How I Earned an Extra $40,800 in Two Years Without Lifting a Finger

how to earn an extra $40,800 in two years

Despite the fact that I have the best roommates in the world, I’ll occasionally remark, “I’m tired of having roommates.”

And Will replies: “Are you $1,700 per month tired of it?”

I don’t need to respond. The answer is obvious. The minor inconveniences — sharing a refrigerator, waiting to use the washing machine — pale in comparison to the additional $20,400 per year that our roommates contribute to our mortgage. It’s a total no-brainer.

In the past two years of living with roommates, we’ve collected $40,800 — enough money to buy a rental house that provides a stream of income for the rest of our lives. (More on that below).

But before I get there, I want to clarify that this isn’t a post about living with roommates. It’s a post about an ever-important concept called Opportunity Cost, critical to anyone who wants to supercharge their wealth.

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Should You Pay Down Your Mortgage or Invest the Cash?

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Should You Pay Off Your Mortgage or Invest?Touchy subject time: Should you pay down your mortgage rapidly OR invest the cash?

This question always brings out the punches, kicks and jabs. People have STRONG emotions about debt, even low-interest mortgage debt.

Through Afford Anything lens of “Stop Shouting, Start Thinking,” let’s walk through the potential consequences. You decide.

Everything Has Risk. Period.

Most people want to pay off their mortgage for three reasons:

#1: Emotion: Peace-of-mind
#2: Risk-Management: Reduce the chance of a foreclosure
#3: Savings: Lower their interest payments

These are all great reasons. But nothing is the “best” choice in a vacuum. It has to be compared to an alternative.

Alternative #1: Spend the money on champagne and strippers. Obviously a terrible choice.
Alternative #2: Invest the money. Okay, this could be a valid option. Let’s explore it.

Stocks, historically, have yielded an 8 percent long-term annualized return over the past few decades. Legendary investor Warren Buffet predicts that number will be closer to 7 percent in the coming years. For the sake of argument, let’s assume Buffet is right.

Now let’s rephase the question. Are you willing to pay extra to get rid of your mortgage faster?

That’s not a rhetorical question. Missed opportunity has its price. If you’re willing to pay the opportunity cost for the sake of reducing your risk — Great! Go for it! You might be leaving money on the table. If you’re okay with that, then you have your answer.

Notice I asked if you’re willing to pay the opportunity cost. That doesn’t mean you will. No one knows what the future holds. If the markets perform as they historically have done, you’ll miss opportunity. But if stocks tank, you’ll come out ahead.

There’s risk in every decision, even the decision to become debt-free.

Should you save or pay off debt? Or invest? Each option has pro’s and con’s.

Paying off your mortgage has:

  • Guaranteed interest savings
  • Limited upside
  • Unknown missed opportunities

Investing is:

  • Risky
  • Greater potential for upside
  • Stronger chance to capitalize on opportunity

Opportunity Cost

You have $100,000 in cash. (Congrats!) You also have a brand-new 15-year mortgage with a balance of $100,000, at 4 percent. (For simplicity sake, I’m leaving taxes out of the equation.)

Scenario A: You pay off your mortgage. You save $33,143 in interest payments. You invest $739 per month, the amount that would’ve been your mortgage payment. You contribute every month for 15 years and it grows at 7 percent. At the end of the term, your portfolio is worth $237,706. Hooray!

Scenario B: You invest the entire lump sum in the market. You make no additional contributions. In 15 years, your portfolio is worth $284,894. You’ve also paid $33,143 in mortgage interest, which you subtract out. Your net gain is $251,751. Wahoo!

Under this scenario, you’ve lost the opportunity to make $14,045 by paying down your mortgage early. Boo! That’s a strong argument for investing.

On the other hand, you’ve enjoyed peace-of-mind, which DOES have a value. You have less risk, higher liquidity and more flexibility.

Is that peace-of-mind worth $14,045? You decide.

Scenario C: You invest the money. The market tanks. You lose your job. Your house gets foreclosed on. Your spouse leaves you, your dog bites you, and even your goldfish won’t look at you anymore.

It’s a worst-case scenario, but it’s possible. Now the $14,045 looks like cheap insurance.

(What about borrowing to invest in real estate? Here’s my take.)

Quit Being Ideological

You know what’s funny about being a personal finance blogger AND a real estate investor? I hear ideologues on both sides of the aisle.

Finance bloggers, as a group, tend to have knee-jerk reactions to the word “debt.” Debt bad! Debt bad!

Real estate enthusiasts tend to have the opposite reaction. Gimme leverage! More and more and more leverage!

