Financing Real Estate Investments For Dummies

Ralph R. Roberts

Real estate professional and coauthor of

Foreclosure Investing For Dummies

Chip Cummings

Real estate financing expert and author

• Evaluate potential lenders

• Maximize your cash flow

• Finance through private lenders

• Tap into government programs

Learn to:

Financing Real Estate

Investments

Making Everything Easier!

™

Open the book and find:

• Real-world advice on financing

without tying up all your capital

• How to get prequalified or

preapproved for a loan

• Questions to ask your lender

upfront

• Ways to avoid common beginner

blunders

• How to protect your personal

assets from investment risks

• Bargain-hunting hints for

low-cost loans

• Strategies for surviving a credit

crunch

• Ten pre-closing steps you must

take

Ralph R. Roberts is an internationally acclaimed real

estate agent, speaker, investor, and consultant. Chip

Cummings is a real estate lending expert, a Certified

Mortgage Consultant with more than 25 years of

experience, and a seasoned real estate investor. Roberts

and Cummings coauthored Mortgage Myths: 77 Secrets

That Will Save You Thousands on Home Financing.

$21.99 US / $25.99 CN / £15.99 UK

ISBN 978-0-470-42233-5

Business/Real Estate

Go to dummies.com

for more!

Want to be a smart, successful real estate investor?

This no-nonsense guide contains everything

you must know to make the right choices about

financing your investments — from the various

options available and the impact on cash flow to

the tax implications and risk factors involved. You

also get tried-and-true tips for surviving a down

market and using current investments to finance

future ones.

• A crash course in real estate financing —

understand standard terms and concepts, learn the

various sources of investment capital, and gather

all essential facts and figures

• Weigh your options — decide which type of

ancing is best for your circumstances and

incorporate it into your real estate investing plan

• Finance residential properties — evaluate

idential loan programs, navigate the loan

application and processing, and handle the closing

• Invest in commercial properties — know the

ferent property types, choose the one that meets

your investment goals, and discover unique sources

for financing

• Tap into unconventional sources — discover the

s and cons of “hard money,” capitalize on seller

financing, partner to share risk and equity, and

invest on the cheap with no-money-down deals

Your practical guide to

scoring cash to fuel your

real estate investments

Financing Real Estate Investments

Roberts

Cummings

Spine: .576 in

02_422335-ftoc.qxp 3/11/09 11:50 AM Page viii

Financing Real Estate

Investments

FOR

DUMmIES

‰

by Ralph R. Roberts and

Chip Cummings with Joe Kraynak

01_422335-ffirs.qxp 3/11/09 11:49 AM Page i

Financing Real Estate Investments For Dummies

Published by

Wiley Publishing, Inc.

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Published simultaneously in Canada

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01_422335-ffirs.qxp 3/11/09 11:49 AM Page ii

About the Authors

Ralph R. Roberts, CRS, GRI, is a seasoned professional in all areas

of real estate, including buying and selling homes, investing in real

estate, and building and managing real estate agent teams. He has

been profiled by the Associated Press, CNN, and

Time magazine,

and has done hundreds of radio interviews. He has authored and

coauthored several successful titles, including

Flipping Houses For

Dummies, Foreclosure Investing For Dummies, Foreclosure Self-Defense

For Dummies, Mortgage Myths: 77 Secrets That Will Save You Thousands

on Home Financing, and Foreclosure Myths: 77 Secrets to Saving

Thousands on Distressed Properties!

(John Wiley & Sons); Protect

Yourself Against Real Estate and Mortgage Fraud: Preserving the

American Dream of Homeownership

(Kaplan); and REAL WEALTH by

Investing in REAL ESTATE

(Prentice Hall).

To find out more about Ralph Roberts and what he can offer you

and your organization as a speaker and coach, visit

AboutRalph.com.

For details on how to protect yourself and your home from real

estate and mortgage fraud, check out Ralph’s blog at

Flipping

Frenzy.com

. And don’t miss the latest addition to Ralph’s family of

Web sites and blogs,

GetFlipping.com, where Ralph offers addi-

tional information and tips on the art of flipping houses and invest-

ing in foreclosures and pre-foreclosures. You can contact Ralph by

emailing him at

RalphRoberts@RalphRoberts.com or calling

586-751-0000.

Chip Cummings, CMC, is a recognized expert in the areas of real

estate lending and e-Marketing, and is a Certified Mortgage

Consultant with more than 25 years in the mortgage industry and

more than a billion dollars in sales volume.

Chip has written hundreds of articles and appeared numerous times

on radio, television, and in various magazines including

Entrepreneur,

Mortgage Originator, Real Estate Banker/Broker, and The Mortgage

Press

. He is an experienced professional in all areas of real estate

financing, including residential and commercial mortgages, govern-

ment lending, regulatory and compliance issues. He is past president

of the MMBA (Michigan Mortgage Brokers Association), and is a

licensed mortgage broker and lender in Michigan.

As an international speaker, he has addressed groups and organiza-

tions of all types, and trains thousands of mortgage professionals

from around the country every year. Chip is a certified national

trainer for continuing education in more than 40 states, and has

served as an expert witness in state and federal courts. He is also

the author of

ABC’s of FHA Lending and Stop Selling and Start

Listening! – Marketing Strategies That Create Top Producers

(Northwind), Mortgage Myths: 77 Secrets That Will Save You

Thousands on Home Financing

, Foreclosure Myths: 77 Secrets to

Saving Thousands on Distressed Properties!

and Cashing In on Pre-

foreclosures and Short Sales

(John Wiley & Sons).

01_422335-ffirs.qxp 3/11/09 11:49 AM Page iii

Chip lives in Rockford, Michigan with his wife Lisa and three chil-

dren, Katelyn, CJ, and Joe.

To learn more about Chip Cummings, his many successful products

or how he can help your organization as a speaker or business con-

sultant, visit

www.ChipCummings.com. To receive a complimen-

tary subscription to his multimedia e-newsletter and online events,

check out

www.eCoachingClub.com. You can also reach Chip by

emailing him at

info@ChipCummings.com or by calling

616-977-7900.

Joe Kraynak (joekraynak.com) is a freelance author who has

written and coauthored numerous books on topics ranging from

slam poetry to computer basics. Joe teamed up with Dr. Candida

Fink to write his first book in the

For Dummies series, Bipolar

Disorder For Dummies,

where he showcased his talent for translat-

ing the complexities of a topic into plain-spoken practical advice.

He then teamed up with Roberts to write the ultimate guide to flip-

ping houses —

Flipping Houses For Dummies and delivered encore

performances in

Foreclosure Investing For Dummies, Advanced

Selling For Dummies

, and Foreclosure Self-Defense For Dummies. In

Financing Real Estate Investments For Dummies, Joe assists Chip and

Ralph in delivering the ultimate guide to scoring some cash to fuel

your investments in real estate.

01_422335-ffirs.qxp 3/11/09 11:49 AM Page iv

Dedication

From Ralph: To real estate investors and professionals who are

dedicated to supporting and promoting the American dream of

homeownership.

From Chip: To my assistant Debbie Forth who has managed to keep

me organized for the last 14 years, and to my wife Lisa who puts up

with all the crazy hours and remains my #1 fan.

Authors’ Acknowledgments

Thanks to acquisitions editor Lindsay Lefevere, who chose us to

author this book and guided us through the tough part of getting

started and to our agent, Neil Salkind of StudioB (

www.StudioB.com),

who ironed out all the preliminary details to make this book possible.

Chad Sievers, our project editor, deserves a loud cheer for acting as a

very patient collaborator and gifted editor — shuffling chapters back

and forth, shepherding the text through production, making sure any

technical issues were properly resolved, and serving as the unofficial

quality control manager. Megan Knoll, our copy editor, earns an editor

of the year award for ferreting out our typos, misspellings, grammatical

errors, and other language faux pas-es, in addition to assisting Chad as

reader advocate — asking the questions we should have asked our-

selves. And, we tip our hats to the production crew for doing such an

outstanding job of transforming a loose collection of text and illustra-

tions into such an attractive bound book.

