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How Does Equity Work? Things You Should Know

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Home equity is where homeowners gain wealth through living in their home. Equity can go up when the property value increases, and it can go down as you pay your mortgage. You can think about it as the part of your home that you truly own in comparison to your mortgage.

It sounds complicated, but it’s really not. We’re going to break down equity and help you answer the question of “how does equity work?”

Quick Navigation
What Is Home Equity?
How Does Home Equity Work For Me?
What Are the Risks of Borrowing Against Home Equity?
What Is a Home Equity Line of Credit?
What Is a Home Equity Loan?
Home Equity Line of Credit or Home Equity Loan?
What Questions Do I Need to Ask?
Going Forward with a Line of Credit or a Home Equity Loan

What Is Home Equity?

First, think about how much your mortgage was originally financed for and then look at your current balance. The difference is the initial equity that you have in your home. To give you an example, imagine you purchased your home for $$, and your current remaining balance is $$. That gives you $ in equity, but it doesn’t stop there.

Now, imagine that you purchased your home five years ago and since then, your property value has increased to $$$ for your home. That means if you were to sell your home, you could ask for $$$ because it reflects the current property value.

Take that $$$ and subtract your current balance on your mortgage, the $$ , and you end up with a difference of $. That $is considered to be your home equity.

How Does Home Equity Work For Me?


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To build your home equity is going to take time, and it can just as easily plummet like many experienced when the housing bubble burst all those years ago. Like everything else, though, if you can hold on to your home through the rough patches, the value will go up again eventually.

Equity can be compared to something like a 401k or savings bonds. The money is there, but you can’t spend any of it without some work. As an example, you can borrow against the equity in your home through something called a home equity line of credit or a home equity loan. Anything borrowed is added to the existing principal.

Another way to access the funds is to sell your home or other property. Being able to access your funds is helpful in case of an emergency or when you need to make immediate improvements to your home. Bonus – you can use home improvements as a tax deduction on your tax return.

What Are The Risks Of Borrowing Against Home Equity?

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A line of credit and home equity loans put your home down as the collateral to borrow the money from the bank. That’s a serious commitment to paying off the loan because if you were to become unable to make payments, your house could go into foreclosure.

Something else to consider is the way the property value changes. If you borrow $ against home equity, then your remaining balance of $$ climbs to $$$ that you will have to pay. If your home value drops to $$$, then you owe more than the home would be worth.

If you have to move or sell your home when you’re in that kind of scenario, then you are going to have to face the possibility that you may lose significant money on the sale. The result could be that you won’t be able to move as you wanted.

Obligations for Lines of Credit, Home Equity Loans, and Mortgages

By now, you understand that a line of credit or home equity loan is going to be money taken out against your home. Like your original mortgage, the ramifications are huge if you can’t make the payments. If you’ve ever heard of multiple mortgages, the additional loans on top of the original mortgage are what those are referring to.

The good news is that home equity loans have a much shorter term compared to mortgages. While a 15-, 20-, or 30-year mortgage are standard fare for mortgages, a loan or line of credit is typically going to have a repayment term of just a few short years.

Having the money available in home equity isn’t enough to get a loan or a line of credit. You will have to have your credit checked, and your debt-to-income ratio will also be verified. If your bank or other lender deems you to be worthy, then you’ll qualify for one or the other.

What Is A Home Equity Line Of Credit?

Most people have credit cards and understand that you use a credit card to make purchases that you have to pay off later. A home equity line of credit functions much the same way. They have draw periods or a limited amount of time that you can withdraw funds up to the approved limit.

You can usually choose between an interest-only period or a period where you can pay interest as well as the principal. The first is going to take you longer to pay back while the second option is going to allow you to pay your credit line back at a faster rate.

At the end of the draw period, you have to pay everything back, and you are not likely to be able to renew your line of credit until after it has been paid. You may also be stuck with an adjustable interest rate which can impact the amount you have to pay back.

What Is A Home Equity Loan?

A home equity loan gives you a lump sum that is due back at a fixed rate over a pre-determined time frame. It works similarly to a personal loan except the collateral is your home. You will be expected to pay a set monthly amount to the tune of an included compound interest rate.

Compound interest means that you’ll be paying interest on your interest with each subsequent year. It is not unusual for a loan of $ to result in paying back closer to $ once everything has been paid back.

Home Equity Line Of Credit Or Home Equity Loan?

Deciding if you want a line of credit or a loan is going to depend on why you want or need the funds. If you need money to maybe pay for an extravagant event, like a wedding, and don’t intend to borrow anything else, then a loan is going to be best. It will have an adjustable rate, but at least you’ve only pulled what you need.

On the other hand, let’s say you’re going to help your son or daughter pay for their college tuition every semester. With that in mind, you may want to get a line of credit that you can draw from and pay back as needed for every semester. It allows you to borrow the money as you need it. Smaller amounts that are borrowed periodically also end up costing less than a loan because you can pay them back faster.

What Questions Do I Need To Ask?

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When you’re asking yourself how does equity work, you also need to ask yourself a few questions to help you decide how to best use your equity. Decide when you need it and for how long you need to have access to the funds. Credit card consolidation is more of a short-term purpose while college tuition is more of a long-term scenario.

You’ll also need to determine what kind of monthly payment you’ll be able to handle as well as whether or not you can control yourself if you have an open line of revolving credit. Don’t forget to make sure you know your rates, repayment periods, and any other possible consequences.

Missing payments or not paying at all can result in losing your home, so you need to be sure you can reliably make the payments. There may be other restrictions in place, too, like not being able to rent out your home for the duration. Whatever you do, make sure you read the fine print.

Going Forward With A Line Of Credit Or A Home Equity Loan

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If you can justify, and with good reasons, why you should dip into your equity, answering “how does equity work” can help you make an informed decision. It’s important to know the possible consequences as well as the benefits of going forward with a home equity line of credit or a loan.

Ask questions, research your market value and current creditworthiness, and then you’ll be better equipped with necessary knowledge before entering a repayment agreement you may or may not be able to live with.

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Filed Under: Financing Property

Penny Wise Pound Foolish: Things You Should Know

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Have you ever heard of the British saying, “penny wise, pound foolish?” It’s an interesting saying and can put your spending and investing habits into perspective if you know what it means.

We bring this concept to you because we understand that everyone loves to save money, but you may not be realizing you’re doing it all wrong. That’s what the saying is all about, so we’re going to list a few pitfalls that you may not see until they’re spelled out for you.

Quick Navigation
Penny Wise, Pound Foolish – The Meaning
1. Neglecting Medical Care
2. Buying Items for the Family
3. Credit Card Transfers and Their Implications
4. Finding the Lowest Gas Price
5. Avoiding Tax Specialists or Accountants at Tax Time
6. Shopping at Garage Sales and Thrift Stores
As Newton’s Third Law Says…

Penny Wise, Pound Foolish – The Meaning

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For starters, you need to know that pennies are smaller amounts of money and pounds are larger amounts in British money. People that are penny wise, pound foolish tend to want to cut expenses on what they think are the small things to save money. 

The result is a more considerable, more expensive cost later on because things weren’t done correctly the first time around. Pound foolish refers to the larger amounts of money that end up getting spent when they didn’t have to be in the first place.

1. Neglecting Medical Care


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Neglecting your personal medical care is a big one for people when they think they’re saving money. Many people don’t want to have to pay the copayments for what they believe is a minor cold. On the surface, it makes sense because the copayments add up, right? Even more so when you have a family.

