One of the most common questions I get about lease option property investment deals is “What happens if a tenant doesn’t pay their rent?” Protecting deals is paramount to success in real estate investing so the answer to this question is essential information!
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What Happens If A Tenant Doesn’t Pay Their Rent?
Joe: What happens when a tenant doesn’t pay their rent? This is always the big fear for everybody who wants to be a landlord. And I just did a video about this because of the Corona virus and because of people losing their jobs and what happens. But, let’s go into, in a general way, how this looks. So, this will apply to before the Corona virus and after the Corona virus and what’s going on in the country.
Joe: If people don’t pay their rent, it does create an impact on you. So, if you’ve bought a property Subject To and you have a mortgage on that property or maybe you went out and got a loan, God forbid, to buy that property. You’ve got to pay that mortgage. So, let’s say you’ve got $150K property, you’ve go to pay $1,000 a month and you have $1,200 a month of income that’s coming in on that property.
Joe: And that $1,200 covers your principal, interest, taxes and insurance. And then, of course, you have to pay property management on top of that if you’re not managing your own properties. So, if that tenant doesn’t pay their rent you still have potential repairs for that property. If the plumbing stops working, if the heating stops working, if the roof starts to leak, you’re the landlord – you’re probably going to have to cover those costs.
Joe: And, you’ve got to make that mortgage payment. And if you don’t make that mortgage payment, then you’ve got to take out a loan. It’s going to damage your credit. And if you didn’t take out a loan and you bought it Subject To, you still have to make that payment to a mortgage company so you can protect the credit of the seller that you bought the property from. And if you don’t protect that credit, that may be even more important than protecting your own credit because it’s the right thing to do.
Joe: So, you have money coming out of pocket. If you don’t have any reserves, that’s a problem. If you buy a property like this and you don’t have any reserves, you’re in trouble. You need to have reserves when you own rental property. And the way that you do that is typically you sell that property on a lease option. So let’s say I go out and sell that same property on a lease option, get $5,000 down, I take that $5,000 and I put it in a bank account. I don’t spend that money. I don’t live on that money. If I’m going to do the For Rent Method and I’m flipping properties, then I can spend the money. But if I’m going to take just this one property, and it’s the only property that I’ve got. I take this $5,000 and I put it in an escrow account, just put it someplace safe where I’m not going to touch it.
Joe: That way, when that property goes vacant, or your tenants don’t pay, you’ve got a little bit of money to cover the mortgage until you can get them out of there or until they can start paying again. And once that happens, then you can get back on track.
Joe: Now, if they move out you can go sell it to another person, get another $5,000 lease option fee. And that $5,000, maybe you don’t need to keep it all. I think you should keep a couple, three months of rent for each property that you’ve got. But if you have ten properties, you don’t have to keep $50K in reserve. You could probably keep $5,000 or $10,000 and you’d probably be fine. Even in the worst time of the recession of 2008, 2009, I had a 20% vacancy rate. I don’t know what that’s going to be now in this time of the Corona virus. We might have vacancy rates that are much higher than that. We might also have government assistance to make that stuff be taken care of. So, we’ll see how that plays out.
Joe: But there’s a very good chance that it’s going to be kind of painful for landlords. And if you’re a landlord who doesn’t have any reserves, it can cause you to lose your property. In 2007 and 2008 I saw many, many investors lose their properties because they took out mortgages. If you can learn to do this stuff without mortgages you’re going to be better off. And if you learn how to build a portfolio that allows you to keep reserves and build reserves as you’re building the portfolio, you’re going to be much better off. So do those things to make that happen.
Joe: Now, let me go into a little bit of speculation about mortgages and tenants. Because what if we didn’t have tenants? What if nobody was a tenant? What if everybody owned their own property? What if we had a mortgage banking system that didn’t charge interest, that didn’t require good credit? Maybe they look at your income and say hey – and I’m just speculating here – I don’t know all the ramifications, and I’d love to hear your comments. Put them down in the comments section below. I’d love to hear your comments on what you think of this, if I’m just like, completely off my rocker or not. I don’t think I am.
