Contrarian View on an Emergency Fund

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There are many teachings out there that talk about a safe, sustainable, and efficient way to wealth being many streams of income. This diversifies and provides multiple avenues for growth, but also mitigates risk and protects your larger portfolio against any one stream failing.

Our financial portfolio meets those goals. Instead of having an emergency fund sitting in a savings account earning 0.03% interest (that’s literally our savings account interest rate, and that’s the ‘special’ relationship rate), our money is put to “work,” earning more money for us.

INDEX FUNDS

Probably the simplest and most common example of multiple streams is index fund investing. A quick read of JL Collins’ “The Simple Path To Wealth” will teach you that through index fund investing, you have an ownership share of every company the index fund covers. Some are matched to S&P 500 companies, some to International, some to the DJIA, and most to the “Total Market.” Mr. and Mrs. ODA invest in the “Total Market Index Fund,” through Fidelity, in our IRAs and taxable investment portfolio. By owning a small part of every publicly traded company, we own that many streams of income. Any one company going belly up will only be a blip on the radar of that index fund, and, over enough time, it will go up, and up a lot. This is as risk free of a true investment as you can get. 

Being Federal Employees (Mrs. ODA no more, though), we both have access to the Thrift Savings Plan (TSP) for our 401k’s. The TSP provides a group of 5 index funds to choose from: Government Securities, Fixed Income Index, Common Stock Index, Small Cap Stock Index, and International Stock Index. 

In times of market upheaval, we can ‘escape’ to the Government Securities fund, and pending a nuclear winter or alien attack, is guaranteed to be paid (TSP.gov). However, with this little risk also comes little reward, so it won’t grow fast. With index funds and a safety spot, our TSPs are about as low risk a retirement investment as you can have. Note that Index Funds through Fidelity or Vanguard (for example) and the TSP have the industry’s lowest fees on their funds, so we won’t lose our nest egg to management costs either. 

REAL ESTATE

Outside of anything related to the stock market, we have 12 single family rental properties. Each of these houses operate as their own small business, with long term tenants in most of them (that have thankfully all been able to maintain rent payments through the pandemic). If one or two houses did lose their tenant, or have an AC break, or a roof needing replaced all at the same time, the other houses (businesses) can pick up the financial slack. A few of the properties are owned outright, so the lack of a mortgage certainly helps the whole portfolio’s cash flow. And actually, we did have to replace/repair multiple roofs and HVAC units at the same time in the summer of 2020! On top of the individual homeowners insurance we have on each house, we have a Commercial Liability Umbrella Policy covering anything above and beyond the individual policies.

DIVERSITY

We also have some money tied up in more actively managed mutual funds – investments we owned before we discovered index fund investing – and individual stocks. However, I can’t bare the capital gains taxes required if I were to sell them and shift that money over to an index fund. But – they’re there in case of an emergency.

That Federal job I mentioned – I’m lucky to have about as much job security as any W2 employee can have in this great nation. Through the shutdown a couple years ago, I had 2 paychecks delayed, but my rental properties made it so that I didn’t have to worry about our finances. Otherwise, a safe, consistent paycheck is something I can count on – with health insurance for our whole family that comes with an annual out of pocket maximum of only $10,000.

So we have a W2 income, 12 rental property small businesses providing monthly cash flow, and a slew of stock investments diversified across all markets. We have diversity that mitigates risk and shields us from small “emergencies” manifesting themselves as such.

We view “medium” emergencies as something that can be solved with a new credit card deferring needing to truly “pay” for our expenses until life gets back to normal. You’ve seen a past post discussing our perspective on strategic credit card usage (and the Chase cards specifically). Twelve to fifteen months of no interest on a credit card can get anyone out of a financial bind when emergencies hit. We haven’t found a reason to NEED this option, but know that it’s always out there if the perfect storm of bad luck were to ever hit.

For these “small” and “medium” emergencies, stocks could be sold before we would need to be faced with something like not being able to pay utilities, buy food, or get foreclosed on. We simply don’t view a “large” EMERGENCY cropping up with any higher than a near non-zero probability given the shielding and structure we have built out of our total financial portfolio.

I can’t fathom what that perfect storm would look like. Six months of expenses can easily be found in selling our stocks if all of our tenants suddenly stopped paying rent, for example. But if a pandemic isn’t going to make that happen, what would?

All this to say – Mrs. ODA and I keep very little cash liquid to cover our “emergency” fund. Outside of a couple thousand in our checking account to cover regular monthly/cyclical financial obligation fluctuations, we don’t have any dollars NOT “working for us.” Whether it be investing in index funds, contributing to IRA/401k, or paying down mortgages to eventually achieve more cash flow, we put all our money to work. We see the rewards of this strategy far outweighing the risk of encountering a debilitating financial emergency, and therefore don’t follow the traditional personal finance advice of keeping X months’ living expenses in cash handy at a moment’s notice.

House 6: Easy Peasy

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This is probably our easiest house to own; the closing process was the hardest part here. We closed on House 5 & 6 at the same time, so I’ll cover the closing story here because House 5 has a lot else to be said when I write out that whole saga.

TENANT

This property has a property manager on it (10% monthly rent). She processed a couple of applications at the onset, and it took 2 weeks to find the tenant. The lease started on August 18, 2017, and that’s been the same tenant in the house to date.

Rent is $850 per month. She pays on time, and it’s usually early. She just asked about her renewal, and we decided to keep her rent at the same price, even though it’s the start of her 5th lease term. Our cash-on-cash return was ahead for the last 4 years, so even though our taxes have increased by $400 since we purchased the property, we decided it was best to keep the tenant than to get a few more dollars per month.

She asked if she could paint the kitchen cabinets that were definitely old, and we figured they couldn’t be made any worse. When a tenant wants to make your house their home, it’s most often is a sign they make taking care of the property their priority, and that they want to stick around for a while.

We had to treat the house for ants over this last year, but the only real issue we’ve had on this house is that the main sewer line had to be replaced due to corrosion and tree stump intrusion into the pipe. The poor tenant had her toilets backing up into her house. It was $4,000 to replace the line from the street to the house. Honestly, I expected it to be more.

