Two people contacted me last week that are coming to Uruguay to buy modest pieces of real estate. In both cases, people from the US are planning on using Equity Lines of Credit based on the prime rate to finance the purchases. They also plan and renting the units.
This could be a terrible idea if one is on a budget. Here’s why.
Say you’re buying a 2 bedroom property for $125,000; with closing costs (9%) the total tab will be about $136,250. With 50,000 down, the financed amount is 86,250. Existing Equity Lines today frequently have rates at prime, 5.25%. The monthly interest cost is $377/month or 4,524 annually. There are too many Performa possibilities to be specific, but lets just say it will be a challenge to cover the interest costs with rental income. That’s before taxes, utilities, common area (if any), management fees and furniture costs are considered.
Just six months ago prime was 8.25% and the monthly tab would have been $593, about 216 more per month. The negative monthly cash flow in the example would easily top $300/month. If your reaction is big deal, great! Your finances are probably pretty sound; it’s not a lot of money. However, if feeding a property perhaps $4,000/year is worrisome, be careful!
I firmly believe this is the onset of an inflationary cycle. Interest rates will go up and they could shoot past 8.25% like a bullet. For those of you too young to remember, the last time we had a cataclysmic inflation burst, prime went to 20%. Even if rates only reach 12%, the monthly interest rate expense in the example bulges to $863. Negative annual cash flow from the interest alone becomes $10,356 year.
If you share my feeling about the risk, look into a second mortgage with a fixed rate.
Plan on prosperity and prepare for disaster. Use credit wisely. Be Safe.
Stay Tuned!
Steve Bowman
Entries (RSS)
June 3rd, 2008 at 8:02 am
[...] company with the topic, I want to share an article with you I wrote for another publication called Interest Rate Risks. I won’t waste time restating my case (backed up with a detailed analysis of an actual [...]