Guest article by Doug, Founder of honorandequity.com
There are countless stories of individuals buying multiple homes they could not afford in the buildup to the 2008 housing market collapse. Many of these individuals had to file for bankruptcy as a result of their financial decisions. Every day, people buy homes they shouldn’t buy, and this is true for investment properties as well. Just because the bank will give you a loan for a property, doesn’t mean you are financially ready to buy that property. The banks are looking out for their bottom line – not yours. So what are some things you should think about before you get that first investment property? Let’s dig in.
Get Your Personal Finances in Order
Ideally, you should have no consumer debt with the exception of a mortgage on a primary residence. Consumer debt usually comes with higher interest rates and includes ‘bad debt’ like car payments, credit card debt, and pay-day loans. Before you buy investment properties, you should aggressively pay down these loans and free yourself from them. Dave Ramsey has a great strategy for helping people become debt-free. Paying these loans off ties into the next step: raise your credit score! Lenders need to see that you are a ‘good borrower’ which means you have a steady income and you pay all your bills on time. You should target at least a 700 credit score.
You will also need cash reserves to cover surprise capital expenditures, vacancy costs, and repairs. I set aside $5,000 in a high-yield savings account per property. There are different ideas and techniques for addressing cash reserves, and I’ll admit mine is more conservative than most but it makes me sleep better at night. For example, if I own three properties, I would need to have $15,000 set aside for cash reserves and get that number to $20,000 before I buy a fourth.
Important Disclaimer: These real estate cash reserves are different from your personal ‘emergency fund’ for unexpected personal expenses.
Ok let’s sum up these up:
- No consumer debt.
- Raise your credit score to at least 700.
- Have sufficient real estate cash reserves
Make Sure Your Spouse/Partner is 100% on Board
People love surprises – but surprising your husband or wife with an investment property is a terrible idea. It’s a big financial decision, so you should make sure you and your spouse are in agreement. Many times, an individual will have a much higher risk tolerance than their spouse – and this is totally normal. You should sit down and have a serious conversation to determine your shared risk-tolerance, long-term goals, and strategies you are comfortable using to achieve those goals. Maybe your spouse isn’t ok with you doing a long-distance fix-and-flip with someone you met on the Bigger Pockets forum, but they would be ok with investing in an apartment syndication with someone you both know and trust. The bottom line is: you have to communicate with your spouse/partner and ensure you’re both on the same page before you commit to investing in anything – especially real estate.
Educate Yourself about Real Estate
This one may seem obvious, and if you’re reading this article you’re already doing it! You must educate yourself about the type of real estate in which you want to invest. There are so many fantastic and free resources out there. I’ve learned most of my real estate knowledge through podcasts and there are hundreds of different shows to choose from. The Bigger Pockets podcast is a great place to start, and I will probably do another article soon about my favorite real estate and personal finance podcasts.
My second favorite way to learn about real estate is through books. The real estate book I recommend the most is Chad Carson’s “Retire Early with Real Estate”
which is designed for a beginner real estate investor. Chad – who has an excellent podcast as well – does a great job of explaining the basics of real estate investing.
Real estate is a powerful way to build long-term passive income, but it’s a big commitment. You and your family must be financially and mentally ready for your first investment property. Being prepared before you begin the process is crucial! Otherwise, you may find yourself in a terrible financial position.
As Warren Buffett wisely said: “It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes”.
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