LOAN DECISION

Option 1 – 20% down payment – conventional 30 year fixed at 4.95% with 0 points
Option 2 – 25% down payment – conventional 30 year fixed at 4.7% with 0 points

We weighed these two options for our loan (purchase price of $66,000). The difference is an increase of $3,300 in down payment to save $5,700 worth of interest over the life of the loan. Being that we closed on several houses in a short period of time, we chose Option 1. Having cash for the down payments and closing costs of the other houses was more important than the marginal savings in interest of putting 5% more down.

We’ve been paying down this mortgage. At the time of our decision on which house to pay extra principal towards, this was the smallest loan amount with a relatively high interest rate. We started paying extra towards this mortgage in October 2020. To date, we’ve paid an additional $35,500 towards principal, leaving a balance of just under $14k.

CLOSING

During the Spring and Summer of 2017, we saw a lot of houses. We also made offers on a lot of houses that didn’t end up going anywhere, either because there was no consensus on a purchase price or because the home inspection was unsavory. We closed on House 4 at the end of June, walked away from a deal on one house due to a home inspection issue, and then closings on House 5 & 6 got lost along the way by the attorney’s secretary. We worked with a specific attorney who we had a great relationship with, and who eventually helped us with a difficult purchase (see the story for House 8), but this was a hiccup.

The attorney’s office let us know they were unaware of these two closings around June 20th (in reality, they just missed the ‘all clear’ to move forward with a title search, but they were definitely made aware of them), which left us scrambling. Our rate lock expired July 7, and the secretary responsible for filing all the paperwork was taking her vacation the week of July 2. Since she was taking the week off, our attorney scheduled a surgery of his for the same time, so the office was closed. She said she would find a way to make it work, but then we didn’t hear from her and had to reach out to the attorney himself. Here’s that email, outlining all the details.

It wasn’t until June 30th that our attorney confirmed he was able to hand off our closing to another attorney’s office. We had a few questions about their fees, since we explicitly stated that we didn’t want it to cost us more because we had to change our closing location, and then the secretary there got defensive and gave us an attitude. I was quick to call her on it, explaining that we just wanted to better understand the break down of what they put on our closing disclosure. She backed down, and then we had an awkward interaction a few days later when we showed up in her office to sign the paperwork. It’s interesting how people don’t understand that writing in capital letters can come across as rude. Turns out this other firm was an old law school friend of the attorney we normally use, and they worked out a favor among themselves on the fees to ensure they didn’t lose any future business from us.

At the end of the day, we closed on the houses on time and without costing us anything extra, but it wasn’t a stress-free path to get there.

Luckily, this house has been easy to manage and the tenant has worked out perfectly. Our rent at $850 far exceeds the 1% Rule; with a purchase price of $66,000, our monthly rent goal would be $660. Tax assessments have recently risen given that the local market has appreciated substantially, so we will consider a rent increase in the future. However, at this time, having a long-term tenant on a house that has hardly any issues is more important than risking a rent increase and having her leave.

Mortgage Evaluations

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Rate Sheet Options from your Lender

When reaching out to a loan officer, there are a lot of options to choose from. I’m hoping to break down the decision-making here. I’ll share how we ended up with several different options, too.

Basically, it boils down to: 

  • Put enough down to avoid paying Private Mortgage Insurance (PMI)
  • Don’t pay more than 20% unless there’s a decent incentive. 
  • Don’t pick a loan term shorter than 30 years unless there’s a decent incentive. 
  • Carefully evaluate any Adjustable Rate Mortgages (ARMs).

PMI

I broke down PMI in a previous post: PMI – Private Mortgage Insurance. We suggest doing whatever you can to meet the requirements to avoid paying this. The cost of PMI can be a couple hundred dollars per month, which is money that can be put towards the principal balance of your loan or other bills, rather than in the bank’s pockets. There are also hoops to jump through to remove PMI early, which may include paying for another appraisal on the house ($400-$700!).

LOAN TERMS

A conventional loan will likely require 20% to avoid paying PMI. There are some loan options out there that may allow a smaller down payment without a ‘penalty’ (e.g., PMI, higher interest rate), but 20% is the standard, and is usually required when purchasing an investment property.

There may be an option to put down more than 20% or you may think you can afford to pay a higher mortgage each month, so you’re interested in a shorter loan term. Unless there’s an incentive (e.g., lower interest rate, better closing costs), stick with the bare minimum to get the loan.

If there is an incentive, you’ll need analyze the math and your goals to determine if committing extra money to a higher down payment or a larger monthly payment is worth it. If you have extra cash each month, you can pay more towards your principal rather than pigeon holing yourself into a higher monthly payment. Plus, if you have more cash liquid, you may be able to purchase another rental property, which will increase your monthly cash flow.

While we evaluate the loan terms on every house purchase, I’ll share the details of the two most “unconventional” options we chose. Two things to note: 1) lenders add a ‘surcharge’ to the rate for it being an investment property, typically around 0.75%, which means the rates aren’t going to be the great, super-low, rates being advertised; and 2) the term “point” means a fee of 1% of the loan amount.

HOUSE #2

For House #2 (purchased in 2016), we were informed that if we put 20% down instead of 25%, the rate would increase 0.25% on average. If we assume a 30 year conventional loan, 20% down at 4.125% equates to about $69,700 paid in interest (assuming no additional principal payments); 25% down at 3.875% equates to about $60,800 paid in interest. By putting an additional $5,850 as part of our down payment, we saved about $9,000 in interest over the life of the loan.

Once we determined that we’ll put 25% down, we then had to figure out the appropriate loan length. On this particular offer, 30 year amortization wasn’t an option for us because we would have had to pay a point to get a competitive rate. We chose a 20 year amortization because the house already came with a well qualified tenant, we didn’t expect a lot of maintenance and repair costs due to the house’s age, and we didn’t have an immediate need for a higher monthly cash flow based on our place in life at the time.

While our long term goal was to have rental property cash flow replace our W2 income, this house was early in our purchasing. At the time, we were focused more on paying off House #1 (higher rate and a balloon payment after 5 years). Frankly, we didn’t truly understand the power of real estate investing at this time, and didn’t know how much it would accelerate the timeline for us to meet our goals. By decreasing our loan length, we increased our monthly payment, but also lowered the total interest paid over the loan’s life by over $22k. Since more of our monthly payment is going towards principal reduction than had it been a 30 year amortization, this loan isn’t on our priority list to pay off early.

