Traditional mortgage. Most people will go this route where you save 20% of the purchase price for the down payment. Anything less than 20% down you will have to pay PMI (private mortgage insurance). PMI is a % of the overall outstanding mortgage balance, it is insurance in case you the borrower defaults on the loan. PMI is an upfront fee of 2.25% on the loan plus additional .05% every month. On a $400,000 loan that is almost 200 dollars extra per month. Under the new guidelines PMI is like the herpes of mortgages, once it’s on the loan you can never get rid of it. The only way is to refinance into a new loan, and who knows what rates will be at that time.
First time home buyers=lower down payments. In expensive markets it’s very difficult to put 20% down. For first time home buyers in Hawaii you can put as little as 3-5% down, based on state programs. If you don’t have 20% down but are a first time home buyer with 10% I would recommend getting a piggyback loan. A piggyback loan means you’re taking out a traditional first mortgage of 80% of the house value, then get a 2nd mortgage which is an equity line for the remaining 10%. The 2nd mortgage is always at a higher interest rate and is adjustable, which means the interest rate adjusts every year. This will avoid PMI, since the 2nd mortgage is only 10% of the loan it will be manageable. Don’t worry about rates going to 7%+, it’s as likely to happen as another 20 years of 20%+ stock returns. Not all loan banks can do this, so it’s important to shop around and find a loan officer that can.
Of all my properties I have never put more than 5% of my own money down. The only time that 25% was put down was when my wife bought her condo. Never once have I ever paid any PMI.
Negotiating closing costs. Home owners are very irrational because of the emotions involved when selling, their family home is surely the nicest or well kept home in the neighborhood. They often get insulted if they receive an offer too low, why they spent all this time and effort to upgrade their house. They don’t understand that Little Timmy pissing on the walls as a 2 year old doesn’t add value to the house. It’s their memories, not yours. If you find a place you like and a seller unwilling to lower the price offer near the asking price. In your offer ask the seller to pay your closing costs. Closing costs usually run 1-2% of the purchase price. Ex: Unit is priced at $400,000 you offer $399,000 plus seller pays closing cost. Let’s say it’s $5000 for all fees associated with closing costs that means you’re really getting the unit for $394,000 ($399,000- $5,000 closing cost)= $394,000.
This often works if the property has been on the market for 30+ days. Why would a seller do this? Once everything closes on paper it shows that the unit sold for $399,000 or 99.8% of asking price. Sellers don’t like lowering prices because that means they overpriced their property. Paying for closing costs allows the seller to save face and tell everyone that they got a full price offer. Real estate agents will often push for that over lowering the price because it helps the comps in the area. (“comps” is similar sold properties which is what the banks will use to determine your loan.)
When I bought my last rental property for $360,000 I negotiated for 2% back to pay all my closing costs and lower the interest rate on my mortgage. My net cost for the property was $352,800 however the price was recorded at $360,000 which helps all the values in the building.
ARM vs. Fixed Mortgage. The average home owner changes homes an average of 5 to 7 year. Unless it is your forever home I would recommend an adjustable rate mortgage which is often 1% cheaper than a fixed. Weren’t ARMs the reason for the housing crisis? No, pay option ARMs were and they no longer exist. Pay option ARM barely even covered part of the interest and when they reset it became a toxic loan. Homeowners who had ARMs actually benefitted because interest rates dropped over the last five years.
Using hard money for fixer uppers or major renovations. First rule of real estate investing is use as little of your money as possible. If you buy a property that needs a lot of repairs (often D quality properties) most banks will not lend on it. Real estate flippers will often borrow from private investors or lenders at a higher interest rate (often 10%+) to purchase, fix and flip. Despite some making high six figures they often don’t risk their own money. This is for the advanced real estate investor, since I hold my properties for the long term this isn’t a route I recommend.
Using an equity line for an all cash bid. For those who have a lot of equity in a hot market I would recommend getting a home equity line of credit (HELOC). The bank will loan up to 80% of your home value (called LTV=loan to value). Your house is worth $400,000 and you owe $100,000 you can get a HELOC for $220,000. In some hot markets where investors are using all cash offers to score the best deal this is how you can level the playing field. You can often bid 10% below the selling price and beat out multiple higher offers because the banks can close the deal within two weeks. My friend in Arizona despite offering $30K higher than all cash offers kept losing out on deals. Making an all “cash” offer can save you thousands on a home.
Once accepted you pull the money from your HELOC to buy the property. When the property closes you do a cash out refinance. Here’s how it works: Buy the property for $150,000 and pay from your HELOC. Once it closes go to a different bank and do a cash out refinance for 75% of the home value. (The banks require 25% equity). In a cash out refinance you’re taking money out of the property so you would take $112,500 out ($150,000 X.75) and pay down your HELOC. Using this method allows you to purchase a rental property at a discount, with a renter to help you build your wealth.
When we bought our house we needed to come up with $200,000 for the down payment due to the size of the mortgage. It would take me years of saving and tens of thousands in missed investment opportunities to come up with that kind of down payment. Otherwise I would have to sell a property then roll it into the new house, losing an investment property. I used an equity line on one property and a cash out refinance on another in order to get into our home. Every month our renters help “pay” a part of our down payment back.
How did you buy your first property? If you’re looking for a rental how are you intending to finance it? If you don’t own real estate what plans do you have to purchase some?