Net Worth Challenge

After two months of cleaning, repairing, and painting, our hard work will begin to pay off. As of tomorrow, our new rental property is rented and will be bringing in some much welcome cash flow each month. Our new tenant signed the paperwork tonight and will receive the keys to the rental property tomorrow morning. Now, onto the our next property.

I received a good question from one of our readers and wanted to respond to it through a new post. (In reality, my response to the comment was getting lengthly and lended itself best for being it’s own post!) Thank you for your questions, Tony — you’ll find my answers below!

Tony said,

on March 22nd, 2007 at 3:24 pm

Congratulations on your purchase.

By the way, what is the state and general area of your property for the purchase price of $73,600, if you don’t mind me asking? Around my area, it’s closer to $500,000, ins @ almost $1000/yr (State Farm), prop taxes @ $6000+/yr.

One more question, what is “principal paydown� and how did you come about with it at $68?

Thanks for the congratulations note, Tony. My wife and I are excited — but VERY anxious to finish all the work. Painting has become quite the chore and is taking longer than I predicted.

Our home and our new rental property are located in the Midwest. The typical 3-bedroom, 2-bathroom single family home is around $160K to $180K. Of course, there are similar homes with lower prices (and higher prices) — it mainly depends on the area you’re looking at. But that range is typical for a nice home in a nice area.

Now ours was a lot less for two key reasons: (1) located in an outlying suburb and (2) its one half of a duplex building. The purchese price of our property was $92,000. We made a down-payment of $18,400 and took a loan for the remainder, which was $73,600.

The princial paydown refers to the amount of the bank loan that I am paying off each and every month. The mortgage payment I make to the bank includes two components: (1) interest and (2) principal. Now my payment is fixed, so the monthly mortage payment will always be $466. We can figured out the principal paydown amount using a couple different ways — one would be to create an amortization chart and another would be to use a simple math formula. The math formula is easier to talk about in this comments section, so I’ll discuss that one below.

First, I need to know the interest that will have accumulated by the time I make my first payment. I’ll use that information and add it to the loan amount to find out what my new loan amount is BEFORE I make my first payment to the bank.

73,600 — Beginning balance of bank loan
(+) 399 — Interest, calculated as: 73,600 * (.065 / 12)
—————-
(=) 73,999 — Owed to the bank the day I make my first payment

I’ll then take this number and subtract my fixed payment amount. This will give me the new loan amount AFTER my first payment is made.

73,999
(-) 466 — My fixed, payment amount.
—————-
(=) 73,533 — New amount that is owed to the bank AFTER I make my first payment.

The last step is to calculate how much the loan balance decreased. This is the “principal paydown”.

73,600 — loan amount BEFORE making payment
(-) 73,533 — loan amount AFTER making payment
—————-
(=) 67 — principal paydown

Now, another good question is, what does this number represent? When my wife and I purchased the property, it could be said that we fairly valued the property to be the same as our purchase price. (Yes, this is looking at it in simpler terms) So in this case, we believe the value of the property to be $92,000. Since we took out a loan with the bank, in essence we do not own the entire property yet. Instead, my wife and I only own $18,400 of the property —- which was the amount of money we paid as a down payment. This number is the equity we have in our home. The bank owns the remainder, which is $73,600.

As we make payments to the bank each and every month, slowly but surely our loan balance is going to drop. We are paying down the principal of that loan. After our first payment was made, the bank now only owns $73,533 of the property and we now own $18,467 of the property. So as time goes on, we’ll own more and more of the property as our “equity” in the home increases and the “loan balance” from the bank decreases.

This is probably a LONGER answer than you may have been looking for, but it’s a great refresher for many of us. The other thing to remember is that over time, the interest and principal portions of our fixed monthly payment will change. The amount of interest we are paying will slowly decrease and the amount of principal will increase. Our “principal paydown” numbers will continue to increase with each and every payment. Now how did I come up with the “principal paydown” amount from my previous “Numbers” post? I looked at the principal paydown numbers for an entire year and found the average. Over the course of a year our bank loan will decrease by $822 or, roughly $68 per month.

I hope this answered all your questions. It’s a good excercise for me to go back through the numbers and make sure I have been calculating everything correctly. Thanks for the great question. Let me know if I can clarify anything further. Perhaps I’ll upload an image of our amortization chart (done in Microsoft Excel) in the near future. It’s a great visual that is an alternative to running these calculations by hand.

