PMI – Private Mortgage Insurance

Don’t pay it. Get creative for your down payment. Here’s a brief on how PMI works and how we avoided paying it.

What is PMI?

A lender typically requires PMI when the loan is greater than 80% of the loan-to-value (LTV) ratio because it’s higher risk for them. If a buyer has less of their own money as equity in the property, the bank views this as a higher probability the homeowner will default on their loan. With that, the PMI is required until the borrower reaches at least 80% for the LTV ratio and the loan is in good standing for at least 5 years. This typically means that a borrower needs 20% of the purchase price as a down payment. There are a few exceptions, but overall, if you don’t have a 20% down payment, you’ll be paying PMI.

PMI can be up to 2% of the loan balance. The lender uses your credit score/history, the down payment amount, and the loan term to evaluate your risk and set the PMI rate.

While there are requirements that the PMI must be removed when your loan hits 78% and 5 years in good standing, you can request the removal of PMI earlier if your house value has risen (e.g., market fluctuation, improvements you made). If you request the removal of PMI, you may be required to pay for the new appraisal, which is an added cost. You should weigh the cost of the appraisal against the remaining payments. In a broad example, if the appraisal costs $450, and your monthly PMI is $120, then as long as you have more than 3 months left before hitting the 78% LTV ratio, it’s worth paying the appraisal fee to have PMI removed. There is also a risk that the appraisal doesn’t come back with a high enough house value, so you should be confident in your home’s value before requesting said action.

How did we avoid paying PMI?

While we were more than qualified to purchase a home in the D.C. suburbs based on our debt-to-income ratio, we restricted ourselves to what we could afford as the down payment.

A bank qualifies you based on your debt-to-income ratio. If you have low recurring monthly bills, then you’re qualified for a larger loan. At the time, our only recurring monthly payment was on my vehicle, at about $350/month. The bank pre-qualified us for about $700,000. Sure, we could “afford” a monthly payment on a $700,000 mortgage, but then we couldn’t eat, sit on furniture, or do anything else. 😉 We’d also be paying PMI because we didn’t have 20%, or $140,000, to put down.

Also due to our low debt-to-income ratio, we couldn’t qualify for any programs that would allow anything less than a 20% down payment for a mortgage. We set our purchase limit at $350,000, which meant we would need $70,000 for the down payment, plus closing costs. Due to the limited inventory at that price in the DC suburbs and the knowledge that we were pre-qualified for double what we were searching for, our Realtor kept pushing us to raise our purchase price. However, we advocated for ourselves and kept our focus on what we could afford as our down payment so we wouldn’t pay PMI. After months of searching and seeing places that were literally missing floors and walls, we increased our search to $400,000, hoping that if we found something in the 350k-400k range, we could negotiate it to 350k.

Our move to the D.C. area was not in our original plans. Mr. ODA had been saving through high school and college, expecting to buy a house in a lower cost of living locality. When we moved to D.C., we knew that we would need to change our expectations and day-to-day actions. We rented an apartment in Fairfax, but we didn’t want to be putting over $1600 per month towards rent for long, and we’d prefer to be paying towards a mortgage and building equity in a home. Positives to owning a home: mortgage tax deduction, appreciation, and the equity building that you get back when you sell the home.

While we rented, we were conscious of our spending. We aimed to spend less than $10 per day on food between the two of us, and we limited how much we ate out. We did activities with Groupons or coupons.

We moved to DC in December, and over the summer, we put an offer on a flipped foreclosure. The listing was $384,900; our offer was $380,000 with $2,000 in closing costs. It was denied by the bank, as we were told we were the 2nd best offer of 3. The next day, we got a call that the bank countered our offer. Apparently, the first offer attempted to negotiate their offer further, and the bank moved on to us. They countered $380,000 with no closing costs; we accepted. We now had to scrounge up about $80k for closing. 

