If you're a candidate for the Save For College Nomad model, you're probably short on sleep so I'll try to keep this short. It is just one of the five types of Nomads.
Save For College Nomads
The Save For College Nomad is typically a strategic thinking parent of young children with a good to great job who realizes that they need to be planning now to be able to pay for college for their kids while they're still relatively young. The sooner you start, the easier (and less expensive) it will be.
In the most vanilla of versions (and there are lots of variations), you would be buying a property, moving in and living there for one year before converting it to a rental property. You'll repeat this 10 times.
In an ideal world, you start this plan the year your first child is born (or earlier). I'll show you the math if you start a little later below (towards the end).
Save For College Nomad Model Assumptions
I've made some assumptions to create this model for you and I'll be explaining what my assumptions are. We can evaluate the Save For College Nomad model with other assumptions to see how that affects it as well and I will do that in the future for you.
I will tell you that I believe, deep down, that the assumptions I use are very conservative but let me know if you'd like me to run it with different assumptions.
I've modeled buying 10 houses over 10 years in this example. I am using an actual property that is currently for sale in Northern Colorado as of July, 2015. So, yes, these numbers are real.
You'll be buying the first property for $238,875. That price would include 2% in closing costs in the form of Seller Concessions.
We've assumed that property values are going up at a rate of about 3.0% per year. As of the time of this writing, we're seeing significantly higher than that. This is conservative.
An appreciation rate of 3.0% means that the house we bought in year 1 for $238,875 would be worth $246,041 in year two.
We've also assumed that we're buying similar houses each year so that the house we buy in year two will be purchased for about $246,041.
The following chart shows you the value of the houses we're going to be buying over the first 5 years so you can see the trend. Of course, we'll be buying 10 houses over 10 years with this model.
Save For College – Financing Nomad
I know you have young children, but we will be moving into these properties. Why? One of the main reasons we will be moving into the properties is the benefit of owner occupant financing.
This allows us to have a much smaller down payment. Instead of 20% down (or more), we're typically able to buy a home with as little as 3% down. I've assumed we're putting 5.0% down on each house. Lower down payments allows us to leverage more and increase our return on investment. If you want a less leveraged model, consider putting more down for each house.
If you're putting 20% or more down, you probably don't need to move into the house either. Less than 20% down and you're probably going to need to move in to the house to get that financing in our current lending market.
IMPORTANT SIDE NOTE: Want to reduce your risk and improve cash flow? It makes sense to put more than 5.0% down. Minimizing your down payment maximizes your return on investment. More down means more cash flow (or less negative cash flow in some cases).
Negative Cash Flow Is Really Just Deferred Down Payment
Put more down, get more cash flow. So, if we put 20% down, instead of only 5.0% down, we probably would have had immediate positive cash flow on properties you bought.
If I were you, I'd look at and consider the negative cash flow as really just financing the down payment over a period of time. Instead of coming up with a full 20% down, you could put the 5.0% down and make monthly payments (in the form of negative cash flow) for the first few years (see below for actual time) to make up for the difference in down payment.
If we had put a full 20% down, we would not have had negative cash flow at all.
The down payment required for buying your first house is $11,944 (that's 5.0% down). Here's a chart showing that amount (which I'll be building on as we add additional houses).
Private Mortgage Insurance (PMI)
If you're putting less than 20% down, you're going to have PMI or Private Mortgage Insurance. However, we can choose how we pay the PMI and in this case we are going to be paying for it by agreeing to pay a slightly higher interest rate and use the credit we receive for selecting a higher interest rate to do a one-time, up front PMI payment.
That slightly higher interest rate is 4.500%. If it seems higher than what you might expect, it is because we raised it to allow us to get a credit and pay for PMI up front.
Rental Income and Expenses
Since we will be moving into each property for the first year and living there, we will not have any rent on the property in the first year.
Play pretend with me for a moment though: if we were to rent the first home in the first year, it would rent for $1,500.
Rents over time go up. Ask any tenant if you want proof of that. In our model, we've assumed that rents are going up at a rate of 2.0% per year.
I believe that's conservative, but what does a 2.0% per year rent increase rate really mean? It means that when we are ready to rent the first property we bought at the beginning of year 2, the monthly rent on it will be $1,530 per month.
I could go into a lot of detail about the expenses on the rental properties (and I do when I explain the other types of Nomads). I'll try to get you some extra sleep by skipping that for now. You can always read about it later. Suffice it to say, I do take into account expenses on your rental property will go up over time.
Rental properties need to be maintained and I do budget for that in the model as well.
In this model, you're managing the property yourself. You could pay someone to do it for you if you wanted.
If you'd like to see what I modeled for rent and expenses on the property, see the interactive chart below, but you can skip it if you're not feeling like digging into that level of detail right now.
