By Paula Pant
Imagine: You're a beginner real estate investor. You want to flip a house for the first time. You don't have much money.
Someone recommends that you get a Home Depot or Lowe's credit card, which offers 0-percent financing for 12 months, and use that credit card to fund the material purchase costs for your flips. What little cash you have can be used to pay for labor (and/or your own sweat equity can be used for labor). You'll presumably sell the house within a few months, use the profits to pay off the credit card before a single penny of interest is due, and pocket a decent payout, as well. Should you do it? In my humble opinion: Abso-freaking-lutuely NOT. No, no, no, no, no.
I don't have insanely strong opinions when it comes to most real estate investing topics. If you ask me if you should flip houses, become a landlord, try wholesaling or stick to REITs, I'll shrug and say, "Well, that depends." Then I'll walk you through the pros and cons of each. If you ask me if you should buy rentals in stable vs. shaky neighborhoods, I'll tell you that it depends on your goals and risk tolerance.
But I'm a fundamentalist on the issue of credit cards. I firmly believe that if you can't pay a credit card in full, immediately, on the same day that you make a purchase -- don't use it! Why? I can explain my stance in one word:
You hope that everything goes according to plan. You hope that your labor and material costs are close to the amount you estimated. You hope that you don't find any nasty surprises. You hope that the city inspector doesn't throw a wrench in your plans. You hope that you can sell the house in the amount of time you estimated, for the amount of money that you estimated.
Oh, you know that not everything goes according to plan. So you made conservative estimates. You tacked a 20 percent margin of error onto the material and labor costs. You pinned a 10 percent margin of error onto the after-repair value. And you hope that those margins of error are sufficient. But hope cannot defeat the reality of risk.
ANYTHING could happen that might derail your plans. The city could condemn your home. A major earthquake could cause your home to collapse and insurance could refuse to pay for the damage. Or Wall Street financiers could buy subprime mortgages and sell them to Norway as AAA-rated collateralized-debt obligations, feeding a complex chain reaction that results in housing values plummeting by 50 percent. All those situations sound far-fetched, I know. But s--t happens.
If you've borrowed at reasonable interest rates (e.g. single-digits), the fallout from risk-gone-wrong won't be as bad. It'll still be a setback, of course, but assuming you've leveraged wisely, it will be manageable. If you have tens of thousands in debt on a credit card which suddenly escalates into a 29 percent interest rate, though, you've dug yourself into the deepest pit of a hole that's going to be excruciating to climb out of.
When Can I Use a Credit Card?
Refer to my rule: Don't use a credit card unless you can pay the bill in full, immediately, on the same day that you make a purchase. If you have $20,000 sitting in a savings account, earning 1 percent interest, and you want to make a $20,000 purchase on your credit card at zero-percent interest for a year, go ahead. You have the cash in the bank to pay the credit card in full at a moment's notice. And you'll pocket the 1 percent spread. Congratulations, now you have an extra $200. (Personally, I'd spare myself the trouble and just pay the card immediately, but if you want to pinch pennies, be my guest.)
But if you don't have the cash on hand, don't subject yourself to the risk of getting hit with high-double-digit interest rates. It's not worth the risk.
Paula Pant runs a content marketing company and writes a blog, Afford Anything, which discusses wealth, freedom and living life on your own terms. This article was originally published on BiggerPockets.com.
See more on BiggerPockets.com:
5 Things Mom Taught Me That Made Me the Real Estate Investor I Am Today
How I Decide What I Buy
29 Pieces of Advice From a Seasoned Real Estate Investor
More on AOL Real Estate:
Find out how to calculate mortgage payments.
Find homes for sale in your area.
Find foreclosures in your area.
Find homes for rent.
Follow us on Twitter at @AOLRealEstate or connect with AOL Real Estate on Facebook.