Guide to Getting Loans on Investment Properties. Mark Ferguson. Copyright 2013 All rights reserved Invest Four More Proprietary

Transcription

1 Guide to Getting Loans on Investment Properties Mark Ferguson

2 Table of Contents Guide to Getting Loans on Investment Properties... 1 Should you get a loan for investment properties?... 3 Why are the returns better when you get a loan on a rental property?... 3 Leveraging your money allows you to buy more rental properties... 4 Advantages of rental properties are multiplied with leverage... 4 Downside to buying more rental properties... 4 Waterfall effect... 5 Conclusion... 5 Getting a loan on a Rental Property... 5 Using Hard and Private Money... 6 What is hard money?... 6 Private Money... 7 Hard-money refinance to Fannie Mae loan... 7 Traditional Banks... 8 Conclusion... 8 Summary... 8

3 Getting Loans on Investment Property Should you get a loan for investment properties? I m trying to buy as many rental properties as I can, because of the low interest rates and the incredible returns I am seeing on my current rentals. Many people feel paying cash is the best option when investing, but when you get a loan you increase your returns substantially. You cannot get the incredible returns I get, or buy nearly as many properties if you pay cash. The key to my strategy and obtaining great returns is being able to leverage my money. Leveraging means you are not paying cash for investments, but using other people s money in order to use less of your own. By using other people s money, you can buy more properties and increase your returns on the total cash invested. If you pay cash, your returns decrease dramatically and all the benefits of owning rental properties decrease as well. For me, financing properties is the best way to increase my wealth. Why are the returns better when you get a loan on a rental property? I am going to use some really basic figures to outline the benefits of leveraging your money. If you buy a $100k house with cash and make $500 a month in cash flow, you will make about 6% cash on cash returns. Cash on cash return is the actual cash return you are seeing on the cash you have invested into the property. If you buy a $100k house and put 20% down, you will have a mortgage payment, but the returns on your cash invested increase. If you are paying a 4% interest rate, your principal and interest payment will be about $382. You are only making $118 a month cash flow after subtracting the mortgage payment, but you are making 7% cash on cash return, due to the lower initial investment.

4 Even though the cash on cash return is 7% you are actually making much more than a 7% total return in the above scenario. You are also paying down the principle on the loan by an average of $118 each month. That $118 equals another 7% return on your money that you would not have on a cash purchase! You ve more than doubled your return by getting a mortgage instead of paying cash. The really exciting part about using leverage is when you get higher cash flows the returns increase even more. If you can make $800 a month cash flow without a mortgage, you will be making 9.6% cash on cash return. With 20% down on the same property you would cash flow $418 a month after the mortgage payments and make over 25% cash on cash return just from cash flow! The way to make big money in rental properties is finding properties that will give you big cash flows and buying as many as possible while leveraging your money. I currently make over $500 a month cash flow on all my properties after expenses and mortgage payments. Leveraging your money allows you to buy more rental properties The best part about leveraging your money is it allows you to buy more properties. You can buy three or four homes with $100k instead of just one home paid for with all cash. If we use the cash flow figures from above and buy three rental properties instead of one, we can now make $1,254 a month cash flow instead of $800 a month. Not only does your cash flow increase by purchasing more properties, but the equity pay down increases, the tax benefits increase and the appreciation increases. If you are able to purchase homes below market, then every time you purchase a home, your net worth increases as well! Advantages of rental properties are multiplied with leverage Rental properties have many tax benefits including depreciation. The IRS lets you depreciate a percentage of your rental properties every year and write that off as an expense. If you have three houses instead of just one, you can get triple the tax deductions. If you have three properties instead of one and your market appreciates, then you also have the benefit of triple the appreciation. It is the same situation if rents go up; the more properties you have the more money you will make. With multiple rental properties you are also paying down the loans on three properties, which increases your returns as well. When you think of the tax savings, possible appreciation and equity pay down the returns shoot through roof by leveraging your money. Downside to buying more rental properties There is a downside to buying more rental properties. You will have to pay out more money for repairs and improvements since each property will need repairs not just one. You will also have three rental properties to manage instead of one. However, if you are able to cash flow $400 or more with a mortgage you will still be way ahead of the game by leveraging your money. You will also have more total cash flow coming in, which is very important in my system.

