This is part 2 in my series about 3 Paths to Free & Clear Real Estate.
If you’re just joining me and need to catch up, I write about using real estate to help you reach a destination of financial independence.
A simple goal of free & clear (no debt) real estate is a measurable and powerful goal that helps you achieve financial independence.
Your free & clear goal might be, for example, to own 10 houses that together rent for $12,000 per month ($1,200 per house) and net $7,000 per month after expenses.
In other words you put $84,000 per year in your pocket.
So, this series of articles gives you three general paths that may help you climb the mountain towards your free & clear goal.
This article will explain #2 – The Snowball Plan.
The Snowball Plan
Like plan #1, the second plan is also safe and steady, but it differs by introducing some debt. This addition of debt allows you to pay higher prices and buy higher-quality properties than with the All Cash Plan.
The Snowball Plan basically works like this:
- Save cash for down payments
- Purchase several income properties using conservative, low-interest loans.
- Save 100% of the real estate income plus extra savings from a job.
- Use all savings to apply towards one of the loans each month until one loan is paid early.
- Use all savings + new free & clear income to apply towards another loan until paid early.
- Repeat until all loans are paid off.
A Snowball Plan Example
Let’s say you want to end up with 3 properties free & clear. You could do more of course, but this will keep my example simple.
You decide to buy easy-to-manage single family houses. Your target properties might be 3 bedroom, 2 bath homes with a garage, in a solid neighborhood in a good school district.
Let’s say each house rents for $1,200. After subtracting $500 in operating expenses, which does not include your mortgage payment, you would net $700 per month.
Since you have good credit, at today’s rates (in 2014) you plan to put 20% down and get a 4.5%, 30-year mortgage.
You work hard for a few months, and you buy three investment properties. Here are the numbers:
So, to purchase these three houses, you needed $90,000 cash plus good credit.
Here is what your positive cash flow would look like once you get all three properties rented:
As you can see, your rentals produce $579 per month in positive cash flow. I also assume you would save an extra $500 per month from a job or other income source.
In this plan, the main point is to snowball your mortgages (i.e. pay them off faster and faster over time) by eliminating one mortgage as quickly as possible, and then the next, and the next.
To do this snowball, you use every bit of the positive cash flow and extra savings to make an extra-large monthly payment on one mortgage.
Here is what that would look like in this case:
$579 … positive cash flow from rentals
$500 … extra savings from job
$487 … regular mortgage payment (Loan for House #1)
$1,566 per month = extra-large mortgage payment
This massive extra payment begins the snowball. Each time a mortgage is paid off, the additional savings are then added to the next loan. So the snowball gets bigger and bigger.
How fast does it accumulate in this case?
Mortgage #1 = free & clear in 70 months
Mortgage #2 = free & clear in another 48 months
Mortgage #3 = free & clear in another 35 months
So in a total of 12.75 years or 153 months, you have your 3 properties free and clear. This means all $2,100 of net operating income from the rentals goes into your pocket.
You have essentially started with a $90,000 investment, added $500/month for 153 months, and ended up with $2,100 per month for life.
Not bad! And if $2,100 per month is not enough, you can buy more properties in the beginning or buy more properties at the end using your extra cash flow.
Benefits of the Snowball Plan
No plan is perfect. But, I think you’ll find that The Snowball Plan has several big benefits.
Benefit #1 – Control:
Success does not depend upon inflation, luck, speculation, or a Wall Street expert.
What does it depend upon?
- Buying good properties, up front.
- Financing with a good loan, up front.
- Remaining a disciplined saver for 13 years.
These can be done with a little education, focus, and soul-searching.
Most real estate investors I know like this idea of having more control. They like that success depends upon their own efforts, not someone they don’t even know on Wall Street.
Benefit #2 – Visible, Measurable, and Steady Progress:
The progress you make in the Snowball Plan is visible, measurable, and steady.
You can literally track your progress month by month as you payoff your mortgages. Each chunk that is taken out of your mortgage is one step closer to your end goal.
The psychological benefit of this visible progress is HUGE.
Personal finance teacher Dave Ramsey often says that success with money is 80% behavior and only 20% math.
In other words, we are not robots, no matter how rational and intelligent we think we are. Visible and measurable progress gives us a little reward that reminds us “You’re on your way. Keep going!”
While rising stock prices can also give us visible and measurable feedback, they often roller-coaster up or down and terrify even the most self-disciplined of us.
Instead, progress with the Snowball Plan is steady and gets better and better over time.
Benefit #3 – Flexibility:
Real life is unpredictable, and our plans should be flexible to reflect that reality.
The Snowball Plan can be slowed or stopped as needed.
If you hit a major job crisis that cuts your extra savings, you can temporarily hold off on the full Snowball until you get back on your feet. You will actually continue making progress, just a little slower.
You are also flexible to decide how many or how few properties you want in the end. A bigger portfolio of free and clear properties will require more cash and more time invested, but you’ll have a bigger cash flow in the end.
My hope with giving you a plan like this is not to tell you exactly how it will happen in your life.
Former president and general Dwight Eisenhower famously said “In preparing for battle I have always found that plans are useless, but planning is indispensable.”
That is the idea here.
My plan will be useless if you think the details will happen exactly like I’ve written them here. But it may be very helpful if it gets you planning and thinking and moving forward.
So as I often do, I want to end my words with a challenge to you.
- Is the Snowball Plan something you’d like to implement?
- If so, what is the next step?
- When will you get started? (Now is a good answer:)
In the next article, I’ll give you the third and final free and clear plan, Buy 3-Sell-2.
Enthusiastically your coach,