Half the emails I receive about this topic come from people who say, “Are you going to pay off your houses as fast as possible?” The other half ask, “Why aren’t you borrowing more?!”

Don’t make decisions based on ideology. Everything financial, even debt payoff, comes at a price. Everything carries risk. Risk wears different costumes, appears in different forms. But it’s there.

Avoid knee-jerk reactions and zombie ideology. Weigh the risks. Make a spreadsheet. Calculate missed opportunities. Imagine the worst-case scenario and ask yourself if it’s something you can live with.

Make choices based on information, not ideology.

Then decide for yourself.

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How Much Does It Cost to Maintain A House?

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When we first purchased a house, we thought the only expense would be the mortgage. Haha!

Little did we realize that the mortgage is only the beginning.

Homeowners pay for an absurd amount of operations, maintenance and repairs:

Trash service. Water and sewer bills. Gutter cleaning. Termite treatment. Pest control. Power-washing. Replacing the siding, windows, roof, fascia, rotted joists, appliances, floorboards, drywall holes. HVAC tune-ups. Reinforcing a crumbling foundation.

The list goes on …

How can you estimate home repair costs? Read on.

What’s in a Mortgage?

First, let’s start with the obvious expense that leaps to everyone’s mind: the mortgage.

Your mortgage payment consists of four elements:

  • Principal (Your Equity/Ownership)
  • Interest
  • Property Taxes
  • Homeowner’s Insurance

Together, these are called “PITI” (Principal, Interest, Taxes, Insurance), which leads to the obvious joke: “Homeowner? What a pity!!”

How much will this cost? As of January 2015, the national average interest rate is 3.63 percent on a 30-year fixed loan for borrowers with good credit. If you’re cash-out refinancing a home, add one to two percent to the standard mortgage rate. If you’re putting less than 20 percent down (which I don’t recommend, unless you’re getting a screamin’ deal), you’ll also need to fork over private mortgage insurance, or PMI.

Insurance

As a general rule-of-thumb, homeowners insurance costs $4 per every $1,000 in home value, per year. (Or $400 per every $100,000 in home value.)

For example:

House: $200,000
Divided by 1000 = 200
Multiplied by $4 = $800

Homeowner’s insurance on this $200,000 house would cost $800 per year, which divides out to $67 per month.

Again, that’s a broad rule-of-thumb, so give yourself “wiggle room.” Remember: rental properties carry higher insurance premiums.

If your rental property is vacant, you’ll need “vacancy insurance,” which is more expensive than regular insurance. (We pay an additional $70 per month, on top of our regular homeowners insurance, for vacancy protection on a rental property that’s only worth $50,000.)

Water

When it comes to utilities, you control your destiny (within limits).

When we purchased our three-unit apartment building (triplex), the water bills regularly came to $350/month, or $120/month per apartment. Ouch!

So we embarked on an all-out Water Bill Offensive. We installed low-flow toilets, low-flow shower heads, and low-flow faucets coupled with additional aerators. We even redesigned the yard to minimize water usage. Eventually, we wrestled the water bill down to $120/month — only $40 per month per apartment. Hooray!

The moral of the story: You can chop (some) of your costs by more than half — but it’ll take focused effort in the beginning.

Trash

This rate will vary based on your city. We own 5 houses in Georgia, and pay around $33/month for every single-family home.

My triplex costs $100/mo for trash ($33 per unit * 3 units), because the City of Atlanta regards each unit as a separate home. Not all cities insist on charging multi-unit houses as “separate” houses, so research the policies of your particular city. If you have more than 4-5 units in a single building, it’s often cheaper to just forgo the city trash services and rent a dumpster through a private company (assuming your city allows this.)

Repairs and Maintenance

Here’s one of the BEST rules-of-thumb I’ve ever heard: Repairs and maintenance will cost one percent of the purchase price per year. In other words, for every $100,000 worth of house, you’ll spend $1,000 per year on maintenance.

“WTF? That sounds way too high.”

Au contraire, my friend.

  • Basic vinyl windows cost $250, including installation, permits and haul-off, and need replacement every 30 years. If your home has 20 windows, they cost $166 per year.
  • An asphalt-shingle roof on a 1,500-square-foot house will cost around $10,000 and needs to be replaced every 25 years. Your roof costs $400 per year.
  • Carpet, padding, installation, haul-away and disposal costs $15 per square yard and needs replacement every 8 years. If your home needs 100 square yards of carpeting, this costs $187.50 per year.

Apply this to everything: Water heater. HVAC. Gutters. Siding. Paint. Plumbing. Toilets. Shower valves. Countertops. Cabinets. Sink basins. Floor tile. Porches and decks. Appliances. Smoke alarms. Even outlet covers (yes, little things add up, especially when labor costs are involved).