Benefits of Rental Real Estate
When we talk about owning rental real estate we typically discuss the following four benefits.
Since we're planning on using this primarily to save for college, I'm going to focus on these three (and largely skip the tax benefits/depreciation):
- Cash Flow
- Debt Pay Down
Benefits of Rental Real Estate for the Saving For College Nomad
How does the Saving For College Nomad help you pay for college for your kids? Let's start with one property and then I'll show you what happens when you add additional ones.
1 House in Year 1
The following shows the benefits from the first house for the first year only.
Properties tend to go up in value over time; that's appreciation. In the first year, on the first property you buy, the property will go up in value $7,166. That's 3.0% of $238,875.
Debt Pay Down
Each month you make a mortgage payment, you're paying down how much you owe. During the first year, you'd pay off about $3,661 on your loan.
You're not renting it the first year, so you get no cash flow.
And yes I did just show you a chart with nothing on it. I did it for a reason: to show you that you have no cash flow in year 1.
Here comes another blank chart. You don't get depreciation on a property you're living in and you're living in it in the first year.
This just takes what we discussed in the four charts above and summarizes it for you. Nothing fancy just a stack on the left showing you the appreciation and debt paydown and column on the right showing you what they both, combined, add up to be.
2 Houses in Years 1-2
I already showed you the first year with one house. Now, let's look at the second year when you bought your second house and converted the first one to a rental.
No big surprises in the two charts above. It shows how much each house went up in value (that's appreciation) and how much you paid off on each loan.
Now, let's talk about cash flow. You start renting the first house in year 2 and as you can see below you have some negative cash flow (deferred and financed down payment). I talk about this a lot elsewhere, so I won't focus on it here.
The following chart shows you the depreciation you start to get on the first property in year two when you convert it to a rental.
I have drastically over-simplified depreciation. You'll want to talk to your tax advisor about it and how it will actually impact your unique financial situation. I won't be talking about it much more below because I'll largely ignore these benefits.
And, here is a chart summarizing the returns you're getting for each house. The orange column to the right is a total for all houses.
2 Houses, Years 1-3
I'm going to keep building on what I've been sharing so I can show you how to pay for your kids' college educations (and probably a lot more). Let's see what happens over 3 years.
- Buy a property in year 1, move in and live there for a year
- Buy a second property in year 2, move in and live there for a year
- Convert the first property to a rental after you move into the second property
- Convert the second property to a rental after you move into your third property (not shown in this example… we'll do that in a moment)
Debt Pay Down
(Negative) Cash Flow
5 Houses over the First 6 Years
Fast forward a bit… here are 5 houses over 6 years so you can see what starts to happen.
Total Invested for Saving For College Nomad
Just how much money will you need to pay for college with Saving For College Nomad? Let's look at this in more detail.
The amount of money you'll need is broken down into two major parts: down payments to buy houses and negative cash flow for the first few years you rent a property.
If you put more down, you can get rid of negative cash flow. Or, you can finance the down payment by paying the negative cash flow. It is up to you.
Even though depreciation might help offset the negative cash flow on properties, I'm going to include it in the chart below as if you don't get the depreciation benefit to be conservative in the Saving For College Nomad model for you. I'd rather be conservative and have you be pleasantly surprised when it is not as bad as I said.
So, here is a chart showing you the total amount invested in 10 down payments at 5.0% of the purchase price (1 for each house in the first 10 years). And, the sum of all the negative cash flows of all the properties for that year.
If you started this plan when your first child was born, by the time your child is 23 you no longer have negative cash flow at all.
The chart below shows the same stuff as above in a different way. Instead of showing a breakdown of how much per year you'll need to invest, it shows you the total you'd need.
If it seems like a lot of effort, it is. But, is it worth it? I think so. Here's the end result.
You bought the 10 properties over 10 years. You moved into each one. You converted each to a rental property after living there for a year. You held on to the 10 as rentals for 18 years (until your first child is about to start college). You end up with 10 rental homes with $2,104,000 in equity.
See the following chart to see this visually.
Do you think that we might have overshot your goal of paying for college by a little bit with $2,104,000? Hmmm… I'm not so sure. Here's the math.
Assume that college with out-of-state tuition, fees, room and board is about $40,000 per year today. Do you know how much it will cost in 18 years assuming a 5.0% cost increase per year? How about $91,681 per year? Yes, let's dig a little deeper.
|Year||Kid #1||Kid #2||Kid #3||Total|
If you have 3 kids going to college, you're pushing $1,245,727 and that's assuming none of them decide to get an advanced degree (no doctors or lawyers, huh?).
One great thing about Saving For College Nomad is that you can access the funds for college in several, very flexible ways.