We also wish to express our appreciation to the National Association

of Mortgage Brokers, National Association of Realtors

, the Mortgage

Bankers Association of America, and the Michigan Mortgage Brokers

Association for their support and assistance.

We owe special thanks to our technical editor, Patrick Lecomte, for

flagging technical errors in the manuscript, helping guide its con-

tent, and offering his own tips, tricks, and insights from the world of

real estate financing.

01_422335-ffirs.qxp 3/11/09 11:49 AM Page v

Publisher’s Acknowledgments

We’re proud of this book; please send us your comments through our Dummies online regis-

tration form located at http://dummies.custhelp.com. For other comments, please con-

tact our Customer Care Department within the U.S. at 877-762-2974, outside the U.S. at

317-572-3993, or fax 317-572-4002.

Some of the people who helped bring this book to market include the following:

Acquisitions, Editorial, and

Media Development

Project Editor: Chad R. Sievers

Acquisitions Editor: Lindsay Lefevere

Copy Editor: Megan Knoll

Assistant Editor: Erin Calligan Mooney

Editorial Program Coordinator: Joe Niesen

Technical Editor: Patrick Lecomte, MA, MBA

Editorial Manager: Michelle Hacker

Editorial Assistant: Jennette ElNaggar

Cover Photos: © Comstock Images

Cartoons: Rich Tennant

(www.the5thwave.com)

Composition Services

Project Coordinator: Patrick Redmond

Layout and Graphics: Melanee Habig,

Melissa K. Jester, Christine Williams

Proofreader: ConText Editorial

Services, Inc.

Indexer: Potomac Indexing, LLC

Publishing and Editorial for Consumer Dummies

Diane Graves Steele, Vice President and Publisher, Consumer Dummies

Kristin Ferguson-Wagstaffe, Product Development Director, Consumer Dummies

Ensley Eikenburg, Associate Publisher, Travel

Kelly Regan, Editorial Director, Travel

Publishing for Technology Dummies

Andy Cummings, Vice President and Publisher, Dummies Technology/General User

Composition Services

Gerry Fahey, Vice President of Production Services

Debbie Stailey, Director of Composition Services

01_422335-ffirs.qxp 3/11/09 11:49 AM Page vi

Contents at a Glance

Introduction.......................................................1

Part I: Gearing Up for Financing

Your Real Estate Investments..............................7

Chapter 1: Taking a Crash Course in Real

Estate Investment Financing ..............................................................9

Chapter 2: Shielding Your Personal Assets from Investment Risks...25

Chapter 3: Gathering Essential Documents, Facts, and Figures.........43

Chapter 4: Scoping Out Prospective Lenders.......................................61

Part II: Financing the Purchase

of Residential Properties..................................77

Chapter 5: Finding the Residential Loan Program

That’s Right for You ...........................................................................79

Chapter 6: Bargain Hunting for Low-Cost Loans ..................................93

Chapter 7: Navigating the Loan Application and Processing ...........105

Part III: Financing the Purchase

of Commercial Properties................................127

Chapter 8: Picking the Right Commercial Property Type for You....129

Chapter 9: Exploring Sources of Financing

for Commercial Properties .............................................................149

Chapter 10: Securing a Loan to Finance

Your Commercial Venture...............................................................163

Part IV: Sampling More Creative

Financing Strategies ......................................173

Chapter 11: Financing in a Pinch with Hard Money

and Other Tough Options ...............................................................175

Chapter 12: Capitalizing on Seller Financing ......................................193

Chapter 13: Partnering to Share the Risk and the Equity .................207

Chapter 14: Profiting from No-Money-Down

and Other Creative Deals................................................................219

Part V: The Part of Tens..................................231

Chapter 15: Ten Ways to Avoid Common Beginner Blunders...........233

Chapter 16: Ten Steps to Take before Closing ....................................239

Chapter 17: Ten Tips for Surviving a Credit Crunch..........................245

Glossary........................................................251

Index.............................................................261

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Table of Contents

Introduction .......................................................1

About This Book .........................................................................1

Conventions Used in This Book ................................................2

What You’re Not to Read............................................................3

Foolish Assumptions ..................................................................3

How This Book Is Organized......................................................3

Part I: Gearing Up for Financing

Your Real Estate Investments......................................4

Part II: Financing the Purchase

of Residential Properties .............................................4

Part III: Financing the Purchase

of Commercial Properties............................................4

Part IV: Sampling More Creative

Financing Strategies .....................................................4

Part V: The Part of Tens...................................................5

Icons Used in This Book.............................................................5

Where to Go From Here..............................................................5

Part I: Gearing Up for Financing

Your Real Estate Investments...............................7

Chapter 1: Taking a Crash Course in Real Estate

Investment Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Pumping Up Your Purchasing Power with Borrowed Money ...10

Minimizing your potential by owning

property free and clear ..............................................10

Maximizing your potential with

other people’s money.................................................10

Paying cash with borrowed money..............................11

Brushing Up on Basic Real Estate Financing Lingo ..............12

Identifying types of lenders...........................................12

Grasping different loan types........................................13

Brushing up on important legal lingo ..........................14

Pointing out mortgage concepts ..................................16

Examining equity ............................................................16

Looking at loan-to-value (LTV)......................................17

Distinguishing Investment and Home Financing...................17

Paying a premium for riskier investment loans..........17

Using quick cash to snag bargain prices .....................18

Accounting for taxes on your capital gains

(or losses)....................................................................18

Protecting your personal assets...................................19

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Exploring Common Sources of Investment Capital ..............19

Tapping your own cash reserves..................................20

Borrowing from commercial lenders ...........................21

Obtaining a hard money loan........................................22

Financing your purchase through the seller ...............22

Taking on a partner ........................................................22

Prepping to Meet with a Lender..............................................23

Gathering paperwork and other info ...........................23

Crafting a business plan.................................................24

Chapter 2: Shielding Your Personal

Assets from Investment Risks . . . . . . . . . . . . . . . . . . . 25

Understanding Why You Need to

Protect Your Personal Assets ..............................................26

Limiting Your Personal Liability by Forming an LLC............26

Understanding the pros and cons ................................27

Setting up an LLC............................................................28

Taking and securing title to real estate........................28

Eyeing Sub-S corporations and partnerships .............29

Transferring Personal Assets via Trusts................................30

Weighing the pros and cons of owning property

in another’s name .......................................................31

Gaining asset and tax protection

with an irrevocable trust ...........................................32

Considering real estate investment trusts (REITs) ....33

Staying Away from Promissory Notes

with Recourse Clauses .........................................................33

Opting for a nonrecourse loan......................................34

Negotiating the recourse clause...................................34

Avoiding cross-collateralization ...................................35

Steering Clear of Real Estate and Mortgage Fraud ...............36

Telling the truth on your application...........................37

Dodging predatory lenders ...........................................38

Saying “no” to inflated appraisals ................................39

Turning your back on cash-back-at-closing

schemes .......................................................................40

Avoiding illegal flipping..................................................40

Defending yourself against chunking schemes...........41

Refusing a builder bailout..............................................41

Acting with integrity: The golden rule .........................42

Chapter 3: Gathering Essential Documents,

Facts, and Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Examining Your Credit Reports...............................................43

Obtaining free copies of your reports..........................44

Checking your credit score ...........................................45

Inspecting your report for problems ...........................46

Financing Real Estate Investments For Dummies

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Repairing your credit and boosting your score..........47

Avoiding mistakes that can sabotage

your loan approval...................................................................48

Chasing Down Vital Paperwork...............................................49

Delving into your personal financial information.......49

Accounting for business income ..................................53

Documenting the property you plan to purchase......54

Show Me the Money: Identifying Sources of Ready Cash....59

Sources of cash for down payments,

closing costs, and prepaid items ..............................59

Rainy day funds: Cash reserves....................................60

Getting Prequalified or Preapproved......................................60

Chapter 4: Scoping Out Prospective Lenders . . . . . . . . 61

Borrowing Directly from Banks...............................................61

Weighing the pros and cons..........................................62

Conventional loans.........................................................64

Subprime (nonconforming) loans ................................65

Dealing with a Middleman (or Woman): Mortgage Brokers ...66

Weighing the pros and cons..........................................67

Shaking the branches for a broker ...............................68

Checking a broker’s credentials....................................68

Taking the Hard-Money Route through Private Lenders .....70

Borrowing from Uncle Sam: Government Loan Programs ......72

Financing through the Seller ...................................................73