I’m sorry it’s been a while since the last post. During the last two weeks I have been busy (yes, my wife isn’t that interested in the “tough work”) getting the property ready for rental. The items I’m taking care of are:

• Paint ceilings
• Paint walls (primer + regular coat)
• Paint doors
• Steam-clean carpet
• Replace air vent covers and air intake covers
• Replace all window blinds
• Replace thermostat
• Replace outlets and light switches
• Replace outlet and light switch cover plates
• Purchase refrigerator
• Clean, clean, clean!

It seems like a tall list — and it is! My wife and I knew the property needed some extensive repairs before it would be ready for rental. I’m pleased to report that I’ve made quite a bit of progress on my repairs, though. I’ve been busy painting all the ceilings and preparing the walls/trim for priming this weekend. Also, I purchased all the parts/items we needed from Lowe’s because of a nice Lowe’s 10% Off Coupon that is given to new/existing home purchasers.

Now that I have all the items and I’m well into the middle of my “to do” list, I’ll begin thinking about putting an advertisement in the newspaper and placing a sign in the front yard of the property. Basically, I need to start taking actions to get people calling me and get people walking through the property. This will be my first priority after paint is on the walls.

It’s official, my wife and I are now owner’s of a second rental property! We woke up early this morning to go down to our realtor’s office and sign all of those important papers. I am glad to report there were no “surprises” in the closing cost numbers. Our first purchase had a few items that we were not expecting, but this time everything went much more smoothly. Now that we’ve closed on the property, I have the keys and will be anxious to begin getting it ready for rental.

As I mentioned during our February Net Worth Update, I expect our expenses in March to increase considerably due to the closing costs associated with the home purchase and the materials I intend to purchase to clean, repair, and get the property ready for rental. The property needs a little work, to put it lightly, so hopefully these expenses won’t get too out of control during the month. The race is now on to get everything finished and find a renter for this property!

I usually look at four numbers that make up the total monthly expense of a rental property: (1) mortgage payment, (2) property taxes, (3) home insurance, and (4) improvements/repairs. Note: all numbers below have been rounded up to the nearest dollar

1. Mortgage Payment — We are financing our property with a fixed-rate, 30-year loan. We intend to make a 20% down payment and will finance the remainder. The interest rate is 6.50% and there are no points to pay on the closing date. This means that our loan with the bank will be $73,600 and our monthly payments will amount to $466.

2. Property Taxes — The property has an assessed value that is higher than the contract sales price. While this may not typically mean much, in this case we have a good amount of evidence (sales price, appraisal, comparables in neighborhood) to appeal the assessed value from the county. I’ll talk about this process in the coming months as I prepare my appeal. For these purposes, however, I’ll assume that yearly property taxes will equal the amount paid last year, which was $1,400. This amounts to a monthly payment of $117. My wife and I do not have to escrow this payment, but each month we intend to add it to our money market account to earn interest before the property tax payment is due at the end of the year.

3. Home Insurance — I did not do much shopping around for home insurance on this property because of time issues and the rapid approach of the closing date. Therefore I purchased a policy from our regular homeowners and auto insurance company, which is State Farm Insurance. Our yearly premium is $379, which amounts to a monthly payment of $32. My wife and I do not have to escrow this payment, but each month we intend to add it to our money market account to earn interest before the homeowners insurance payment is due.

4. Improvements/Repairs — Even if the property is brand-new, there will still be periodic improvements and repairs that need to be made. I put aside money each month into an “improvements/repairsâ€? fund for my rental property. Through my own calculations I have determined the need for $77 a month into this fund.

Adding these four amounts together gives me a total monthly expense of $692. At the very, very least I will need to rent the property for this amount. I have every intention of listing it for a higher price and I believe the neighborhood can support a monthly rent of $830. At that rental amount, I would have a cash-flow of $138 per month. My cash-on-cash rate of return for the year would be 7.89%, assuming full rental throughout the year. If I included the principal paydown, which is the amount of the bank loan that gets paid off each month, my rate of return for the year would be 11.77%. Please note, I’m using my down-payment PLUS anticipated closing closes when determining these rates of return.

