Much of this story has already been talked about in previous posts. You can read about how I ended up buying this property in the midst of having our future plans drastically changed by the loss of a new house that we expected to move into and a job loss. And you can read about the headaches of dealing with this property over the last five years.
I try to put pictures and subheadings in all my blog posts to make the reading more enjoyable and interesting. But with this one, I am just going to get it out and get it done. I’ve been kinda dreading writing this part of the real estate journey because it’s the only part I am ashamed by my actions. But, it is part of my story and I am not going to leave out the bad parts. Plus, if I can prevent someone else from doing the same thing, that is a good thing.
This would be the summer of 2011. My wife and I have been married one year. We are living in the mobile home that I purchased for $1,000 and fixed up. (You can read about that in this post.) We have just found out that my boss wants more than we can afford for the house that we have designed and planned to live in for the next many years (but that he has been footing the bill for).
I really want to buy something at this point. I want to have rental property and I also am ready to buy a “real house” for us to live in. Problem is, we don’t have a very high income. Keely has just finished up her last year of school and is only making a few hundred dollars a month from her fledgling photography business. I am making about $1,200 per month on the farm and another $500-$800 a month at another part time job. I believe I still have some contract payments from a couple mobile homes I bought and sold (you can read about that in this post).
So, all in, the most we can qualify for is a $70,000 house if we go with traditional financing. And we have a few thousand dollars in savings.
I need to stop for a moment and go on a little rabbit trail. We have NO debt at this point. I cannot stress enough how important having no debt has been to our financial journey. When we got married, Keely had some money saved and invested in some mutual funds. I had college debt of about $1ok and a personal loan to a family member (another 10k) that I had used to fund the mobile home investments.
With Keely’s savings, some wedding money, the pay-off of a mobile home, and a little over one year of using every extra dollar we could scrape together, we had all our debts paid off. We have since borrowed money for the purchase of real estate but we have never had any consumer debt. I imagine our story would be quite different if we had car loans, credit card payments, and student debt still hanging over our heads.
I know we wouldn’t have been able to save like we did, which would have prevented us from saving money for down payments. I also know that we wouldn’t have qualified to buy the first property.
Alright, back to the story. I start looking on Craigslist for anything that I might be able to buy. I am not working with a real estate agent. I’m basically looking for a property the same way I looked for the six mobile homes that I bought two summers prior. Every day I look at all the houses on Craigslist for sale that are around $70k or less. I pay particular attention to the properties that say something like “owner carry” or “seller terms”.
This is the way I sold the mobile homes so I know that this type of purchase is just between the buyer and the seller. I don’t have to go through the bank if I can find an owner carry property.
Fortunately, at least for us, this is 2011. Home prices have tanked, foreclosures are all over, and interest rates are down near 4%.
I find this little house near downtown that is listed for $65,000. It is move in ready and the listing says that the seller is offering a two-year contract. This seller is an investor. They bought properties at auction, or at foreclosure, fixed them up to a decent standard and then resold them with an option to carry the loan for a couple years.
The investor knows that it’s harder to qualify for a loan right now and that many people have messed up credit and they need time to get their finances back in order before they can qualify for a bank loan. This is why he is offering the 2-year contract.
I go to look at the home and it looks pretty good to me. I talk to my lender and ask for a pre-approval letter. I take that letter and send an email to the owner. I offer him $65,000 and ask that he pay $2,500 towards closing costs. He counters with a sales price of $67,500 and $2,500 towards closing costs. If you’ve never purchased a house before, this was a pretty common practice when prices were down and it was a buyers market. It increases the loan amount but decreases the amount of money that is needed up front.
At this point, I should explain the type of financing I was using. This is important because it is a mistake I made and I wouldn’t want you to make this mistake as well. I have applied for an FHA loan. They only require a 3% down payment. But this is only for an owner-occupied house. I was to sign a paper as part of the loan documents that “I instead to use this as my primary residence.” I asked the lender, about how long I would need to use this as a primary residence. They were kinda fuzzy in their response and said something like at least six months.
I didn’t really care to live in this house. Our mobile home was larger and frankly, it was nicer too. Keely certainly did not want to live in it. I mainly wanted it as a rental.
I asked the lender, about how long I would need to use this as a primary residence. They were kinda fuzzy in their response and said something like at least six months. And they said the word “intend” left it a little open-ended. I also mentioned the dilemma to the seller who said something along the lines of “the banks have taken advantage of so many people, I wouldn’t worry about them as long as you intend to pay them.”
I went forward with the loan, knowing full well that I never intended on living there unless for some reason I couldn’t find a tenant. I knew that I wasn’t trying to take advantage of the lender and that I’d make good on my mortgage commitments.
But, I heard what I wanted to hear and I justified it to get what I wanted. By purchasing a property that was to be a rental property and never intending to live in it, I could be accused of bank fraud. I thought of what I was doing as twisting the rules, not breaking them. And there is a great correlation between that and sin, but I won’t get into that right now.
The point is, I should have done one of three things. I should have lived in the home for a period of time before renting it out. Or I should have taken the option to buy it on an owner carry and spend the next two years saving money to get the necessary 15-20% downpayment/equity to get an investment mortgage. Or I should have just not purchased that property.
After I had purchased the property and explained how I did it to a family member who has owned a lot of property they let me know that I had really put myself in a position that I could get in trouble for. I called the lender and asked them what I should do. They recommended I wait at least one year before trying to buy another property and that I’d have to do it with a conventional loan since you can’t have two FHA loans anyway.
I did end up waiting a year before trying to buy another property. This time we were trying to buy a property that we were actually going to live in. We went with the same lender and were just days away from closing on the house. The offer had been made and accepted. The appraisal had been paid for and completed. All we were waiting for was final loan approval. The underwriter looked back at our landlord history. They saw that we had not lived in the home before renting it out. And they rejected our loan because they thought we were going to do the same thing again.
The lesson I learned through that process was that it is ok to be creative and work within the system. But it is not worth the risk of damage to my family and my character to do things that could be seen as underhanded or wrong, even if nobody ever finds out. I have certainly continued to make mistakes and will continue to make them, but I strive to do the best that I can do.
The silly thing about that situation? I could have just bought the property with on an owner carry contract and everything would have been totally above board and without fault. I think the interest rate was like 2% higher (6% instead of 4%). And I think I was acting with a little anger at my boss who had fired me with no warning after 2 years of working for him.
But that is no excuse. There are plenty of opportunities out there and if I have to stretch the truth to make something happen, it just isn’t worth it. I am glad that I learned the lesson I did, but I wish I hadn’t learned it the way I did.
To wrap up the story…we bought the house, got a renter into it right away and had good cash flow from day one. They lived there for 1.5 years with almost no problems (the roof leaked which caused some drywall repair) and then moved out. I got new renters in there within days of the first tenant moving out. I didn’t screen them properly because I was more concerned about getting a tenant quickly. That decision ended up costing me about $13,000 three and a half years later. But that’s a story for another time. I’ve already written about some of it in another post title “Is rental property worth the headache?” In that post I go over the numbers, but not really the story behind the numbers. I’ll do that in my next post regarding my real estate journey.