Here’s the kicker for this one. Let’s say you decide not to get checked for medical care even though you’re feeling nauseous and dizzy. You figure maybe it’s because you’re tired or just perhaps dehydrated, and all you need is rest.

That’s when the other shoe drops. Now, you’ve got a fever and other symptoms. You’ve gotten progressively worse, and it’s only when you managed to drag yourself out of bed to visit the doctor to find out you had strep that turned into scarlet fever.

The moral of the story is if you had just taken yourself in when you were in the early stages, you would’ve only had to pay the copay and maybe something for antibiotics. Now, you’re missing work, potentially losing money because of the missed work, and you still have a copay and medicine that you have to pay for.

2. Buying Items For The Family


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This one is a tough one because this depends on a few things. Parents know that kids grow out of clothing quickly and so may have a hard time justifying spending large amounts of money on quality clothing. That makes sense for children, at least to some extent. 

There are other things like backpacks, as an example, that would be better for you if you spent the money to buy a good, quality bag instead of the cheapest option. Consider that a quality backpack can run anywhere between $$-$$$ for a single bag. It seems like a lot up front, but if you’re replacing a $ bag once a month for the entire school year, by the end, you’ve likely spent close to $$$ or more.

That translates to overspending by as much as $$ for that single backpack you could have purchased to begin with. Replace the backpack with a bag for your computer, a purse, really anything, and you’re still left with the same thing – being penny wise, pound foolish.

3. Credit Card Transfers And Their Implications


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You’ve seen those instances where you have a 0% interest rate if you apply for a new credit card and then transfer an existing balance to the new card. If you are in the market for a new car, house, or anything else where your credit needs to be checked, you’re hurting yourself when you do this.

Sure, you’ll save all kinds of money when you transfer the other credit card balance, but the impact of a new credit line can mean a lower credit score. A lower credit score translates to higher loan rates or higher interest rates on new purchases. Once again, you’ve saved pennies while the choices you’ve made could have cost you thousands more.

It could go even further from there because now, you’ve got another credit card that has to be paid and your old credit card is empty. If you’re transferring balances to save money, you need to take a hard look at yourself and question whether or not you’re really smart about your spending habits. You may not like what you see.

4. Finding The Lowest Gas Price


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Gas prices fluctuate every year. There’s no real way around that. Chances are that you’ve considered trying to find the lowest price for gas when it was time to refuel in order to save some money. You know where this is going.

So you’ve found that the lowest price is fifteen minutes away while there is another gas station that is all of two minutes from your home. True, the closer one is a few pennies more expensive, but if you’re driving thirty minutes total drive time to get to and from the less expensive one, are you really saving money?

The answer to that is no. Not at all. Instead, not only are you using the extra savings in gas that you got when you do the extra driving, but you’re also adding extra wear and tear on your vehicle that didn’t need to happen.

5. Avoiding Tax Specialists Or Accountants At Tax Time


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If your tax return is more complicated than your basic W2, you need a tax accountant. Seriously. You may think that you can do it, and while you’re not wrong, you’re also not exactly right. Not hiring one may save you a few hundred dollars, but it can cost you thousands later. Let’s give you this scenario and see what you make of it.

Imagine that your spouse is a contractor overseas and is making six-figure income on an annual basis courtesy of this job. Because they are abroad, there is an amount at the beginning that is considered tax-free. The remaining amount must have taxes paid, but if you’re in-country for less than a pre-determined amount of time, legally, you might be able to postpone payment. Of course, you shouldn’t, but you can.

If that’s not enough to make your head spin, imagine your spouse coming back home for good, filing taxes, and realizing that because a tax accountant was not hired in the beginning, the taxes were done entirely incorrectly. Now you owe thousands of dollars in back taxes because you were unaware of tax laws. Penny wise, pound foolish, anyone?

6. Shopping At Garage Sales And Thrift Stores


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As long as you know your limitations, these can actually be great places to save money. On the other hand, if you like to visit garage sales and thrift stores as a hobby and tend to buy things on impulse, it may not be the greatest thing for you to do.

There’s another saying about saving money and going broke all at the same time, and that’s what happens here more often than not. Your kid sees a NERF gun that he really doesn’t need, but you figure, hey, it’s only a couple dollars. Doesn’t seem like that much, right?

At least you think so until it happens again and again. The next thing you know, you’ve got fifty NERF guns in your home and only two kids. What makes things worse is that some of them are duplicates, and you really didn’t need to buy them. That two dollars turned into a hundred dollars pretty quickly.

The moral of that story is that if you had limited yourself in the beginning, then it would have been money saved. If you lost control of your spending, it seems like suddenly, you’re pretty pound foolish.

As Newton’s Third Law Says…

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For every action, there is an equal and opposite reaction. You can also think of this in terms of the consequences of your actions. You may think you’re doing an excellent job of saving money when the reality is that it is flowing through your fingertips like the sands in an hourglass.

Before you look at how you want to save money, consider the potential consequences of what you’re doing. Is it worth driving an extra fifteen minutes to save some money on filling up your gas tank? Is that cheaper backpack really worth the cumulative costs?

Do yourself and don’t be penny wise, pound foolish. Your wallet will appreciate having more money on the backend because you were willing to take the right path up front.

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How To Avoid Capital Gains Tax

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If you’ve never heard of it before, there is such a thing as capital gains tax. It is a separate tax from other types of taxes like sales tax, property tax, payroll tax, and income tax. Capital gains tax specifically affects people that work with investment assets.

Sounds clear as mud, right? Stay with us, and you’ll see that it’s not nearly as complicated as it might seem. You will also learn how to avoid capital gains tax or deal with it if you can’t avoid paying the necessary taxes.

Quick Navigation
First, the Basics of Capital Gains Tax
What Are Capital Gains?
What Are Capital Gains Tax Rates?
How Are Capital Gains Taxed?
Long-Term Gains
Short-Term Gains
Do You Pay Capital Gains Tax When You Sell Your Home?
How Can You Offset Capital Gains?
A Few Last Tips on How to Avoid Capital Gains Tax
Savvy Investors and Capital Gains Taxes

First, The Basics Of Capital Gains Tax

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Capital gains tax rates can be extremely high with rates as much as nearly 40% of the capital gains, so it is no wonder that people want to avoid the tax if possible. Before we get into that, let’s start by getting into what capital gains are and how the tax rate is applied.

What Are Capital Gains?

We begin by setting the stage with this simple scenario. Imagine buying a car that you paid $$ for. It may have been a fixer-upper or a classic car that needed some TLC. You undergo the improvements and pay another $ in repairs making the total money that you have put out a full $$$ for this car.


You decide that same year that you’re going to sell the car and ask $$$ for the sale price which is $$ more than you have in the vehicle. If you sell the car at your asking price, then your capital gain is $$ in that single transaction. That money is taxable under capital gains tax law.


The situation is similar with stocks that are sold in less than a year for short-term gains as well as long-term gains. The only difference is that if you have capital gains as a result of selling stock and then take those gains and invest them into an IRA or a 401k, you won’t have to pay taxes right away.

What Are Capital Gains Tax Rates?

There are a couple of different categories that capital gains fall into – short-term and long-term. Short-term gains are a result of assets that are in your possession for less than a year from the time of acquisition. Long-term gains are assets that you have had for a year or longer.