HOUSE #3

For House #3, we evaluated the rate sheet for the loan term, interest rate, and down payment percentage again. This house was purchased a few months after House #2, so those rate decisions were fresh on our minds. We were quoted several options: 1) 20% down at 4.25% for 20 or 30 years, 2) 25% down at 3.75% for 20 or 30 years, or 3) 25% down at 3.25% with 0.5% points for 15 years.

As you can see, there’s no incentive to pick the 20-year term because it’s the same rate as a 30-year term. If we have additional cash, we can make a principal-only payments against the 30-year term rather than unnecessarily tying up our money.

At first, we thought paying points was an absolute ‘no.’ However, points aren’t a bad thing. Paying down your rate up front can save you an appreciable amount in interest. Plus, points are tax deductible.

Now for the breakdown of each options. Let’s say the house purchase was $110,000 (because it wasn’t an exact number, and it’ll just be easier to use a ‘clean’ number like this). Microsoft Excel has an amortization template where you can plug in the loan terms and see the entire amortization schedule. 

Option 1: 20% down payment equates to a loan amount of $88,000; the annual interest rate is 4.25%; the loan is for 30 years, with 12 payments per year. If we make no additional payments, this totals about $67,800 worth of interest paid over the life of the loan.

Option 2: 25% down payment equates to a loan amount of $82,500 at 3.75%. If we make no additional payments, this totals $55k worth of interest paid over the life of the loan. This requires an additional $5,500 brought to the closing table, but saves almost $13k in interest. It also decreases our monthly principal and interest payment (i.e., not including escrow) from Option 1 by $50.

Option 3: 25% down payment, 3.25% interest, and 15 years (instead of 30 years) equates to just under $22k paid in interest. To obtain the 3.25% rate, it required “half a point.” If a point is 1% of the loan amount, that would be 1% of $82,500. This rate only required 0.5%, so that meant paying $412.50 as part of closing costs along with the additional $5,500 of down payment required for 25%. However, the shorter loan length means that monthly payment is increased (between Option 2 and Option 3, the difference is $197.63).

For about $6k, we pay a higher monthly payment, but we also save a significant amount of interest over the life of the loan. The short loan term of 15 years means this one is also not on our radar to pay off while we focus on paying down other, higher interest and higher balanced, mortgages. In this case, the benefits of the big picture math outweighed the increase in monthly payment.

We are five years in on this mortgage and are already seeing significant reduction in the outstanding principal due to the amortization schedule becoming favorable more quickly. In 10 short years more, our house will be fully paid for, through rent collection, without a single dollar of extra principal payments from our other financials. What a great feeling.

ADJUSTABLE RATE MORTGAGES (ARMs)

An adjustable rate mortgage can be beneficial depending on the terms and how long you expect to own the house. For us, we expect to hold our investment properties for a long time, so it wasn’t worth the risk of an ARM. Many times lenders won’t even offer an ARM on an investment. However, when we purchased our DC suburb home, we knew we didn’t expect to be there for more than 5 years, so we chose a 5 year ARM.

After a positive experience with that decision, we also chose an ARM on our second primary residence. We chose a 5 year ARM, even though we expected to be there longer than 5 years. We figured we would either accept the new rate, if there was one, at the end of the 5th year, or we would refinance when necessary. As a result, Mr. ODA monitored rates and refinance options over the last year or so. Unexpectedly, we sold that house 3.5 months shy of the end of the initial ARM term so we didn’t have to do anything.

I break down all the details of an ARM and our decision making in a recent post.

SUMMARY

When I reach out to my lender to ask what the rates of the day are and begin the process of locking a rate on a new loan, I ask for options. These options are in the form of a “rate sheet.” When you ‘lock’ a rate, you’re actually locking the ‘rate sheet,’ not the individual decisions of loan length and percent down. For every house, we evaluate the rate savings that can come from doing something less “conventional” than a 30-year fixed at 20% down mortgage. Our decision is based on what’s best for our goals and our cash in-hand.

As shown above, in our early decisions, we favored shorter loan terms for rate savings. but since House #3’s purchase, we noticed how much more we cared about low monthly payments and low down payments to allow us to buy more properties along the way. Every investment property loan since House #3 has been the ‘standard’ 30-year fixed at 20% down. Because of this perspective shift, we were able to buy six properties in 2017, which gives us about $2,000 in monthly cash flow that we can then use to pay down mortgages.

March Financial Update

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I realize that some of the items that I share each month will be repetitive, but I’m catering to new readers that may not have seen the previous month’s details. As always, feel free to reach out if you have any questions about this information.

SPECIFIC LARGE CHANGES FROM LAST MONTH’S UPDATE

Paid $8,000 towards an investment property mortgage. This property’s mortgage balance is just under $14k, and we expect to have it paid off in the next 6 months. It would be earlier, but we’re also paying off another mortgage at this time, so we’re putting money towards that one next.

Mr. ODA cashed a few savings bonds that were mature, so we brought in $622 that wasn’t planned.

MONTH’S EXPENSES

Every month, $1100 is automatically invested between each of our Roth IRAs and each child’s investment accounts.

We had all the tenants except two pay their rent on time, and the other two houses paid on the 12th (typically when a tenant is late, the balance is paid on the next Friday of the month – pay day). Our rental income is $12,353, and we pay our business partner about $2,100 (we collect the rent and then pay him to cover the mortgages he holds and his half of the ‘profit’ after the mortgages are deducted from rent). We made it through the month with no investment property costs! We did have a tenant power wash our house out of the kindness of their heart though.

  • We paid about $5,900 for our regular mortgage payments.
  • Our grocery shopping cost us $500. We did the trial period for Walmart+. Unfortunately, the first two weeks of that trial period were destroyed by back-to-back ice and snow storms, so we couldn’t ever get deliveries scheduled within a couple of days. Once life went back to normal, there were plenty of delivery times available, even same day. While it was convenient, it wasn’t worth the annual fee and tipping the driver each time, so we cancelled it.
  • We spent $57 on gas, and $83 eating take-out.
  • We made some purchases that aren’t typical: ski season pass for next year ($119), medical bill ($70), and some furniture and odds and ends for the house (~$1,500).  
  • $464 went towards utilities. This includes internet, cell phones, water, sewer, trash, electric, and investment property sewer charges that are billed to the owner and not the tenant. Last month I shared that our electric bill was very high. We learned through the course of 6 HVAC company visits that our unit was not running properly, and that meant our heat strips were essentially on since we moved in ($$$). We will seek financial compensation from the builder once our next electric bill comes in.