Cash-Flow Profit per Month:
$830 rent - $692 monthly payment = $138 cash-flow

Total Cash Investment:
$18,400 down payment + $2,600 closing costs = $21,000 cash investment

Cash-on-Cash Rate of Return:
($138 cash-flow x 12 months) / $21,000 cash investment = 7.89% return

Rate of Return, including Principal Paydown Numbers:
(($138 cash-flow + $68 monthly principal paydown) x 12 months) / $21,000 cash investment = 11.77% return

There are three key elements I’m leaving out of my calculations. The first is that I’m assuming full rental throughout the year. In reality, this will not always be true. To come up with more accurate numbers, I should assume a certain level of “vacancy” in the rental property. This would LOWER the rates of return listed above.

The second element is that I’m not taking into account potential appreciation of the rental property. The home should appreciate in value over time. Eventually, when my wife and I decide to sell the property, we will be able to “cash in” on that appreciated value. However, for our regular purposes of renting the property, this element does not affect us much. If we were to estimate a certain level of “appreciation value” in the property, this would INCREASE the rates of return listed above.

The third element is the effect on my wife and my income tax return.  Having a rental property gives us several benefits during tax-time that effectively lower the cost of having and running the property.  If I were to include these benefits in my calculations, this would INCREASE the rates of the return listed above.  However, as the rental property begins to generate positive income after all the expenses are taken care of (and yes, this includes depreciations since we’re talking about income tax returns), my wife and I will have to pay taxes on those profits.  If I were to include these benefits in my calculations, this would LOWER the reates of the return listed above.
Well, there you have it. Those are the base numbers for this rental property. As you can see it is difficult to get a definitive rate of return calculation without making some assumptions.  For this rental property and this neighborhood, I am making certain assumptions that I may not make with other properties — mainly my confidence in keeping it rented the entire year.  I’m sure I’ll have more discussions on this in the future, but for now, wish my wife and I luck as we go into our closing date for this new property!!!

After some intense negotiation (well, maybe not as intense as I’m making it sound), we have come to an agreement with the sellers and will be purchasing an additional home to use as a rental property. This additional property is a single-family, attached dwelling — basically a half-duplex. The previous owners purchased the unit as a townhome for $96,000 about a year ago, but have since outgrown the place. The property originally listed for $99,000 and my wife and I negotiated the price down to $92,000. We are very excited about our purchase and look forward to renting it out in the coming month.

Our negotiations ended a couple weeks ago, right after my last post that talked about our loan pre-approval process. Since that time I (yes, my wife is leaving this work up to me) have been frantically finalizing the terms of our loan, coordinating a home inspection, ordering an appraisal, preparing to purchase home insurance, and planning the transfer of funds into our checking account. I’ll talk briefly about each of these items below:

• Home Inspection - Although this is not required by our lender, I still feel better having a thorough inspection done by a licensed professional. The home inspection did not turn up anything drastic, which I was pleased to hear. I consider it to be a well spent $225.
• Appraisal - This is an item required by the lender and typically ordered by the lender. However, as the home buyer, my wife and I have to pay the bill at closing. The appraisal came in at $93,000, which I believe to be lower than the value of the property. The positive result from this appraisal will be the fact that I can appeal the assessed value that the county has recorded for this property. Currently the county values the property at $110,000 — and charges property taxes based on that assessed value. If I can successfully appeal that assessed value, which hopefully will be easier with the appraisal document, I will be able to lower my yearly tax bill. The appraisal cost us $425.
• Home Insurance - I have been working with State Farm Insurance to get a rate on home owner’s insurance for this property. Since it will be used as an investement property, the insurance merely has to cover the structure and not the contents. It will be up to our renters to obtain rental insurance in order to protect their belongings. Our preliminary rate for the year will be $330. This number may change after a thorough inspection is conducted by State Farm Insurance today or tomorrow.
• Planning the transfer of funds into our checking account - This may seem like a small step, but it’s important for me to plan out the transfer in order to minimize my tax liability for 2007. A majority of the money we are using to purchase this home exists in our “house fund”, is invested in a mutual fund. Selling part of our mutual fund creates a taxable event and we will have to pay capital gains taxes on any profits from our investment — which should be significant (that’s good and bad). Therefore, I am trying to shuffle around money that is held in cash, checking, or money market funds in order to minimize the amount of mutual funds that we’ll have to sell. I will not be to avoid selling part of our mutual fund, so it is a certainty that next year I’ll have some capital gains taxes to pay.