5 Waterfall effect In my system all your extra cash flow is spent paying down one mortgage at a time. The more cash flow coming in, the faster you can pay off a property. With my rentals, I take all the cash flow from my rental properties and pay off one mortgage at a time. If you buy three properties cash flowing $1,254 a month you can pay off a 30 year mortgage in 4.5 years with this technique. In only 4.5 years you will have a house paid off free and clear plus two other homes producing income! Once you pay off that first mortgage the waterfall effect begins. The extra cash flow from paying off the mortgage goes into paying off the next mortgage even faster. I will have my first rental property completely paid off three years after I purchased it! The principle and interest on the mortgage that was paid off above equals $382. When that mortgage is paid off that $382 a month equals $4,584 a year, which will go toward paying off the next mortgage. If you can keep buying properties, their cash flow will pay down the mortgages even faster. Pretty soon you will be paying off mortgages in a year or less with all the cash flow coming in and that is when the fun really starts! Conclusion When asking yourself should you pay cash for a rental property, consider all of these factors. In my opinion it is much better to use other people s money and increase your returns versus paying cash. Some people are very averse to any risk and don t want any debt at all. If the idea of debt makes you sick to your stomach, maybe paying cash versus getting a loan is the best route for you. I will continue to get as many loans as I can, to buy as many rental properties as I can, because of the incredible benefits rental properties offer. If you have decided you want to use leverage to purchase rental properties, what is the best way to finance? Getting a loan on a Rental Property If you are buying your first rental property, it is not extremely difficult to obtain financing. You will have to qualify for the rental property and have a down payment. With almost every investment property, you are going to have to put at least 20% down unless you use hard or private money. If you have less than four mortgage in your name you can get a loan through traditional lenders or mortgage brokers. The rates should be very competitive and you should be able to get a 30 year fixed loan. Here are a few things to remember when getting a loan on an investment property. You must qualify for the investment property loan and your personal residence loan if you have one

6 You must have the down payment amount and usually at least 6 months reserves for the rental property mortgage, taxes and insurance. You will usually pay a slightly higher rate on a loan on an investment property. I see anywhere from.5% to 1.5% higher. You will have to pay closing costs for the loan including loan origination fees, prepaid insurance, taxes and other fees. This amount is usually about 3% of the purchase price. Most lenders will require the home to be in lendable condition meaning the heat, plumbing and electrical work among other items. Once you have four or more mortgages it gets much more difficult to obtain financing on investment property. I will talk more about this in just a minute. Using Hard and Private Money Before we get into obtaining loans when you have more than four mortgages, I want to talk about short term financing options. Hard money is used by many investors as a short term solution to fund Real Estate deals. Hard money can be used to fund fix and flips or buy other properties until longterm financing can be put in place. I fix and flip homes as well as invest in long-term rentals, but personally I do not use hard money. When you use hard money, it is usually more expensive than traditional financing and I have other short term financing in place. Hard money is still a great option for many investors, but I will also discuss other short-term financing options. What is hard money? Hard money is a type of financing used to finance properties for a very short term like 6 months or a year. Hard money lenders use much different terms than a traditional bank. The first thing you will notice when you finance with hard money lenders is they charge a very high interest rate. Most Hard Money Lenders are charging 14 to 16 percent and points for their money. Points are a percentage of the total loan and can add up quickly when a hard money lender is charging 2, 3 or even 4 points on a loan. The advantage of a hard-money lender is they may loan the entire amount of money you will need to complete a deal. Most Hard Money Lenders base the amount of the loan on the After Repaired Value or ARV. You may hear they will loan 65 or 70 percent of ARV, but that is not the percentage of the purchase price, that is how much the house will be worth once you fix up the home. Here is an example of how one Hard Money lender structures a deal. You buy a home for $60,000, the ARV is $130,000 and the lender says they will go up to 70% ARV on the property. The hard money lender will loan up to $91,000 on the house based on the ARV. The hard money lender will need bids or estimates for repairs and they will pay out the money for the repairs like a construction loan. They will pay 25% of the repairs needed at closing and the other payment will come in 25% increments as the repairs are completed. The lender won t charge you any interest or points until you sell the home and then you pay them one large payment for the loan principle, interest and points. This particular Hard Money Lender charges 15% interest and 4 points, but they will reduce the points paid after you do a few deals with them.