SUMMARY

Our net worth increased by $45k from last month’s update. This change is mostly due to the value of our houses increasing and our mortgage balances decreasing.

Chase Rewards Portal

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GENERAL THOUGHTS

We have several Chase credit cards, both that are active and ones that we used in the past. As we shared in the past, we open new credit cards when we have one or several large purchases to make, so we’re typically looking for a 0% introductory rate for at least 12 months, a sign-on bonus, and no annual fee. We also do a little bit of travel hacking, so even if the card doesn’t hit these typical ‘requirements’ of ours, we’ll open a card if it comes with a sizable sign-on bonus.

Chase offers several cards that have specific rewards categories (e.g., airlines, Disney). However, our general thought process is that if you earn “cash,” you have more flexibilities than being tied to one specific category. Weigh your lifestyle; if you’re the family that does Disney every year no matter what, then maybe a Disney bonus is worth it for your finances.

CHASE CREDIT CARDS

I highlight several of the Chase cards and their main bonuses in a previous post. We currently are using:
– Chase Sapphire Reserve: Has an annual fee, comes with a statement bonus after spending a certain amount after opening, $300 in statement credits as an annual reimbursement for travel, earn 3X points on grocery store purchases per month, dining, and travel booked after the statement credit is earned, and several other bonuses.
– Chase Freedom (now called the Freedom Flex): No annual fee, rotating 5% cash back reward categories each quarter (e.g., gas, internet, grocery).
– Chase Freedom Unlimited: The offerings on this card are slightly different than when we opened them, so I’ll focus on what’s currently available. Sign-on bonus of $200 cash back when you spend $500 in the first 3 months from account opening, no annual fee, 5% on purchases made through Chase Ultimate Rewards, 3% on dining and drugstore purchases, and 1.5% on all purchases.

We’ve also been able to utilize their business card options. However, since several reward categories overlap with others that we have, these are no longer active. We met the requirement for the sign-on bonus, then slowly paid down the balance on the card (while always making more than the minimum payment) over the 0% introductory period, ensuring we had a $0 balance before the interest rate’s introductory period expired. We typically leave a credit card open, but don’t use it, when we’re no longer benefiting from the card’s rewards (e.g., when the reward overlaps with another credit card we use frequently), but we did close the Ink Business Preferred because of the annual fee.
– Chase Ink Business Unlimited: Earn 1.5% cash back for business purchases, offers a sign-on bonus and introductory 0% interest, and has no annual fee.
– Chase Ink Business Preferred: Earn 1% points for all purchases and 3X points for shipping, advertising, internet and phone, and travel. This card has an annual fee of $95.

THE REWARDS PORTAL

We utilize several Chase cards for differing types of bonuses. Chase allows you to transfer points earned from different Chase cards into one account. This is a big bonus for us because we have the Chase Sapphire Reserve card, which offers 50% more value on the points earned when they’re redeemed for travel through Chase Ultimate Rewards than if you took them out based on their straight cash value (e.g., 50,000 points are worth $750 toward travel). That means we’re earning more cash back on those categories and then more when we use those points for travel costs.

Here’s an example: Currently we get 5% cash back on internet with the Chase Freedom card. We pay our internet bill of $45 each month for this quarter. We earn $2.25 cash back or 225 points that gets transferred to the Sapphire Reserve travel portal, where it’s now worth $3.375 for booking travel costs.

We have used the portal several times to book our hotels, car rentals, and flights. Most recently, we searched for a hotel stay. We were able to search for the lodge, review the different types of rooms, and book using our points. Here’s the breakdown of our purchase within the portal.

Chase is also offering 50% more value (100 points equals $1.50 in redemption value) when you redeem points for grocery store, dining, and home improvement store purchases, as well as donations to select charitable organizations. We utilized our points to give ourselves statement credits for several restaurant purchases from the past 90 days that were made on our Sapphire Reserve card.

SUMMARY

We’ve strategically opened new Chase cards over the last 10 years. I wouldn’t recommend opening 3 new cards at once, but, like us, open them as you have a need to cover large purchases. A large purchase looming allows you to meet a fairly high spending threshold to earn the sign-on bonus (e.g., spend $4,000 in the first 3 months to earn a bonus), and opening a new card should give you a 0% introductory interest rate so you can give yourself a free loan for a year or sometimes longer.

Chase offers an array of cards, which have different reward offerings. A positive to Chase’s portfolio is that you can merge your rewards earned on different cards into one portal. This has been especially beneficial because we have the Sapphire Reserve, where your “points are worth 50% more when you redeem for airfare, hotels, car rentals and cruise lines through Chase Ultimate Rewards®.”

DISCLAIMER: Chase has no affiliation with this post; we just love what they have to offer. Be sure to read all fine print on the cards discussed here, and don’t assume we’ve covered all the details that are required to earn the bonuses. All Chase card names and their rewards portal name are registered trademarks of JPMorgan Chase & Co.

House 3: Quick story

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Quick post about our 3rd investment property purchase. After we closed on House #2, the seller said he was interested in liquidating the house next door, which was a mirror image of the house we just purchased. The story here is how the offer was made.

We agreed to purchase for the same bottom line as House 2. There was some confusion about what “bottom line” actually meant, where we meant it should account for our side of the transaction not using a Realtor. It took us over a month to go through the financials and have an agreed upon purchase price.

We purchased House 2 for $117k with $2000 back in closing costs. Our first offer on House 3 was $113,400. The selling agent countered that he came up with 117,000-2,000-1,170 (commission to our agent on that house) = $113,830, but he had to forward the offer to the seller. Then we received this from the seller:

The selling agent agreed that Mr. ODA’s math was closer to accurate than the sellers, and that if it came down to a few hundred dollars difference, he was willing to eat that from his commission since he didn’t have to pay to take pictures and list the house.

And so here’s the final response from Mr. ODA, and a view into how his brain works. He never fails when it’s math.

