[Today’s post is by Dee who blogs over at color-me-frugal.com]
My hubby and I have known for a long time that we want to own rental properties and develop a passive stream of rental income to supplement our earned income. Eventually, it would be awesome if we could one day have enough passive income to cover all of our expenses. That’s the dream, anyway!
We have actually been so enthusiastic about the prospect of rental income that as soon as we had enough cash saved up a few years ago we could not wait to buy a property! However, there was one tiny problem- at the time we were living in State A, where we knew we weren’t going to stay. We were both from State B, where we hoped to move back to one day. About 20 hours driving distance separated the two places.
Did we let a little problem like living out of state deter us from our dream of becoming landlords? We most certainly did not! Since we knew we were going back to State B one day, it made sense to us that we should buy a rental property there even though we were living in State A at the time.
That makes sense… right… right?
Yeah, that’s what the banks thought too.
In our defense, we knew exactly which town in State B we wanted to own rental property in. We had lived there for two years when we were in school. We even knew exactly which part of town we wanted to buy in. We had a friend there who agreed to be our property manager until we moved back, and she had even found us a tenant whom she knew personally.
The year was 2011. Early that year we traveled there to visit friends and shop for property. We found several good rental candidates, but the one we put in an offer on was a 3 bed 2 bath in the part of town that we wanted. It was close to the business district and a hospital (one of the major employers in town), and it was in a great school district. Even better, the previous owners had done some remodeling and really spruced it up (since we were going to be long-distance owners for a while, it was important to find a property that did not need a ton of work).
But that didn’t stop banks from thinking we were crazy!
Looking back, I think we approached the situation really naively. And we seriously underestimated what the real estate bubble had done to the process of obtaining a mortgage.
We had no trouble getting a mortgage pre-approval. We both have credit scores around 800 and we had a 25% down payment (which we were told we would need for a rental property). We have solid credit histories.
However, that was only first blush. We had a mortgage broker who was able to shop multiple banks on our behalf. Once we had to start submitting more paperwork and the banks began to realize that we were really serious about this whole buying-an-out-of-state-rental-property thing, they began to get nervous. They were also nervous about the fact that the property had recently been renovated, which meant that the price had jumped from what the previous owners had bought it for.
I could not even tell you how many pieces of paperwork we had to submit for that mortgage. In addition to all the standard mortgage application paperwork, we had to submit two years worth of tax returns. Companies that we were doing freelance work for had to submit statements to indicate that they were in fact paying us to do legitimate work for them, as our freelance income was where a great deal of our down payment was coming from (I guess banks wanted to make sure we weren’t dealing drugs!) We had to submit a copy of our property management agreement before we’d even bought the property or officially hired our property manager. Our proposed property manager had to verify that she had a tenant ready to move in.
Banks were so freaked out by the fact that we were out of state that they made us write up and sign a document to state that we had in fact been to the property and had seen it (they apparently would not consider lending to us if we hadn’t physically visited the property). We also had to write a “letter of intent” to explain to banks why exactly it was that we thought it would be a good idea to buy a rental property in that location when we lived out of state. Literally every other day the mortgage broker called us to tell us about another piece of paperwork that the banks wanted to see. It was such a headache. Even though we’d had the foresight to designate a closing date two months away, the closing date still got pushed back because of all our bank issues.
Don’t forget appraisals
Another issue we had to contend with was the fact that it had recently been renovated. Through this process we learned that banks aren’t super wild about lending money for property which has recently been renovated and seen an increase in value- it makes them nervous that somehow they are going to get screwed if you default on the loan. Because the banks were soooo nervous about this, we actually had to have two appraisals done to verify that the property was worth the selling price.
All for nothing?
In the end, it still wasn’t enough! I know- groan! Between the banks being completely freaked out about us being long-distance landlords and the fact that the home had recently been renovated, in the end no big banks wanted to take us on.
Last minute deal saver
At the last minute we were actually able to get a local bank (where I’d had a checking account for over ten years) to give us a loan. What they gave us was a five year balloon with an interest rate of 6.75%. The advantage of doing this was it allowed us to buy the property and at the time was the ONLY way we were going to get to buy it. The disadvantage: we would have to refinance within five years or risk having to pay the balance on the loan at the end of the five year balloon. But since 6.75% wasn’t a very good interest rate we would have wanted to refinance anyway!
A year later we refinanced. We got a much better deal the second time around and locked into a 30 year mortgage at a 4.5% interest rate. We love that property and it has been cash flow positive practically since the day we bought it! Amazingly, the tenants that our friend found stuck around for the crazy mortgage ride and they moved in almost immediately after we closed on the property. They’ve been great tenants for three years now.
- Our biggest take-home from this is that we would never again try to buy a rental property outside the state that we are living in!! Even with a great credit score we were raked over the coals and kind of got screwed on the first mortgage that we had on the place.
- Banks look a lot harder at properties that have been recently renovated or “flipped,” and therefore it may be harder to get a mortgage
- Hindsight is of course 20/20, but it probably would have been a better idea for us to be patient and just wait until we moved back to State B to buy a rental property!
- One of our favorite quotes is relevant here: If it’s easy, it probably isn’t worth it
Do you think we’re nuts? Do you think you would ever consider rental properties as an investment? If you already own rental properties, do you live near them?
About the Author: Dee is a personal finance enthusiast and blogger who is working hard to live a frugal lifestyle, ditch debt, and create multiple streams of income. She hopes to inspire others to achieve their financial goals by doing the same and writes about the journey on her blog, Color Me Frugal. Follow her on twitter @ColorMeFrugal, Like Color Me Frugal on Facebook, and be sure to check out her blog.