Lease options ..................................................................73

Land contracts ................................................................74

Teaming Up with a Cash-Heavy Partner.................................74

Opting for a limited partnership...................................75

Going the corporation route .........................................76

Part II: Financing the Purchase

of Residential Properties ...................................77

Chapter 5: Finding the Residential Loan

Program That’s Right for You . . . . . . . . . . . . . . . . . . . . 79

Understanding Why Finding the Right

Residential Loan Is Key ........................................................79

Choosing a Loan Type to Maximize Your Cash Flow............80

The power of OPM (other people’s money)................81

Interest-only mortgages.................................................82

Grabbing a hold of ARMs...............................................83

Hybrids.............................................................................85

Hard-money loans: Private investors...........................85

Taking Advantage of Government-Secured Loans................86

Tapping the FHA for a loan............................................86

Viewing Veterans Affairs (VA) loans.............................89

Table of Contents

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Financing Real Estate Investments For Dummies

xii

Considering REO loans ..................................................89

Tapping into state and local grants and loans............90

Digging up USDA Rural Development loans ................92

Avoiding the Prepayment Penalty Trap .................................92

Chapter 6: Bargain Hunting for Low-Cost Loans. . . . . . 93

Understanding How This Interest Thing Works....................93

Keeping simple with simple interest............................94

Grasping the concept of amortization .........................94

Telling the difference between the

interest rate and APR ................................................96

Exploring how adjustable rate mortgages work.........97

Paying interest upfront with points .............................98

Considering the Mortgage Term .............................................99

Accounting for Closing Costs ................................................100

Getting socked with origination fees .........................100

Forking over other fees................................................100

Examining the Good Faith Estimate ...........................102

Calculating a Loan’s Total Cost .............................................103

Chapter 7: Navigating the Loan Application

and Processing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

Completing Your Loan Application.......................................105

Walking through the parts of the loan application...106

Reviewing the lender’s disclosures............................108

Supplying the requested documentation ..................111

Signing a release of information .................................112

Following the Loan Processing Trail ....................................112

Getting up to speed on the underwriting process ...113

Obtaining an appraisal or AVM ...................................113

Having the property inspected...................................114

Obtaining a survey .......................................................119

Navigating the Closing............................................................120

Keeping your attorney in the loop .............................120

Dealing with the preliminaries....................................120

Signing the documents.................................................122

Knowing your right of rescission . . . or lack thereof ...122

Dealing with surprises .................................................123

Financing Other Types of Residential Properties...............124

Digging up money for vacation properties................124

Financing investment properties................................125

Purchasing vacant land................................................126

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Table of Contents

xiii

Part III: Financing the Purchase

of Commercial Properties.................................127

Chapter 8: Picking the Right Commercial

Property Type for You. . . . . . . . . . . . . . . . . . . . . . . . . . 129

Estimating the Income Potential

of a Commercial Property ..................................................130

Calculating effective gross income (EGI)...................130

Calculating Net Operating Income (NOI)...................131

Estimating the property’s true value .........................132

Projecting future profits with a pro forma ................133

Dwelling On the Thought of Multifamily Homes.................134

Two- to four-family homes...........................................135

Garden apartments.......................................................136

Large multifamily properties.......................................136

Crunching the numbers ...............................................138

Buying and Renting Out Office Space:

The A-to-D Grading Scale ...................................................139

Investing in Retail Real Estate ...............................................140

Collecting your cut of gross sales...............................141

Comparing strip malls and convenience stores .......142

Running Your Own Hotel or Motel........................................142

Distinguishing between flagged

and unflagged properties.........................................143

Encountering income challenges................................144

Checking Out Industrial or Warehouse Properties.............145

Calculating income and costs .....................................145

Considering storage facilities......................................146

Exploring Mixed-Use Properties ...........................................146

Sampling Some Special Use Properties................................146

Restaurants and bars ...................................................147

Gas stations ...................................................................148

Adult foster care ...........................................................148

Chapter 9: Exploring Sources of Financing

for Commercial Properties . . . . . . . . . . . . . . . . . . . . . 149

Sizing Up Various Commercial Loan Programs ...................150

Exploring the middle market (local

and national banks)..................................................150

Hitting up the private sector:

Hard-money lenders .................................................151

Financing Main Street property

with Wall Street money ............................................152

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Financing Real Estate Investments For Dummies

xiv

Pursuing Government Loans .................................................153

Financing housing and medical facilities

through FHA loans....................................................153

Tapping into economic development

funds and grants .......................................................154

Securing a loan through the SBA................................154

Harvesting investment capital through the USDA....156

Getting a hold of a CDBG .............................................157

Deconstructing Construction Loans ....................................158

Financing Fixes with Rehabilitation Loans ..........................158

Exploring Other Creative Financing Options ......................159

Borrowing from pension programs

and life insurance companies..................................159

Enlisting the services of venture capitalists .............160

Sharing the costs and the equity................................161

Participating in participation loans ...........................161

Taking on a partner ......................................................162

Considering other potential sources of capital ........162

Chapter 10: Securing a Loan to Finance

Your Commercial Venture . . . . . . . . . . . . . . . . . . . . . . 163

Deciphering the Broker-Borrower Agreement ....................163

Accounting for Upfront Fees .................................................165

Obtaining Third-Party Reports..............................................167

Verifying a property’s market value

with an appraisal ......................................................167

Plotting the perimeter with a survey .........................168

Inspecting the title........................................................168

Obtaining an engineering report ................................169

Getting a clean bill of environmental health.............169

Navigating the Closing............................................................170

Protecting yourself with title insurance ....................170

Insuring your property ................................................171

Attending to existing tenant rights.............................172

Part IV: Sampling More Creative

Financing Strategies .......................................173

Chapter 11: Financing in a Pinch with Hard

Money and Other Tough Options . . . . . . . . . . . . . . . . 175

Weighing the Pros and Cons of Hard Money .......................176

Perusing the pros..........................................................176

Considering the cons ...................................................177

Managing the Expense of a Hard-Money Loan ....................179

Calculating points.........................................................179

Adding up the interest .................................................180

02_422335-ftoc.qxp 3/11/09 11:50 AM Page xiv

Table of Contents

Subtracting the tax savings .........................................180

Paying back the loan sooner to save money.............181

Locating Local Hard-Money Lenders....................................183

Asking your broker for leads.......................................183

Networking through local investment groups ..........183

Perusing ads in local newspapers ..............................184

Searching the Web ........................................................184

Getting preapproval .....................................................185

Hitting Up Friends and Relatives for a Loan........................185

Grasping the pros and cons ........................................186

Identifying the moneybags in your circle..................187

Drawing up an agreement............................................187

Honoring securities laws .............................................189

Financing Fix-Ups with a Home

Equity Loan or Line of Credit ............................................189

Understanding home equity loans and LOCs ...........190

Maxing out your LOC ...................................................190

Applying for an LOC .....................................................191

Supplementing Your Financing with Credit Cards..............191

Eyeing the pros to credit card use .............................191

Choosing a credit card with low

interest and plenty of perks ....................................192

Chapter 12: Capitalizing on Seller Financing . . . . . . . 193

Buying Property on Contract with a Land Contract...........193

The ups and downs of buying

a property on contract.............................................194

Inspecting the title........................................................195

Beware of the due on sale clause ...............................197

The how-to: What you need to do ..............................197

Protecting yourself against fraud ...............................199

Renting to Own with a Lease Option Agreement................199

Grasping the fundamentals of a

lease option agreement............................................201

Using the lease to earn some cash .............................202

Dealing with the option................................................203

Paying Close Attention to the Forfeiture Clause.................206

Chapter 13: Partnering to Share the Risk

and the Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207

Differentiating between a Partnership

and a Joint Venture .............................................................207

Weighing the Pros and Cons of Partnerships......................208

Finding a Partner with the Right Stuff ..................................210

Scoping out prospective partners..............................211

Checking a prospective partner’s qualifications......212

Making sure your partner has what you need

and needs what you have ........................................213

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xvi

Drawing Up a Partnership Agreement..................................214

Drafting the agreement ................................................215

Complying with the tax code ......................................217

Avoiding Common Pitfalls......................................................217