He paid 4% commissions to agents on the last purchase. That 4% was derived from a $117k sales price, which equals $4680. That $4680 gets subtracted from my funds at sale, or $115k. $115,000-$4,680 = $110,320. Thus his “net” that he “walked away with.” If that “net” were to be matched on this price, you would take $110,320 and divide it by 0.97 which would equal $113731. As a check, if you take 3% of $113731 it is $3,411. Subtract $113,731 from $3,411 and you get $110,320 – the same ‘take’ as he got from 1718. An arbitrary reduction in price of just Krissy’s portion of the commission is incomplete, as your 3% is no longer equal in each transaction. The way your math works, his walk away is $113830 less the 3% = $110,415. That is more than he took from 1718. Since I know that Mike is willing to “walk away with” $110k, I offered a purchase price that, when reduced by your 3% commission, comes to $2 shy of $110,000, his stated in writing goal for this transaction. 

We paid $113,732 for the house. 🙂

TENANTS

This house has had the same tenants since we purchased it in 2016. We raised their rent by $50 in 2019, and we expect another $50 increase upon their renewal in a few months. The house has appreciated greatly since we purchased it, which has caused our taxes to increase from $750 twice a year to now $870 twice a year), which we need to account for in the rental income of the property.

They take good care of the house, and they actually border on being too cautious about maintenance needs. We’ve had several issues with the plumbing, which has culminated in it being their children putting things where they shouldn’t be, which means the cost is on the tenant because it’s not routine maintenance.

The tenant replaced a stove and refrigerator, at their expense and with the understanding that either they leave those behind or replace them with reasonable, working appliance. For the stove, they sought approval from us to upgrade their stove to something that’s more conducive to his culinary expertise. We told them that they could replace the stove there, but that a working stove must be there upon their vacating the unit. About a year ago, we were there for a maintenance call and noticed an upgraded refrigerator, which they didn’t tell us about. We again told them that since we provided a refrigerator with the unit that a working one must be put in its place when they vacate.

This is the house that we installed a backsplash in the kitchen. The tenant said that he cooks a lot and there’s been grease splatter that’s been hard to keep off the flat-painted wall. We agreed that a backsplash is better for the longevity of the house. There were several options available, so we even let the tenant pick from a few samples. We did the peel and stick style, so we saved on cost and labor, but accomplished the goal of an easy-to-clean surface.

Twice, they’ve reached out to us about a rent-to-own offer. We aren’t interested in selling because our financial goals require a month-to-month cash flow, this house is newer and still in good condition, and we have a low rate mortgage on it; but knowing how much the house has appreciated, we may be interested in a 1031 exchange option if the offer is right.

House 2: The Exclusivity Agreement

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House 1 was purchased from a family member because we saw an opportunity when they were getting ready to sell their townhome. House 2 was purchased because we were looking for a way to make our profit from the sale of our first home to get to work for us. While in the process of purchasing House 2, the seller said he was interested in liquidating the house next door, which was a mirror image of House 2, and so that became House 3. Both House 2 and House 3 came with tenants, which was a big advantage, but delayed a few lessons in rentals for us.

After we sold our house outside of DC, we moved just outside of Richmond, VA. We spent a few months looking at the neighborhoods and analyzed the markets available in Richmond. I was more interested in the college area, where it’s a market I knew well, having been a college kid who rented in an old house that was sectioned into apartments. Mr. ODA was more ambitious (in my opinion), looking into neighborhoods that families would rent in. Many investors are looking to rent in areas of Richmond that fit the quintessential Richmond mold (e.g., walkability to restaurants and shops, bike routes). However, these houses don’t come close to hitting the 1% Rule.

We’ve purchased several houses on the east side of town, and they’ve worked out very well and most don’t have turnover. The value of House 2 since we purchased it has increased by about $70k as the neighborhoods in the area continue to decrease crime and increase value. Both houses are about 13 years old, 1200 square feet, and have 3 bedrooms and 2 baths. All of the rooms except bathrooms and kitchen are carpeted, which is something we’ve since tried to stay away from.

THE EXCLUSIVITY AGREEMENT

After we saw House 2 and wanted to make an offer, our Realtor relationship went downhill. We had a Realtor for our home purchase when we moved to the area, and we continued the relationship to have access to the MLS. After we purchased our home and started looking for rentals, we soon learned that our Realtor 1) had an agenda to get the most commission, regardless of the best deal or our interests, and 2) kept pushing areas she knew versus areas we were interested in. We had made it known that we wanted to buy several properties, and I believe by the time we wanted to make an offer on a house, she realized we weren’t looking to further this relationship after this deal. Since she had shown us a few houses, we expected to see this deal through with her. That’s when the straw broke the camel’s back. We received the offer to review, and it came with an exclusivity agreement.

An exclusivity agreement is a contract established by the Realtor to protect their interests. If the client signs it, then it means that the client is committed to that agent for the terms in the agreement (e.g., a single purchase, a period of time). We hadn’t needed one in Fairfax, and the one we had for our personal home contract covered a month’s time. When we received the contract for House 2, the exclusivity terms were until October 4, 2016, from the date of the contract, which was May 4, 2016. We requested the date be changed to match the “close no later than” terms in the contract, which was June 17. That’s when the bs-ing commenced. I’m sure the average buyer wouldn’t have noticed nor cared. We saw right through it, and she kept digging in deeper with holes in her story and guilt.

First, she claimed that she made it 6 months (although it was 5 months) so that it gets through closing and we didn’t have to sign again. We countered with three pieces of logic: 1) the field can accept an address, so change it to the house’s address to cover us for the entire time it took us to get to closing, whenever that may be; 2) the exclusivity period on our personal residence’s contract expired long before we actually closed (because it was a new build, and the contract was signed before construction began), but we never had to re-sign an agreement; and 3) we never experienced a 6-month closing on a routine purchase.

Instead of addressing that the field could accept the house’s details rather than a period of time, she said: I’m committed to helping you guys look for houses and make offers, are you committed to working with me? Red flag. When we said we wanted it changed to the house address, and that we didn’t mind signing on for each property we made an offer on, she furthered the guilt with: We have know each other for almost a year and I honestly didn’t think it would be such an issue. If you are not willing to sign it I am not going to be able to work with you. If it’s not supposed to be a big deal for us, why is it a big deal for you/your broker?

