The money ($12k) in question is coming from a rental property in California. The money is from a HELOC of 8.5% (thank you for lower interest rates, hahaha, it used to be at 9.5%, but still it’s not a lot of difference). It’s not fully used.
As for the wisdom of making a property cash flow negative by equity withdrawal, it is not recommended for most conservative people, but I have taken it into account already. The number to watch is called “cash on cash”. Whenever you are borrowing money to make money, the “cash on cash” calculation is key in order to make your decision.
So I am borrowing money at an interest rate of 9% (more or less). However, the property generates a cash on cash of 18%. That cash on cash number means I am able to generate enough cash flow to pay back the loan at an accelerated rate if I wish.
Risky? Yes. Can use of this make a property in California go from cash flow to negative? Yes. SO WHAT. The new property generates enough cash flow by itself to offset that negative.
Let’s also look at the ROE. We took $12k from a rental property and now it’s cash flow negative (it’s not, but let’s say it is). Let’s say I will pay back that loan in ten years at a rate of 9%. The rental property will now be cash flow negative at $152/mo. The new property’s ROE is 43%. For the cost of $1824 a year (the $152*12), I have generated a value of more than $17000 ($12k+12k*(0.43)).
So again, so what if the property is cash flow negative? I’ve been able to generate enough money to pay it back potentially in the first year. Also, let’s remember, I am only borrowing $12k. My household generates that in a month. So the risk to me is somewhat minimal.
Is this process for everyone? HELL NO. Everyone I have described this process to personally has called me crazy. =shrug= But think about it – the equity in the properties we have we can’t access unless we either sell the property or we refi the money out. This process allows me to generate money out of something that was previously doing NOTHING. That to me is a win-win.
But like I said, there are risks. I have offset that risk somewhat by various methods – doing due diligence, making sure the cash on cash calculation fits my requirements, and lastly my household generates enough income on its own so that a $12k hit means little. It hurts, but my household has $400k in liquid accounts (apart from the real estate).
I read here (and on other blogs) about how people will MEW (mortgage equity withdrawals) themselves into a new boat, or a new car. We did none of that. The money we take out of the properties, we make sure it generates a decent return.
I don’t have a fear of negative cash flow as most people on this board do because I know that in the long run, it will pay off for me. And this negative cash flow mentality has also made it unable for most people to see how to get rich using real estate.
Again, here is the math for emphasis:
$1824/year in negative cash flow => generates $17000 in value.
$1824/year in negative cash flow for rental property =>
generates $3600 in cash flow, leaving you $1776 left over to pay the loan.
Anyways, remember, math is your friend.
Also remember, because of the above, many people have called me CRAZY.