Chapter 14: Profiting from No-Money-Down

and Other Creative Deals . . . . . . . . . . . . . . . . . . . . . . 219

Financing Your Down Payment with a Second Mortgage ...220

Taking out an 80-20 loan ..............................................220

Disclosing your second mortgage ..............................221

Wholesaling for Fun and Profit..............................................221

Buying and selling options ..........................................222

Assigning a purchase agreement ................................224

Selling the Tax Benefits ..........................................................226

Trading Spaces: 1031 Exchanges ..........................................226

Qualifying for a 1031 exchange ...................................228

Meeting the deadlines..................................................229

Selling Other Equitable Interests ..........................................229

Leaseholds and other rights .......................................229

Naming rights, air rights, and

other unimaginable stuff..........................................230

Part V: The Part of Tens...................................231

Chapter 15: Ten Ways to Avoid Common

Beginner Blunders . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233

Focusing on More than Just a Low Interest Rate................233

Getting Preapproved ..............................................................234

Doing Your Homework: Property Research.........................234

Making a Reasonable Down Payment...................................235

Comparing at Least Three Good Faith Estimates ...............236

Viewing at Least Ten Properties before Making an Offer...236

Checking Your Credit Score before Applying for a Loan ...237

Buying with Your Brain and Not Your Heart........................237

Monitoring the Pulse of Current Market Conditions..........238

Calculating the NOI and DSCR

on Commercial Properties .................................................238

Chapter 16: Ten Steps to Take before Closing . . . . . . . 239

Get and Review a Copy of the Appraisal..............................239

Review the Title Commitment

and Obtain Title Insurance ................................................240

Review All Closing Documents..............................................241

Review a Copy of the HUD-1 Closing Statement .................241

Get an Insurance Policy .........................................................242

Do a Walk-Through on the Property.....................................242

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Obtain Utility Final Readings and Schedule

the Transfer .........................................................................243

Review Updated Tenant Rent Roll ........................................243

Have Certified Funds or Wire Transfer Ready to Go ..........244

Confirm Date, Time, and Location of Closing......................244

Chapter 17: Ten Tips for Surviving

a Credit Crunch . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245

Expand Your Search................................................................245

Choose Properties More Carefully........................................246

Focus on Foreclosures ...........................................................246

Look for Short-Sale Opportunities........................................247

Buy REO Properties ................................................................247

Search for High-Equity Properties ........................................248

Shift from a Buy-Sell to a Buy-Hold Strategy .......................248

Team Up with Your Mortgage Broker...................................249

Offer Your Agent a Bonus.......................................................249

Partner Up and Get Creative .................................................250

Glossary.........................................................251

Index .............................................................261

Table of Contents

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Introduction

eal estate investing is an expensive habit. You need money to

finance the purchase, renovate your fixer-upper, and cover

the holding costs while you prepare to sell or rent the property.

The good news is that it doesn’t all have to be

your money. In fact,

the less of your own money you can use and the more you can

borrow, the bigger the return on your investment. Add the poten-

tial credit and market woes like the first decade of the 2000s, and

investing in real estate also becomes a bit more of an adventure.

Lining up financial resources well in advance of scouring the neigh-

borhood for investment opportunities enables you to pounce on a

bargain and gives you leverage in negotiating the price you ulti-

mately pay for a property. When you place an offer on a house and

other bids come in, the seller may accept your offer of thousands

of dollars less simply because you have the financing in place to

quickly close the deal. Ready cash also frees you to plan and begin

rehabbing the property immediately instead of waiting around for

sluggish loan approvals and credit checks.

If you’re thinking that you can’t possibly get your mitts on enough

cash to finance your venture,

Financing Real Estate Investments For

Dummies

is the book for you. Here you discover the best sources

for investment capital and how to go about tapping into these

sources to fuel your next venture.

About This Book

This book isn’t a get-rich-quick guide to investing in real estate

or a guide or a tutorial on how to buy property with no money

down (although we do cover that topic).

Financing Real Estate

Investments For Dummies

delivers what the title promises — a

treasure map that shows you where to find sources of real estate

investment capital and guidance on how to dig it up.

Ralph and Chip are both seasoned investors. We’ve each built wealth

through investing in real estate — buying and selling fixer-uppers and

buying and renting out both residential and commercial property.

Although we have used our own money on occasion to finance our

purchases and renovations, we’ve primarily succeeded with the

use of other people’s money (OPM). Our grandmothers were our

first financial backers, but we’ve expanded our options since then.

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We have more than 50 years’ worth of combined experience in

buying and selling real estate and securing the financing to do it. In

this book, we share what we know with you, showing you how to

tap into loans from banks; mortgage companies; private lenders;

federal, state, and local government programs; and more. In the

process we cover financing for both residential and commercial

properties.

Conventions Used in This Book

Compared to other books on financing real estate investments,

Financing Real Estate Investments For Dummies is anything but con-

ventional, but we do use some conventions to call your attention

to certain items. For example:

⻬ Italics highlight new, somewhat technical terms, such as hard

money,

and emphasize words when we’re driving home a

point.

⻬ Boldface text indicates key words in bulleted and numbered

lists.

⻬ Monofont highlights Web addresses.

Financing the purchase and renovation of residential properties,

such as homes, is quite different from financing the purchase and

renovation of commercial properties. You deal with different

lenders who use different methods for evaluating your loan appli-

cation and the property you’re planning to buy.

In this book, we cover both types of financing, but you should

know up front the differences between residential and commercial

property:

⻬ Residential: One- to four-family dwellings classify as residen-

tial properties, which qualify for residential financing.

⻬ Commercial: Properties used to conduct business and any

rental properties designed to house more than four families

qualify as commercial real estate. Loan approval for these

properties hinges more on the property’s potential for gener-

ating sufficient income to make the payments than on the bor-

rower’s financial strength.

In addition, even though you see three author names on the cover

of this book — Chip, Ralph, and Joe — the “we” is usually Chip and

Ralph talking. Joe is the wordsmith — the guy responsible for

Financing Real Estate Investments For Dummies

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keeping you engaged and entertained and making sure we explain

everything as clearly and thoroughly as possible.

What You’re Not to Read

Although we encourage you to read this book from cover to cover

to maximize the return on your investment, we realize that in

today’s busy world you may have time to read only the information

pertinent to your situation. If so, you can safely skip anything you

see in a gray shaded box. We stuck this material in a box for the

same reason that most people stick stuff in boxes — to get it out of

the way, so you wouldn’t trip over it. However, you may find the

stories and brief asides uproariously funny and perhaps even

mildly informative (or vice versa).

Foolish Assumptions

We assume you already mastered the basics of investing in real

estate. If you haven’t, we encourage you to pick up a copy of either

(or both)

Real Estate Investing For Dummies, 2nd Edition, by Eric

Tyson and Robert S. Griswold, or

Commercial Real Estate Investing

For Dummies

by Peter Conti and Peter Harris (Wiley).

If you’re interested in flipping houses or focusing on foreclosure

properties, check out

Flipping Houses For Dummies or Foreclosure

Investing For Dummies

by Ralph R. Roberts with Joe Kraynak. If

you’re thinking of becoming a landlord, we strongly encourage you

to first read

Property Management For Dummies by Robert S.

Griswold. Not everyone has the right stuff to be a landlord, but if

you know what you’re getting into before you take on the role, you

can significantly improve your survival odds.

How This Book Is Organized

Financing Real Estate Investments For Dummies facilitates a skip-

and-dip approach. It presents the information in easily digestible

chunks, so you can skip to the chapter or section that grabs your

attention or meets your current needs, master it, and then skip to

another section or simply set the book aside for later reference.

To help you navigate, we took the 17 chapters that make up the

book and divvied them up into five parts. Here, we provide a quick

overview of what we cover in each part.

