Get Rich With Real Estate: Strategic Ways To Finance Properties

Parking - street view 2For new readers who want to learn more about real estate you can start here:

On Why I’m Bullish On Real Estate
The Tax Benefits You Receive
How To Value Real Estate In Any Market

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?

Comments

  1. I bought my house using a first-time homebuyer program that allowed me to put less than 20% down. I would love to have a separate rental property within the next 10 years so I will have to look into various financing options when I get to that point.
    DC @ Young Adult Money recently posted…How to Stay Safe When Buying and Selling on CraigslistMy Profile

  2. We bought our current house, and our other two houses as well, with the 5% down minimum, due to a simple lack of education about how money works. Won’t make that mistake again, that’s for sure!
    Laurie @thefrugalfarmer recently posted…Choosing Long-Term Success over Immediate GratificationMy Profile

  3. I don’t have a PMI, but this caught my eye: ‘once it’s on the loan you can never get rid of it’! I thought with the recent RE crash and new regulations, things would’ve gotten simpler for the potential homeowner – this just seems wrong!
    Moneycone recently posted…What should you do if you shopped at Target between Nov 27 and Dec 15My Profile

  4. We bought our first house with 3% down, but had the dreaded PMI. We honesty were so green at that time, we didn’t understand it. We built our current home and didn’t have to put anything down because we purchased the land in cash and I guess that counted as enough equity. Our next rental will likely be purchased with our HELOC. I like the idea of an all cash offer.
    Kim@Eyesonthedollar recently posted…What Do You Really Want for Christmas?My Profile

  5. Thank you for sharing all these options. Home ownership has always seemed like such an impossibility due to prohibitive cost, but if I only have to put 5% down and I can negotiate the closing cost, it might actually be possible.
    Stefanie @ The Broke and Beautiful Life recently posted…How to Deal With Unsatisfactory Customer ServiceMy Profile

  6. One of our rental properties is actually our “starter home.” We just turned it into a rental after living in it for one year. It made things easier that way since we qualified for a very low interest rate.
    Holly@ClubThrifty recently posted…Earn a 5 Night Vacation With Flights for FreeMy Profile

  7. Our first property was with a traditional 80/20, fixed rate, 30 year. It was in rough shape and we fixed it up with cash savings. We’ve since refi’d into a 15 year fixed rate when rates dropped.
    Our second property was purchased as “all cash” via a family loan. Then we used our cash to get the property into rentable condition.
    Our third property (undeveloped residential lot) wasn’t eligible for typical financing since we aren’t planning on building on it. So we got a HELOC on our second property (we found the max any HELOC could get us was a 55% LTV), and maxed out that HELOC and matched the HELOC funds with cash savings to buy this residential lot.

    I think in general the best thing is to know your area –
    FL is a bit different – our closing costs are significantly higher as a percentage of home price (we’ve paid 3%-4% on all of them), and loan origination costs on traditional mortgages are really high as well. (Title insurance costs here have gone up significantly over the past 5-6 years.)
    So for us it’s largely a matter of comparing cost of capital. We could have pulled up to 70% out of our second property if we used a traditional mortgage, but it would have cost us about $3K in fees to get access to that $50K. Instead, we pulled out 55%, ~$38K for ~$200 in fees.
    Mrs. Pop @ Planting Our Pennies recently posted…Happy FestivusMy Profile

  8. steven lau says:

    Great ideas although I Dont have enough cash in my home for a meaningful equity line. Something to consider when i build enough up.

  9. Charles,

    Another great piece on real estate investing. As you know I am interested in the last option you noted, since we have paid off our home and do have some cash available. With the cash out refinance on the rental (that you paid cash for, with the HELOC on your primary home), do you find you have to play closing costs? I’d love the option all the more if I could avoid those fees.
    Done by Forty recently posted…Use Value and Exchange ValueMy Profile

    • DBF with so much competition you can find a bank which will credit you on your HELOC so its essentially free. You would need to keep it open for three years. On a cash out refinance you can have zero closing costs, the bank will pay for it but you pay a higher interest rate. An example is the rate on an investment is 4.75% with $4000 in closing costs, you opt no closing costs the rate will be 5.1% . Over the long term no closing costs will cost you extra, since you’re using it as a rental your tenant pays for it. It’s also tax deductible, this is the best way to minimize out of pocket.
      Charles recently posted…Get Rich With Real Estate: Strategic Ways To Finance PropertiesMy Profile

  10. Thanks for the valuable insight!
    Once I finish paying off my mortgage, then I will be able to save up some money for other things.
    Even still, I think that real estate is just a money making business, even though it is for a good cause.
    Thanks,
    David
    David recently posted…You Only Live Once (YOLO)My Profile

  11. I don’t have my own property yet and no plans in acquiring just yet but I would one day want to. It is a dream I am working on right now. I don’t know how long it will take me but I am positive that one day, I will be able to fulfill that dream that is why I like reading posts like this, anything that will teach me to do it wisely when the time comes.
    Jen @ Frugal Rules recently posted…How to Get out of Debt: Thoughts for the New YearMy Profile

  12. Negotiating closing costs is a good idea. On my first house, I didn’t have enough for 20% down so I had to pay for PMI which I vowed never to do again. I also had a 5 year fixed ARM on that first property which worked out well. I knew it was a starter home and I wasn’t there for 5 years. I realized a nice gain on the property too.
    Kay @ Green Money Stream recently posted…Can’t Keep Up? Save Time and Money With Once A Month CookingMy Profile

  13. Where were you when we bought our first home?! :) Great material here!

    One thing we did right was avoided a PMI by paying the downpayment. One thing we regret was paying points! Live and learn..!
    Moneycone recently posted…Laziness is my vice and I put it to good use!My Profile

  14. Nice idea..Thank you for sharing all these options.
    prabhat singh recently posted…What to ExpectMy Profile

  15. We’ve been considering buying a rental property, but are still in the beginning stages of saving up the down payment and researching our options. I’ve heard that some lenders require you have 25% or more down payment for rental properties, has that been your experience, or the standard 20% down was enough to secure the loan?
    KK @ Student Debt Survivor recently posted…6 Tips for Dealing with DisappointmentMy Profile

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