LENDER TAKEOVER! This weeks blog post has been taken over by my wonderful loan officer, Nelda Cales at Movement Mortgage.
There comes a time when you begin to seriously consider how you will fund your children’s education. If you began thinking about this before your little one could walk and now you are attending weekend sporting events-it’s time to take action. A typical cost is upwards of $9,500 for in-state tuition per year for the 2014-2015 school year. Real estate continues to be one of the top wealth building investments for Americans and provides investors with a tangible asset. There are alternatives to funding college education such as investing in whole life insurance policies, a state sponsored 529 plan, or plain old disciplined savings. Real estate, on the other hand, can provide multiple potential tax advantages throughout the course of ownership, allowing deductions for mortgage interest, depreciation, expenses for maintenance and upkeep, as well as other favorable tax considerations. Real estate can also be an income-producing asset.
For many, real estate doesn’t seem like an obvious choice because becoming a landlord can seem daunting. Frankly, if you are in the right financial position, owning real estate can be an excellent vehicle to fund passive income later in life or provide liquid savings when the market signals a time to sell. Unlike other investments that provide little tax benefit, real estate provides monthly cash flow and value through building equity.
Here’s how the numbers break down:
Consider purchasing a $95,000 property with a 20% down payment, creating a loan of $76,000 and closing costs of approx. $3,500.
To most aggressively pay off a mortgage as quickly as possible, a 15 year loan would be the best option because it minimizes the interest paid to the lender and it allows the property to be paid off or nearly paid off by the time college expenses begin. The total payment including taxes and insurance is approximately $772. If the property rents for $900 after expenses such as management fees, this might be a break-even situation on the surface. Consider that while the property is rented, the tenant is making the payment and creating the equity for you and you are netting the tax benefits of owning rental property. In 15 years, the property is owned free and clear and there is now a cash flow opportunity on a monthly basis to provide extra money to your college student. Imagine now being able to send your college student money without touching your bank account. Another option is to sell the investment property prior to your child going to college and you will then be able to pocket the profits and pay for tuition outright.
Some skeptics would say “I am not rich and owning real estate is for rich people.” I have been working in this industry for the last 20 years; the reality is that some of my clients have committed to higher car payments than this investment can cost AND investing has the potential to make you money. While it is true that those who own real estate typically have more wealth, take a moment to consider that the very reason people get rich is that investing in real estate can create wealth.
What if the 15 year option is too aggressive? There are more affordable options if you cannot take the most aggressive option of a 15 year repayment.
A 20 year loan would require a $690 monthly payment, including taxes and insurance. Again, if you rent for $900, you can pocket the income or, better yet, reinvest the income into another savings vehicle or make principal reduction on the note. When it’s college time or 10 years into the investment, the balance would be $46,086 – now allowing you to sell and benefit from the profits. One last option would be a 30 year fixed loan which would have a monthly payment of $595, thus creating a nice monthly cash flow of a few hundred dollars per month. Consider taking those funds and starting an investment account for future college expenses.
The two concepts that make buying investment property today a great option for parents looking to offset college expenses are cash flow and equity. First, as you receive monthly checks, the difference between the loan payments on the mortgage and the rent collected can be used to supplement your child’s expenses or fund additional investments. Remember, if you can afford it, opt for the shortest financing so the rent checks can be all profit as quickly as possible. The second concept is that property typically appreciates at a faster rate than a savings account. As a tenant is paying down the loan, you own an asset that can be liquidated into cash. What we didn’t talk about specifically is the write-offs or potential tax benefits of owning additional property during the 10-15 years before the child is ready for college. This is the time where we as parents are earning our highest levels of income. Since I am not a tax adviser, I recommend a discussion with a tax consultant.
Of course, I want to be fair in giving consideration to the downside of becoming a real estate investor. The numbers above are a very real depiction of the potential. As with any investment, there is risk.
Property appreciation is not guaranteed, but from 1900 to 2012, average housing prices increased at a rate of 3.1% annually, slightly above the rate of inflation during that same period.
There are upfront costs and outlay with the investment, such as a required down payment of 10%-20% and closing costs that are typically 3% of the purchase price. Additionally, you should be prepared with reserves for when the property may not be rented or if there is a major repair.
When you are ready to sell, there are costs for listing the property that become subtracted from the profit. The good news is that nothing is paid out until the house is sold.
There is real potential in investment properties. Prices are low. Interest rates are low. Money is available. Real estate investing can provide wealth building opportunities, cash flow, and EVEN a way to put kids through college. If you would like to have a discussion about whether real estate investing may be an option for you, please contact me.
For more information, contact Nelda F. Cales, NMLS 450923 at 910-787-4313. Nelda.Cales@Movement.com