Financing Your Property “No Money Down” – Part 3
- Continued from Part 2 -
Bird-Dogging Properties
A very creative technique involves you acting as a “bird-dog”. If you are not familiar with “bird-dogs”, they are hunting dogs that point out birds hiding in shrubs and bushes for the hunter. As the bird-dog you find investments for others to make, for a fee. A common fee is a flat fee of a few thousand dollars for each property purchased. The work involved on your part is finding the deals. If you have a stable of investors you should have people looking in different areas, some looking for properties to purchase to live in, others for property to flip, and others looking for rental properties. You may find sellers by placing small ads in penny-saver (free) type newspapers such as “I buy houses, any condition, any price” or posting signs on bulletin boards and other public places, contacting owners in foreclosure, locating owners of abandoned properties and letting people know that you buy properties.
A good way to find buyers is to network at your local real-estate investor club. The advantage of this technique is that you never have to invest money in purchasing a house. You simply pass on the deal to someone who can make the investment and will pay you a fee for your finding the deal. You do not have to have credit or money to use this technique. The disadvantage is that you will not maximize your profit. When you are using this technique, be sure you are referring deals to people who will pay you. Tell them up-front what your fee will be if they buy the property and get agreement from them to pay the fee before you give them the property address, owner contact information and other details. Also, be sure you are referring deals to people who are ready, willing, and able to make the investment in the property.
The double-closing technique involves your simultaneously purchasing and re-selling the property. Done correctly, you use the money of your buyer to pay the money to the seller. You take the difference between the low price you bought the property for and the high price you sold it for as your profit. This technique can be a little complicated to pull off. You must coordinate closing with two separate parties at the same time. If one of the parties is not able to close you can find yourself in breach of contract as the buyer or seller. The most likely problem is that your buyer does not have the ability to close – his mortgage falls through or he has some other problem causing him not to be able to settle on time, or maybe not at all. If at all possible you should be prepared to close on the property yourself if your buyer does not come through. You should also schedule settlement in advance of the final deadline to settle to protect yourself from your buyer just needing a little extra time to settle and you not having it because you are at your deadline to settle with the seller.
The advantages to this technique are that you will not have to qualify for and obtain a mortgage, nor do you have to pay mortgage costs, title insurance fees and other financing expenses. If you are taking title to the property you will still have to pay transfer tax and other charges. You will not have to pay any holding costs (property taxes, insurance, utilities, etc.) because you will not own the property for any extended time period.
If you are going to try this technique, try to obtain the right to show the property to prospective tenants, buyers, inspectors, etc. during the pendency of your agreement of sale, be sure to find a buyer who puts down a significant deposit and is pre-approved for a mortgage (or who does not need a mortgage at all), and settle prior to the deadline on your agreement to purchase so that your buyer can have time to straighten out any problems he has in settling in time.
You should also be sure to write your agreement of sale so the limit of your liability if you cannot close is the deposit you have down (a “liquidated damages clause”) and make the deposit small ($500 or $1000). An alternative but similar technique is assigning your agreement of sale to another. I will discuss that below.
Assign Agreement of Sale
Another technique is to assign the agreement of sale to another. This means that for a fee, you will allow someone else to take over your position as buyer on an agreement of sale. The typical legal rule is that agreements of sale are assignable unless assignment is specifically prohibited in the agreement. Most form agreements of sale contain prohibitions against assignment. The agreement of sale included in my forms set does not prohibit assignment. The advantage of assigning the agreement of sale is that you will take your profit when you assign the agreement and will not need to worry about setting up closing or your buyer not being able to close. Be sure your buyer assumes all of your obligations under the agreement of sale (in writing) and that you collect your money at the time you assign the agreement.
This is a true “no money down” technique and does not require you to obtain a mortgage or other financing. To make this technique work you need to negotiate a very beneficial agreement of sale that someone else will want to take over for you so much that they will pay a fee to take over the agreement. Remember that if the agreement of sale does not state that it is not assignable, you can assign it. You will not, however, be released from performance unless the seller agrees to release you, so be sure the person you are assigning the agreement to will follow through with the purchase.
An interesting technique is to auction a property as soon as you own it, or while you have it under agreement but have not yet closed. If you can negotiate a great price, you can hold an auction to resell the property. If the resale price is high enough this is a way to locate a buyer for you’re “double closing” (discussed above).