Short-term gains are typically taxed the same way your income is taxed depending on your total taxable income. If you have less taxable income, your tax rate goes down or vice versa, with the tax rate topping out at almost 40%. The car in the above scenario would have been considered short-term capital gains.


Long-term gains would be reflected in a transaction that happens to an asset that you have had for a year or longer. To give you an example of how that would work, imagine that you purchased stock several years ago for a set price. You decided to sell that stock and the resulting difference is $10,000 in capital gains. Because you owned the stock for longer than a year, you qualify for a lower tax rate.

How Are Capital Gains Taxed?

Capital gains are taxed according to your taxable income. That means that the taxes you can expect to pay are a reflection of the tax bracket that you fall into according to the IRS.

Long-Term Gains


As per the Tax Policy Center, “Taxpayers in the 10 and 15 percent tax bracket pay no tax on long-term gains on most assets; taxpayers in the 25-, 28-, 33-, or 35- percent income tax brackets face a 15 percent rate on long-term capital gains. For those in the top 39.6 percent bracket for ordinary income, the rate is 20 percent.”

The numbers are important to recognize because depending on which tax bracket you fall into, you may very well not have to pay capital gains tax on long-term gains. For reduced tax rates, you want to sell your assets after you have owned them for a year.

Short-Term Gains


As stated earlier, short-term gains are taxed as ordinary income with a 3.8% tax on investment income if your income is more than $ as a single taxpayer or $$ for married filing jointly. Investment income includes things like dividends that are issued to stockholders.

Do You Pay Capital Gains Tax When You Sell Your Home?

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The good news for homeowners that are looking to sell their homes is that in most situations, your home sale is exempt from capital gains tax laws. There are specific conditions that you have to meet to exclude any capital gains from being taxed when it comes to selling your home.


First, you have to own your home for a minimum of two years in the previous five years leading up to the sale. Your home also has to have been your primary residence for a minimum of two years during that same five-year time frame. You also can’t have sold another home during the previous two years and excluded that gain to avoid the tax.


Full stop that means that you can’t use a rental property that you’re selling as an asset that you can claim an exemption on unless you lived there previously. If you’re investing in a rental property that you have no intention of living in, and then you sell it, there is no avoiding that capital gains tax. The only exception, known as a 1031 exchange, is if you roll the proceeds into a similar investment within six months of the sale date.

How Can You Offset Capital Gains?

Capital losses are one of the keys here when it comes to learning how to avoid capital gains tax. Capital losses can offset your capital gains because things that go up must come down. This especially applies to investors when you consider the way stocks can play against each other.


Imagine that you’ve received $$$ in long-term gains as a result of selling a stock. You also sold another stock but have $$ in losses from that sale. That means that the only amount that you can expect to pay capital gains taxes is on the $ difference between the gains and losses as a result of selling both stocks in the same calendar year.


On the other hand, capital losses can roll forward into another year if they’re over $ in a calendar year. In other words, if you sell a stock that results in $$$ in losses, and you sell another stock that results in $$ in gains, you can match losses for that year. 


The remaining $$ can be rolled over into losses for the next year and every year provided that the losses that continue to roll over are more than $ each calendar year. For investors, this is a key approach when it comes to how to avoid capital gains tax.

A Few Last Tips On How To Avoid Capital Gains Tax

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There are a few other ways to avoid paying some of the tax if not all of the tax. It depends on your circumstances and what you’re willing to do.

As an example, you can also sell when your total taxable income is low. Having a lower income means your capital gains tax is also decreased. Choosing to sell long-term assets when your income is lower is fiscally smart because it saves you money.


Reduce your taxable income where you can, too. That means you need to get as many credits and deductions as possible prior to filing your income tax return. Credits and deductions include donations to non-profit organizations, IRA or 401k contributions, or even otherwise expensive medical procedures that need to be done. Dental work, anyone?

Savvy Investors And Capital Gains Taxes

There are many different ways when it comes to how to avoid capital gains tax. Savvy investors know the loopholes and work to keep as much of their income as possible, but don’t misunderstand that it is easy to do.


Sure, there are certain approaches that are easier like selling low-performing stocks or claiming the primary residence exclusion, but there are many other complex approaches, too. Take the time to research ways to avoid the tax and learn all you can. After all, you earned your money, and you deserve to keep it.

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Dissecting What’s Included in the Reserve Price of a House

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If you’ve ever searched for any kind of product online, you’ve probably seen online auction sites like eBay, but have you ever seen auctions for homes? They do exist, both online and in-person. 

Quick Navigation
What is a Real Estate Reserve Price?
Making an Offer on Home with a Real Estate Reserve
What Happens When the Reserve is Met?
What Happens When the Reserve is Not Met?
Buying Real Estate in an Auction
Establishing an Account or Presenting Cash
Understanding How Earnest Money Works
The Short Sale Auction
Making the Bid and Meeting the Reserve Price

Chances are that you’ve even seen the perfect house as you search listings with something in the description that says it’s available at auction with a reserve price. What exactly does that mean?

What is a Real Estate Reserve Price?

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Over on Realtor.com, someone had the same question. The individual was interested in a foreclosed property that was owned by a bank. Originally, the asking price was $34,900, and later the price was dropped to $31,410. 

The property reportedly had a lien and was up for auction. According to the individual, the reserve was met, but there was no indication of what the reserve price was. In the end, there were questions about how much to offer. 

A real estate reserve price is a price that the lender, or bank, is willing to accept on a given property. It isn’t always public, and it can be difficult to guess what an appropriate amount would be when making an offer.

Making an Offer on Home with a Real Estate Reserve

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If the reserve isn’t met, then the owner can refuse any and all offers that were made. When deciding what to request as a reserve price, that depends mainly on what the owner is willing to do. Banks that own foreclosures typically let homes go at values that are much lower than market price but are still fair to the property and the situation.

When the reserve is not public, then you need to be fair and put out the highest number you’d be willing to pay for that property. Consider what is fair given the condition of the home if you can see it, and compare market values in the area.

In making an offer, you do need to realize that if you offer a lower price than the asking price, you may or may not get the property. It’s all a risk and a chance that you’re participating in when you make an offer on a home that is up for auction. If you make a fair offer, then you’re likely to fair better, but it’s still no guarantee your offer will be the one that is accepted.

What Happens When the Reserve is Met?

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As discussed, the reserve is the absolute lowest price that the seller, most often a bank, is willing to accept for a given property. Once that reserve has been met, the seller is legally obliged to sell that property at the highest bid that exceeds the reserve price.

If the offer only just makes the reserve price, the seller is still legally bound to sell the auctioned property. With that, it’s in the best interest of the seller to set the reserve price for an amount that they will be satisfied with receiving.

Generally speaking, reserve prices remain hidden, and the only person that actually knows the reserve is the seller. In setting the reserve price, it has to be equal to or greater than the starting price. In the scenario mentioned above, it is entirely possible that the reserve price was $34,110, and hence the reserve was met. More often, the starting price is lower than the reserve to encourage higher bids.

At the same time, the reserve could have been $60,000 if that would have been fair for the condition of the house. Fairness includes taking into account the lien that would have had to be paid and the surrounding market value of the property. The bottom line is it’s a risk you have to be willing to take.

What Happens When the Reserve is Not Met?

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The simple side of things is that if the reserve is not met, then the seller is not obligated to accept any offers. The seller has the opportunity to accept the highest offer, but they are not legally forced to do so.

Instead, the seller is more likely to offer the house in a subsequent auction in hopes of receiving better offers. If this happens again and the reserve is not met, it is possible to continue the cycle for as long as the seller chooses. The alternative is to have the house listed with an agent.