We looked into a Thrift Savings Plan (Federal government’s 401k) loan. Many warned us against the idea, but our research showed it wasn’t as much of a concern as others let on. The details of this loan option are on another blog post. We decided to each take a residential loan from our accounts. I took a $15,000 loan and Mr. ODA took a $25,000 loan. We also borrowed $5,000 from Mr. ODA’s parents and paid it back within a couple of months. We avoided PMI.

An argument heard about not owning a home is that it costs a lot to maintain a home. While owning the home for 3.5 years, we gutted the main floor bathroom ($4,000), replaced the AC ($3,600), replaced the hot water heater ($1,100), resolved termite issues with treatment and wall replacements ($2,000), laid carpet in the basement living area, improved the yard through grass maintenance and purchased a shed, and painted a few rooms. We sold the home for over $60,000 more than we purchased it for (tax free since it was our primary residence the whole time), far more than the minimal expenses we put into it.

Key takeaways from our experience:

  • The efforts we put in to avoid paying PMI meant we had another $100-200 in our pockets per month. Instead of padding the bank’s ‘pockets,’ we paid ourselves back with interest into our retirement account.
  • We lived below our means, saved, and kept focus on the big picture.
  • We pushed ourselves to our financial limits to begin building equity in a home, rather than paying rent to a landlord (or in our case, an apartment company). The efforts put in that year have paid off time and time again, starting with selling the home 3.5 years later for a profit that led to some of our first rental purchases.

House #8

I shared that I would tell the stories of our home purchases. Instead of starting with #1, I decided to start with the most interesting. This property was being sold by a licensed Realtor, so we had a false sense of security. It ended up being the sketchiest (technical term) deal we’ve done. This is in Virginia.

We started with a home inspection, which revealed several issues. We requested the HVAC condensate line be cleared and the water in the backup pan removed. We also agreed to have our attorney withhold $1,300 at closing, to be paid to a contractor of our choice after closing, to repair other items found during the inspection. I can’t remember why we were handling the home inspection items, but that should have been the first red flag.

Our closing was scheduled for 8/18.

We were told that the HVAC repairs agreed upon were completed. We went to check on the progress of cleaning out the house and the HVAC repairs on August 10th. The HVAC’s backup pan still had water in it, and the house was filthy (after being told it was ‘vacant’ and ‘cleaned’). Plus, the electric was turned off. We had our Realtor reach out to the seller to cover our bases. Here’s his email:

While waiting for a response on this email, we checked with our closing attorney to ensure everything else was ready for closing; it wasn’t. We fully expected a “we’re clear” response, but instead we were told they were having trouble clearing the title. We weren’t given the specifics, but that’s not what you want to hear a week before closing. It ended up being cleared, but that was one more thing to worry about!

As typical, we had to do a final walk-through of the house to ensure it’s in the same condition (or better) as it was when we went under contract. Knowing how poorly the seller communicated over the previous month, we wanted to see the house the day before closing, rather than right before we head to the closing table. The electric was still not turned on, and it wasn’t cleaned. Our Realtor contacted the seller again. We were assured it would be addressed, and the electric would be on. We made plans to walk through the house in the morning.

Our Realtor was unavailable that morning, since this wasn’t supposed to be part of the schedule, so he sent a team-member to let us in. As luck would have it, she dropped the lockbox key below the front porch, so we couldn’t get in. We called our attorney and postponed the closing to later in the day. The Realtor was able to obtain a copy of the key to let us in, where we learned the electric was still off.

I contacted the electric company. I explained that I was the buyer, and the seller kept saying the electric would get turned on, but here we are at the 11th hour with nothing. The woman on the other end couldn’t tell me what she was seeing since it wasn’t my account, but she carefully played with words to let me know: sorry, hunny, but there’s no way this electric is getting turned on while under this person’s name because there is a high outstanding balance. She assured me that if I put it in my name, there wouldn’t be any issues. However, I wasn’t about to pay fees and put it in my name before the house was legally mine.

