city was like, no. And I was like, oh. So definitely you want to verify that with your building and safety department.

David:
California is like a grumpy father from the 1950s. They love to say no. Now, if you are able to split into two different lots, the question becomes very relevant of how much the small house is worth and how much the big house is worth. They have separate ARVs, and then we can confidently and accurately address whether you should make the small house bigger. If you’re not able to put one lot into two and sell these as two different parcels with their own tax assessor’s number, this becomes a moot point. You never know what an appraiser’s going to give you. If you’ve got two houses on one lot, they typically give you the square footage of the main house, and then they take some percentage of the square footage of the smaller unit, but you don’t know how they’re going to classify it, you don’t know how they’re going to value it.
If there’s not a lot of comps in the area where you’re having houses with an A DU or two houses on one lot, there’s really no way they can go buy. I’ve seen somebody had a property with an A DU, and they gave it almost no value. I’ve seen a person that had two houses on one lot, and they gave the value of one of those houses the same as an A DU. It’s such a box of chocolates. You never know what you’re going to get when it comes to this. So the first step is you need to figure out, can we separate this one lot into two if we cannot Making that second house bigger could give you equity, but you cannot count on that and it could give you more cashflow, which you probably can count on. So if you’re getting a sizable amount of increased rent to make the smaller house bigger, now we’re talking because a renter isn’t necessarily going to care if the lot has been split into two legally.
They just want to know if they have the privacy of their own lot. So you could take these two houses on one lot, put fence in between them, give them their own driveways, and as far as a renter’s concerned, that is their own property. It functions like one even if legally it’s not one. So if you’re getting a really big increase in cashflow, forced cashflow here, I would look into expanding that smaller home and making it bigger. Totally. But your question was how to finance this. I think Rob and I are probably on the same page if I know this guy, which I think I do, our stomach’s a little bit queasy about this. We don’t love all of the uncertainty and the variables in this equation for someone that doesn’t already have the capital in the bank waiting to be spent. Is that the same thing you’re thinking, Rob? Yeah,

Rob:
They do kind of have the capital. They have equity in the house, not particularly the capital, but they did say they have liquid stocks. The problem is when you sell stocks, you take a huge hit. Yes. So yeah, would I prefer them to have cash? Yes, but it does seem like they are financially stable, their

David:
Capital’s in the form of stocks or equity, right? So now not only are you taking risk by spending money to make this thing better, but you’re taking additional risk by taking on more debt through getting the equity out of the home or taking a capital gain sit on selling your stocks and losing the future upside of the stocks. So you’re trading a relative amount of certainty for a large degree of uncertainty. That’s where my hesitancy comes on this deal. I feel like the whole thing becomes clear if you can split this one lot into two now, it just becomes a very simple understanding of I have a 550 square foot house on its own lot. If it was a 1500 square foot house, what would it be worth? There’s no way an appraiser can fight with you on this. It’s not subjective anymore, really. I guess that’s the linchpin, this whole thing. Do you see any angle that I’m missing here?

Rob:
Well, I mean, I’m just going off of their assumptions that they would get a couple hundred thousand dollars of equity by just renovating everything. And if that’s the case, I think they could just do a straight cash out refi and just renovate everything. But there’s three or four scenarios that they crammed into this. So I think really before they move forward, they have to really ask themselves what it is they’re trying to get out of this. Are they going for equity? Are they going for cashflow? Are they trying to split this so they can sell one property and make a ton of money? Because while all are really great things, if they’re trying to do everything at once, it’s going to make this whole plan a nightmare because they’re trying to solve for, they’re trying to check every single box. So I think if your number one goal is cashflow, figure out what that plan is to get you the most cashflow.
If your number one goal is more equity, more net worth, figure out how to do that. If your goal is how can I make $700,000 and get a huge lump of cash, then go for that. But right now it honestly feels pretty unclear what the vision is. I don’t blame them. They have a lot of options, which isn’t a bad thing, but in this scenario, it can actually distort clarity pretty easily because right now I’m like, oh, I don’t know. I guess you could do, you could. All of this is feasible. What do you want? More equity, cashflow, or cash?

David:
Great point. There’s also the element of this person bought a property with a lot of potential. I’ve seen this happen many times with investors and they’re trying to maximize the use of the property to its highest and best use. And you can’t see the forest for the trees. You get lost in the details of this specific property without even asking yourself, if I’m going to dump $300,000 into something, would I be better off to just go buy a fixer somewhere else and I can add more equity, more straightforward, even though you can improve this property? Is this the highest and best use of your capital and your time and your energy and your attention to throw it into this thing? Look at a couple other opportunities in different areas, different states, or even buying another property like this before you commit to going all in on a complicated rehab like this.

Rob:
Oh, one thing I was going to say. Nevermind.

David:
No, you got to say it now. You’ve created a cliffhanger.

Rob:
You said life is like a box of chocolates. You never know what you’re going to get. And I’m like, inside the box of chocolates, there’s pictures of the chocolates and exactly what you’re going to get. So it begs the question, if that little picture guide existed before

David:
Forests,

Rob:
Gump Gump came out as a movie,

David:
Just thought about

Rob:
That. Where if Forrest Gump influenced the chocolate industry, and I think that’s something we should all think about over the next few days.

David:
Let us know in the comments on YouTube if you think that those pictures existed before Steven Spielberg produced Forrest Gump or if that came later. Alright, everybody, not only have we talked about chocolates and tattoos, we’ve also talked about quite a bit of real estate. We’ve talked about how to use the sneaky rental strategy when you’re having trouble qualifying for another loan, how to handle bookkeeping as you scale refi considerations when to take on a massive and confusing project versus keeping it simple. When to use secured versus unsecured debt to consolidate payments. And what advice have Dave Ramsey, Rob and I both like. And remember, we want you to be featured on a future episode of Seeing Green. So please head over to bigger ps.com/david where you can submit your question or you can send it to me on social media if you want to follow Rob and I, our social media handles are in the show description, so please go check us out there. And lastly, please make sure you subscribe to the show to be notified when future episodes come out. And leave us a comment and let us know what do you think about the great chocolate debate? This is David Green for Rob. Stupid is as stupid. Does AB solo signing off?

Rob:
I’m not a smart man, Davey, but I know what ROI is.