A friend once told me how he purchased two houses on a $60,000 take home pay. The first house cost about $300,000, the second property cost $1,200,000. I was amazed and very curious about how he could afford the first house let alone the second house. I had to ask and he was half-generous, half-proud to share his secret.

He said he attended a couple of real estate seminars run by the infamous real estate guru, Robert G. Allen. Of course, he only knew Robert Allen as the smart real estate guru who helped tons of people become millionaires.

Own 10 Properties And You'll Be Set For Life
He then proceeded to explain how he managed to buy his first house. After attending the two seminars, he went shopping for a house in California. Houses in California are not cheap. He found one he liked. It was priced at $300,000. Obviously, with his income, it was very hard for him to secure a loan that big. He had saved up $10,000 for the down payment.

"I was desperate. I really wanted the house. So I searched high and low for any loan I could get regardless of the interest rate." he said. He did find one, but at a killer interest rate of 12%. According to what he learnt from Robert's seminar, the first house is usually harder. But once you buy it, it'll be easier for you to purchase more properties. The trick is simple. Buy your first property. Refinance and with the home equity purchase your next property. Repeat until you own at least 10 properties. After that, you'll have rental income for life.

Three years after buying the first property, he refinanced his mortgage at a 10% interest. He pocketed a $60,000 check for his home equity. Later he bought his second property with the $20,000 from the check he received. So now, he "owns" two properties. But he's having trouble making the monthly payments. He's relying heavily on rental income to cover the monthly payments. If he couldn't find anyone to rent his second property, he'll have to find some other source of income to cover the payments. Still, he's proud that he bought the properties. He said he's looking to buy another property in the neighborhood of $500,000 when he refinances the second property.

AnalyzingThe Deals
Now, I'm not a homeowner. I don't have any experience buying a house. But looking at it purely from a mathematical perspective, I don't see how he could have profited from the deals he made.

Let's dissect his first purchase. For simplicity, we'll ignore the closing costs, interests and taxes. The house was purchased with a $10,000 down payment with a $290,000 mortgage. Assuming he's paying $2500 monthly for 36 months, he's paid $90,000. That leaves him with a $200,000 mortgage. When he refinanced the mortgage, his house has appreciated $60,000. But now he's financing a $260,000 loan because he took the $60,000 check instead of using that check to pay down the loan so the loan amount remains the same. Usually, when you refinance at a lower interest rate, your monthly payment goes down. In his case, it has gone up because now he's financing a bigger loan than before albeit at a lower rate. Had he applied the check towards his loan, he would have saved $2,000 in interests:

($260,000 x 0.10) - ($200,000 x 0.12) = $26,000 - $24,000 = $2,000

To make things worse, he used $20,000 from the check he received to purchase a second property worth $1.2 million. With an additional $1.19 million mortgage, he's more in debt than he ever was! I'm surprised he's still considering buying a third property when he could be losing his second property if he couldn't find someone to rent it. The monthly payment for the second property is around $6,000/month. That's more than his monthly income!

I don't know what Robert Allen said to him, but whatever it is that Robert said, it certainly convinced my friend that he could be rich simply by buying properties, even if he's buying at the risk of defaulting the loan.

Am I missing something here? My simple mind is telling me the deals don't make economic sense. But I have some doubts about my knowledge of real estate. If you have experiences in this type of deals, please enlighten me.

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