In the game MONOPOLY, “Money can be loaned to a player only by the Bank and then only by mortgaging a property. No player may borrow from or lend money to another player… In life away from the game, getting a mortgage can be a complicated, tedious, nail-biting and hair-pulling ordeal. In MONOPOLY, it’s quite simple. Unimproved properties can be mortgaged at any time. No haggling or negotiation is necessary – or, for that matter, allowed. The ‘Mortgage Value’ is printed right on the property deed.”
– Alan Axelrod, Everything I Know About Business I Learned from MONOPOLY
In less than two weeks, I will be over at Julie’s parents home on Salt Spring Island to celebrate Christmas. I fully expect that we will play at least one game of MONOPOLY. It’s not just family fun for the Broad’s though. Her parents have been investing in commercial and multi-residential real estate for over 25 years. It’s never a relaxing game. Everyone is out to win. It’s not just about pride … it’s about proving your real estate investing prowess, or at least it feels like it!!
The reality is that MONOPOLY is much simpler than real life. Thankfully, unlike in MONOPOLY, there is more than one way to finance a property. You can ask your father-in-law or you can get a first and second mortgage. You can assume someone else’s mortgage or get financing from the vendor.
And best of all in real life, you can get a mortgage broker working for you, and they will handle the time consuming part of shopping the mortgage around and coming up with the best options given your personal situation. It’s not to say that you can’t get a good deal if you go directly to your bank, but what we’ve found is that banks have a well defined box that they want everyone to fit in, and as a real estate investor, you probably aren’t going to fit nice and neatly into that box. Maybe on property #1 you will, but pretty soon you won’t. And, a mortgage broker that works with real estate investors will know who to talk to and where to find the type of mortgage product you need. (In October we did a five part interview with our mortgage broker which you can check out on our website…we covered everything from buying a property in a corporation to Americans buying in Canada and Canadians buying in the U.S.).
What financing options are available to you?
Hopefully after last week, where I discussed down payments for your real estate investments, you understand that I am not going to teach you how to do “no money down” or 100% financed deals. They are so risky and stressful that it’s just not the way we would recommend you get into real estate. So, I am not going to specifically address the questions our readers have sent in about getting 100% financing.
“Where to start? What’s the best way to finance?” – reader from Loveland, COInstead, I am going to focus on the many questions that revolved around just understanding the basics around financing property purchases:
- “How to talk to mortgage guys to come up with creative ways to do deals.” – reader from Johns Creek, GA
- “How do you get a hold of the necessary funds to fund a deal/property with the market as it is right now.” – a reader from Tempe, Az
First, let me say that the banks ARE still loaning money. The tap has not turned off, so don’t throw your hands up and say “I’ll never get a loan”. That said, it is a bit more difficult, but with interest rates at historic lows, it’s a pretty darn good time to at least give it a try. And if you aren’t successful with the bank, know that there are private money lenders, sellers willing to finance and a few other options. If you don’t like these alternative options as much, you can always use one of them for financing for a year or two, and then try the bank again once the smoke has cleared from the current financial crisis.
So, let me take you through the essential things you need to know before you set out to fund your investments.
The Most Common Sources of Financing Real Estate Deals:
Banks:Well, actually, I should call these traditional lenders because it does include credit unions and trust companies, but mostly you’ll think of banks when you think of a traditional lender. This is typically your cheapest source of funds, but they have very rigid rules about what qualifies for a loan from them.
Sellers:Also called Vendor Take Back Financing or VTB’s, seller financing is basically when the seller of a property will essentially leave some of their equity in their property (instead of taking cash for it) and the buyer will borrow it from the seller and make monthly payments towards paying it down. You can typically expect to pay the seller a slightly higher rate than you’d pay a traditional lender, but many sellers are willing to do this because they get a guaranteed return on their money and their money is secured against the property. It’s also the only way certain properties will sell. If the buyer doesn’t make payments, the seller can often just take back the property. However, this only works when the seller has quite a bit of equity in the property or owns the property completely.
Secondary Lenders:Companies that provide higher interest rate loans to candidates that do not fit into the traditional bank boxes.
Equity Lenders:More common in commercial real estate than in residential real estate investing, but it’s essentially a company that will loan money based on the value of the property alone. They usually will loan up to 60% of the property value no matter who is the borrower.
Private Lenders:When you think of private money you might think of the mob or someone backed up by a tough guy with a baseball bat. Maybe that is because they are also called “hard money lenders”, but the reality is that it’s anybody or any company that has money in a fund that they will loan to an investor. You can expect to pay a higher interest rate and often a fee for their loan, but there are many options in private money.
With the exception of Equity Lenders and possibly sellers (VTB’s), every other lender on the list will pull your personal credit score, so make sure you know your credit score and are working on increasing it.
For us, we typically try for seller financing on every deal. We have often been able to get the seller to take a second position (which means they will provide a small portion of the financing and will sit second on the mortgage behind the bank). We’ve only been able to get complete seller financing once. Usually the vendor wants their cash out for a different purchase or they just don’t have enough equity in the property.
When properties aren’t selling, which is the case in many areas in North America right now, motivated sellers who have 50% or more equity in their properties will be more likely to hold a short term VTB just to sell their property…so you should always ask!
You will find that every deal is different. Our first two deals were financed by banks with 10% down and 5% down respectively. Our third deal we assumed the mortgage from the seller and got a small loan from our real estate agent that was secured against the property.
We’ve done seller financing on several deals, but to be totally open with you, most of our investments have been purchased using our mortgage broker who shops us to every traditional lender she knows, and finds us pretty darn good rates with lenders who are willing to get creative!
Next week, as we roll into part 4 of our “Rev N You Readers Biggest Real Estate Investing Questions” series, we are going to answer the biggest question we get asked at social gatherings: “Is now a good time to buy?”. The answer might surprise you. Sign up for our Rev N You with real estate newsletterto make sure you get the article!
Published December 15th, 2008