One of the first things we learned in the real estate market was to not sign an exclusivity agreement. It eliminates your rights as a buyer and ties you unnecessarily to an agent. On the Realtor’s side, I understand that a lot of time and effort goes into working with clients, and there is a possibility that one Realtor shows a client a house, but that client uses a different Realtor to sign the contract, which causes the agent who showed the property to lose the commission. However, I believe that if there’s a good relationship with the Realtor and client, it shouldn’t need to be in writing that they’re committed to each other. I also don’t believe that it’s routine that a Realtor shows several houses to a client, and then that client finds someone else to make an offer. I was also surprised that it’s at the contract stage in the process, and not at the showings stage.

When she wouldn’t write the offer without us signing an unnecessarily long exclusivity agreement (again, we were willing to sign it as associated with this offer/property), we called our old Realtor and asked if she could write the offer for us even though she didn’t cover that area. (An Agent’s license covers the whole state, but typically their access to the MLS is confined to local metro areas unless they want to pay for other regions.) She wrote the offer for us. She also introduced us to a loan officer who we have used for every property purchase since then, and recommended to others.

EXPENSES

This house is relatively new, so we haven’t had any major expenses. We had a couple of HVAC service calls, one was a legitimate concern and one was a misunderstanding by the tenant on how it works in extreme temperatures. What we haven’t paid for in physical house repairs, we’ve made up with in learning new things about tenants.

TENANTS

We had a tenant move in right before we closed on the house. She had gone through a divorce and was living on her own. At the end of the year, she got back together with her ex-husband and moved out. We touched up the paint, cleaned the carpet, cleaned the kitchen and bathrooms, and then listed the house for rent. We chose two ladies, one of which had a criminal record for forgery a few years prior. Other than that, they were the best qualified financially.

Our only issue in the first year was that they had a ‘friend’ look at our HVAC unit. We told them that it’s not their property, and had anything been wrong, it would have been on them to fix because we didn’t authorize tinkering with our very-expensive property. The issue was that it was 100 degrees outside, they had the thermostat set at 60, and it wasn’t getting to that temperature. That’s not surprising. Our technician went out, checked the unit, and explained to them that when it’s that hot, you can’t expect it to get to such a different temperature in the house. He suggested using fans.

They moved in June 1, 2017 and one of the ladies is still there.

At the end of their second year, we increased their rent by $50/month to $1100. This is still under market value for the house, but not having to turnover the unit was more important than a drastic increase in rental income.

In February 2020, we learned a new aspect of the law – domestic disputes. One of the ladies reached out to us and requested to be released from the lease because she had a restraining order filed on her roommate. We researched the requirements associated with restraining orders (because the two she gave us were expired) and then her rights as it related to being a tenant. She had paid her portion of the rent each month, so we weren’t aware of issues. We released her from any responsibility immediately and notified the roommate. Per Virginia Code, the remaining tenant is responsible for the entirety of the lease from then-on. We gave her the opportunity to vacate the property within 30 days if she could not pay the full lease amount going forward, but she chose to stay on the property.

The world shut down a month later. Other than an issue here and there with our other properties, this one has been the most affected. She doesn’t communicate up front anymore when she won’t be able to have rent on time. We received a letter from her stating that she had been furloughed, but things in the letter didn’t look professional and piqued my interest (recall the forgery charge). I called her employer who informed me that her hours were cut, but she was not furloughed; the woman who answered the phone sounded exasperated and indicated she had explained this to our tenant several times. I informed the tenant that I had done an employment verification and that we could be flexible, but rent was still expected. Then a few months later, after she didn’t pay rent or tell us what was happening, she claimed she couldn’t pay rent because of an issue with a check showing up. We requested her employment information again, and I verified she was fully employed. When I asked her what was going on, she stated that she wasn’t required to tell me where her rent was coming from and whether she was employed didn’t mean she could pay rent. Fun.

Then, a few months later again, I received an email from the Commonwealth of Virginia asking me for my tax identification number and other information because our tenant had applied for rent assistance. I was confused because the rent assistance program was for unpaid rent balances, and she was fully paid. I watched the rent assistance program training and attempted an application myself so that I could see how the process works before I questioned anything more. I verified that the program was indeed for past due rents and couldn’t be requested for future rent. I contacted the State office to gather more information, and the tenant had submitted that she didn’t pay January 2021’s rent, which she had. The State made a note in her file. I informed the tenant that the program was for past due rents, which she had none, and that she was not qualified for such a program, but we were willing to work with her if she had any problems paying rent timely in the future.

Each time she’s not paid full rent by the 5th of the month, she has paid rent in full before the end of the month. After she took full responsibility of the property’s rent and lease, we had her sign a new lease with just her name. That lease ends on June 30 this year, and we’re currently decided whether we’ll offer her another year at an increased rate (last increase was 2 years ago) or we’ll request her to vacate the property.

ARM – Adjustable Rate Mortgages

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An ARM is when the interest rate applied to the loan balance varies throughout the loan. The loan is typically amortized over 30 years like a conventional loan would be, but the interest rate is variable. There is an initial fixed interest rate for a pre-determined period of time (e.g., 5, 7, 10 years). The rate then adjusts based on prime rates, with a maximum amount allowed for the increase each period of time (e.g., a maximum 1% increase each year for 5 years). This is where people find ARMs alarming, but note these two important points: 1) an ARM can’t jump an egregious amount at the end of the initial fixed term (usually no more than 1% or 2% in one year, outlined by the lender at the beginning), and 2) the rate is based on interest rates at that point in time.

Usually, the benefit of an ARM is a much lower interest rate during the initial term. If you know that your ownership in the property will only be for 5, 7, 10, etc. years, then this is where the benefit is realized. Amortization schedules ‘front-load’ the interest** (e.g., your monthly payment is the same total ($500); your payment in year 1 will be broken out as $375 interest and $125 principal; year 20 will be broken out at $150 interest and $350 principal).

**Every dollar of your loan is being borrowed for a length of time determined by the outstanding principal on the loan. At the beginning of your loan, all 30 years are being borrowed, so the proportion of principal to interest of each monthly payment results in far more interest being paid. Every month you pay a little bit of principal, gradually decreasing your outstanding principal amount, meaning you are no longer borrowing it and will pay slightly less interest with each monthly payment.**

Therefore, if your interest rate for the initial term is less with an ARM than it would be with a fixed rate loan, you’re saving considerable interest for the time that you own the property. You’ll need to compare the interest rate savings during the discounted initial term of an ARM with the 30-yr fixed quote your lenders offers. Also evaluate an ARM based on how long you anticipate owning the house. If you’re looking to hold a property for more than 7 or 10 years, an ARM’s benefit is probably too risky since interest rates after that timeframe are unknown. Also, the more years your ARM offers for an initial fixed period, the less the discounted interest rate is.