This is where we learned that a good attorney is worth his weight in gold. We never really understood the role of a closing attorney, since all our closings had gone smoothly (I mean, we could sign all the closing documents in about 20 minutes at this point). Since the electric wasn’t on, and we couldn’t verify the condition of the home, as required by the contract, our attorney withheld $5,000 of the settlement proceeds. The seller’s attorney was NOT happy, but it was entertaining to watch from our standpoint. 

We had been provided a ‘receipt,’ dated 8/17 (the day before closing), that indicated an HVAC repair man had been out to do the work required. We are pretty sure that this was falsified. There was no electricity in the house that day, and there was still water in the pan on 8/18. Here’s the email I sent to our attorney releasing the $5,000 withheld, less the cost of my HVAC technician performing the repairs.

It cost me $125 for the HVAC technician’s trip. Our attorney told the seller’s attorney that he would release the $5000 less the $125. The seller’s attorney said he didn’t have any authority to allow that; so our attorney said he didn’t have any authority to release the $5000. Well, the seller’s attorney decided $4875 was better than nothing, and I got my $125 back.

All in all, everything fell into place, but there were many days and hours that felt like we were about to fall into a pit.

We purchased the house for $89,000, plus the $1,300 for contractor repairs, and the seller paid $2,000 of our closing costs (this minimizes the amount we have to bring to closing and allows us to leverage every last dollar we can for maximum efficiency). Our first lease was for $995/month, exceeding the 1% Rule. We closing in mid-August, and the first lease didn’t execute until October 1, which was one of our longer vacancies. That tenant renewed her lease once. Currently, the rent is $1,025/month. We sought $1,050 for a 12 month lease, and the prospective tenant negotiated an 18-month lease at $1,025. We accepted this because it was rented in October, and an 18-month lease brought as back to spring-time turnover. Even though taxes have risen since the purchase, we still maintain the substantial cash-on-cash return that is provided for in trying to obtain the 1% rule on investment real estate purchases.

After closing, I painted nearly the entire house (including the trim) over the course of a week; the house looked significantly better with just a fresh coat of paint. We also had to do a more thorough cleaning job than we’ve typically had to do on houses we purchase, including caulking the tub and cleaning the carpet.

We replaced the dishwasher with the first tenant, and then replaced the refrigerator after the second tenant kept complaining about the seal not working well. Most costly, the house has had several roof and siding issues. The kitchen was an addition with a flat roof, which typically causes problems. We replaced the gutters, fixed the flashing, repaired some siding, and then eventually replaced that part of the roof altogether. We also had to replace a cracked window, which was surprisingly under warranty. It took a lot of work to find the window manufacturer and a local distributor, but it surprisingly all worked out because it was a stress fracture and covered under a lifetime warranty.

Leveraging Money – Mortgage is not an ‘Eight Letter’ Word

Dave Ramsey has convinced (too many) people to pay off their mortgage and be “debt free.” Then you have Robert Kiyosaki telling people not to buy a house because its a liability, but never seems to address that you still have to pay for a roof over your head somehow. We subscribe to a different view – make your money work for you. There are certain types of debt that could truly benefit you, and a mortgage is one of those.

If we worried about paying down our mortgage, we wouldn’t have near the savings and investments we do, and wouldn’t be able to establish enough rental income to replace Mrs. ODA’s income, and being well on our way to replacing Mr. ODA’s. 

We lived below our means, took some loans, and bought a house in one of the more expensive regions of the country – DC suburbs (oh, and while paying for a wedding). We knew we’d have no trouble qualifying for a mortgage and paying the monthly payment, but we didn’t want to pay Private Mortgage Insurance (PMI), which meant coming up with 20% to put down (i.e., about $80,000). In fact, we were pre-qualified for double the purchase price of a house than we were comfortable with because we were more focused on our down payment threshold than what we could support as a monthly payment (which is how a bank will pre-qualify you based on your other monthly debt payments).

Our first, expensive, little house that jumpstarted our investing before we even knew

Our primary goal to enhance our savings in the months leading up to the house purchase was to keep the cost of our daily food intake below $10 between the two of us. We were cautious with how we spent money on groceries, whether we ate out (meaning no buying lunch during the work day), and the types of activities we did. While most of our meals consisted of macaroni and cheese and pb&j, we did ‘splurge’ a little more once in a while (read splurge as meaning “2 for $20” at Applebee’s, not steak dinners). That year of actively watching what we spent paid off in ways we wouldn’t know down the road.