- Sell the properties. This is my least favorite, but you could sell the properties and use the proceeds to pay for college with cash. I like this least because you lose the asset that is growing in value and throwing off more positive cash flow with each passing year.
- Borrow against the equity in your properties. Instead of selling, refinance your properties and access the equity to pay for college. This is my second favorite way because you're probably getting very favorable interest rates buying the properties and replacing that financing with less favorable refinances.
- Borrow for college and let the cash flow from the properties pay off the student loan debt. This is probably my favorite. Let the positive cash flow from the properties pay for your kids' college educations.
I want to talk about the cash flow from your properties, but first let's wrap up the discussion on equity. The equity in your properties in year 18 when your kids start college through year 23 when the last one finishes ends up at $3,153,557 and is shown below in the equity chart.
And finally, I will show what it looks like as you keep the properties past year 23 through 40. You may want to use these for retirement yourself or pass them on to your kids. There's another Nomad model for that too by the way. You end up, 40 years from when you started, with $7,565,236 in equity. Not a bad supplement to retirement, huh?
Cash flow is a little more complicated because over the first 15 years or so (when you're still heavily investing towards saving for college), your net cash flow is negative. The following chart shows you the period of negative cash flow. We've already taken this into account above when we talked about the total amount you'd have invested so this is NOT in addition.
For years 11 through 18 (I'm assuming you'd start paying for college for the first child in year 18), you finally can see the negative cash flow goes away and you get completely positive in your cash flow as shown in the chart below.
After year 18, we see a steady climb in cash flow each year giving you more and more power to pay for college debt should you choose to use that option.
When your first child is done with 4 years of school (year 21) your yearly cash flow would be $18,162.
By the time all three kids are done with college in year 23, your yearly cash flow would be $24,221. Here's a chart showing net, spendable cash flow over those years.
Is that enough to pay their student loans? If not, just wait… cash flow grows pretty aggressively each year allowing you to pay off student loans quickly and easily.
You may be wondering what the total picture is with cash flow and equity from doing the Saving For College Nomad model over a 40 year period. Here is a chart showing the entire 40 year period.
It sounds like a lot of work, why not just invest in stocks? Let's take a look and see.
Would I Do Better With Stocks Than Saving For College Nomad?
What if instead of investing the down payments and negative cash flow into doing the Saving For College Nomad model, you bought stocks? What if you were able to get a full 10% return per year over the same 18 year period with stocks? How well would you have done?
The total investment of $237,775 would have grown to be $738,456 by year 18 with stocks performing at a pretty aggressive 10% per year. Compare that to the equity in the 10 houses for the Saving For College Nomad model of $2,104,000 and the Nomad model is a clear winner.
It may be best if I show you a table showing you how they compare side by side. So, here is my table with a description of each column below the table.
|Year||Amount Invested||Stocks @ 10%||Nomad Equity||Nomad Cash Flow||How Much Better Doing Nomad|
- Year: shows you the year number for doing the plan (whether that's stocks or Saving For College Nomad).
- Amount Invested: the amount you invested in the stock market or the amount you invested in Saving For College Nomad including down payment and all negative cash flow.
- Stocks @ 10%: the value of your stock portfolio in that year including your initial investment and all the returns you've earned through that year assuming a rate of return of 10% per year.
- Nomad Equity: the total amount of equity for all houses you've earned at that point. It includes the down payments you've made because we calculate it by looking at the houses current value minus the then current loan balance.
- Nomad Cash Flow: this is the sum of all the cash flows to that year. When we are negative, we are double handicaping catch up Nomad for the “How Much Better Doing Nomad” because we count it as both an “Amount Invested” and also a negative return on that investment. It doesn't matter though, Saving For College Nomad is still better.
- How Much Better Doing Nomad: Add up the “Nomad Equity” and “Nomad Cash Flow” and subtract the “Stocks @ 10%” to see how much better it is to do Nomad through that year.
Saving For College Nomad Summary
In summary, the Saving For College Nomad model could be a great way to save for college and have a great supplemental plan for retirement.
It would require that you buy 10 houses over 10 years and move into each one to minimize the amount invested while maximizing growth.
For some, the moving each year is a real inconvenience especially with young children. However, would you be willing to move 10 times to have $1,318,570 more than investing in stocks when your kids are ready for college?
What if I threw in an extra $9,404 per year in cash flow that increases to $24,221 per year by the time they're out of college to aggressively pay off their student loans? Plus, when you've paid off all their student loans, you'll have an extra $241,474 per year in net cash flow for your own retirement when all the properties are free and clear without any mortgages.
So, unless you're willing to invest significantly more than $235,140 in the stock market over the next 18 years (averaging about $13,063/year) or somehow, maybe magically, get higher than a 10% return on your money consistently each year your best plan to save for college might be doing Save For College Nomad.