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Financing is the key to real estate investment. You want to
use as much OPM (Other People's Money) as possible.
No Money Down
There are still people who believe that they will start
their real estate empire with a no-money down approach. The
irony is that if you have good credit, you can build a spec
home with a construction to perm loan with very little out
of pocket cash. For about the same amount of money you will
waste on seminars, CD's and coaching you could build a
$250,000 home and flip it in a year or so for about
$275-$280K. Our investors do it all the time. Its really not
a big deal.
There are many lenders that will loan out 95% on new
construction. You just need to know where the projects are
and what areas to buy in. It takes some money and a
financial reserve to make money in real estate. But, you
don't have to be rich. If you have equity in your current
home, you can get 100% financing without taking out a second
mortgage.
You can use the equity in your home without taking out a
second mortgage to secure a 100% loan for your investment
property. So you tap the value of your home without paying
off a second mortgage.
Mortgage Brokers - The good, the bad and the ugly
Most of the mortgage brokers I have met were honest,
knowledgeable professionals. However, the ease with which an
unsuspecting, uninformed consumer can be cheated has drawn a
number of less than honorable individuals into the mortgage
business. We provide guidance in this area for our clients.
But, you are of course free to go anywhere you want for
financing.
An unscrupulous mortgage broker can help you buy a house you
can't afford and will be only too happy to take it off your
hands down the road when the bank is on the verge of
foreclosing.
I know a very successful real estate investor who finds more
distressed owners than you could ever dream of. His secret -
he is a mortgage broker who will be only too happy to put
you into a house you can't afford, help you finance a rehab
you will get killed on or continue to refinance your
property until there is no equity left and you are about to
lose it all. Then he comes in for the kill.
You need to learn how to shop for a loan. I will be candid
with you and tell you right up front, it will take some
effort and education on your part. Since you are going to be
a real estate investor, the education is worthwhile. After a
time you will be able to find some good mortgage brokers to
work with who will appreciate your continued business. We
will be glad to make a few referrals to you.
Some Tips on Mortgages
Construction to Perm Loans
We get involved with a lot of spec home building. It is a
great way to get into real estate investing and make an
excellent profit on a relatively low up-front investment.
Currently, we have a lender who will offer 95 - 100%
financing to individuals with good credit. Needless to say,
this is a no-brainer. They use a construction to perm loan.
This means they use a single combination loan, where the
construction loan becomes permanent at the end of the
construction period.
Construction loans usually run for 6 months to a year and
carry an adjustable interest rate that resets monthly or
quarterly. In addition to points and closing costs, lenders
charge a construction fee to cover their costs in
administering the loan. (Construction lenders pay out the
loan in stages and must monitor the progress of
construction).
When the construction is complete, the loan can convert to a
short term ARM so you can keep your payments low until you
sell the property.
With these type of loans, you lock in the interest rate for
the permanent loan now. It doesn't have to float and expose
you to higher rates.
Adjustable Rate Mortgages (ARM)
With a fixed-rate mortgage, the interest rate stays the same
during the life of the loan. But with an ARM, the interest
rate changes periodically, usually in relation to an index,
and payments may go up or down accordingly.
Lenders generally charge lower initial interest rates for
ARMs than for fixed-rate mortgages. This makes the ARM
easier on your pocketbook at first than a fixed-rate
mortgage for the same amount. It also means that you might
qualify for a larger loan because lenders sometimes make
this decision on the basis of your current income and the
first year's payments. Moreover, your ARM could be less
expensive over a long period than a fixed-rate mortgage, for
example, if interest rates remain steady or move lower.
Against these advantages, you have to weigh the risk that an
increase in interest rates would lead to higher monthly
payments in the future. It's a trade-off where you get a
lower rate with an ARM in exchange for assuming more risk.
The Index
Indexes are pegged to overall interest rates. Your best
choice is an adjustable mortgage that uses an index with
relatively low volatility, which means the one that is least
vulnerable to frequent or major swings in interest rates.
Also, the longer the term of the index, the more the
borrower is protected from short-term interest rate
fluctuations. For example, an ARM with a six-month U.S.
Treasury bill index is more volatile than one with a
one-year index. Federal Cost of Funds or the 11th District
Cost of Funds indexes (known as COFIs) are considered the
least volatile. Other popular indexes include Treasury
securities (known as T-bills) and LIBOR (the London
Interbank Offer Rate).
Discounts
Some lenders offer initial ARM rates that are lower than the
sum of the index and the margin. Such rates, called
discounted rates, are often combined with large initial loan
fees ("points") and with much higher interest rates after
the discount expires.
Very large discounts are often arranged by the seller. The
seller pays an amount to the lender so the lender can give
you a lower rate and lower payments early in the mortgage
term. This arrangement is referred to as a "seller buydown."
The seller may increase the sales price of the home to cover
the cost of the buydown.
A lender may use a low initial rate to decide whether to
approve your loan, based on your ability to afford it. You
should be careful to consider whether you will be able to
afford payments in later years when the discount expires and
the rate is adjusted.
Here is how a discount might work. Let's assume the one-year
ARM rate (index rate plus margin) is at 10%. But your lender
is offering an 8% rate for the first year. With the 8% rate,
your first year monthly payment would be $476.95.
But don't forget that with a discounted ARM, your low
initial payment will probably not remain low for long, and
that any savings during the discount period may be made up
during the life of the mortgage or be included in the price
of the house.
Summary
If you are an investor and will be out of the house in less
than 5 years, an adjustable rate mortgage can work out very
well for you. If you plan to be there longer, there are many
other techniques you can use to keep your payments low.
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