There are two basic types of auctions, absolute auctions and reserve auctions. Absolute auctions are where the property is sold regardless of price. The seller is stuck selling to the high bidder. A “reserve auction” is where the seller decides at the conclusion of bidding if the price is high enough. The “reserve price” is the minimum the seller is willing to sell the property for. The reserve price is usually not disclosed.
I recommend that sellers hold a reserve price auction without disclosing the reserve. As a buyer, I prefer absolute auctions unless I know the reserve and it is low enough for me to be interested.
If you are going to auction a property immediately, you need to have control over the property. Do not try to do this with the seller still occupying the property. Put into your agreement of sale a clause that allows you to auction the property. Do not leave the clause hanging out all alone. Bury it with similar items like letting inspectors in to see the property and showing the property to prospective tenants. The clause would be something like “Seller agrees that Buyer shall have access to the property at all reasonable times to show the property to building inspectors, termite inspectors, architects, engineers, prospective tenants, buyers, offer the property for sale or rent, erect signs advertising the property, advertise and list the property for sale or rent with a broker, auctioneer, or any other party, at Buyer’s sole discretion.”
A creative way to approach this kind of transaction would be to work out a deal with a lazy or cash strapped homeowner where you would fix-up the property while it is under agreement, hold an auction (at your expense) and split the proceeds above a certain base amount (the base amount would include the costs to repair and auction the property and some minimum to the seller). The auction would be disclosed right up front to the seller and you would not thus run into any objections at the time of the auction. If you work out that kind of deal stipulate in the agreement that you are planning on auctioning the property and that you will control the auction (who conducts it, the minimum price, etc.). Be sure that agreement is in writing or it will not be enforceable.
The Five Day Sale Method
There is a fascinating book called “How to Sell Your Home in Five Days” by William Effros. When I last checked it was about $12.00 in discount book stores. I read the book and really enjoyed it. I have never tried this particular sale method, but I know at least one person who used the method and had great success. The book shows you how to generate a lot of excitement around your house sale, how to prepare the house, how to advertise it, and how to conduct the sale. The sale is very similar to a silent auction.
In all auctions buyers can get excited by the competition and sometimes pay over fair market value. I think following the “How to Sell Your Home in Five Days” method could easily generate that excitement. An advantage over a traditional auction is that you would not have to pay any auctioneer’s fees to sell. You could implement this method in one of two ways. One way is to conduct the sale before you close, and then either assign your agreement of sale to the winner of your “Five Day Method” sale or close first then immediately resell the property using this method. The first scenario would be preferable because you would not have to close using your own money and could just assign the agreement of sale at your lower price to the winner of your five day sale. Your profit would be the difference between your purchase and sale prices. The second choice is an alternative that would allow you to sell quickly, but you would still have to close and would incur closing costs and short term holding costs.
Buy Using an FHA Mortgage
The FHA is an agency of the federal government called the “Federal Home Administration.” Since 1965 the FHA has been a part of HUD – the United States Department of Housing and Urban Development. The FHA is charged with assisting people to become homeowners rather than renters. It is a product of the great recession and was started in 1934 when only 4 of 10 households owned homes, and the only loans available required 50% down payment and offered payouts of three to five years with a balloon payment at the end! Talk about tough terms!
The FHA has at least two programs that might be of interest to you as an investor or home buyer. The 203(k) “Buy and Fix-Up” loan and the “No Money Down” loan require only a low 3% down payment. The Section 203(k) program is for the rehabilitation and repair of single-family properties. It is only for owner-occupants. You can buy up to a four unit building (you must live in one unit) but it is not for buildings you are not going to live in. When a buyer wants to purchase a house in need of repair or modernization, with most loans the buyer has to obtain a separate loan to purchase the house and to do the rehab work. Once the house is fixed up the buyer has to refinance with a permanent mortgage. It is expensive to obtain and process all of those loans. The Section 203(k) program is different because the borrower can get just one mortgage loan to finance both the acquisition and the rehabilitation of the property. The mortgage amount is based on the projected value of the property with the work completed, taking into account the cost of the work.
To be eligible, the property must be a one- to four-family dwelling needing at least $5,000 in repairs or improvements. You can even borrow money to make up to six months of mortgage payments while you are renovating the property! The first $5,000 in repairs must “affect the health and safety of the occupants.” Minor-or cosmetic repairs by themselves cannot be included in the first $5000, but may be added after the $5000 threshold is reached. Some examples of eligible improvements that “affect the health and safety of the occupants” include structural repairs, installing bathrooms, finishing an attic or basement, repairing termite damage, adding a garage, remodeling a bathroom or kitchen, abating lead based paint, installing carpeting or other flooring.