Introduction

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Part I: Gearing Up for Financing

Your Real Estate Investments

When you become a real estate investor, you’re essentially building

a business; you should build it on a strong foundation. In this part,

we cover the basics, providing you with definitions of standard ter-

minology and concepts you’re likely to encounter, introducing you

to the various sources of investment capital, showing you how to

protect yourself against potential risks, and leading you through

the process of gathering all the documents and other information

you need to apply for financing.

In the process, we reveal the power of using OPM to gain leverage

and expose your own money and other assets to less risk.

Part II: Financing the Purchase

of Residential Properties

In this part, we explore the many residential loan programs cur-

rently available, show you how to compare different loan packages

to find the one that costs the least overall, and lead you through

the loan application process from filling out the forms to closing.

By the end of this part, you should have the financing you need to

start hunting for residential real estate investment opportunities.

Part III: Financing the Purchase

of Commercial Properties

In this part, we introduce you to the most common commercial

property types, so you can choose the type best suited to your

investment goals and evaluate the properties based on their poten-

tial for generating a positive cash flow. We take you on a tour of

some of the unique sources of financing available for commercial

ventures. Finally, we step you through the process of applying for

commercial real estate loans from application to closing.

Part IV: Sampling More Creative

Financing Strategies

In this part, you discover the pros and cons of hard money — cash

that’s generally easier but more expensive to borrow for purchasing

Financing Real Estate Investments For Dummies

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investment properties. We also show you how to finance the pur-

chase through the seller by purchasing properties on contract,

how to partner with an investor who’s cash heavy, and how to

track down no-money-down deals.

These options aren’t for everybody, but when you’re in the market

for investment properties and can’t get your hands on conven-

tional financing, these unconventional sources can be a deal saver.

Part V: The Part of Tens

The Part of Tens is the highlight of every For Dummies title, offer-

ing quick strategies, tips, and insights on whatever subject the

book covers. The chapters in this Part of Tens reveal how to avoid

the ten most common mistakes when financing real estate invest-

ments, which questions you should ask prospective lenders, ten

steps to take to prepare for your next closing, and ten strategies

for surviving a credit crunch.

Icons Used in This Book

Throughout this book, we sprinkle icons in the margins to cue you

in on different types of information that call out for your attention.

Here are the icons you’ll see and a brief description of each.

We want you to remember everything you read in this book, but if

you can’t quite do that, be sure to remember the important points

flagged with this icon.

Tips provide insider insight from behind the scenes. When you’re

looking for a better, faster, cheaper way to do something, check out

these tips.

“Whoa!” This icon appears when you need to be extra vigilant or

seek professional help before moving forward.

Where to Go From Here

Financing Real Estate Investments For Dummies is sort of like an

information kiosk. You can start with the chapters in Part I to

master the basics and then skip to Part II if you’re planning on

financing the purchase of residential property or Part III if your

focus is more on commercial properties.

Introduction

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For a quick primer on financing the purchase of real estate invest-

ments, check out Chapter 1. Chapter 4 is a great place to start if

you’re not sure where to start looking for lenders — this chapter

touches on everything from banks and mortgage companies to pri-

vate lenders and partnering with others who have cash.

We do consider Chapter 6 required reading. All too often investors

get burned because they focus too much on interest rates and not

on other factors contributing to the overall cost of borrowing

money. This chapter offers a quick way to compare two loans side-

by-side to determine which one costs less over the life of the loan.

If you’re planning to invest in commercial properties, Chapter 8 is

also required reading. In this chapter, we show you how to evalu-

ate different types of properties the way lenders do it when you

apply for a loan.

If you’re looking for information on a very specific topic, flip to the

back of the book, where you can find a comprehensive index of key

topics.

Financing Real Estate Investments For Dummies

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Part I

Gearing Up for

Financing Your Real

Estate Investments

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In this part . . .

he key to scoring affordable ﬁnancing and keeping a

bigger chunk of your after-tax proﬁts from real estate

investments is preparation. By understanding the leverage

you can gain using other people’s money (OPM) to ﬁnance

your investments and having all your ﬁnancial records in

place, you increase your odds of securing ﬁnancing with

attractive terms and interest rates.

By understanding tax laws and loopholes before you get

started, you can lay the groundwork necessary to maxi-

mize your tax deductions and exclusions and keep more

proﬁt for yourself. And by understanding the differences

between different types of lenders, you gain access to

additional sources of investment capital you may never

have considered.

In this part, we help you build your real estate investment

venture on a ﬁrm foundation so you have ready access to

cash while minimizing your exposure to risk.

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Chapter 1

Taking a Crash Course in

Real Estate Investment

Financing

In This Chapter

䊳 Gaining leverage with other people’s money

䊳 Deciphering key terms

䊳 Grasping the difference between a home and investment property

䊳 Discovering vital sources of real estate investment capital

䊳 Getting ready to meet your lender

re you eager to set out on the road to building wealth through

real estate? Although we hate to hold you back, we do dis-

courage you from moving forward without the proper preparation.

Our advice doesn’t necessarily mean, however, that you need to

read the entire book from cover to cover before you purchase your

first investment property.

Here, we provide a quick primer on real estate financing along with

what you need to do to secure financing for your real estate invest-

ments. We also provide a generous supply of references to other

chapters in the book where you can find more detailed information

on specific topics. So without further ado, let the real estate financ-

ing primer begin.

Don’t let negative economic and credit information dampen your

desire to invest in real estate. The best time to purchase real estate

is when prices are low. You can still find and secure financing; you

just may need to look and work a little harder and smarter to get it.

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Pumping Up Your Purchasing

Power with Borrowed Money

If you have any reservations about borrowing money to buy real

estate, you need to overcome those reservations by developing a

better understanding of leverage — using borrowed money to buy

more and better properties, thus improving your chances of earn-

ing bigger profits.

In the following sections, we show you why the goal of owning a

property free and clear isn’t such a smart move, reveal the secret

of leveraging the power of borrowed money, and explain how you

can offer “cash” for properties even when financing the purchase.

Although we encourage investors to borrow money to increase

their leverage, keep in mind that borrowing money can carry signif-

icant risks. As an investor, you can take action to minimize the

risks — by carefully evaluating your real estate market and proper-

ties under consideration, overestimating costs, underestimating

profits, developing realistic backup plans, and so on; however you

can never completely eliminate the risk. You have to decide for

yourself what an acceptable level of risk is.

Minimizing your potential by owning

property free and clear

For many Americans, paying off their mortgage early and owning

their home free and clear is the real American dream. Life would be

so much better if they didn’t have to deal with a house payment.

For real estate investors, however, owning property free and clear

means that valuable equity is locked up in those properties —

equity they can use to finance the purchase of other revenue-

generating real estate. Don’t get caught in the trap of thinking that

paying off a mortgage loan is a smart move — it may be a noble

goal, but it’s rarely a savvy strategy.

Maximizing your potential

with other people’s money

Other people’s money (or OPM for short) is money that you borrow

from other people to finance your investments. OPM isn’t much of

a secret. Assuming you own a home, you probably used OPM to

buy it. You may have put down 5 to 10 percent of your own money

as a down payment and then borrowed the rest.

Part I: Gearing Up for Financing Your Real Estate Investments

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In most cases, OPM helps you earn a profit. When you calculate in

the appreciation of the home, the tax savings it represents, infla-

tion, and other factors, you’re likely to earn more money off the

home than you pay out in interest over the life of the loan —

barring a major housing meltdown.

The same applies to your real estate investments. The more OPM

you can put to work for you, the more you stand to earn — as long

as your earnings from it exceed the cost of borrowing it. For more

info about OPM, check out Chapter 5.

Paying cash with borrowed money

In the world of real estate, cash is king. The buyer who shows up

with cash is in a significantly stronger position to purchase a prop-

erty and negotiate an attractive price and terms than a buyer who

shows up needing financing.

Chapter 1: Taking a Crash Course in Real Estate Investment Financing

Dealing with a major credit crunch

The mortgage meltdown, foreclosure epidemic, and global financial crisis that all

came to a head in 2008 led many real estate investors to believe that credit had all

but dried up. Banks were failing left and right, and the United States was forced to

step in with more than $1 trillion in economic rescue funds to keep cash flowing to

individuals and businesses that needed credit. Surely, real estate investors would

be the last on the list for cheap and easy credit.