In our current very low interest rate environment of 2020/2021, ARMs are rarely beneficial compared to a 30 year fixed rate.

An ARM is identified by 2 numbers. A 5/1 ARM means that the initial rate period is 5 years, and it can change every year thereafter for the life of the loan. A 5/5 ARM means that the initial rate period is also 5 years, but it can only change the interest rate every year for the 5 years after the initial term expiration. Here’s an example of a 5/1 ARM quote. It shows that the initial period is 60 months (5 years) and the maximum the rate could ever be is 5% more than the initial term, but that doesn’t mean there’s a guarantee of an increase since the interest rate is still based on the rate sheet at that time.

We found ARMs to be beneficial for our primary residences. We had several people try to talk us out of locking in an ARM. However, once we investigated the loan terms, we learned that there are strict parameters around your rate changes that absolved some of the risk others were using to dissuade us from the option. Yes, it’s a gamble, but interest rates have remained fairly steady or decreased over the last 10 years of our home ownership.

When we moved just outside of DC, the move was solely to get back to living together because our jobs had separated us. Being in the Federal government, the easiest way for both of us to get a job was the DC area, but we didn’t want to live in that metro area with the higher cost of living and a lot of traffic for very long. The rate terms offered were 4% on a 30 year fixed, or 2.5% on a 5 ARM. We owned the house for 3 years and 2 months. Over 38 months, we paid just over $23k in interest. Had it been the 4% on a 30 year fixed, it would have been over $37k in interest, which is a $14k savings. By paying less interest, that means that more of each monthly payment went towards principal than it would have, resulting in $4,700 more to principal. Additionally, by having a lower interest rate, our monthly payment was $250 less. Over 38 months that’s $9,500 less we had to pay, freeing it up to save and invest in other ventures.

For our second primary residence, we also had an ARM. We expected our time outside of Richmond, VA to be longer than the DC area, but not forever. I was uncomfortable with a 5/1 ARM and wanted the 7/1 ARM, but Mr. ODA picked the 5/1. We owned this house for 4 years and 9 months. Our interest rate was 2.875%. At the 61st month, it could have risen by 2% for the first year and 1% for each of the next 4 years. Had we gone with a conventional 30 year loan, the interest rate was going to be 4.125%; we would have paid $54k in interest during our ownership. With the ARM, we saved $17k in interest, put $5,300 more towards principal, and paid over $11k fewer in monthly payments.

We purchased our current residence a few months ago. We have a 30 year fixed conventional mortgage at 2.625%. Since interest rates are so low now (you can see how previously, we’d be around 4% for a conventional and got lower than 3% by choosing an ARM, whereas now interest rates are less than 3%) and we plan on being here for a much longer time, we didn’t pick an ARM.

As illustrated in the examples for the first two properties we lived in, ARMs can be a powerful option in strategizing your mortgage to work most efficiently for you. They are not without risk, so pros and cons must be weighed along with future forecasting of your life situation. If used in the best circumstances, they can help you shift tens of thousand of dollars away from interest and towards principal and other investments to aid in reaching financial freedom.

2020’s Expenses and Activity

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When people talk about having rental properties, usually the first thing we hear is, “I don’t want to hear about a clogged toilet at midnight.” Does your toilet clog at midnight? No. So why do people think that tenants have issues that you wouldn’t typically see in your own house? A tenant can’t expect service faster than you’d get on your own property.

Even when there’s a month that requires a lot of our attention to be on rental properties, it’s still always worth the income/expense ratio. 2020 was a year of big expenses. However, I kept the perspective that we had several properties that we didn’t even hear from, and this was just one year of 4 so far.

Here’s a look back at what happened with our rental properties in 2020.

House #7 required a roof replacement. We have dealt with leaks since we purchased the house, and the time finally came that the replacement was more cost effective. This house also required HVAC repairs and plumbing replacement. Since we purchased the house, we had issues with the upstairs bathroom sink not draining properly. After several attempts to unclog it, our plumber finally made the call – it wasn’t a matter of cleaning a clog, it was time to replace corroded copper pipes… from the second floor to the crawl space. And so we did that. We then had to pay someone else to repair the drywall. All together, this house cost us $7,600. However, about $4k of that was the roof, which has to be depreciated over 27.5 years, so we only claim about $75 of that cost this year.

House #1’s roof has also troubled us from the start, but it’s under HOA control. We had a leak that was bad enough to require the HOA’s attention. It was a multi-week process to get them to even acknowledge me, and I have no intention to ever own a townhome again. I like having more control over my property than being in a position to hound an HOA to address a water-related issue as I watch more rain in the forecast. In the end, they repaired it, but we’re responsible for the drywall repair, which was $76.

House #6 required the main sewer line from the street to the house to be replaced, which was $4k including the scoping trip to put a camera in the pipe and see how deteriorated it was.

We had quite a few HVAC issues this year, after only having 1 issue on all our houses (well 2, but that second one was someone driving over our unit and insurance covered it). We had House #3 require a new fan, which was $635. House #9 had an entire HVAC replacement at $5k, depreciated 27.5 years. House #12 required HVAC work at $500.

We had to replace a dishwasher, stove, washing machine, and refrigerator among the properties as well. These were the major purchases and don’t account for several smaller plumber and electrician trips that were needed among the properties.

On the positive side of things, we paid off one loan, paid $23,500 paid towards another, and refinanced a property (reducing our monthly payment by $104).

Of 12 properties, we had to turnover 3. Turnover is the most time consuming to us personally because it requires our attention to touch up paint, fix things, order appliances, and coordinate any other maintenance issues. Then we need to handle listing the property and showing it when we don’t have a property manager, which was the case for 2 of our properties.

In March, we had the tenant at House #11 request a renewal of their lease. A couple of weeks after signing the renewal, they requested to be released from the lease because they were moving to another state. We worked with them, for a fee, to be released from the lease, and they vacated the house as of April 30. I had to repaint, clean the bathrooms and kitchen, fix a few things, and clean the carpet (which was only a year old at this point). We listed the house, had several inquiries, and had it rented on May 7.