The other program you may be interested in is the 203(b) program which is used to purchase or refinance a principal residence with up to 97% of the purchase price being financed by the FHA. This is also an “owner occupant” program. The loan limits on FHA loans are generally between $150,000 and $300,000 depending upon where you live and whether you are financing a one, two, three, or four units building. You can look up the financing limits in your area on the FHA website at http://www.hud.gov.
The FHA programs are “no money down” because they require less then a five percent down payment. The FHA guidelines are liberal with respect to credit (your credit does not have to be perfect) and allow you to spend a good amount of your income on housing expense, which may be important if you want to “stretch” to get into a nicer home or neighborhood.
Buy Using a VA Mortgage
The United States Veteran’s Administration administers a loan program for veterans which usually require no down payment at all. Loan can be as high as 100% of the value of the home, but generally cannot exceed $240,000. There is no monthly “MIP” (Mortgage Insurance Premium) that is normally charged when the buyer puts less then a twenty percent down payment on a house. The loans are assumable to a new buyer. For loans made prior to March 1, 1988 there is no credit check on the buyer and the loan can be assumed without the VA’s approval. For loans made after that time the VA has to approve the buyer’s credit.
You can make use of the VA program in a couple of ways as an investor. First, if you qualify for a VA loan (you must be a veteran, widow of a veteran, or have served in the armed forces of a country aligned with the US) you can use your eligibility to buy a home “no money down”. If you are not a veteran, you can assume a mortgage already in place on a property. If you find a VA-financed property being foreclosed upon, you should talk to the present owner about assuming the mortgage. Remember, if the mortgage is put into place prior to March 1, 1988 you can assume it without having to qualify for the loan. If the loan was placed after that time you just need to apply to the VA to assume the loan or you can just reinstate the loan and make payments.
Be warned that if you reinstate and make payments the lender can still foreclose if the title to the property has changed (i.e.; the property was deeded to you) but you can always sell or refinance before the foreclosure. I also find that lenders do not typically foreclose when the payments are being made. Usually they are not even aware that the property has changed hands. You can see more information on the VA Home Loan Program at http://www.homeloans.va.gov.
FHLMC stands for the Federal Home Loan Mortgage Corporation. It is often called “Freddie Mac”. Freddie Mac is an institution chartered by the United States Government that buys mortgage loans from the lenders that originate them, and then sells shares in the loans to investors. Thus Freddie Mac is one source of mortgage funds lent by your local bank or Mortgage Company. If the loans go in to default, the FHLMC sometimes ends up owning the mortgaged property. At any given time Freddie Mac advertises that it has thousands of foreclosed homes available for sale all across the country. Freddie Mac then resells the property with“no money down” program called “Homesteps”. The loan program is for an owner occupant only, and allows you to buy with a 5% down payment, and that can be reduced to a 3% down payment if your family will help out by providing up to a 2% (of the purchase price) “gift.”
Additionally, Freddie Mac keeps your closing costs low by eliminating the requirement of an appraisal (typically $275 or so), eliminating “junk” fees used to make more profit for the mortgage company, and not requiring private mortgage insurance (“PMI”) which is usually required for transactions where the buyer put less than 20% down
A terrific “No Money Down” method is to obtain a credit line on your existing home that you will use to purchase investment properties. The credit line is like a credit card, but it is secured against your home. No interest accumulates and you have no payments due unless you use the credit line. Some of the benefits to this kind of financing include that the interest on the credit line is usually tax-deductible (check with your accountant to verify your particular situation), the credit lines usually have low interest rates, and you can write out a check at any time you need money.
In addition, you can often obtain large amounts of credit using this method. The disadvantages of this financing include variable interest rates, the credit line is usually renewed annually, must sometimes be paid off in full at least once per year, and you have your house at risk if you default on the loan. Due to the large increases in value that have happened over the past few years many people have a lot of equity in their homes. That equity can be tapped using a credit line supplied by your local bank or Mortgage Company. This method of financing is “no money down” because you are not taking any money out of your pocket to obtain a house. You are able to finance everything associated with your new home purchase – the purchase price, closing costs, home inspection, etc. This is a good way to obtain a property that needs some work. Instead of becoming involved with relatively complicated, onerous, and expensive construction financing, you buy the house, pay for the work with your credit line and then refinance the property or resell it.