Actually, the credit crunch didn’t put real estate investors out of business. In fact,

in many cases, it made conditions better for investors:

⻬ When the bubble burst, properties became much more affordable. Investors

could buy better properties for less money.

⻬ As millions of people worked through foreclosure, demand for rental properties

soared.

⻬ Financial institutions, eager to rid their books of empty, expensive, cash-sucking

foreclosures, became more willing to offer great deals. I (Chip) just had a client

pay $82,000 for a brand new property with a market value of about $275,000. The

bank had taken it back from a builder, was more than glad to just get it off the

books, and was willing to finance it with a 15-year loan.

A credit crunch doesn’t mean that financing disappears — it just means that you

probably need to look for it in some unusual places. Even FHA has investor financ-

ing with 25 percent down — and a lot of foreclosures they’re willing to deal on.

Throughout this book, we show you how to tap into these markets — credit crunch

and all.

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When we say cash is king, however, we’re not advising you to show

up with a suitcase full of money. We’re telling you to show up with

preapproved financing — a financial backer who can deliver the

cash on closing day. In other words, although you’re financing the

purchase as explained throughout this book, you’re still placing

yourself in a position to offer cash.

Brushing Up on Basic Real

Estate Financing Lingo

Throughout this book, we toss around some jargon common in the

real estate and mortgage lending industries. To the average con-

sumer, these terms may sound Greek, but we assure you that

they’re part of the English language. In the following sections, we

define the most common and often misunderstood of these terms.

Identifying types of lenders

The moneymen and -women you deal with when securing financing

for purchasing investment property play various roles in the

process. You need to know whom you’re working with:

⻬ Commercial lenders: They’re financial institutions rather

than individuals. They include banks, credit unions, mutual

savings banks, savings and loan associations, and stock sav-

ings banks. (Chapter 9 discusses commercial lenders in

greater detail.)

⻬ Private lenders: A private lender is any individual who loans

money outside the channels of institutional lending. This

person can be a friend or relative, such as your Aunt Mabel,

or an investor. Real estate investors often rely on private

lenders for access to investment capital when banks and

other financial institutions turn them down. (For more about

private lenders, check out Chapter 11.)

⻬ Mortgage banker: Mortgage bankers are financial institutions

that directly fund home loans and either service those loans

themselves (arranging and collecting monthly payments and

managing any escrow accounts) or sell the mortgages to

investors and contract out the servicing of the loans.

⻬ Servicer: The servicer is the institution contracted or

appointed to collect the monthly payments from the bor-

rower. They have to account for all payments and disburse-

ments and provide yearly statements showing all transactions

within a mortgage account to the borrower.

Part I: Gearing Up for Financing Your Real Estate Investments

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⻬ Mortgage broker: Mortgage brokers are licensed by the state

to assist borrowers in finding mortgage lenders, comparing

loan programs, applying for mortgage loans, and securing

financing for purchasing real estate. They act as the eyes and

ears for many different mortgage lenders.

⻬ Loan officer: Loan officers work for mortgage bankers or bro-

kers to assist clients in securing financing for purchasing real

estate. They essentially do the same thing brokers do, but

they have to work for a licensed broker or lender.

⻬ Loan originator: Another name for a mortgage broker or loan

officer.

See Chapter 4 for more on these types of lenders.

Grasping different loan types

Throughout this book, we introduce you to various types of loans

for financing the purchase of real estate, including conforming and

nonconforming loans, jumbo loans, and hard money loans. In the

following list, we define the most common loan types and toss in

some additional information that you may find useful.

⻬ Conforming loan: A conforming loan is one that meets the cri-

teria set forth by Fannie Mae or Freddie Mac — the organiza-

tions that purchase the loans and then package them up to

sell on Wall Street. In general, to qualify for a conforming loan,

the borrower must

• Show sufficient income to cover monthly payments.

• Have enough cash for a down payment and reserves.

• Have a good credit history.

For additional details about conforming loans and current cri-

teria, visit the Fannie Mae Web site at

www.efanniemae.com.

⻬ Nonconforming loans: These include everything else outside

the Fannie/Freddie box. Sometimes referred to in the market

subprime or even exotic loans, they’re bought by other

financial companies or investment banks and packaged to be

sold to Wall Street investors. When the subprime market suf-

fers, as it did starting in 2008, far fewer of these types of secu-

rities make it to market.

⻬ Conventional loans: These loans are outside the sphere

of the government. In other words, they’re not FHA- or VA-

secured loans and aren’t underwritten by any government

agency.

Chapter 1: Taking a Crash Course in Real Estate Investment Financing

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⻬ Jumbo loans: As its name suggests, a jumbo loan represents a

lot of money — specifically, more money than you can borrow

under the limits of a conforming loan.

⻬ Hard money loans: Also referred to as bridge loans, they’re

typically short-term, high-interest loans that enable investors

to get their mitts on some cash in a hurry. You can expect to

pay several points upfront (a

point is equivalent to one per-

cent of the total loan amount) plus up to double the going

interest rate. (For more about hard money and strategies for

using it to your advantage, check out Chapter 11.)

⻬ Government loan programs: The government isn’t really in the

business of loaning money to homeowners and investors, but

it facilitates the process for lenders by insuring the loans — if

the borrower defaults on the loan, the government steps in to

cover any losses for the lender.

The two most common government loan programs are Federal

Housing Authority (FHA) and Veterans Administration (VA)

loans. But federal, state, and local governments also provide

loan programs to encourage investment in disaster areas and

neighborhoods that they’re seeking to develop. Within the

FHA and VA programs are some great hidden opportunities for

investors. (See Chapter 4 for more about specific government

loan programs.)

Brushing up on important legal lingo

Even though real estate deals are generally classified as financial,

they involve plenty of legalities, especially in relation to who owns

the property or has a stake in it. Although real estate–related legal

terms can fill an entire dictionary, you should have a working

knowledge of the following three:

⻬ Deed: A deed is a legal document that grants rights to a prop-

erty. Whenever you purchase a property, whoever is handling

the closing must file the deed with the county’s register of

deeds to make the transfer of ownership official. As the offi-

cial owner, you have the right to borrow against the property

and transfer your rights of ownership.

Be careful signing any deed, especially a

quitclaim deed (the

deed that allows a property’s owner to relinquish all rights to

the property). Real estate con artists often use the quitclaim

deed to hijack property from unwary owners. They may hide

a single page quitclaim deed in a stack of papers, fooling the

owner into signing the document without knowing what

they’re signing. Then, they run down to the register of deeds

and file the deed, making themselves the new owners, so they

can take out bogus loans against the property.

Part I: Gearing Up for Financing Your Real Estate Investments

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⻬ Lien: A lien is a legal claim that a creditor holds against a

property in lieu of payment. Several parties can place a lien

on a property, including the lender who holds any first or

second mortgage, the county tax assessor (for unpaid taxes),

and contractors (if they financed the repairs or renovations).

As an investor, knowing who (if anyone) has a lien against a

property you’re purchasing and the monetary value of that

lien is important. All lien holders need to be paid in full upon

sale of the property. If the property has a lien against it that

the seller fails to disclose, you may become liable for paying it

when you take ownership of the property.

⻬ Promissory note: Whenever you borrow money, you have to

sign a promissory note pledging to pay back the loan in full

according to terms of the loan, which always specifies a dead-

line for full payment. Think of a promissory note as an IOU (as

in “I owe you” this amount of money).

The promissory note is your pledge to pay back the loan. The

mortgage or deed of trust names the property as collateral in

the event that you default on the loan.

Chapter 1: Taking a Crash Course in Real Estate Investment Financing

Who gets first dibs?

In the event of a foreclosure, certain liens take

precedence

over others, meaning

that when the property is sold at auction, certain lien holders are paid off first:

⻬ Tax lien: The proceeds from the foreclosure sale pay off any unpaid property

taxes first.

⻬ First mortgage: If any money from the proceeds of the sale remain, it pays off

the first mortgage or as much of the first mortgage as possible. This is also

referred to as a

senior lien.

⻬ Second mortgage: If the homeowner took out a second mortgage, any remain-

ing proceeds from the sale go toward paying it off. Any second (or third or

fourth) mortgages are also referred to as

junior liens

⻬ Construction liens: If money still remains, it goes to the next lien holders in order

of precedence.