At the same time, if there is a house that has been on the market before in the same situation, the seller may be more willing to accept a lower offer just to be rid of the property. If you come across a house for auction, check the history to see if it has been foreclosed on and how long ago that happened.

If a house was foreclosed on a while back, then there is a good chance that this house has been up for auction before. Like any seller, the longer a house or other property stays on the market, the more likely is that the seller will be willing to accept a lower offer.

Buying Real Estate in an Auction

miniature house

The process is reasonably straightforward, even if it seems complicated at first. Most sites and auction houses list properties as “as-is” which means that if you bid on one, you’re going to receive the property exactly as it stands. You may not get to see it, so you’re putting your faith in something you’ve never laid eyes on.

That also means you can’t renegotiate on price if you find something afterward like something significantly wrong with the property. It doesn’t matter if you find black mold in the walls because you agreed to buy the house as it stood. That’s what makes it scary and uncertain.

Once you’ve come to terms knowing that you have no control over the final condition of the property, you can start by getting to know the auction process.

Establishing an Account or Presenting Cash


If you’re bidding on a property online, then you’ll need to open an account and have some way to prove that you have your earnest money ready if your offer is accepted. You may require financing before getting to this point, so check with your auction site to see what their policies are regarding financial requirements.

If you’re bidding in an auction at a brick-and-mortar auction house, you’ll need to have your earnest money available right then and there along with the remainder in full. Typically, you’ll go up to a counter and present your funds as proof that you have the finances available should you win the auction.

Understanding How Earnest Money Works


In some cases, they will hold your funds for you as their guarantee that you will not back out of your bid if you were to win. Many auction sites and houses will require you to present your earnest money before being allowed to bid to protect themselves, too.

You may have even read situations where people lose their earnest money at auction sites or auction houses, but that’s generally not entirely true. Earnest money is only lost if someone makes a bid, wins the auction, and then chooses to cancel the offer.

The Short Sale Auction


Short sale auctions are auctions where the bank may not necessarily own the property, but the property might be in foreclosure proceedings. The seller, which is not the bank in this instance, could have already accepted an offer pending the bank’s final approval.

This is where it feels like things get shady. The bank can actually place the home in an auction with the purpose of getting a higher offer. It is entirely legal and allowed as the bank is legally entitled to the highest offer it can get. In short sale auctions, the bank makes the decisions even though it does not yet own the property.

If the bank puts down a reserve price on the auction, but the price is not met, then the previous offer accepted by the seller becomes the selling price. This is markedly different from a normal auction that can be placed on the market repeatedly if the reserve price isn’t met. 

Making the Bid and Meeting the Reserve Price

Understanding the difference between bidding on a bank-owned, foreclosed property and a privately-owned property in foreclosure has an impact in how auctions take place, especially where reserves are concerned. It can be the difference in keeping or losing your earnest money if you don’t understand what type of auction you’re participating in and the rules that govern. 

Even though sometimes these types of sales seem complicated, it’s an excellent opportunity to purchase homes well below market value, therefore, saving you thousands of dollars. It might take a little more work on your behalf, but if you’re prepared, you could walk away the proud owner of a steal of a home.

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Filed Under: Financing Property, Tools & Resources

Old vs New Houses – Which is a Better Investment?

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The question is not as easy to answer as it used to be. Once upon a time, newer homes were more expensive than older homes and were thought to be of superior quality. With the way times have changed, that’s not always true, but it’s not always wrong either.

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Advantages to Buying Older Homes
Advantages to Buying Newer Homes
Disadvantages to Buying Older Homes
Disadvantages to Buying Newer Homes
Other Factors That Impact Old vs New Homes
It’s Time to Buy Your Home

Neighborhoods change as do the people living in them, and entry-level homes can’t compete with some of what the older homes can offer. It’s an interesting conundrum as you compare old vs new homes to decide what is the best path forward for your situation.

Advantages to Buying Older Homes

old victorian themed house

Depending on how old the home is that you’re looking for, it is entirely possible that the older home has stood strong for a century or longer. Even if it has been there for a few decades, you know that it has stood the test of time, so you can feel good about purchasing a home built by experienced craftsman from the days of yore.

Larger Lots

Older homes also tend to have larger lots. That translates to larger yards perfect for kids to play in or have families spend time outside. It also means that the home likely has a garage or a neighboring alleyway. The extra space between homes is also nice because no one wants to feel like their neighbor is looking into their home from the kitchen window.

More Character

Homes that have been around a while also tend to have more character than their more contemporary counterparts. Imagine a Victorian home, and you can picture the carved details in the walls, the staircase, and all the other little things that meant something when they were originally done.

Advantages to Buying Newer Homes

New homes are new shiny things that attract your eyes, but with good reason. There is a level of comfort knowing that you’re the only person that has ever been inside that home. You know every nook and cranny, why a door got replaced, or that time a wall got repainted because your toddler got a hold of a Sharpie. You know the entire history.

a new residential property in the market

Built-in Warranties

A new home also has a bunch of different warranties in place. You’ve got a warranty for the A/C unit, the heater, the roof, the plumbing, the walls, the structure – everything. Builder warranties are excellent as you find those smaller and sometimes more significant issues that pop up when you own a brand new home. Since it’s all covered under warranty, you don’t have to pay to fix any of those things.

The Most Efficient

New homes are also built to be efficient, which is a huge step forward from older homes. Some even have solar panels incorporated into their design to encourage a lower energy use. Everything is insulated, and windows are often dual-pane to keep your home warm in winter and cool in summer.

Code Compliance

Builders follow the most updated codes to keep your home compliant. That means that you won’t need to do any updates on your own or hire someone to make them happen. Your new home comes to you ready to go, lock, stock, and barrel.

Disadvantages to Buying Older Homes

Older home

As wonderful as older homes can be, there are some definite drawbacks to purchasing one of them. Many a homeowner has complained that it feels like there is always something else to replace or repair. The ground shifts over time which can result in foundation repairs or sloping floors that weren’t there fifty years ago.

Lack of Code Compliance

Other changes that older homes have to contend with include wiring and plumbing. Since the homes were first built, there’s a good chance that there have been updates to the electrical or plumbing code. To get an older home up to code, that means that you may have extensive replacements to make.

Smaller Storage and Living Spaces

Remember, too, that these homes were built in a different time. Homes built in the early 1900s were designed with a different philosophy in mind. It was a time when people didn’t have quite as much stuff to store which means fewer closets, spaces for storage, and possibly not even a garage. Another interesting change since the times these homes were built is in relation to the size of a family. Large families were the norm back in the day, and still, these houses that are older are generally smaller than a modern home. They tend to have fewer rooms, so it may or may not work for your family’s arrangement.

Disadvantages to Buying Newer Homes

Newer homes tend to be called “cookie-cut” homes meaning that they look like every other home in the neighborhood. There is no customization and very little character. For first-time home-buyers, that may not necessarily be a deal breaker, though, because these homes are easier to build which means they also cost less.

By the same token, these homes will have a similar floor plan to your neighbor. If that matters to you, you’ll have to come to terms with the fact that someone else has a home nearly identical to yours in every way.

a new house for sale

Trees Take Time

Landscapi​​ng also takes a hit on newer homes. Because the developments are new, the time has not been there to allow for vegetation to take root and grow. Older neighborhoods have beautiful trees and lush vegetation that has happened naturally over time. Newer homes need a homeowner that can afford to do that, and unfortunately, that’s not usually the case.