Three and a half years later, we sold our house for a $60,000 profit and purchased a home in the Richmond area for less than what that first house cost us when we bought it. That left a substantial balance in our savings account that needed to get to work. 

We’re not interested in preparing for doomsday. In an emergency, there’s hardly anything that can’t be put on a credit card. If we can’t pay off the credit card, we have money in the stock market that can be liquidated within 24 hours to pay it. This perspective is particularly possible because we live a lifestyle that allows for a high savings rate while Mr. ODA is still W-2 employed, which means we’re even more unlikely to need stock liquidation to cover expenses. We weigh the risk of a possible emergency against not having our money make more money, which gives us the ability to live less conservatively. Since we’re not interested in maintaining 3x our monthly income in a savings account at 0.01% interest rate, the next option to discuss is paying down our primary residence mortgage. 

Our mortgage rate was 2.875%, a very cheap lending rate [this was a 5-year Adjustable Rate Mortgage (ARM), a topic we can discuss in a future post on weighing mortgage options]. The question we had to ask was whether paying down the mortgage at a low interest rate was more beneficial than the income we could bring in with a rental property. If we paid more than 20% for our new primary residence’s down payment, was that going to provide us a greater cash flow to leave our careers before typical retirement age? 

No, it wouldn’t allow us to leave our careers. So, we put the balance of money from the sale of our first home into the stock market and investment properties to make it generate income instead. 

Our first investment property purchase was in February 2016. Since then, we’ve purchased twelve other investment properties, with the most recent two being in September 2019. Mrs. ODA’s income was replaced by our rental property cashflow by the time our son was born in August 2018; that’s within 2.5 years after we purchased our first investment property. 

Of our 12 investment properties, two have mortgages paid off. First, there’s a maximum of 10 mortgages you can have when lending under Fannie Mae. There are ways around this in theory, but that’s another post. One of the mortgages we paid off because it had a balloon payment coming due. Another mortgage was paid off because it had a low balance and was one of the higher interest rates among our properties. Currently, we’re working to pay down two other mortgages due to their relatively high interest rates (5.1% and 4.95%), and each have a balance around $26,000 now. We’re choosing to pay down mortgages in this season instead of purchase new rental properties because we are not finding properties in decent condition that meet the 1% Rule. Plus, not having a mortgage on a property immediately increases your cash flow if you want to live off that monthly income rather than W-2 employment. 

Had we chosen to pay down our primary residence mortgage instead of leverage our funds through mortgages, we’d still have a mortgage payment of over $1,500 per month and no other income strings. Instead, we still have a mortgage payment for our primary home, but we also have the cash flow that replaced Mrs. ODA’s six-figure income.

Choosing Properties

Choosing Properties

Mr. ODA has regular emails come in with new listings in the areas we’re interested in. While some of our houses are 2 bedroom, we find it easier to rent 3 bedroom houses. We also are looking to the possibility of resale, which is better for the 3 and 4 bedroom houses.

First, we look at the condition of the property. We’re interested in properties that can be immediately rented, meaning we’re not looking for remodel projects. Most of our properties purchased required no work to prepare it for a renter, and they are typically recently updated. When I say these houses were recently updated, they weren’t top-of-the-line finishes.  Here’s an example of one we purchase 4 years ago, and the pink knobs are still there!

There are a few properties that took slightly more work. We purchased one property that required a whole-house paint job (including trim work) that took a week doing it myself. We also attempted to rent another property with old carpet on the main floor. The potential renter asked if we’d be willing replace it or refinish the floors; we ended up taking a week to refinish the floors, which has paid off in the long run.

Typically, we’re going to replace appliances, paint, and scrub the place down to prepare it for renting. We’re not looking to overhaul the building or do massive capital improvements for that first renter. However, I’ll note that it doesn’t mean we don’t eventually do that. Just this past year, we had several roof replacements/repairs, plumbing replacements, and HVAC repairs.