In September, we had the tenant at House #7 request to be released from her lease because she was buying a house to take advantage of low interest rates. The Fall isn’t a good time to be listed a house for rent, but it’s hard to not help someone help themselves like that! We agreed to release her from the lease for 2 months worth of rent. Shortly after that agreement, an old tenant of ours reached out asking if we had something coming available in October or November, and this house fit her request perfectly. I met her to show her the house and had a November 1st lease signed the next week. We asked the new tenant if she could move out before October 31st, and we would refund her for the days she left early. We spent two days touching up paint, fixing an old water leak patch (the roof had since been replaced by the drywall work in the laundry room hadn’t been addressed), and cleaning the house. Our paint touch up was far from perfect, but we didn’t have time to repaint the whole house. I offered the new tenant an incentive of $50 per room and $25 per paint can if she wanted to paint herself, and she actually did 3 rooms so far.

The final house that had turnover is managed by a property manager. Our house was the first the tenants had rented, and they didn’t quite understand all the details of having to give notice that they were leaving. We worked with them while they went back and forth deciding if they wanted to renew or leave. While our lease stipulates that we require 60 days notice if they plan to leave at the end of the lease, we wouldn’t typically post the house for rent more than 3 weeks out. They eventually decided they wanted to leave the house, but then at the last minute asked for more time. We had a lease lined up for two weeks after they were going to vacate, so we were able to give them an extra 10 days in the house. Once they left, we had the carpet and house professional cleaned, and I touched up some paint. The property manager handled the listing, showing, and background checks. The new tenants haven’t asked for anything since they moved in back in July.

We were not heavily impacted by the pandemic. We hadn’t realized it until the Spring, but nearly all our tenants work in health care, which is just an interesting coincidence. During 2020, we only had one tenant that we had to constantly keep up with regarding her employment and ability to pay rent. She didn’t always pay on time, but we would have all the month’s rent before the end of the month each time. Then we had a tenant here or there that needed another week or two to pay rent in full, which we had no problem allowing. We didn’t collect any late fees in 2020.

While a year of several big expenses can be overwhelming, it’s helpful to know that this has not been our norm and the issues were centralized to a few houses. It also helps that 5 of our houses have long term renters (renewed more than once). Having a tenant renew their lease saves us time and money.

Doing Your Own Taxes: Set Yourself Up for Success

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I manage all the financials for my family. Mr. ODA makes the maneuvers, and I record them. Excel is where our organization lives and dies. Sure, I have a degree in Finance and Information Technology Management (i.e., Excel), but it doesn’t need to be complicated or difficult to make tax prep easy for you.

This level of organization allows us to do our own taxes. After the first year of purchasing rental properties, we thought we’d have to hire someone to do our taxes because it would be complicated. It’s not any different than filing your own personal taxes. The software systems available online walk you through the entire process. Each property’s income and expenses have to be entered separately, which is time consuming if you have several properties, but it isn’t difficult.

The most important thing to be ready for your taxes is to make it a whole year activity. If you record income and expenses as they occur, it’s less of a hurdle when the year is over. By recording the activity all year, it then becomes a verification process when the year is over, thereby reducing the possibility of missing something or recording something wrong.

At the beginning of each year, I create a projection of income and expenses, which helps Mr. ODA adjust his W2 tax bracket throughout the year so that we break as close to even or owe very little when it comes to tax filing. Let me dive into that aside quickly.

Go back to Mr. ODA’s tax posts:
– TAXES! Part 1 – What are Marginal Tax Brackets?
– TAXES! Part 2 – Is Your Bonus at Work “Really” taxed more?

Taxes Part 2 is what I’m particularly referring to, but you may need the lesson in Part 1 to know what that means. There are IRS penalties if you fail to pay your proper estimated tax (when you don’t pay enough taxes due for the year with your quarterly estimated tax payments, or through withholding, when required). Title 26 of the United States Code covers the penalties. Essentially, the IRS is saying, “You have to estimate your annual taxes owed, and you’re not allowed to only pay us taxes on April 15th every year, but you have to pay the taxes over the course of the year.” People get excited to receive a refund from their taxes, but really that’s just an interest-free loan you’ve given the government. Perhaps some people do need that forced savings, but wouldn’t it be nicer to have that extra money in your pocket throughout the year?

Back to the point…

I create a new workbook every year with each house having its own spreadsheet. Schedule E is going to require you to put your income and expenses, per property, not as a whole, so it’s important to have expenses assigned to a particular house. I set up each spreadsheet in an Excel workbook to identify all known costs for the coming year. Not all of these apply, but these are typically the categories of my known costs for each year: property management, HOA, utilities (City of Richmond bills the owner (not tenant) for sewer fees), property taxes, insurance, annual mortgage interest, cost basis depreciation, and prepaid points depreciation. There’s also a chance that you’re carrying appliance depreciation costs (meaning, the purchase of a washer, dryer, refrigerator, etc. aren’t recorded as an actual expense in the year purchased, but are required to be depreciated over its useful life).

As the year goes on, I record any mileage (record the actual miles along with the mileage cost) and maintenance costs. The IRS posts the standard mileage rate for each year here. If a roundtrip to a rental property is 40 miles, then the expense is calculated as 40 miles multiplied by the standard mileage rate, which is $0.56 for 2021. I’ve learned over the years that the software systems just request your miles and do the calculation for you (which is smart and safer on the calculation side), but we want to know what the calculation is going to be, so I enter it as $22.40 in my spreadsheet.

You’ll be expected to input the days your property was vacant, so record that once it’s known.

Each spreadsheet is linked to a master sheet at the beginning of the workbook that shows the net income and expenses for each property. The difference of these amounts are what Mr. ODA uses to adjust his W4 deductions.

I personally assign costs month by month so I can keep track of them, but it doesn’t even need to be that fancy. A running list of these expenses are enough.

The categories are based on what’s going to be requested through Schedule E.

Then in January/February of the following year, I go through my filing cabinet and my email to ensure I’ve captured all of the expenses that I have receipts for, and vice versa to ensure that if I’ve recorded an expense, I have a receipt for it. Having already captured the expenses throughout the year serves as ‘checks and balances’ and doesn’t make the task feel too overwhelming.