Small Investor Financing
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Real Estate Investor Loans Under a Million
Real estate investors make money by using leverage. That means using as little of your own money as you can to control as much of other people’s money as possible. The ideal real estate investment is 100% financed, earns enough Net Operating Income to meet the debt service, and is appreciating in value, while providing tax shelter for other income.
When you invest $20,000 in a $100,000 property, a (very likely) 3% annual appreciation earns you a 15% annual return on your investment. If you can buy with $10,000 down you get a 30% return. When you buy with no money down, the return is ?
100% financing can be fairly easy for a small investor. You start with seller financing or a first mortgage from one lender, then borrow the down payment from another. The most difficult element to achieve in the ideal investment equation is an NOI that covers all the debt service.
Types of Traditional Loans
Home-Equity Loans
Borrowing against the value of a home is the loan of choice for most small investors. Home Equity Loans are easy to get and have relatively low interest rates.
Most local banks will loan up to 75% of an owner-occupied home’s tax assessed value, without closing costs including expensive and time-consuming appraisals and surveys. Some aggressive lenders will loan a much larger percentage of a home’s value, but are likely to charge closing costs and points.
Another possible bonus from a home loan is that you do not need to use the loan proceeds for a business purpose in order to deduct the interest. Loans secured by the value of a home are the only kind of deductible interest expense left to most consumers. You can deduct the interest on up to $100,000 of an equity loan on your principal residence and use the money for anything you wish.
Compare the costs
Compare application charges, annual fees and closing costs, as well as the interest rates, from several lenders before you buy a loan. Some lenders offer loans with no fees or other up-front costs as a way to attract new customers. Most others have some kind of trade-off between costs and rates, so you need to compare carefully.
Two kinds of home-equity loans
Home-equity credit lines typically operate like rotating lines of credit or charge accounts. The lender will establish a maximum amount that you will be able to borrow. Then you borrow against that line of credit whenever you choose just by writing a check. The interest rate is usually variable and may even change from month to month.
Lump-sum loans are the other option. You receive a fixed sum of money, usually at a fixed interest rate, and pay it back in monthly installments.
Refinance an existing mortgage
Refinancing your existing mortgage is another way to borrow new money against the value of your home. A refinance may be the best choice if you need to borrow against your equity, and your current mortgage rate is more than one and a half percent higher than the mortgage rate you can get today.
If your home has appreciated in value, or you've paid off a significant portion of your mortgage, you may be able to borrow more than the amount remaining on that mortgage, and use the extra money for other purposes. Most lenders will accept a much higher loan to value ratio at a lower interest rate on a refinance, than they are willing to consider using an equity loan. However, refinancing often costs 3% to 5% of the loan amount, depending on the price of a new appraisal and other fees. It also can take as long as getting a first mortgage, typically 30 to 75 days.
Always remember that you are putting your house up as collateral with any kind of mortgage loan. That means if you can't repay the loan, you are likely to lose your home.
Business loans
In order for the interest to be deductible using non home related loans, you will need to sign a Business Purpose Affidavit at the time of the loan.
Borrowing Against Stocks and Bonds
Loans against securities you own are probably the cheapest source of money after a home-equity loan. With a so-called "margin loan" from a brokerage firm, you can usually borrow up to 50% of the value of stocks. Bonds are even better. Some brokers will let you borrow more than 90% of the value of US Treasury securities. Interest rates on margin loans are always very competitive. The main risk with a margin loan is what happens if your securities drop in value.
If the stocks drop far enough (the amount varies by brokerage firm), you may get a "margin call" and be required to deposit more money into your account. If you don't have the cash, you could be forced to sell your stocks to pay off the loan, usually when the stocks are at a low.
Interest on margin loans can be deducted only against investment income, not against ordinary earned income. If you have $100 in dividend income, for example, you can deduct up to $100 in margin loan interest.
Unsecured Personal Loans
The best kind of personal loan you can get is one based on your earning capacity or net worth, but is not secured by the specific assets you own. These loans are typically set up as personal credit lines. The maximum credit amount you can borrow unsecured from any one bank is likely to be about 10% of net worth. The interest rate is usually tied to prime. The so-called "prime rate" is the rate of interest offered to the bank’s most creditworthy customer. Most personal credit lines will carry an interest rate from a half to two points over prime. It is a good idea to set up personal credit lines at more than one bank, whenever possible.
Secured Personal Loans
Most personal loans are secured by possessions. The most common personal loans are for cars, boats, or similar assets with a published value. You may be able to use just about any other tangible asset as collateral for a loan, as long as your lender can easily determine the actual value of the collateral.
A certificate of deposit or savings account secures another variation of a personal loan. For example, if you have a 3.5% certificate of deposit, you would be allowed to borrow the same amount of money for one or two percent over the rate you are receiving. Although you're paying more for the loan than you're getting from the CD, this type of loan can make sense if you need money quickly and want to avoid the penalties for early withdrawal that many certificates of deposit carry. You can then pay off the loan when the CD matures.
Loans From Retirement Plans
You may be able to borrow against a defined-contribution retirement plan, such as a 401(k) or company profit-sharing plan. There are limits on these loans: You can borrow only up to half of your vested balance or $50,000, whichever is less. You have to repay the loan within five years (loans used to buy a home can have a longer payback period), and interest is not usually deductible. You also have to repay the loan in full if you leave your job. Employers may impose other limits on these loans or forbid them entirely.
When you pay interest on a 401(k) loan, that money goes back into your account. So you are, in effect, paying the interest to yourself. However, you are giving up the interest that the money would have otherwise earned, tax-deferred, had it remained in your account.
These loans should be approached with caution. If you don't follow all the restrictions, the Internal Revenue Service can hit you with a bill for income taxes on the money you borrow, as well as a 10% penalty.
Borrowing Against Life Insurance
If you have a whole-life or other cash-value insurance policy, you can borrow against the value of that policy, often at interest rates near the prevailing mortgage rate. However, your insurance death benefit is reduced by the amount you borrow. If you die while the loan is outstanding, your estate will receive less than the policy's face amount.
Most cash-value policies let you decide when and how fast to repay a loan. But if you don't repay the loan and enough interest accumulates on it, you could lose your insurance coverage and also have to pay taxes on part of what you borrowed.
Credit-Card Loans
Taking a cash advance against a credit card is one of the quickest and easiest ways to borrow money. Just put your card into an automatic teller machine or write a check and the money is in your hands. However, credit card advances should only be used as "bridge loans" until other financing can be arranged. Easy money is almost always the most costly. Interest rates on credit-card loans are often the maximum allowed by law and routinely approach 20%. Additionally, most cards charge a cash-advance fee of 1% to 3% of the amount you borrow.
Because of the high cost, the only time credit-card advances make good sense is when you can save a great deal with an immediate purchase, and the loan will be very temporary.
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