We want the house to be in good condition to keep a renter there (we’ve actually had very low turnover), make it easy to re-rent it when there is a vacancy, and to make it attractive for any future sale. We’ve noticed that homes that were typically owned instead of rented are in better condition than if it was managed by a landlord. We seem to struggle wanting to move forward with houses that are currently rented because of all the deferred maintenance.

We have been under contract on multiple houses that we walked away from after the home inspection (e.g., knob-and-tube wiring, vertical clearance requirements on stairs, remnants of a previous fire found, poor patch work). Don’t feel like you’re in too deep if the inspection comes back to show a lot of improvements are necessary. It’s a hard mentality to talk yourself (and your partner) through because you’ve spent time looking at the house, reviewing rental comps, possibly reviewing current lease agreements, and spent the money and time for the home inspection. But keep in mind that it’s not worth purchasing the house and spending more than you’d like to keep the house standing and rentable.

Then, in broad strokes, we’re watching the 1% Rule. This means the monthly rent should be 1% of the purchase price (e.g., a purchase of $100,000 house should yield $1,000 per month in rent). Review current rent prices in the immediate vicinity. We’ve purchased houses in areas that have several rental properties, so it’s been fairly easy to identify a rate based on the number of bedrooms and bathrooms, as well as the amenities we can offer (e.g., appliances, lease term, parking availability). In future posts, I’ll provide the details of each of our purchases.  

Here’s a break-down of our current properties related to the 1% Rule. 

You can see that we didn’t hit the 1% on 5 of them. The first had a tenant when we purchased it 4 years ago; we’ve risen the rent once and plan to raise it to $1200 at the renewal term in July (so raised the rent $50 every two years). The bottom two were in a market that we were unfamiliar with, and even though we thought we would yield $990 easily for rent (yes, is still below 1%), the houses were in excellent condition, so we looked to the future value in the decision making. Unfortunately, we didn’t close on these until September, which is difficult to find renters. We didn’t have many showings at ~$1,000 rent. We ended up lowering the rental price by offering an 18-month lease so that the future rental timeframe was in the spring, and we offered the rest of October as free.

Mr. ODA developed a spreadsheet to calculate all the costs associated with owning the house, which helps determine whether the house fits our portfolio goals, especially if it doesn’t exactly meet the 1% Rule. This spreadsheet makes assumptions for routine maintenance costs, capital improvement costs, vacancy assumptions, insurance, mortgage interest, etc. Calculate the monthly rent less than the monthly cost of each of these assumptions to arrive at the monthly cash flow. Annualize the monthly cash flow, and then divide it by the down payment and closing costs to arrive at a ‘cash-on-cash’ return, which we’re looking to be at least 8-10%.

Next, we examine the neighborhood. We have thresholds for prospective tenants, which typically yields to a middle-of-the-road neighborhood. We’re not looking for a perfect, upscale neighborhood to own a rental because these types of homes rarely meet the 1% Rule. I utilize Trulia to examine the crime rates of the area. We want to offer homes that are in reasonable city locations.

I had fully vetted one house and determined it was worth our purchase. A similar house, with an upgraded kitchen, was for sale a couple of blocks away. I assumed it was the same neighborhood and didn’t do my due diligence. The house showed very well online, and we had several showings from qualified individuals, but then they’d check the house details, only to find out that it was in a high crime zone. We ended up having to lower our credit score threshold to find a renter (compensating with additional security deposit), then had difficulties for over a year collecting her rent, which really should have been expected. We have since sold off that property. 

If all these steps, including the cash-on-cash evaluation, should take about an hour. If we get this far, we go see the house. If the house is in the condition we expect it to be based on the pictures, we make an offer. Our Realtor will write up that offer the same day. Recently, many houses have been in a multiple-offer scenario. This is another trap to not get sucked into. After so much time vetting the house, it’s easy to be attached, especially if you find very favorable data (e.g., you can get rent higher than 1%). It’s not worth owning the house if you have to purchase it at a higher price than you’re comfortable at; it must be a business decision, purely based on the financials.