All of these items have been taken care of and our closing date for the purchase of the property is NEXT WEEK!!! Since the closing takes place in March, our net worth update for February should not be affected too greatly — but the numbers from March will certainly be different than originally expected. I’ll try and share some additional numbers regarding this investment property over the weekend.

I mentioned a few weeks ago about our intention to purchase another rental property this Spring. After gathering the required financial documentation (statement of assets/liabilities, current account statements, etc) I was able to get preliminary information from our bank — in essence a loan pre-approval. The reason I use the word ‘preliminary’ is because I had asked the bank to not pull a credit report. Until I’m completely certain of intention to purchase a particular property, I do not want to have any unnecessary inquiries on my credit report.

We intend to use the home as a rental property, therefore the bank gave us their investor rate, which is slightly higher (about half a percent) than the primary residence rate.

• 20% Down Payment: 30-Year Fixed @ 6.675%, 0 points, and small closing costs
• 30% Down Payment: 30-Year Fixed @ 6.500%, 0 points, and small closing costs

Loan rates have certainly increased since our first purchase, which was a duplex a few years ago. However, these numbers are certainly manageable for our next rental property endeavor. I had the bank give me two rates, using a 20% down payment for one and a 30% down payment for the other. Originally I was not interested in purchasing the property with anything less than 20% as a down payment, but I may ask the bank to quote me a rate using a 10% down payment — just to see what the numbers look like.

Now that I have the rate information I need, my next step is to begin evaluating potential properties. As I mentioned earlier, I have been searching for several months and have created a list of properties that I consider great candidates for rental homes. There is one in particular that I am prepared to make an offer on today. I’ll post the details about that in the upcoming days.

My wife and I have been very pleased with the purchase of our duplex a couple years ago. Instead of purchasing a home, we decided to purchase a rental property that would “kick start” our rental portfolio. Our plan was to purchase an entire duplex building, live in one side, and rent the other side out. Although my wife originally wanted the house, she has been very happy with our accomodations and has no regrets when it comes to the choice we made. The side we live in is very nice and truly feels like a “little home.”

Well, it’s been a couple years and again my focus has turned to the rental market once again. I would like to purchase an additional property to add to our portfolio, but this time the focus is a little different. This time around we are looking for a house that would make a great home for my wife and I, but also would be a great rental when it came time for us to move on. We are going to keep the duplex and rent out both sides when we move out and into our new home. Eventually, when we outgrow this new home, the plan is to keep it and rent it out.

For the past several months, I have been actively searching through real estate listings and trying to keep a pulse on the market. I have stepped up my search during the last few weeks and have notified our realtor about our intentions. I have also organized the necessary paperwork in order to begin the bank pre-approval process. I expect to receive information from one bank tomorrow and will post that information when it comes in. Since I am only looking for preliminary rate information, I have asked the bank to not pull my credit report at this time. I do not want any unnecessary credit inquiries on our credit reports until we get closer to finding a property.

During my search I have been utilizing some great, online sources of information. I typically visit the following types of sites in order to get the best feel of the local market:

1. Local Realtor Websites - Used for routine home searches and for viewing photos of properties.
2. Google Maps - I often find that the local relator websites have clunky mapping interfaces that are difficult to use and not nearly as clear as Google’s alternative.
3. Zillow - This is a great site that attempts to show specific values of homes. In my area, the values are inflated beyond what the local market truly is priced at. However, I find this to be a useful tool when viewing specific neighborhoods. I can easily see where higher and lower priced homes are located compared to the home I am looking at. It gives me a great, neighborhood perspective.
4. County Tax Records - Logging onto my local county’s website allows me to sift through mountains of great data. First, I am able to pull up tax information and even recent sale information on specific houses. Second, I am able to compare the house I am looking at to the other houses on the same street. This is valuable information that was once only available to realtors. Now, because of technology and local county’s pushing for easier access to public records, I am able to utilize this information in my initial search.

These are just four of the main resources I use when I initially search for homes online. After I’ve compiled a list of homes that meets my criteria, then I’ll call up my local realtor and ask to visit the homes.

After graduating college, my wife and I wanted to get a good start in building our “financial foundation.” Both of us had been good savers in college and we planned on continuing our savings habits after starting our new jobs. I’ll admit it was tough to resist the temptation to spend our larger, post-college, real-job paychecks at first — and instead devote a large chunk of our new income to items such as retirement and other long-term savings goals. But after a short while we both became used to the new savings habits and started realizing how much it would help us in the future. Flash forward two years and it seems that our asset accounts are growing and the plan we created is working well for us.