Far From City Life

If you want to live near the hustle and bustle of a larger metro area, then you’ll be disappointed in the location of a newer home. They are not typically built somewhere near a busy downtown scene. Instead, they’re usually a good distance from anything like that. When you consider the proximity of a bustling downtown area to old vs new, older homes win in this category.

Other Factors That Impact Old vs New Homes

comparison between an old vs new house

Upfront costs can also make a difference in what you choose to buy. Older, or established, homes may cost less in your area than a shiny, new home. Newer homes may be less expensive depending on the area you’re looking at, so you need to compare the cost to what you can afford, too.

Home Histories

Also, consider the track record for the older home. You can see its history and how much it has appreciated over the years. That home could be a solid investment that will pay for itself in the years ahead. Newer homes don’t have that kind of history, and it’s far more of a risk in terms of investment. You have no idea if the property value is going to shoot up or go down as more people move to the area. It’s a gamble if investment value is a priority in your search.

All the Latest Amenities

If you want the newer amenities inside of an older home, you’ll need to be ready to take that challenge on, too. There’s nothing that says you can’t hire someone to renovate an older home and bring in the latest innovations to make your dream home a reality.

It’s Time to Buy Your Home

Buying a home is a fun, exciting time that is also stressful and chaotic. Things happen that you don’t plan for like a rescheduled home inspection, closing dates that are pushed back, or finding mold in a wall that you didn’t know about before you signed the dotted line. All of these things can be mitigated to some degree depending on the type of home you buy. When it comes to old vs new, you need to go in expecting there to be some problems in older homes that you’ll be willing to fix. If you don’t want to deal with those potential issues, go for a newer home instead. When all is said and done, you’re going to love your new home as long as you prepare yourself with realistic expectations. By weighing the advantages and disadvantages of each one, you’ll go in with open eyes, and you’ll be ready for whatever is thrown your way.

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Filed Under: Financing Property, Property Investors Resources

Cheap Old Houses: Tips For Finding and Flipping Them

Maximize your profits while minimizing your expenses. That’s essentially what investment can be talked down to: doing the most with little. It’s smart business practice, and can prove to have excellent results. 

Real estate has always been a hotly contested sector regarding competition, but no less so than in recent years.

a cheap old house excellent for flipping
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Go for the Cheap Old Houses
Everything Needs a Little Work

The 2008 housing crisis put the entire stock market into a bit of a chokehold, after all.

Yet, despite after such catastrophe, the market has rebuilt itself, especially when it comes to real estate. There are opportunities to be had all over the country, so long as you can capitalize on the juiciest bits available. While many investors may be looking at expensive properties, lavish homes, and exorbitant structures, you may want to take a step back. Consider all of your options. Why go for what everyone else is going for, after all?

Go for the Cheap Old Houses

That’s right, invest in what no one’s looking at. Investment, after all, is a long-term game. While these properties may not look like much now, with a little love, care, and effort they can become highly profitable at a fraction of the price. Cheap old houses can be found just about anywhere you look, and they aren’t getting a whole lot of love and care.

Sure, you’ll need to put some effort in to bring this property back up to sellable shape, but that’s a part of the job. In reality, the money you pour into fixing up a cheap old house will still be less than you would have paid for a new one. Not only will you be renovating and obtaining a new property at a much lower price than you usually would, you can even consider it a gift to the neighborhood.

duplex properties ready for flipping

Of course, now the question might be on the tip of your tongue: where can you find these cheap old houses? That’s why we’re here. Finding these sorts of houses isn’t all that hard, so long as you know how to look for them. You’re just a few tips away from finding new investment opportunities.

Find What’s Been Sitting on the Market for a Long Time

Let’s face it, cheap old houses are generally not at the top of the list when it comes to purchasing real estate. The longer they sit, and the worse shape their in, dictates a certain value about them. These properties tend to fall to the back of the line, where they’re left without any new buyers to view them. Think of it like finding a dog at the pound. Ideally, the longer a house sits on the market, the lower the seller will sink to to get it off their hands. No one wants to be paying for two houses at the same time. That’s extraordinarily expensive.

Old houses usually have problems that buyers aren’t interested in dealing with: structural damage, poor location, fees and the like. They might simply not be looking far enough ahead. Cheap old houses aren’t going to be first on the list, that much is clear. 

Your job is to find the diamond in the rough.

a property ready for flipping

Make sure to ask the right questions as well. Why has this house been on the market for so long? What’s the neighborhood like? What caused the previous residents to vacate the premises? Gathering information is crucial to evaluating the worth of a property.

Find Houses That Have Been Foreclosed

The very thought of having a foreclosed home may send shivers up your spine. However, if you’re investing, then it could very well be the next best opportunity for you. Someone may be miserable because of it, but what’s done is done. You can make your move now.

a foreclosed real estate property

Foreclosed homes happen because a homeowner fails to pay their mortgage. If they do, the bank takes their home, and they’re forced to sell it. These offer some of the best deals you can find on the market. You may be thinking that these are relatively recent vacancies.

That’s generally not the case. There are more than enough foreclosed houses that banks have been sitting on, waiting to get rid of. That’s where you come in. Sometimes these foreclosed homes may be in horrific shape, but certainly not all of them. It might take a bit of picking through the rubble, but you’ll find gems amongst the ash and dust. Sort them out, brush them off, and give them a thorough examination. If you don’t find something that fits your interest, give it time. Something is bound to show up. Foreclosed homes generally have a bit of a stigma to them. They’re considered to be less than viable investments, properties that have irreparable damage, or are below market value for good reason. That’s certainly not always the case. While other investors may be looking at the higher-end models, finding a cheap old house can easily beat them out in the long run.

Search Low to High

This tip may seem a bit obvious, but it’s easily overlooked. Whenever you’re looking for new real estate opportunities, make sure your search takes into account what you’re looking for. For the most part, real estate searches list potential properties by high to low, by what have been put up most recently, or by some other category. They never start off by listing low to high.

Now, these properties don’t take into account several important factors: neighborhood, condition, or competing values. However, these are the best sources to start with when you’re looking for cheap old houses. They may not look like much, but they offer more than what you can see from the curb.

house with garage

Look Constantly

There’s a good chance you won’t find what you’re looking for immediately. You may get lucky, absolutely, but we wouldn’t wage our best on that happening. Those who persevere are those that find the most success. Perhaps you don’t find your ideal house at first, but you need to keep looking until you do.

house with a modern look and a pool as its attraction

Cheap old houses are tossed around the market, transferring from owner to owner. There are plenty of sellers that don’t appreciate their real estate for what it could be. Essentially, their loss is your gain. If you spy a property that fits something like this description, take initiative. If you aren’t sure, don’t be afraid to ask questions. Your peers will provide you with all the information you need.

Ask Around

Networking is the most essential resource in the investment market. Communicating with both fellow investors and sellers permits untold amounts of information to gather valuable intel for investment. The fact is, one piece of information leads to another, and that leads to another. Everything is connected.

couple consulting an agent

The most you ask, the more likely it is you’ll find something you need. The more cheap old properties you find, the more offers you’ll be able to make. Don’t be afraid to skimp on the amount of offers you make before making your perfect offer. Make as many offers as you can afford. Sure, you might find that ideal property you’ve been looking for, but there’s no guarantee that you’ll get it. If you make offers on several properties, you’ll have more chances of succeeding on one of them than none. You don’t want to come away empty-handed, after all.