Keep an eye on listings daily or weekly to keep a pulse on the neighborhoods you’re interested in, evaluate the property condition, consider the 1% Rule and evaluate the detailed financial cash flow, don’t skip the home inspection nor should you ignore the results of it, and keep it a business (not emotional) decision.

Mrs. ODA Taking Over

Back in 2018, my husband started this blog and introduced himself. I had a different upbringing than him, and he asked me to introduce myself back then, but I didn’t make the time for it (something about being a first-time mom and going back to work 🙂 ). Now I’m ready to take over the majority of this task, but first wanted to share more about me. You can see whether it’s my post or his by the author listed by the post title.

I’ll come right out with it: I didn’t grow up with an allowance. I don’t have a pretty, neat story like he does. I mostly learned about the value of money through hardships in college, and then I let Rob lead my finances before we even started dating. That’s the quick version; now the long.

I had a check register, and my mom taught me how to balance a checkbook. I found the process fascinating and kept up with it, but it was always in terms of play, not actual budgeting of my money. Quick sidetrack: I remember having a sleepover at a friend’s house with 3 or 4 other girls. I was so excited about my new checkbook and how to manage the register, but we went overboard and I regretted how many checks we used in my checkbook. I hid at the top of the stairs to the basement, sulking in my decision and making it awkward for everyone. Things you wish you didn’t remember, but they always seem to surface and renew that 12-year-old’s embarrassment. 

I had chores, but they were expected to be accomplished without payment. Before you feel bad for me, it wasn’t what it seems. My parents were GOOD to us. If I went to the movies with my friend, my dad handed me cash. I used to hang out at the mall regularly. I rarely bought anything other than McDonald’s and candy, but I can honestly say that I don’t know how I made the money to even buy those things (I’m assuming it was related to birthday cards). 

I didn’t have a job until after high school. I really don’t know why; it wasn’t discussed and my friends didn’t work, so it wasn’t a thing I thought about. The first I remember it being discussed was right before graduation. I walked through my town’s main street and asked each business if they were hiring. That’s how I ended up working in a bagel shop every morning at 5:30 am. I was paid ‘under the table’ and continued to not understand the value of money and how taxes affect my pay. 

During the summer after my freshman year of college, my dad told me that I needed to have a job before I could have a car. I was already back at the bagel store in the early mornings, but it wasn’t ‘full-time.’ I applied to several places, but not many places got back to me. I eventually got a second job working at a catering hall in my town, which took up my Friday nights, Saturday days and nights, and Sunday afternoons. For some reason that I can’t remember, this wasn’t enough to meet “full time job” level of income or hours worked because I then started working at K-mart as a cashier. I worked 3 jobs that summer. At the end of the summer, my dad let me bring his car to school (3.5 hours away). I was disappointed that I thought I’d be getting a new(er) car (disclosure: I expected to pay for it, but I thought the goal here was to prove I could make enough money to support the payment of it, and he’d help me get the car).

I was driving home for winter break, and the car just stopped accelerating up a hill on the interstate. Turns out, second gear on the transmission was shot. My dad said I could pay to replace the transmission and the car would be mine. I didn’t like the idea of having an unreliable car 3.5 hours from my family and was still salty about all the hours of work I had put in over the summer. I decided I wanted a leased vehicle because it didn’t require a down payment (amazing logic…), and I ended up with a Honda Civic for about $350 per month. At the time, I was working at JCPenney for about $5.85 per hour while attending school. 

