Monday, September 5, 2016

Why I Went $34,000 Into Debt With My Family

This picture is pretty accurate.  Debt is such a burden and literally sometimes feels like a weight being carried on your back.

(At least, certain kinds of debt can feel that way!)

In this post I will describe why in 2015 I borrowed $20,000 from my Father-in-law, and then in 2016 I borrowed $14,000 from my own Father.

Now, I am thankful to have had the option to borrow from them and the family support that they provided to help me when I was in need, but I don't like that I had to borrow from them in the first place, and I am greatly looking forward to paying them back.  Paying them back is one of my primary goals, listed here.  Read on,

In the spirit of transparency, I started at $24,000 in total debt when Passive Income Dude was launched.  My two lenders: my dad and my father-in-law.  But my original total was much higher at $34K....$20,000 to my father-in-law and $14,000 to my dad. So a $34K starting total, doing some quick math, I have since reduced my debt by $14,000 by diligently paying them back over the course of the last 15 months or so.  Hence, my debt remaining currently is:

Father-in-Law: $10,000
Dad: $10,000

But paying them back for the last 15 months with more still to go has been a test, for sure.  In fact, I contemplated using this picture for this post, because debt literally makes you a slave:

The bible says, "The rich rule over the poor and the borrower is slave to the lender." This quote is simple wisdom for us to both be smart with our money, and to also avoid debt. Take it at its core, whether you are a believer or not.

So to get to the title of this post, I actually accrued this debt in two phases, first with my father-in-law in 2015, and second with my dad in 2016, but really only for one reason: to purchase my North Carolina home.  

The Army sometimes forces you to be flexible (UNDERSTATEMENT of the year!), and so I learned that my family and I were moving from Colorado to North Carolina about a year sooner than I thought we originally would.  This turned out to be quite a blessing in the end, but ultimately we did not have nearly enough saved to purchase another home under that new timeline; specifically, the type of home we wanted, one that we could keep as a great rental property when the Army moved us again, and one that we could get good financing on. More on this later, but financing is huge when it comes to buying real estate, as I've said before. Bottom line, we had about slightly over $20k saved up when it was time to move. So definitely not zero, but not enough.

It turned out that to get our North Carolina home we needed closer to $42,000.  And that was for terrible financing terms.  So we were essentially $20k short of being able to even purchase the property. BIG SIDE NOTE - When you have multiple properties, your debt-to-income becomes very important to lenders. Feel free to email me and I'll explain more in detail, but TRUST ME that this was a major challenge for our third property.

So, thankfully my father-in-law was able to cover the difference.  I'm slowly paying him back and am half-way there now, but starting $20k in the hole does not feel good.

Fast forward a year, and I AM VERY TIRED OF OUR TERRIBLE FINANCING, AND THE $171 I am paying in mortgage insurance EVERY month and that I have to continue to pay for ELEVEN YEARS.  Those were the terms of our contract. Add to that wasteful $171 that I'm also concerned we will be moving again soon and that our anticipated rent is now closer to our actual mortgage payment.  Very little cushion for cash flow after running some number estimates.  All of this makes me start being very concerned that we've got another Missouri property on our hands, due almost solely because of poor financing!  So, ultimately, I knew I needed to refinance and so I decided to do so. Specifically, I refinanced because I was afraid rates were going to rise, which would offset any option for better financing, and that I would therefore lose my window to ever refinance when it actually made financial sense. 

So I talked to my lender and learn that I needed $23,000 to make a refinance work. But mind you I only have about $9000 at that point.  AHH! $14000 short.  $14000 seems like so little and SO MUCH when you are talking about being able to refinance or not being able to refinance. 

Thankfully, my dad was able to help cover the difference, of $14,000. But believe me when I tell you that I have now basically maxed out both my dad and my father-in-law, and I am sitting in $34k of debt with family.  Yikes.

I did not like that at all, but I really tried to maintain a long term perspective on this as an investment. And a good investment actually, once I was able to actually structure the deal to where it made sense. And it is also very important when reading this article to remember that I didn't just have the debt, I also had this:

So to conclude, with this refinance I now had a lot of debt, but I also had a very high quality asset. I did what I needed to get the deal done, and I am now VERY excited about this property's potential. With a conservative rental estimate of what I can charge per month, this property will cash flow around $400/mo in the positive.  Add that $400 of cash flow each month to a 'mortgage debt' pay-down of around $350 each month, and this property is now easily $750/mo in the green. Remember that it is THE TENANT who pays you cash each month, and it is THE TENANT who pays down your mortgage debt.  You simply reap the benefits.