Everything Needs a Little Work

You might get lucky and find a cheap old house that doesn’t need much in the way of repair. Those opportunities are certainly possible, but waiting for one to fall in your lap is optimistic to say the least. Rather than expecting success to waltz across your doorstep, you should go out and earn it. These properties may not be the nicest at first glance, but they certainly can be. Being an investor is a source of pride. You need to have pride in your work, pride in your investments, and pride in yourself. What’s more impressive, investing in an established property or building something up from nothing? Finding value where there initially seems to be none is the hallmark of a great investor. If you need to put a little legwork into perfecting a cheap old house, all the better. When you flip it, it’ll be making all the more money for your efforts.


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Filed Under: Financing Property, Property Investors Resources

Undervalued Properties: Effective Ways to Buy Them

sample of Undervalued Properties available in the market

Planning ahead is the nature of being an investor. Every financial decision is weighed against how the markets will shift in the future. When it comes to real estate, you’re looking for diamonds in the rough. Undervalued properties are essentially what you’re going to be looking for. Every now and then, you’ll find a gem that fits the mold of increasing in value.

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How Do You Go About Buying Undervalued Properties?
Focus Is the Key

The question then is: how do you go about buying these undervalued properties? How do you find them? Combing the market without having an idea where to search out these prizes can prove to be tedious and fruitless. To help pull you out of that rut, we’re going to provide some tips on how to find and buy undervalued properties.

How Do You Go About Buying Undervalued Properties?

As you might come to expect, as any investor will know, searching out undervalued properties requires research and focus. However, once you have an angle on what signs point toward undervalued properties, the search becomes a little easier. There are deals to be had in every corner of the United States. All that you need is to be a little forward-thinking.

slightly damaged house but valued lower than its actual value

Compare the House to Its Peers

To have the best chance of finding that one house hidden in the weeds, you need homes to compare it to. For this, you’ll need to look a bit beyond simple looks. The best undervalued properties may very well end up being the houses that aren’t pretty to look at. They may have an ugly paint scheme, peeling wood, a rickety porch, and that’s only on the outside.

Here’s where the forward-thinking comes in. 

To find the best undervalued houses, you need to see their potential. Compare a $250,000 house to the houses neighboring it that are worth twice as much. It may have been a great house once, but time and use have scraped away its former glory.

abandoned house

Oftentimes, the burden falls on you to return it to its original glamour.Putting in a little legwork is good for investment. It may take some spending, some hard days in the sun, and a whole lot of work, but the end result is a house just as good as the rest on the block, perhaps better. Buying a house that doesn’t quite stand up to par is seeing the future that it holds. It’s an exercise in boldness, tenacity, and insight.

Investment always has a few risks to it. However, if you play your cards right, this crummy house that you polish up to a sheen can exponentially increase in value as the neighborhood develops. It may not look like much now, but given time, its value will catch back up to it. All you need to do is provide it the means to do so.

Examine the Market

This may seem a little bit obvious, but thorough examination always overturns new leaves. However, what you’re looking for now are houses that have been sitting for months on end. 

Usually, there’s something about these houses that make them somewhat undesirable to would-be buyers. There’s any number of reasons that have led it to this waitlist: overpricing, low quality housing, skeptical seller, you name it.

The primary factors that determine whether a house will sell quickly are price, location, and condition. Each of these variables may independently be responsible for houses left gathering dust on the market, or it could be a combination. However, just as these factors determine a house’s worth, they are also indicative of their potential.

A house that has been left on the market because of an overpriced offer can be difficult to wait on becoming undervalued. You may not want to wait on these houses quickly dropping down to a reasonable, profitable level. However, the longer they wait, the more likely it’ll be that they’ll become open to new offers. 

the interior of an abandoned and damaged structure

Sitting on a house isn’t comfortable for any seller.

 As far as location goes, you’re going to have a bit more luck. Areas that have experienced sudden changes in economic stability tend to have houses that plummet in value. This is an excellent time to capitalize on undervalued property. While the location for the time being isn’t as presentable as you’d like it to be, you’re looking at the long game. The region will recover, and when it does, the value of your real estate will rise with it.

As we’ve already addressed, the condition of the house plays a heavy part in how long it’ll stay on the market. For the most part, no one wants to buy an ugly house. What’s not to focus on is the looks, but rather the potential. Once the house has been renovated, it’s going to be much more impressive than when you snagged it.

Study the Sellers

A fantastic way you can go about buying an undervalued property is by looking at the people selling them. Sellers will tell you a lot about the value of their property, and can give away just how undervalued their house is. What you need to look out for are the motivated sellers that want to get their property off their hands.

There are a few questions to ask when you find a motivated seller. Why do they want to get their property off their hands so quickly? What are the circumstances surrounding the seller? How willing are they to negotiate? 

Negotiation is going to be the key factor here. While the seller may be looking at a reasonable price for their property, an understanding of the situation can make that price malleable.

A good source to find information about the state of the seller’s position, as well as the overall value of the property, can come from any involved real estate agents. An agent won’t publicly announce an eager owner, but networking goes a long way. A private one-on-one with an agent can help reveal a method toward a bargain deal - especially if you provide a little motivation yourself.

multiple units of duplex type houses

Making the agent’s life easier is one of the quickest ways to negotiate a better value for the property. If you guarantee that you can close on the house quickly for a cheaper asking price than what is asked for, a motivated seller may become pliable. What’s important to remember is that they want to get this property off their hands. If that involves taking a lower sum, then so be it.

Pay Attention to the Economy

We mentioned before that economic shifts help determine undervalued property. If there’s a huge layoff in an oil centric city, property values may fall. 

While things may seem grim in the short-term, and not very enticing, what’s important to remember is that the economy bounces back. Temporary upheavals in job security, economic growth, and property values spell out opportunity.

Attention to detail is critical. 

If you’ve found that a section of the country has been hit hard by layoffs, recessions, or other changes that impact the worth of local real estate, it’s worth paying attention to. If you succeed on investing in undervalued properties in the present, all that’s left is to wait for the region to bounce back.

a lakeside property

Counting on the inevitability of economic resurgence will return these undervalued properties to better standing. With proper timing, though it may feel unsavory, these areas create prime investments.

Focus Is the Key

The presence of undervalued properties on the market is never going to be forefront. 

Most investors are going to be concerned with obvious, prime real estate. 

If you’re going to find new opportunities for investment, you’re going to have to wade in and search it out yourself. It doesn’t matter how many tips you know, undervalued properties generally don’t reveal themselves.

Any investor knows that focus, dedication, and tenacity are the strong points of a successful investment. You may not find what you’re exactly looking for now, but the real estate market is constantly changing. 

If you give it a little time, more and more properties are going to show up. Having a little bit of patience goes a long way.

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Filed Under: Financing Property, Property Investors Resources

Different Loans For Investment Properties

Many options abound…

roiThere are many ways to finance investment properties.  If you’re not paying all-cash for a property, and you want to utilize leverage to greatly increase your prospective ROI (return on investment), you’ll find many options available to you.  Which one you choose is a matter of personal taste.  And deciding among different investment property loans available, that will suit your temperament and pocketbook, will be critical to your bottom line.

The OPM concept

I have always been a big advocate of trying to use OPM, or other people’s money.  Certainly, as you search for investment properties, it is always a smart idea to ask each and every time if the seller will carry paper – that is, if they will hold a mortgage note on the property you’d like to purchase.  This may be the most advantageous form of investment property loan you can obtain.