Refinance Your Home
You can obtain money to purchase investment properties by refinancing your existing home. You then use the cash you free up to purchase investment properties. This is different from the credit line because interest accumulates all the time since you have the cash. For that reason I prefer the credit line to an outright refinance. Some of the benefits to this kind of financing include that the interest on the mortgage is usually tax-deductible (check with your accountant to verify your particular situation), the mortgage will usually have a low interest rate, unlike a credit line the interest rate can be fixed for the term of the loan, and you have money whenever you need it. In addition, you can often obtain large amounts of credit using this method.
The biggest disadvantages of this financing include that you have your house at risk if you default on the loan, and that you have interest accumulating at all times because you always have the money out. Due to possible large increases in value that have happened over the life of your loan, many people have a lot of equity in their homes. That equity can be tapped by refinancing for more than the underlying mortgage. This method of financing your next property is “no money down” because you are not taking any money out of your pocket to obtain a house. You are able to finance everything associated with your new home purchase – the purchase price, closing costs, home inspection, etc. This is a good way to obtain a property that needs some work. Instead of becoming involved with relatively complicated, onerous, and expensive construction financing, you buy the house, pay for the work with your borrowed cash and then refinance the property or resell it to get your cash back.
Wealthy or Credit-Worthy Partner
A good way to get started in the business is to find a wealthy partner or one who has the ability to borrow money and create a partnership. The structure of the partnership is that you will do the work – finding the property, managing the renovation, resale, and rental, and the two of you will then split the profits. For a deal that I find I want half of the deal for doing all that work. You should enter into a formal partnership agreement and secure your interest in the property through a mortgage or partial ownership of the property. I have a sample partnership agreement in my forms set. You should have a local attorney review and modify the partnership agreement for your jurisdiction and situation.
The same way you can refinance your personal residence, you can refinance an investment property. Using this method you can free up cash to make other investments if you refinance. Some of the benefits include that you convert equity in a property to cash in your pocket that you can then reinvest; the interest payment usually ends up being tax-deductible because you offset the interest against your income from the property; and you take out your cash tax free because it is a loan. As always, check with your tax advisor to be sure of the tax ramifications to you.
The interest rate will be higher when refinancing an investment property and often the term of the loan is shorter and the loan to value is less. Lenders typically want an amortization period of twenty years or less, charge interest that is higher than with an owner occupied residential loan, and want to go no higher than 80% loan to value. I recommend that you never refinance a property such that your payment is so high that you will not have positive cash flow from the rental of the property of at least $150 per month per unit. If you have to put money into a property every month over and above the rents you collect from the property then the property is called an “alligator” meaning it chomps away at your wallet each month. Alligators are not fun to own and you should not put yourself in a position where you own one that you have to feed every month.
Finance with Credit Cards
Some investors finance their investment properties with credit cards. They do this by taking cash advances. The advantage to this type of financing is that it is quick, easy, and it is “no money down” because you can spend the money to cover all your expenses in acquiring a property – purchase price, closing costs, etc. Also, the monthly payment is usually low and you can even transfer balances between cards to lower the interest rate on the money you borrow. Sometimes when you transfer a balance you are offered a very low or even zero interest on the money transferred from one card to another.
The disadvantage is that sometimes credit cards carry very high interest rates. High card balances can also make it difficult to obtain traditional financing. I recommend this type of financing for short-term needs. Use it to acquire a property you want to fix and flip or refinance. It is not the ideal financing for long term.
Unsecured Credit Lines
I have unsecured credit lines with my banks that serve as overdraft protection on my checking account and have check writing privileges. These credit lines are often small when you first start out – just a few thousand dollars, but the amount of credit can grow over time and if you combine a few of these credit lines you may have just the money you need to acquire or fix up a property. The advantage to this type of financing is that it is quick, easy, and it is “no money down” because you can spend the money to cover all your expenses in acquiring a property – purchase price, closing costs, etc. Also, the monthly payment is usually low.
The disadvantage is that sometimes unsecured credit lines carry very high interest rates. High unsecured credit balances can also make it difficult to obtain traditional financing. I recommend this type of financing for short-term needs. Use it to acquire or renovate a property you want to fix and flip or refinance. It is not the ideal financing for long term.
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