And it will only get better with time.  I talk about the details of this property's potential as an investment herebut the key I point I want to make with this post is the following:

YES, the saying is true that it takes money to make money. But understand that when I started this home purchase, I didn't HAVE the money, and I honestly I didn't think I could get it.  But I didn't let that stop me, God blessed me and I DID get it. And now I have an amazing asset on my hands that should cash flow incredibly and increase in equity each month that will only grow and get better with time.  Sure, it'll take awhile of diligent savings to pay the debt off (for those of you who follow my monthly reports, you see that each month) but the asset, with its cash flow, and its equity, and its tax benefits, and its potential for capital appreciation, will far out weigh those initial cash requirements. What a blessing. 

Understand that real estate is a "multi-dimensional" asset class.  You get your return through cash flow, through capital appreciation, through 'mortgage debt' paydown, through tax benefits.  These items should not be overlooked and should not stop you from "going for it" as I had to do in order to get this third property.

We will move from this house towards the middle of next year.  At that point, it will no longer be our home, but will turn into an investment.  I am excited to see how this goes.

I'll close with asking your thoughts on this decision. Does this seem like a wise plan? 

Thanks for reading!

Passive Income Dude


  1. Debt is all a matter of perspective and each person has a different threshold of what they can handle. I personally can't handle any of it!

    I'm wise to the fact that 99% of people who are wealthy have leveraged themselves to get there (Warren Buffett included) but I will remain Debt free until I see a great opportunity.

    I do like the real estate so I wil be watching my local market like a hawk for signs of weakness.

    Keep on moving forward PID!

    1. Ahh Divi Cents! First, I respect you for your self-awareness! I think it was Socrates who said "know thyself"? ..But brother, I have to convince you to get on the leverage side of the house! That is where the massive sums of wealth are created. :) You said it yourself.

      Let me give you an example. In my Colorado property, I put in $17500 of my own money to acquire the property. Last year alone it appreciated 5%. So my home, initially valued around $350,000 went up 5%, to a new value of $367,500. 5% isn't too bad, not low, but definitely not super high like some markets. But here is the awesome part - my investment, my 17,500...with that 5%, I actually just made a 100% return. In one year. That is the power of leverage at work.

      Or consider another example, again using my Colorado house so we can keep the same initial investment numbers: so currently that house cash flows around $330 a month. Above all expenses. So annualized that is $3960 in income. To generate that level of income unlevered in the stock market I would need well over $100,000. You and I both know this. But here, with leverage I am now getting that level of income with just over $17,000.

      One final example, :), since you've got me all fired up and excited now: companies use debt all of the time to achieve a more optimized 'capital structure.' Let me explain. Since the cost of debt is often much cheaper than the cost of equity, companies will take on debt to lower their weighted average cost of capital and thereby increase returns for their shareholders and actually instantly increase their firm value. That's essentially what I am doing here - just lowering my own personal WACC. It's a beautiful thing! Let's discuss more! Thanks for stopping by,

  2. I did get you fired up!

    I agree with pretty much everything you are saying. I actually do consider there to be two different types of debt. Good Debt; leveraged money for investment, and bad debt; borrowed money to buy things you haven't saved for.

    I do think the way you are using debt is the right way to go about it but that is not to say that there is no risk involved.

    As you know, I plan to buy a rental property here in Vancouver. I will have to leverage quite deep to buy it. I just don't want to be that guy who is caught at the top of the market so I have to wait until I am 100% certain that there is no bubble.

    In fact I have opened a margin account and a heloc just for when the next big market crash happens. I'm mature enough now that I know I will not use that money until the proper time but when the time comes I will be buying with someone else's money :)

    1. :), only fired up in an 'excited to discuss' way. I completely agree with you though that there are different types of debt, and that there are risks involved. Trust me, every time I suggest buying another property my wife reminds me of the risks! And to be honest, she is right.

      I think a lot of the risks can be mitigated, to an extent, and that in real estate the risks actually decrease over time, versus staying constant or increasing, but they are in fact there. And you are right in saying that the entry price is a very big component as well to whether it is a good investment decision or not.

      Finally, I'm impressed with your margin and heloc account! That is intense. Perhaps I should be telling you to be careful. :) Just kidding.

      I'm interested to see our progress and what happens each year! Take care,

  3. There is another, indirect benefit from buying real estate using "good debt". Because you have the mortgage obligation, it helps you to be disciplined and not spend excess money on frivolous things. Years down the line, that really matters!

    1. Hey Ferdi, that's totally true. I often forget about that one because the 'forced savings' feels like such a burden sometimes. :) You'll notice if you look very closely at our monthly income/expense reports that we're really only spending around 1.5-2k per month on items outside of homes and gifts. So the forced savings is sometimes very constraining! Thanks for stopping by,