Joe: I think that there’s possibility for this. But I think there’s too many monied interests that would keep it from happening. The people that are running the banks are making all the money. If I have a $100K mortgage and I make 30-year payments on that mortgage, I’m going to pay $300K for that property. If I had only paid $100K – with the same payments – over ten years I would have paid it off with no interest.
Joe: So, if I had no interest on a property, I could have paid that thing off in ten years and I would have owned the property. Also, the money is in our banking system that comes from mortgages. There’s a secondary market, but they get their money from the Federal Reserve. The Federal Reserve makes that money up. It’s created out of thin air. It’s not real. They just put dollar signs on a page. So it’s not real money – they just create that money. So, it’s not really costing them anything.
Joe: So, let’s say that they come up with $100K. You buy this asset, and now you start making payments back to them on a regular basis. Or, maybe you even get in a situation where oh, I lost my job. I can’t pay for a few months. That’s not a problem. Because the government didn’t come up with that money anyway. As long as you’re regularly paying into the taxes and insurance and your covering these costs, it’s not going to be a huge problem for the economy.
Joe: Might be worth looking into modern monetary theory which I think is a fascinating concept. And I’ll just throw that out there because I think there’s some really interesting things that are going on with economics these days and the way people are thinking about them that are worth looking at. And I think it’s also possible that if we had mortgages that were zero, which is what I’m doing, by the way, when I buy properties in these little rural areas, these little rural towns, where we pay these properties off in five years, seven years – ten years at the most.
Joe: Because we’re doing them with zero interest and they’re such cash cows for me, ultimately. They pay themselves off, they’re so safe. The monthly payment’s low – much lower than it would be if I had to pay interest. I mean, it makes so much sense for me to buy it from a seller. It made sense for the seller to sell it to me because I’m going to give them all the money and they’re going to get it sold and they’re not going to worry about it. But it makes sense for me because I don’t have to pay any interest on it.
Joe: So, I’m paying a third of what it’s costing someone who goes out and gets a loan for that property. Or, if somebody who has to come up with cash to buy the property. I don’t have to come up with the cash. I can pay for it a little bit over time.
Joe: If everybody was in a position where they could buy a house for their family and live in that house and make payments on that house in a timeframe that made sense for them and maybe even if it was sporadic, if they lost their job, or something happened, they could file for a deferment or whatever, so that they could stay in their property and not lose it. It would make things so much more stable in our country.
Joe: Our real estate market would be so much more stable and we’d still continue to build houses so all the contractors and all the people that are building houses would make a ton of money doing this because they’re still making the same amount of money whether you have a bank that’s making their 5%, 6%, 8%, you know, on their money. I mean, that’s basically thievery as far as I’m concerned. Interest from a bank that borrows that money from the Federal Reserve that didn’t create that money in the first place – that seems like thievery.
Joe: If I’m going to loan out money to somebody I’m going to charge them interest because I want to get a return on my investment. But it’s real money that I’m investing. That’s not happening with mortgages. At least with Fannie Mae and Freddie Mac. So, it’s a completely different world. And it could change the way our society works where everybody could have affordable housing and if they ever get to a bind, which everybody gets into a bind at some point in their life, everybody goes through this. If you get into a bind, maybe it’s the Corona virus and you can’t make your payments for a few months. Well, you wouldn’t have to make your payments, and you could catch up again and it wouldn’t be adding on to the end because we don’t have the time value of money in the same way.
Joe: Now, this doesn’t work for everything. But it’s an idea and it’s worth thinking about. And I’d love to hear your comments, even if you think I’m a complete idiot. I’d like to hear your comments and your reasoning behind it. And maybe we can think about this process a little bit in the conversation. So, I look forward to your notes.
Joe: Anyway. That was sort of a tangent off from what do you do if you lose your tenants, but maybe the question is what if we didn’t have tenants? What if that wasn’t a real thing? You still have your asset. You can still sell your asset. You can still make money doing other things. It doesn’t have to be real estate.
Joe: All right. If you like this channel, click on Subscribe, click on the bell and you’ll get notifications on it every time I send a new video out. You can also go to PushButtonAutomarketer.com, that’s my automate program for real estate investing. ZerioDownInvesting.com is my six-month mentor program. Both of those are worth a look.
Joe: All right – hope that helps. Good luck.