In the last post I listed these asset accounts along with our liability accounts for the month ending September 2006. Now I would like to dive a little deeper and explain what each line-item represents:

Cash & Savings - The main account I use as a “starting point” for all my financial activities is my checking account. I use this account for direct deposit of paychecks, paying credit card bills, writing checks, and moving money from my different investment accounts. In addition to a checking account, I also maintain a savings account at the same bank. I only keep the bare minimum in the savings account because I can get a higher rate of return elsewhere. I also have a PayPal account for accepting online payments. This account usually has a small balance in it that I periodically transfer into my checking account. Finally, I also keep track of the money I carry around in my wallet (and the money in my wife’s purse). Although the amounts of cash in our wallet and purse are usually small, I still like to track it so that we know exactly where our money gets spent. Overall, I try and manage the balances in our checking, savings, PayPal, and wallet accounts so that only a bare minimum is stored here. Since I can earn a higher rate of return in a money market account, I generally store more money there and less money in the Cash & Savings accounts.

Taxable Brokerage Accounts - This item is comprised of my non-retirement Ameritrade, Sharebuilder and Vanguard accounts. I use the Ameritrade and Sharebuilder accounts for trading stocks, ETFs, and options contracts. I use both accounts because each one has an advantage that I try and utilize as best as possible. The Ameritrade account has lower commission charges and gets used for trading options contracts and for purchasing stocks that do not pay a dividend. The Sharebuilder account gets used for purchasing stocks that pay a dividend, since they offer dividend reinvestment for free. I try to set aside some money each month for investing in the stock market, which is separate from my retirement savings. As of lately, much of my investing in these accounts has been in small-cap and mid-cap stocks. I have been investing in these categories in order to better diversify my overall investment holdings. I also maintain a Vanguard account for short-term and long-term purposes. Instead of storing short-term money in my checking account, I keep this money in a Vanguard money market account. My money market fund at Vanguard holds money for items such as our vacation fund, home insurance fund, car insurance fund, property tax fund, and other such items. I also use Vanguard to purchase mutual funds for longer-term goals. Our house fund is invested in a mutual fund that is riskier, but typically has a higher rate of return than the money market account.

Roth IRA - Although I did not start my Roth IRA account at age 18, the first year available for me to join, I did start at a reasonably young age. My goal has always been to contribute the maximum allowable amount into my Roth IRA each year. When my wife and I were married, I was quick to setup an account for her and began contributing the maximum amount for her as well. I consider investing in our Roth IRA a high-priority. Both of these accounts are held at Vanguard and are invested in Vanguard mutual funds.

401(k) - My wife and I have 401k accounts at both our companies. We setup these accounts as soon as we began our full-time jobs and began contributing money into these accounts from day one. At the bare minimum, our goal has always been to contribute enough so that we earn the maximum matching amount from our companies. Lately, however, we have been putting away much more into these accounts because of tax planning. Because of tax planning, I hope to contribute the maximum allowable amount ($15,000) in my 401K this year. I would like to do the same with my wife’s 401K account, but her company has a limitation on her contribution rate. Therefore, it is impossible for us to contribute the maximum allowable amount for her account while she is at her present employer.

House #1 - Rental/Primary - In addition to starting our savings for retirement when we began working full-time, we also purchased a home shortly after graduating from college. We did not go the traditional route, however, and instead purchased a duplex with the intention of living in one side and renting the other side out. Now that we have lived there for a little over two years, we may start searching for a new home next Spring. We plan on keeping this duplex for many more years and will rent out the side we had been living in after moving to a new home.

Other Assets - The only assets this item currently tracks is the value of our two vehicles. While our cars may not be easily convertable to cash in the future, they are still considered assets and I do feel they should be included. I used the Kelley Blue Book website to determine the fair market value of our cars at the end of last year. I do not plan on making changes to the value of our cars on an ongoing basis each month, but rather once a year at the end of December.

Overall, I am proud of the values of each asset account because it represents progress that my wife and I have been making over the past two years. Believe me, they didn’t automatically start out looking so strong. It will be exciting for me to track the progress of these accounts in the future and to talk about strategies for maximizing the rate of return I am earning on these accounts.