Should You Buy Real Estate With Cash Or Seek Finance?

This is number seven in our series on formulating a real estate investment business plan.

Deciding on how you are going to pay for your property is absolutely crucial. You will need to decide whether you will be using your own money or other people’s money to investment in your mobile home community. Keep in mind if you are obtaining financing you will probably need a minimum 25% down payment for investment property. So if you are purchasing a $500,000 property, then you will need a $125,000 down payment. The question is where are you going to get the money? The following are common financing sources that you can use to purchase your assets:

  • Private money lenders such as friends, family, acquaintances or other investors
  • Owner financing.
  • Traditional financial and lending institutions.
  • Conduit loans. These are pool of loans on similar type properties that are sold to investors. They are regulated by securities laws, and it is difficult to change deal terms once they have been negotiated. There are substantial penalties for early pay-offs too.
  • Savings accounts
  • Equity line of credit
  • 401 (k)

sasvings and mortgage © by 401(K) 2012

The ins and outs of financing
Most new investors do not have cash so they are relying on using other people’s money. Either they must borrower from a private investor such as a friend, family member or a hard money lender. Using other people’s money is a strategy that investors like because they can purchase an investment property with someone else’s money. This is referred to as leveraging. The thing about leveraging is that it can get you in trouble if you leverage too much and find you cannot repay the money quick enough because your property has not generated enough cash flow. So be careful when you borrow that you have a repayment schedule that makes sense and it a realistic one that you can meet.

When you pay back money you borrow, it is generally amortized over a certain period of time. This means a portion of the payment goes towards interest and a portion towards principal. By making your payments, you reduce the principal over time until you have paid off the property. If you are paying interest only, you won’t get the property paid off. This might be okay if you decide to sell it and it has appreciated, but if you intend to hold on to it for awhile, then avoid paying interest only. Caution and minimum risk is the best advice.

Private money lenders may lend you money quickly at a slightly higher rate if you need to rehab the property and turn around and sell it for a profit. They can do so because they do not have to adhere to lending laws like traditional lenders do. They are more interested in whether the property is priced right and when they can receive their return on their investment.

So let’s say in our example above you purchase the home for $200,000, borrow $10,000 to rehab it at 6.5% interest from a private money lender, and then turn around and sell it for $300,000. You still made a profit even though you leveraged the rehab costs. Another example might be that you purchase a distressed property with your line of credit from your personal residence. The property value goes up on your personal residence and our new property. When you go to sell, you make a profit of $25,000 on the new property and you pay off your line of credit.

Now you can take that $25,000 and put it on a down payment on a distressed property that you bought for $100,000 that you plan on keeping and renting out. You obtain a mortgage for $75,000, and you make a positive cash flow of approximately $250.00 a month on your rental income. You leveraged the money you made on the new purchase and were able to buy another property with positive cash flow for under market value. You repeat the pattern and purchase five more homes, you see where there is going. You have acquired more property with equity and positive cash flow.

Careful when leveraging
But again, caution is the word when you decide to leverage. Do not over extend yourself, because if property values plunge, you will end up upside down on your mortgages and risk losing your properties to foreclosure if you cannot afford the monthly mortgage payments.

Qualifying for traditional financing has gotten tougher these days. Lenders want perfect credit scores from their borrowers and larger cash down payments. You will need at least 20% -25% down payment or more to get a mortgage on your investment property and good credit score. Always line up your financing first before you make an offer. The lender or mortgage broker will pre-qualify you and give you a letter to present to the seller or their real estate agent. Shop around for rates.

Working with a mortgage broker allows is a good idea because the mortgage broker does the work for you. Mortgage brokers work with many different lenders and can find you better rates and terms than if you try and do it on your own. You might want to establish a relationship with a couple banks as well. When rates are going up, lock in your rate as soon as you can.

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