During the school year, my parents told me that they wouldn’t pay for me to live on campus in my junior year. They said either I needed to take a loan out or become a Resident Advisor (RA). Being an RA seemed to interfere with my social life, so I decided to move off campus because then I could pay month-to-month with the money I earned instead of needing a loan to pay a semester’s worth of housing up front. However, it wasn’t easy. All my friends were still living on campus, and I didn’t want a random roommate. I lived on the first floor of a house where my landlord lived upstairs. I couldn’t afford it, but I was determined to make it work, meaning I didn’t turn the heat on. I had blankets though … in Albany, NY. My mom didn’t appreciate finding out that I hadn’t turned the heat on by Halloween, and she started sending me some money. She sent me $100 for 6 months in a row, and that covered my utility bills through the winter. 

When I started working, my parents taught me to contribute to my TSP (401k). I put the amount required for full match (5%) because if I didn’t, that would be like throwing away free money. Then they taught me that each time I got a raise, increase my TSP contribution with that difference since I was already living comfortably without it. I followed all of that advice and continue to share that insight with others.

Enter Mr. ODA. He showed up at my office nearly 2 years after I started working there. One night, before we were dating, he asked me my social security number. Odd! He told me I needed to build credit and was signing me up for a credit card that I was to pay off monthly. Multiple people had told me that I should always carry a balance on a credit card to “build credit,” and he was quick to right that wrong. Shortly after we started dating, he had me max out my TSP contributions and start a Roth IRA, and the rest is history. He’s lucky I’m such a quick learner. 🙂

401k/TSP Loans

Working for the Federal government, our 401k is called the Thrift Savings Plan (TSP). We max out our contributions each year. As a means of bridging down payment gaps, we utilized a little-known option – the TSP loan.

Per, “When you take a loan, you borrow from your contributions to your TSP account. Your loan amount can’t exceed the amount of your own contributions and earnings from those contributions. Also, you cannot borrow from contributions or earnings you get from your agency or service.” There are two loan options: general purpose and real estate. There are different requirements to meet for each type of loan.

First, here are some items to consider in the decision-making. While these rules pertain specifically to the 401k program provided to Federal employees, TSP, your employer’s 401k service provider should have a similar program for taking a loan from your account and rules associated with paying that loan back.

  • You have to begin making loan payments immediately after your draw down. A general purpose loan must be repaid within 5 years, and a primary residence real estate loan must be repaid within 30 years but you have control over the amount of each payment, as long as the amortization keeps the repayment within the required period. 
  • You pay interest on the loan, which is set at the ‘G Fund’ rate. According to the TSP website, the interest rate is 0.875% as of 1/17/2021. This interest payment is paid into your TSP account.
  • There is a loan fee of $50. 
  • You must be currently employed by the government to take the loan, since repayment is processed through payroll deductions, and if separating from the government you must repay the loan in full within 60 days of separation.

The common talking point working against using a 401k loan is that you need to weigh the loss of compound growth on the balance of your TSP against what the loan will gain you. Many financial talking heads will warn you of using your retirement account for immediate, frivolous purchases. But, used appropriately and strategically, Mr. and Mrs. ODA fully believe that 401k loans can open up financial doors much earlier than through more “traditional” means. 

Our first loan was for our primary residence. While Mr. ODA was an excellent saver through college, he expected to buy a house for about half the cost of what a very basic house goes for in Northern Virginia. Our opportunity cost was private mortgage insurance (PMI); did we want to pay PMI (an added cost that a bank adds to your monthly loan payment to mitigate the risk if you don’t bring a 20% down payment to the house purchase) or take out TSP loans to make up the difference for our down payment? Taking out a loan was ‘out of the box’ and seemed controversial. However, paying PMI indefinitely and being subject to the bank’s decision on when PMI could be removed was more concerning. PMI is building the bank’s “pockets,” while the interest on a TSP loan is going back to your TSP account. 

We decided to each take a residential loan from our accounts. I took a $15,000 loan and Mr. ODA took a $25,000 loan. By taking a TSP loan, we were losing out on the earnings of the accrued balance, but the repayment to ourselves of the G-fund rate was a reasonable trade off. Plus, we could put any extra money towards the loan at any time, thereby increasing our TSP balances faster. 