We’re not done yet.

Those are replacement costs, but each year, you’ll have maintenance costs, as well. Your carpets need deep-cleaning. Your air-vents need professional suctioning. Your pressure-treated deck needs another coat of stain. You need to shell out for pest control, termite treatments, gutter cleaning, lawn aerating, re-sodding, mulching, weeding, re-sealing the grout around your tub.

Scared yet?

Don’t worry. This is where a “Home Repair Fund” comes into play.

Open a special savings account that’s earmarked specifically for home repairs and maintenance.

Many people don’t like the idea of cash “sitting” in their savings account, earning a return that’s so low it can’t even keep pace with inflation. I’d rather forgo some returns so that I can sleep at night. The water heater can burst at 2 a.m., or the dishwasher can overflow, ruining the carpet, or any number of other things can go wrong. When that happens, I like knowing that I can write a check to cover the bill, without breaking a sweat.

Property Management

This tip applies only to rental properties, of course.

Management usually costs 100 percent of the first month’s rent (for each new tenant), followed by an ongoing 8 to 10 percent fee. In addition, managers may charge extra fees for eviction proceedings, nuisance inspections and other additional work.

Sure, you can manage it yourself — but this takes time, and time is money. If you manage it yourself, you should pay yourself. You can’t pay yourself $0 and pretend your “profits” are higher — that’s B.S. accounting. “Make a profit AFTER paying yourself. That way, you can remove yourself from the equation and the numbers will stay the same.)

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Why a Fixed-Rate Mortgage is the Best Choice

Are you willing to risk your home?

When you buy a home, you will learn that there are two kinds of mortgages: fixed-rate and adjustable-rate.

What’s the difference?

A fixed-rate mortgage gives you an interest rate that never changes. An adjustable-rate mortgage gives you a volatile interest rate: in times of slow economic growth and low inflation, the interest rate will be low; in times of high economic growth and inflation, the interest rate will rise.

Why do some people like adjustable-rate mortgages?

Advocates of adjustable-rate mortgages argue that these give you a shot at getting lower rates than you can ever get with a fixed-rate. In late 2010, when the average fixed-rate mortgage was 4.5 percent, I overheard a guy sitting at the table next to me at a sushi restaurant bragging to his dinner companions about his brand-new, adjustable-rate 3.25 percent mortgage.

It’s true that he’s getting a lower rate than those with fixed-rate mortgages … for now.

You can’t predict the future.

But what’s going to happen in 3 years, 5 years, even 10 years, when interest rates rise and this guy’s 3.25 percent rises to a whopping 6 percent or 7 percent?

Advocates for adjustable-rate mortgages argue two points:

#1: You never know which type of mortgage will end up being cheaper in the end – why not keep open the possibility of a cheaper mortgage?

Of course, that swings both ways. An adjustable-rate mortgage might be cheaper OR more expensive down the road. There’s no way to know. Why take on the added risk and uncertainty?

#2: Paying 7 percent in 10 years — when you owes less on your mortgage — is better than paying 4.5 percent now, when you carry the heaviest loan on your mortgage. In other words, it’s better to owe a low interest rate on a big debt, and a high interest rate on a small debt.

Riiiight. Sounds great in theory. Except for one pesky little point:

Don’t assume that 5 years, 10 years, or 15 years down the road, when mortgage rates rise, you’ll be able to handle the extra payments.

The future is uncertain ...

Let’s say you’re paying $700 a month on your mortgage right now.

Four years later, you and your spouse accidentally get pregnant. With twins! Congratulations! Looks like one of you will become a stay-at-home parent.

The following year, your brother gets sick. You take two months’ unpaid leave to care of him.

Then your furnace breaks down. Your engine explodes. A storm blows a heavy tree limb onto your roof.

Gas prices have climbed to $6.50 a gallon. You need eyeglasses. And – guess what? – your mortgage has skyrocketed to $1,200 per month.

Can you afford it? More importantly — can you say, with absolute certainty, that you are SO SURE you’ll be able to afford any mortgage bill, no matter how high it climbs, at any time over the next 30 years?

“If it gets too high, I’ll refinance,” you retort.

In other words, you’ll put your family’s fate in the hands of a mortgage underwriter. Nice plan, dude.

What makes you so sure that you can refinance? What if you accidentally miss a bill, and your credit gets dinged? What if banks institute even-tougher lending policies? What then?

Are you willing to take this incredible gamble … knowing that if you lose this gamble, you’ll lose your home?