⻬ Homeowners: After all the lien holders receive their cuts, the foreclosed-upon

homeowners get the remaining crumbs, which can actually be quite a chunk of

change if they had a lot of equity in the property.

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Pointing out mortgage concepts

When you take out a loan, the lender requires something of value

(collateral) to make sure it has something valuable to sell and

recoup its investment if you default on the loan. This collateral is

officially presented in the form of a mortgage or deed of trust

depending on the jurisdiction:

⻬ Mortgage: A mortgage is a contract between the lender and

borrower that gives the lender the right to foreclose on the

property in the event that the borrower defaults on the loan.

⻬ Deed of trust: A deed of trust is a mortgage contract that

places control of the deed in the hands of a third party — a

trustee. The trustee has the power to foreclose on the prop-

erty in the event that the borrower defaults on the loan.

The mortgage market is large and complex, but it consists of two

main divisions: a

primary and a secondary mortgage market.

⻬ Primary: This is the market in which you do business. It con-

sists of financial institutions that lend you money.

⻬ Secondary: This is the market where institutional lenders and

Wall Street investors converge. The primary lenders who actu-

ally loan money to homeowners and investors turn around

and sell the mortgages or deeds of trust to investors. This

gives the lenders more money to make available to borrowers.

Examining equity

Equity is the amount of money you’d have if you sold the property

today and paid off the balance due on the loan. More importantly,

as an investor, you can pull equity out of a property by borrowing

against it. This power enables you to put that equity to work for

you in other investments.

Thanks to the credit crisis in 2008 and 2009, the equity require-

ments to obtain financing are growing. Lenders are taking a closer

look at market values, especially in what they call

declining areas —

areas showing a pattern of recently declining housing values. As an

investor, you should be doing the same thing. Be cautious when

calculating equity positions and profit margins.

Although we encourage investors to tap the power of equity, keep-

ing some equity in a property (especially the home you own) is a

good idea. Having equity to borrow against in the event of a finan-

cial setback may save you from foreclosure and bankruptcy.

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Looking at loan-to-value (LTV)

The loan-to-value (LTV) is the ratio of the total loan amount to

the value of the property. If you’re buying a $200,000 home with

$40,000 down and applying for a $160,000 loan, the LTV would be

$160,000 ÷ $200,000 = 80 percent

Generally speaking, lenders want to see lower LTVs for investment

properties than for homes because a lower LTV provides more of a

buffer to cover the increased risks inherent in investment proper-

ties. Check out Chapter 3 for more about calculating the LTV and

how lenders use this number to evaluate risk.

Distinguishing Investment

and Home Financing

Your first real estate investment should be your own home. In fact,

if you don’t own your home, we advise you to put down this book

and pick up a copy of

Home Buying For Dummies by Eric Tyson and

Ray Brown (Wiley) first. Owning your own home carries the least

risk and the most potential tax benefits while bringing you up to

speed on the basics of real estate investing and ownership.

After you’ve purchased a home, you should have a fairly good

understanding of the mortgage loan application and approval

process. (We provide a refresher course in Chapter 7.) However,

real estate financing differs quite a bit when you take on the role of

investor rather than homeowner. You and the lender take on more

risk. As a result, you can expect to pay more for the privilege of

borrowing money. In addition, your borrowing strategy is likely to

change. In the following sections, we cover these differences in

greater detail, so you know what to expect before diving in.

Paying a premium for riskier

investment loans

When you invest in your own home, you literally have a vested

interest in making payments — if you don’t, you lose the roof over

your head. On the flip side, if you lose an investment property, it

may be painful, but it’s never

that serious, and lenders are well

aware of the difference. For them, investment loans are riskier

propositions. To mitigate the risk, they generally

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⻬ Require a larger down payment.

⻬ Demand a larger loan-to-value ratio. (See “Looking at loan to

value (LTV)” earlier in this chapter.)

⻬ Charge more interest upfront in the form of points.

⻬ Charge a higher interest rate.

⻬ Require proof that you have reserves or liquid assets available

in case things don’t go as planned.

The actions that lenders take to mitigate the risks and the interest

rates and fees they charge vary greatly depending on the borrower

and the deal that’s on the table. Just make sure you have all the

documentation and figures ready when you meet with your lender

for the first time, as explained in Chapter 3.

Using quick cash to

snag bargain prices

When you’re shopping for a mortgage to buy a home for your

family, you’re usually looking for a low-interest package, no or very

few points, and attractive terms. With investment properties,

cash

flow

trumps interest rate. In other words, access to cash is often

more important than the cost of the loan. To find out more about

the relative importance of cash flow and how to shop for loans

with the lowest interest rates and fees, see Chapter 6.

If the numbers work, what you pay in interest doesn’t matter.

Interest is just another expense. If you subtract all your expenses

and can still earn the profit you want, paying thousands of dollars

in interest over a relatively short period is acceptable.

Accounting for taxes on your

capital gains (or losses)

When buying and selling a primary residence, you don’t have to

think too much about the tax ramifications of the transactions. In

the United States, a huge chunk of any profit you earn from the sale

is usually tax exempt — up to $250,000 if you own the home your-

self or double that if you and your spouse sell the home.

However, when you’re selling investment real estate, any profits

are subject to capital gains taxes. During the writing of this book,

profits from real estate investments were taxed as follows:

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⻬ Long-term capital gains: 15 percent if you hold the property

for at least a year and a day.

⻬ Short-term capital gains: 35 percent if you sell the property in

fewer than 12 months from the date you purchased it.

⻬ Income tax: If profits from investing in real estate are your

sole income, the IRS may consider it your job and tax your

profits as income, complete with an additional 15 percent in

self-employment tax.

We’re not tax experts. Consult a CPA who has experience dealing

with real estate investors for details on how the government is

going to tax your profits and for suggestions on how to reduce

your tax burden. Your measure of success isn’t how much you

gross but how much you net. By reducing your tax bill, you can sig-

nificantly increase your net gain.

Protecting your personal assets

Just like most things worth doing, real estate investing exposes

you to risk. Perhaps the biggest risk is that you’re working with

borrowed money from lenders who expect you to pay it back. If

you make a lousy investment decision or an investment goes belly-

up despite your best efforts, lenders are going to do everything

legally possible to collect their money.

You also face the ever-present risk of litigation — having a dis-

agreement with a buyer, seller, tenant, contractor, or someone else

that eventually leads to a costly lawsuit.

Eliminating risk isn’t possible, but you can take several measures

to lessen the risk, including operating through an LLC, transferring

personal assets to someone else, or having a qualified attorney

cover your back. Check out Chapter 2 for more details.

Exploring Common Sources

of Investment Capital

You probably picked up this book because you want to start

investing in real estate, but you don’t know where to dig up the

cash to do your first deal. In the following sections, we show you

where to start digging.

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Tapping your own cash reserves

If you’re single, or you and your significant other are on the same

page about this real estate investing thing, cracking into your nest

egg to finance your investments may be the quickest way to get

your fingers on some investment capital.

It’s also the riskiest option, because if anything goes wrong — you

get laid off or fired, become too ill to work, or encounter unex-

pected expenses — you have fewer reserves to keep you afloat. In

addition, limiting yourself to your own resources also limits your

purchase power — you have to buy houses in a lower price range

and may not have sufficient cash to properly renovate the property.

A great way to ruin a relationship is to bet the farm on big profits

without the knowledge and complete agreement of your spouse or

significant other. If your investment doesn’t pan out (and even if it

does), the other person may take offense at not being consulted.

Even with these caveats, many beginning investors have gotten

their start by financing their own ventures — partially or in full.

And you want to know about these resources if you need some

quick cash in a pinch.

Clearing out your bank accounts

Having a few thousand dollars socked away in a savings account is

always a good idea, just in case you run into a cash flow problem. If

that house you bought and fixed up is taking a few months longer

than expected to sell, your little nest egg can help cover the pay-

ments until you find a buyer.

Use your savings as a reserve, not as your main mode of financing.

Having some cash to fall back on can save you in a pinch.