My loan draw was 7/2/2012, and I had it paid off by 3/17/2015. We could have stretched the payment over the full 30 years to fully leverage our money, but at the time, owning rental properties wasn’t on our immediate radar. However, two incentives to pay a TSP loan off faster than a allowed amortization are 1) that you can only have one loan of each kind at a time, and 2) you can’t request a new loan within 60 days after you paid off a TSP loan. Then there’s that opportunity cost; we wanted to get our money back into our tax incentivized account as quickly as possible to get it working for us again. 

Since our experience was positive for these two loans, we kept this option on the table for future transactions. In 2016 and 2017, we purchased 9 rental properties using regular savings from our high savings rate lifestyle and the equity we were able to cash in from the sale of our first primary home. To cover the down payment of the last few purchases, Mr. ODA and I each took a general purpose loan of $50,000, which is the maximum amount for such type of loan. The loan rate at that time was 2.25%, which was a great lending rate back in 2017. We paid my loan off first, fairly aggressively using the cash flow from the rental properties we purchased, knowing that since I would be separating from the government once we had kids it had to be paid sooner than later. Mr. ODA has adjusted the repayment amount per pay check several times since 2017 to meet our cash flow needs. The loan was issued on 9/1/2017 and currently has a balance of $12,370. 

When looking at the opportunity cost comparison for the rental property purchases, we determined that the 4 ways we make money in real estate investing outweighed the likely (and what actually turned out to be very lucrative) gains of the stock market.

  1. Cash Flow – Profit from rent after all expenses are paid.
  2. Principal Pay Down – The amount the tenant essentially pays out of your mortgage payment that goes directly to the equity of the house.
  3. Appreciation – The increasing of property value based on the market.
  4. Tax Advantages – Being able to utilize the tax code in an advantageous fashion as a business owner. 

By carefully evaluating each property to ensure we had near-guarantees of all 4 of these methods working, we thought that the benefits of owning more rentals outweighed the loss of share ownership in our TSP accounts. 

January Financial Update

There are a lot of updates to share over the next few weeks to fully explain how our net worth changed so drastically in two years. For the time being, here’s a snapshot of this month’s status.

*The original post had IRA at $313,630, but that was double counting an investment account between ‘IRA’ and ‘taxable’ categories. The image above was updated as part of the February financial update to reflect the accurate January IRA total.

As a quick summary from where we left off, Mrs. ODA’s 401k loan and that 0% interest credit card were paid off. However, we have a new 0% credit card that now has a $5,000 balance that will be paid off in the next month. One of the investment properties was refinanced, which included a cash out option, increasing the mortgage balance. We purchased two new properties in September 2019.

These updates will occur around the 15th of every month. The investment properties’ mortgages are paid on the 10th of each month, so the majority of changes in our finances occur at this time. Future updates will include spending categories as well.

New Year

In honor of my last post being two years ago, we’re starting this back up! Here’s a summary of what’s been happening, and I’ll delve deeper into specific topics with future posts.

In January 2019, Mrs. ODS was back at work part time after having our first child, burning through sick leave, getting ready to quit her job. In February 2019, the Federal government was shut down for several weeks, and I found other tasks to occupy my time, including being the full-time caregiver to our son. I took a temporary assignment over the summer of 2019, moving my family to Lexington, KY for 3 months. My wife was pregnant with baby #2, which wasn’t easy. On January 2, 2020, she was admitted to the hospital for pre-term labor at 26 weeks. Luckily, they were able to stop contractions and send her home for bedrest for the next 10 weeks. A week after the country shut down, baby girl was born full term and healthy. Living through a pandemic and limiting our social circle while at home with a newborn and toddler (19 months apart) made us realize how we wanted to be closer to family. On a whim, we agreed to move to KY. Everything played out a lot faster than we expected, and we sold our VA house in September 2020, moved into our new home in KY in November 2020, unpacked, celebrated the holidays, and here we are. We both feel better suited to continue to build these efforts started so long ago.

Here are the goals: teaching posts, story (background) posts, and monthly financial updates. Each post will be categorized into one of these for ease of future searches. We’ve made a lot of financial decisions over the past two years and have a lot to share!