7 The cost to do this deal with a Hard Money Lender can add up very quickly. On this deal, the interest will cost you $6,825 and the points will cost you $3,640 if you use the money for 6 months. There are also Hard Money Lenders that will charge lower interest and points, but will want a split of your profits. I don t use Hard Money Lenders myself, because of how much they charge, but for investors who have no other options it can work out well. Hard Money Lenders can help you secure a property below market value when you have not other options. Private Money Private money is money that comes from a private individual. The individual loaning the money is not a bank, mortgage company, hard money lender, or portfolio lender, they are just a person. Regular people will lend money on Real Estate because interest rates on other secured investments are really, really low right now. Have you looked at what the rate is on a CD? For a five-year CD the average is less than 1%! You can t even come close to keeping up with inflation with that rate. Many wealthy individuals are looking for a higher yield investment that is still secured. Loaning on Real Estate may be the perfect answer for them and create great opportunities for investors. The biggest problem with private money is finding the person to lend you private money! There are many websites that claim to have private money lenders they can connect you with for a small fee. In my experience, those websites take your money and connect you with a Hard Money Lender at best. A real private money-lender wants to lend their money to someone they know and trust. They don t want to lend money to a complete stranger who may or may not be trustworthy and not have a clue what they are doing. I am still trying to find a source for good private lenders, but I think I am limited to one option; people I know. I use private money now from my sister who wants a better return on her son s college money. She trusts me, knows I know how to make money, and is willing to lend her money out at a very reasonable rate; 7% with no points. For her, this is a much higher rate than she could get with a CD or other secured investment. For me it is much cheaper than if I were to finance with hard money. Hard-money refinance to Fannie Mae loan It is possible to buy a rental property with no money down using hard money. If you were to finance with hard money loan and finance repairs as well, you can refinance the hard money loan with no seasoning period according to Fannie guidelines. Fannie guidelines do not allow a cash out refinance without a seasoning period, but the home has a much higher loan than the original purchase price, because the repairs were financed. You can get a long-term loan to replace the hard money loan without waiting a year. For example, if you buy a home for $100k with hard-money loaning, 100% of purchase price and financing $35k in repairs. The total loan is now $135k, you fix up the home and refinance using a Fannie loan, which will loan up to 75% of the new appraised value. If the appraisal comes in at $185k, then you could finance up to $135k, but Fannie guidelines will not allow a cash out refinance. You would be able to refinance the full $130k that was loaned to you buy the hardmoney lender. This technique can be rather expensive, because you have to pay the higher

8 interest rate on the hard-money loan, the initial points and then the refinance costs with Fannie Mae. However you just bought a long-term rental and fixed it up with almost no out-of-pocket costs! Traditional Banks There are some banks that will still do short-term loans for investors. They are very hard to find and usually you must have a great relationship with the bank. We use a portfolio lender to finance many of our short-term investments. They charge around 6% interest rate and 1.5 points on our loans. This really is a great deal for us and for the bank because they get a higher rate and fees and we get cheap money. They will only give us 75% loan to value on our original purchase price and can take a week or two to get us the money. In the past, they would finance 100% loan to value and fund us the same day. I am afraid those days are gone forever. Traditional banks can offer another short-term option in the form of lines of credit. Most banks will want collateral in the form of Real Estate in order to issue a line of credit. If you have a house with equity in it, you should be able to get a line of credit from your bank. My bank charges 5% interest rate and will go up to 90% loan to value on my personal residence or 80% on an investment property. Conclusion We use a mix of traditional banks, lines of credit and private money to fund our deals. We are lucky that we have private money available and cash to complete a lot of deals. We will usually get the bank loan for 75% of the purchase price, use private money for the rest of the down payment and use our own money for repairs. Don t be afraid to finance Real Estate with hard money if that is your only option. Summary Being able to finance rental properties is one of the most important factors when building a winning rental strategy. You can make money on rental properties by paying all cash, but the returns are so much greater when you leverage the properties and use less of your own money. When you first start out, it should be fairly easy to get investor loans as long as you qualify and have the money required for down payments, repairs and reserves. Once you starting buying a few properties it will become much tougher and you need to be ready to switch strategies. I think it is never too late to start looking for a portfolio lender who can help you continue to build wealth by allowing mortgages on more than four properties and cash out refinances. Thanks for reading and look for much more at Mark Ferguson