Borrowing against the equity in your home

As your home’s value rises and you pay down the principal, you

build equity. You can often borrow against this equity by taking out

a home equity loan or line of credit and then use the money for

whatever you want, including purchasing other real estate. The

recent credit crisis has made it harder to find these loans, but

they’re still out there for well-qualified borrowers.

We don’t recommend that you cash out all the equity in your

home, but if you have a substantial amount of equity, cashing out a

portion of it can help you come up with a down payment or cover

the cost of repairs and renovations. (For more about home equity

loans and lines of credit, skip to Chapter 11.)

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Financing investments through a self-directed IRA

More and more investors are choosing to set up self-directed IRAs

and other types of retirement accounts that enable them to invest

in real estate rather than in stocks and bonds. The reasoning: Real

estate often provides a better and sometimes even more secure

return on your investment.

With a self-directed IRA, you can buy and sell properties out of

your retirement account. Setting up a self-directed IRA, however, is

no simple matter. Typically, a trust company manages the money

and properties in the account, and all profits and losses from your

investments must stay in that account. Withdrawing money from

the account results in the same IRS penalties you have to pay if

you withdraw money from any type of retirement account.

Consult your financial advisor and accountant for details about

using a self-directed IRA to finance your real estate investments. If

a self-directed IRA isn’t an option, you may be able to borrow

money against your retirement account. Keep in mind, however,

that borrowing against your retirement savings places those sav-

ings at risk, as does any other investment.

Charging expenses on your credit cards

Maxing out your credit cards to purchase a car, clothes, electron-

ics, groceries, and other items that provide no return on your

investment is never a good idea. Using your credit cards to pur-

chase investment properties that offer a solid, relatively quick

return on your investment, however, can be a savvy (though risky)

financial move.

Consider credit cards a last resort to cover the costs of repairs and

renovations if financing is tight near the end of a project. With this

strategy, your investment activities can directly affect your per-

sonal finances, which increases your exposure to risk. For more

about this option, check out Chapter 11.

Borrowing from commercial lenders

One of the best ways to finance the purchase of investment proper-

ties is to meet with a qualified mortgage broker who can help you

find and evaluate various loan programs. These plans are often

your best deals — costing the least in upfront fees and interest.

For more about finding commercial lenders, check out Chapter 4. If

you’re investing in residential property, Chapter 5 reveals the vari-

ous residential loan programs to choose from. If you’re buying

commercial property, turn to Chapter 9 for guidance on choosing

the right loan program.

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Don’t confuse “commercial property” with “commercial lender.” A

commercial property is any property that isn’t a one- to four-family

residential dwelling. A

commercial lender is an institution (as

opposed to an individual) that loans money. In other words, you

can use a commercial lender to finance the purchase of residential

investment property.

Obtaining a hard money loan

When banks and other financial institutions turn down your

requests for investment capital (or you don’t have the time to con-

vince them that a deal is pure gold), consider borrowing money

from a hard money lender, as explained in Chapter 11.

One of the main advantages of a hard money lender is that the

person is likely to accept the property you’re buying as all the col-

lateral needed to secure the loan, so you don’t have to place your

home at risk.

Financing your purchase

through the seller

Property owners who are eager to sell and don’t need all the cash

at once are often willing to finance the purchase themselves. This

tactic enables them to profit in two ways — by selling you the

property for more than they paid for it and collecting interest from

you. Seller financing take either of the following forms:

⻬ Land contract: A land contract is like a mortgage, except the

seller acts as the bank.

⻬ Lease option agreement: A lease option agreement is like a

rent-to-own deal — you lease the property for a specified

period, at the end of which time you have the option to buy it.

For more about seller financing, check out Chapter 12.

Taking on a partner

Whenever you don’t have something (like money, skills, time, or

talent) to accomplish a particular goal, you can acquire those

skills, buy or hire them, or create a partnership with someone who

already has what you need. If you have something someone else

needs and they have what you need, you have what it takes to form

a mutually beneficial relationship. For details on how to partner

with someone who has the cash you need, check out Chapter 13.

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Choose a partner as carefully as you choose a spouse. Partnerships

often end when one person scams the other or disagreements arise

over who’s putting more into the projects and who’s getting more

out of them. Have your attorney write up a contract, complete with

a prenuptial type agreement stating how all the assets will be

divvied up in the event that you part company.

Prepping to Meet with a Lender

Walk into a bank empty-handed and explain to the loan officer that

you need a loan to start investing in real estate, and we can almost

guarantee that you’ll be laughed out the door. Before you even

think about meeting with a prospective lender, get all your ducks in

a row. Copy all the financial documents lenders are going to ask for

and construct a fairly detailed plan on how you’re going to profit

by investing in real estate. This section gives you an overview of

what you need to do before visiting your lender. Chapter 4 pro-

vides complete in-depth info.

Gathering paperwork and other info

Before approving your request for a loan, lenders want to know

whether you’re good for the money — how likely you are to make

the monthly payments and pay back the loan in full. For investors,

this means two things:

⻬ You’re in pretty good financial shape right now and have a

fairly clean credit history.

⻬ The property you’re planning to buy is more than worth the

money you’re borrowing to pay for it, and (if you’re going to

be renting out the property) it will generate sufficient income

to more than cover all your expenses along with the monthly

payments.

To verify your creditworthiness for yourself and be sure you have

all the documents and other information your lender requires, stuff

a folder full of a copy of each of the following items:

⻬ Credit reports from all three credit reporting agencies

⻬ A net worth statement (assets – liabilities = net worth)

⻬ A debt ratio statement (ratio of what you owe to what

you own)

⻬ Last two months’ bank statements

⻬ Last 30 days’ pay stubs

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⻬ Last two years’ federal tax returns and schedules

⻬ Statements of any business income

⻬ Appraisal or comparative market analysis for the property

⻬ Cash flow analysis of the property

⻬ Loan-to-value ratio of the property

⻬ Zoning information for the property’s location

⻬ City and county records for the property

Crafting a business plan

Real estate investors often scoff at the idea of creating a business

plan

— a detailed presentation that shows how an investor plans

to purchase a specific property and earn a profit from it. Investors

often just want to buy and sell and rent out property and make a

lot of money — that’s the plan. They don’t like to think of them-

selves as pencil-necked pencil pushers. If they feel in their gut that

a property is a solid investment, that’s good enough for them.

At least that’s the false image that many people have of investors.

The most successful investors, however, do the math. They crunch

the numbers. And if the numbers don’t work, they don’t do the deal.

Do your homework. Do a comparative market analysis of the prop-

erty to make sure it’s worth what you think it’s worth. If you’re

buying rental property, check the rental history of the property —

the owner’s tax records showing income and expenses. Craft a

business plan showing exactly how this property is going to be a

revenue generator.

Part I: Gearing Up for Financing Your Real Estate Investments

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Chapter 2

Shielding Your Personal

Assets from Investment Risks

In This Chapter

䊳 Grasping the need to cover your assets

䊳 Investing as a corporation to reduce your exposure to risk

䊳 Assigning ownership of certain assets to others

䊳 Avoiding collateral and cross-collateral damage

䊳 Dodging real estate and mortgage fraud

unny thing about lenders — when you borrow money from

them, they expect you to pay it back. To ensure repayment of

a loan, the lender usually requires that you sign a promissory note

and a mortgage or deed of trust. The

promissory note is your per-

sonal promise to repay the loan in full. The

mortgage or deed of

trust

names certain property as collateral for the loan.

If you happen to

default on the loan (fail to make payments as stip-

ulated), the lender has the right to

foreclose (sell your property to

the highest bidder). If the lender can’t sell the property for at least

as much as you owe on it, it may be able to sue you for the differ-

ence

(deficiency) in jurisdictions that allow deficiency judgments.

As an investor, you want to limit the assets that the lender has the

right to seize in lieu of payment. If you fail to make payments on a

loan you took out to purchase an investment property, for exam-

ple, you want to make sure that the bank can’t take possession of

the home you live in, other businesses you own, or other assets,

such as your car. To prevent the lender from going after personal

assets and other business assets as payment, you need to

shield

those assets — keep them legally and financially separate from

your investment properties. In this chapter, you discover various

strategies for doing just that.

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