A key example of seller financing

As an example, I once purchased a four family house where the seller was willing to offer a first mortgage if I put twenty percent down on the sales price.  Now, he wanted to get his price, so at first blush, it looked like a terrible deal.  But when I asked if he would take my terms for a mortgage, the deal became a whole lot better.  At the time, he was willing to offer a first mortgage with an interest rate almost four points less than any commercial bank would have offered.  In addition, roiinvestment property loans from banks traditionally require at least thirty percent down by the buyer.  So I was able to leverage an additional ten percent by going with the seller financing. This was a great way to get a business loan for rental property.
On top of this, the seller offered me a thirty year amortization schedule, with a ten year balloon…plenty of time in which to reap the roibenefits of an unbelievably low monthly payment, and resultant high cash flow – and even greater net income.  This four family house quickly became a huge cash cow for me.   And I had plenty of time in which to refinance to a traditional loan.  So while I ended up paying about ten percent higher in market value than the property was worth, the difference was more than made up for (while I held the property) in net cash flow income and capital appreciation when it came time to sell.  So my advice:  if you can find seller financing, take it.  And don’t be afraid to give the seller “their” price” in return for “your” financing terms.  It could end up being a major financial windfall for you in the end.

Going the hard way

Sometimes it makes sense to go the hard money lender way of financing when looking for a loan for investment property. If you have poor credit, or poor cash reserves, you’ll pay for the privilege of doing business with hard money lenders. Their investment mortgage ratesinvestment property mortgages are usually at least double conventional mortgage loan rates. And their points charged (pre-paid interest) can be triple or quadruple conventional points charged.
I have written in a prior article here how “the average hard money investment property loan is supplied with capital put up by private investors – usually as a pool of money that is used to drive much greater profits for its investors. This private capital is traditionally unregulated, which gives the hard money industry a kind of “Wild, Wild West” feel to it’s practices and reputation. Pejoratively, many consider hard money lenders as sharks feeding off the misery of those in bad financial straits. As a property investor, you will certainly need to approach any hard money investment property loan with a great deal of caution and foresight prior to signing on the dotted line.”

The typical hard money loan

That said, don’t be totally scared off by trying to obtain a hard money loan.  You need to know ahead of time that typical hard money loans carry interest rates that can run anywhere between 12 and 18 percent. Balloon payments are de rigeur, and these mortgages usually come property investing creditdue within 1 to 3 years. In all but rare instances, hard money lenders require being in the first mortgage position, so they can get their money out first if you default.
In addition, typical loan-to-value (LTV) ratios on hard money investment property loans range between 50% to 65%. And this LTV is based upon the “quick sale” market value of the property…that is – what the property will fetch today – not three months from now after you’ve fixed it up. Another potentially scary cost to take into account are points (up front interest charges). Typically, they can run anywhere between 4 to 8 percent of the total mortgage amount.

Going the more conventional route

As I have noted in the past here, “most conventional investment property mortgages are standard income and asset verified loans. They can be conventional 30 year terms, or short-term adjustable rate mortgages (ARMs) with balloon payments. These loans usually requireproperty investing financing a minimum of 30% down in most instances. In that case, you’d be obtaining a loan of 70% of the purchase price. Your loan-to-value ratio (LTV) would therefore be 70%. When buying investment property, you’ll usually want to try to obtain the greatest return on investment (ROI). Leverage (also known as cranking) is one of the ways you can purchase multiple properties over time, and thereby maximize your ROI. Depending upon your credit rating, as well as the type of property you’re purchasing, the down payment required may be higher, and could go up to 50% – and therefore your LTV would be a low 50% as well. In addition, the points charged on the loan (pre-paid interest) are roughly twice as high as for a conventional home loan.”

A word about commercial loans

If you’ll be looking to acquire strictly commercial buildings (these include office buildings, retail stores, warehouse buildings, or rental investment property type - apartment buildinghomes or apartment buildings with at least five units in them, the you’ll definitely need a commercial loan from a lender. Lenders have separate divisions to evaluate and extend credit on these type properties. Since commercial properties are much more specialized, their inherent risk need to be evaluated as a niche within most banks.  Unlike conventional residential mortgages, you can expect that underwriting requirements will be much more stringent by comparison.  For example,  a commercial lender will be poring over your financial statements with a fine toothcomb, and you can certainly count on much more scrutiny of your assets and income, as well as the existing income statement of the property you’re considering purchasing. Also expect rates and points to be higher than standard residential loans.

Going the personal home equity line route

I have also made note here before how it’s a good idea to utilize a home equity line of credit (HELOC) on your own home as a way to leverage investment property acquisitions.  First of all, it’s a very inexpensiveinvestment property loans way of financing.  Interest rates are usually as low as you can obtain from any lender.   Second, the interest is tax-deductible as a business expense.  And third, you can choose to make interest-only payments monthly on the outstanding balance, usually for a period of ten years, knowing that you’ll have a balloon payment looming down the road.  Most times, the balloon will be incorporated into a second ten year payback period, where you’ll be making monthly principal and interest payments. In this way you can utilize the equity in your home to create a credit line for further property investments. You’ll find this a great way to finance further investment property acquisitions. Also, you can structure the loan as a revolving credit line. So when you sell a property, you can pay off the credit line. Then you can take it out again when you’re ready to purchase the next house.
photos courtesy of jackphanginvestment.com, sixi.be, scottyancey.com, hardmoneylendersutah.com, trustdeedinvestment.org, bank-building-psdgraphics.com, en.wikipedia.org, answers.yourdictionary.com
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Filed Under: Featured, Financing Property Tagged With: business loan for rental property, investment properties, Investment Property Loans, loan for investment property, loans for investment properties

Living With A Balloon Mortgage

It’s not that scary…

Most novice property investors tend to be unprepared for the concept Balloon_free_imageof living with a balloon mortgage.  If you’re going to invest in commercial real estate, a balloon payment mortgage will be a given.  And in most residential real estate deals where the owner is offering a mortgage, you can also expect a mortgage balloon payment as well.  So, what is a balloon mortgage you might ask?  The simple answer is that, at the end of the mortgage term, you will still owe a large chunk of the principal on the property you purchased.  The balloon mortgage definition is that the balance will need to be paid, on time, at the end of the term in the form of a large, “balloon” payment for this balance due.

Balloon mortgage definition example

To help define balloon mortgage more concretely, let’s look at an example.  Let’s say you purchase a property for $100,000.  The seller will give you a first mortgage for 75%, or $75,000, and you’ll pay the balance of $25,000 in cash at closing.  However, balloon mortgagesinvestment property mortgages are not like most residential bank mortgages that are self-amortizing, where you pay some amount of principal and interest for either a 15 or 30 year term, every month, like clockwork.  Instead, to keep monthly payments reasonable, a 15 or 30 year amortization schedule may be used, as in residential mortgages, however the actual term of the mortgage is much shorter, say between one and ten years.  The most common ones I’ve seen usually are in the three to five year range.  So obviously, if you’ve been making monthly payments using a 30 year amortization schedule for a 5 year balloon mortgage, quite a lot of principal will be have to be paid off at the end of the term.  And this remaining balance is known as the balloon payment.

