From Building Wealth One House at a Time, Updated & Expanded, by John Schaub.
When I started investing in houses, I was a self-employed real estate salesman with no steady income. Not one banker in my town would loan me money to buy property. As it turned out, that was a key to my success. It forced me to learn how to buy property without going to a bank to borrow money.
Many real estate investors who are millionaires today, started with only a little money. Some did not have a job with a W-2, or great credit. They bought their first property with a small down payment, and then they bought another property as soon as they could. They continued to buy, one property at a time, negotiating better terms and prices as they learned more.
The secret to being able to buy property that will make you large profits is to learn how to borrow on terms that your tenants can repay with their monthly rent. Buying a property with little or nothing down is a great strategy, as long as you can afford to make the payments. If you can’t afford to make the payments, you will never collect any profits.
Banks require investors who want to borrow to make a down payment, often 20 percent, and require good credit. They will only loan 80 percent of the purchase price or appraisal, whichever is lower. If you buy a house worth $200,000 for $150,000, they will only loan you 80 percent of the $150,000.
When you find a bargain, it is often because the sellers need to sell right away. If they could wait ninety days, they would and probably sell for more.
Unfortunately, banks will not make you a new loan in a few days. Borrowing from a bank takes longer and costs more than other sources. When you borrow from a bank you will pay high closing costs and they will charge you the current retail rate of interest. The paperwork you are required to sign will protect the bank, and if you read the fine print, you give them the right to take other assets that you own if you cannot repay the debt.
HERE ARE 5 THINGS YOUR BANKER WON’T TELL YOU:
1.Your banker won’t make a decision fast enough to loan you the money to buy a really good deal. A good deal is when a seller has decided to sell today (or in the next few days) and selling quickly is more important than the price. Often the seller is out of time and needs money today (or very soon) or something bad is going to happen.
I have purchased several homes from sellers a day or two before their house would be sold at a foreclosure auction. Although they may have had chances to sell before, they waited until the last minute to make a decision. At that point, there were few buyers willing to take the risk of buying on such short notice and able to close in one day.
Even though I have great credit and can qualify for a loan, there is not a banker in my town who can close a real estate loan the same day I call him. A home equity loan or line of credit could be used for quick purchases at bargain prices. However, these loans have variable interest rates and some are short-term loans. These terms make them dangerous loans for a long-term investor.
New federal consumer protection regulations (SAFE Act and DoddFrank Act) lengthen the time it takes a homeowner to get a bank loan and to close a real estate purchase. Some sellers just can’t wait that long. Look for sellers who can’t wait, and make them offers that allow them to finance either part of or all of the purchase price.
2. Your banker won’t loan you more than 80 percent of the purchase price of an investment property. If you wait to buy a house until you save up a 20 percent down payment, it may take you years to buy your first house. And, by then, houses will probably be more expensive, so waiting can cost you a lot.
If your goal is to buy a property with a smaller down payment, then you will have to find a lender other than a bank. Some sellers will sell you a property and finance most of or all of the price. Often they are sick—either sick of managing or sick of making payments. Look for burned-out investors who have bought several properties but never learned to manage. They will often sell to you with a low down payment and carry all the financing to get out of management. Even a small payment is more money than they can get when they rent to a tenant.
Some investors try to trick bankers into lending to them by using fake contracts or phony appraisals. This is called bank fraud, and you will go to jail if you get caught. Typically, the lender does not go to jail, just the borrower who provided false statements.
Beware of those who tell you to lie or use devious methods to buy or borrow. Understand that many lenders work on commission and that they are under pressure to lend money. If you are uncomfortable with what they are asking you to do, get a second opinion from another lender or an attorney.
3. Your banker won’t make you a loan when prices are at their lowest. When real estate prices are going up, it’s typically easier to get a loan and bankers will make loans to investors. But when a recession comes and prices fall, banks stop making investor loans. You want to be able to buy when there is a recession. The prices are at their lowest during a down cycle.
4. Your banker won’t make you a loan without regular monthly payments or with the first payment due several months from now.
In fact, bankers typically insist on monthly payments starting right away. This is a problem if you are buying a house that will sit empty for a while.
Sellers will often accept financing with more flexible terms and lower payments in the beginning that would allow you to have cash flow immediately. I have negotiated payments with seller financing starting in six months or longer after the closing date.
5. A banker won’t loan money to someone who really needs it. If you need it, then you must be in trouble or almost in trouble, and bankers hate trouble.
If you know you are going to need money one day, borrow before you need it. You may really need it because you are about to be temporarily unemployed, or divorced, or unable to pay your taxes. Whatever the reason, it will be hard to borrow once you are in trouble.