Income Property Financing
The Proper Financing Is a Key Ingredients to Real Estate Profitable Opportunities
By
Jan 7, 2006, 10:15

A key ingredient of making a sound purchase is acquiring good financing. Good financing is so critical to real estate profits because acquiring certain types of financing allows you to not only earn a profit on it, but also to have the advantage of built-in flexible financing. On the other hand, if you involve yourself with the wrong financing, you'll face higher costs and inflexible loan terms, which inhibit the sale of your property.

Loan Assumption: 

The Wisest Choice The most advantageous arrangement is usually to assume an existing loan, especially if it carries a low interest rate. Certain existing government-backed loans (originated by previous owners) and, in some rare cases, existing conventional loans are fully assumable without credit qualification. Loan assumption is far less expensive and cumbersome than creating new financing under the other customary methods. Assumption of existing loans requires only a small assumption fee of about $50, as opposed to excessive loan origination fees charged by conventional lenders. (Total loan origination costs usually are 4 percent of the loan amount; thus, a loan of $100,000 would cost $4,000.) 

Loan assumption also avoids the hassles of credit reports, appraisals, and employment verification. In other words, loan assumption means no excessive loan fees, no questions, and only a small assumption fee. Not only is loan assumption attractive from a buyer's point of view, but as a seller, you have a built-in advantage because the loan you assumed as the buyer is now fully assumable when you sell. 

Another advantage is that you can later "wrap" this existing loan when you sell at a much higher interest rate, and make a profit on the spread (difference in interest rates). 

Another edge that loan assumption has over other methods of financing is the fact that an assumption merely takes a few days to close, as opposed to other methods of financing, which can take 60 to 90 days to close the transaction. The delays involving new loan origination are very frustrating to investors and can easily be overcome by the smart investor who uses the ease, simplicity, and greater profitability of loan assumption.

Leverage

Part of acquiring the proper financing is the use of leverage. Leverage is the ability to use a small amount of cash to acquire a significantly greater value in assets, such as real estate. Zero leverage would be a full-cash purchase; a purchase 90 percent leveraged would combine a 10 percent down payment with 90 percent financing. Due to the impact of inflation and appreciation on real estate values, you can achieve the greatest yield on your invested dollars by getting as much leverage as possible when purchasing real estate.

As a simple example of leverage, let's look at an investment using 90 percent leverage (a 10 percent down payment), as opposed to purchasing the same property with zero leverage.

Suppose you purchase a property for $50,000 with a $5,000 down payment (10 percent), and a year later you realize an increase in value of 10 percent. Therefore, the property is now worth $55,000. Because you put only $5,000 down on the property and it appreciated $5,000, you realized a 100 percent return on investment ($5,000 return divided by $5,000 invested). 

Now suppose you purchase another property for $50,000 cash (zero leverage), and a year later that property also appreciates to a value of $55,000. In this case, your investment is $50,000, the appreciation is still $5,000, but the return (yield) is only 10 percent on investment ($5,000 divided by $50,000).

From this example, it is easy to see the value of leverage. About the only time a 100 percent cash purchase would be advantageous is when you can buy a property at substantially below market value. Then you can refinance the cash purchase in order to recoup the majority of the cash investment.

To succeed and profit at real estate investing, you must view the financing of real estate as a joint venture with lenders.

However, as the investor, you don't have to share with the lender the profits realized; you are only required to pay lenders the interest on their money. In other words, the debt you incur on a particular property is not really a debt you will pay back with your hard-earned money, but actually a debt that will generate income and appreciation and that you will pay back with a tenant's money after renting the property out and earning yourself a subsequent profit.

Keep in mind that even giant corporations, such as General Motors, which have an abundance of surplus cash, finance their real estate purchases so as to improve their return on investment through leverage.