Doing some simple math

Going back to our example above,  we can use our basic mortgage calculator in our resources section here, and simply turn it into a balloon mortgage calculator.  Let’s say we use a 4% interest rate with a 30 year amortization.  With a mortgage of $75,000, our monthly payment would be $358, and at the end of 5 years, we would have paid down the principal to $67,704, having paid out $14,454 in interest in the five years of the loan.  That $67,704 represents our balloon mortgage amount.  If we don’t pay it off at the end of the term, the seller gets his property back.  Naturally, that would be bad for you.

The refinancing solution

So what if you don’t have the $67,704 sitting around in your bank account at the end of the five years?  Again, a simple solution.  You investment property mortgageswould go out and refinance the property with a commercial bank for this remaining amount, your balloon payment.  This is extremely common, and a very accepted practice.   Most banks are amenable to offering refinance mortgages because by the time your first mortgage is due, you’ve increased your equity in the property substantially – a fact that only helps you qualify even more for a commercial bank’s underwriting standards.  Over a five year period, you may be able to build up an extra ten to twenty percent in equity valuation on your investment property.  And banks traditionally want to ensure that you have at least twenty-five to thirty percent of your own funds already invested when they go to offer you any mortgage on an investment property.

Playing the leverage game

I have written in a prior article here how owner financing offers one of the great advantages of property investing – namely, leverage.  I haveleverage noted how “any money you don’t have to put up yourself when you buy investment property offers you the opportunity to increase your leverage on the purchase. And if you don’t have to borrow from a bank (or worse, a hard money lender) then you will be saving your credit line possibilities for further down the road. And if an owner is willing to take back mortgage paper for at least some part of the purchase price, you will be ahead of the game. Even if that amount is small, or not a first mortgage, it will benefit you. Every little bit of leverage goes a long way. Of course, if you can obtain a first mortgage from the seller, even better still.”

Using your time wisely

Always remember that chasing owner financing may not be the best use of your time.  I have also recommended here that “while owner financing helps you greatly in increasing your overall financing leverage and future options, don’t waste your time making it your number one pursuit when searching to buy investment property. It is still an elusive task and will take an inordinate amount of your time. It would be better to use your time more wisely – time that could be spent on more fruitful property searching. Don’t pass up a great deal investment property mortgagessimply holding out to obtain seller financing. But if you do manage to come across a willing seller offering some amount of owner financing, by all means, don’t pass it up.
You’ll negotiate just as hard as you would normally – but now you’ll be negotiating not just on price, but overall terms of the mortgage as well: interest rate, amortization schedule, and payoff term. Expect any owner financing to be short term – usually 1 to 5 years, but with amortization based on 15 or 30 years, with a balloon payment at the end of the overall term. Like with commercial paper, you’ll eventually have to refinance the overall remaining mortgage amount at the end of the term.”  However, by now you should understand that holding a mortgage with a large balloon payment is not so scary as it might seem.  The ability to refinance at some point down the road with a much greater equity position in the property will make it much easier to refinance.  And that should give you the confidence to move forward and be more accepting of balloon mortgages because of the tremendous leverage they can offer you.
photos courtesy of commons.wikipedia.org, worldpropertychannel.com, allstate.com, mediacenter.dw-world.de, allmandlaw.com
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Filed Under: Featured, Financing Property Tagged With: 5 year balloon mortgage, balloon mortgage, balloon mortgage calculator, balloon mortgage definition, balloon mortgage payment calculator, balloon payment mortgage, define balloon mortgage, mortgage balloon payment, mortgage calculator with balloon, mortgage calculator with balloon payment, what is a balloon mortgage

Can You Learn To Love Hard Money Lenders?

Obtaining money the hard way…

So let’s say you’ve gone the traditional financing route for investment property, and approached your bank for a mortgage.  And you’ve been investment property mortgagesturned down – due to any number of factors:  poor credit, too much outstanding credit, not having enough income to pay for the monthly debt service on the loan – whatever the reason, it ain’t going to work with your regular lender.  Let’s also assume you’ve asked the owner of a property you’re interested in acquiring for seller financing…that is, let them finance the first mortgage on the property.  While this is a great way to increase your leverage on any investment property, it’s also quite rare to find sellers desperate enough to offer owner financing.  In addition, the seller needs to own the building free and clear, with no outstanding mortgage on it for them to offer seller financing.

The last resort?

If these financing routes aren’t working, and you simply don’t have the cash on hand to pay all cash for the property, regardless of the condition, then it’s time to seriously consider using the services of aproperty investing credit hard money lender.  As I’ve suggested in prior articles here before, “when you’ve exhausted all other avenues of property investment loans, crunch the numbers to see if hard money lenders will make a deal workable. Usually used if you have poor credit, or poor cash reserves, as their name implies, you’ll pay for the privilege of doing business with hard money lenders. Their investment mortgage rates are usually at least double conventional mortgage loan rates. And their points charged (pre-paid interest) can be triple or quadruple conventional points charged.”

When all else fails…

Sometimes hard money lenders make perfect sense when all other financing avenues are dried up, and you really feel you’ve found an investment property financing - house protectionexcellent income producing property.   And you want to jump on it by making a quick offer.  I have seen some hard money lenders who don’t simply offer high interest rate, short term loans. I have discovered, and run into, some who would like to become your “partner.” One could say that the sheer hard money definition is like that of a loan shark.  Be very careful if you find any hard money lender offering financing, but requiring a “back-end” amount when it comes time to sell your property.  I had the occasion to inquire of a hard money lender once, and they were quoting me terms that were gangster-like in nature.  These included: only financing fifty percent of the purchase price, a ridiculously high interest rate, with a two year balloon mortgage.  Oh – and they wanted fifty percent of the gross profit upon the sale of the property when it came time for you to sell.  Obviously, any novice investor should stay away from this kind of predatory hard money lender.

Private investors as hard money lenders

So how exactly would I define hard money loan? Simple: swimming in shark-infested waters.  Consider how I have also previously cautionedinvestment property financing - lawyer here how “the average hard money investment property loan is supplied with capital put up by private investors – usually as a pool of money that is used to drive much greater profits for its investors. This private capital is traditionally unregulated…many consider hard money lenders as sharks feeding off the misery of those in bad financial straits. As a property investor, you will certainly need to approach any hard money investment property loan with a great deal of caution and foresight prior to signing on the dotted line.

Leveraging and hard money loans

If you have the cash on hand, you may feel it’s simplest to pay all cash.  However, you lose the ability to leverage in so doing.  I’ve noted before investment property mortgageshow “while paying all cash for a property is the “safe” way of investing, it provides no way to leverage your financial strength. Assuming you could not obtain conventional financing, hard money lenders offer the next best alternative to all cash deals. While your cash flow will be severely impacted because of the relatively exorbitant interest payments on hard money loans, even a small positive cash flow will yield great leverage over several years of making timely payments on the loan. Remember, besides the cash you put up on the property as your down payment, you will be paying off the principal on your hard money loan each month – thereby helping to increase your return on investment (ROI). Over several years, a small positive cash flow will yield much greater ROI’s than an all cash purchase would.

Paying through the nose?

If you’re going swimming amongst the sharks, your protective shark cage is knowledge. You need to know ahead of time that typical hard money loans carry interest rates that can run anywhere between 12 and 18 percent. Balloon payment are de rigeur, and these mortgagesinvestment property mortgages usually come due within 1 to 3 years. In all but rare instances, hard money lenders require being in the first mortgage position, so they can get their money out first if you default.
In addition, typical loan-to-value (LTV) ratios on hard money investment property loans range between 50% to 65%. And this LTV is based upon the “quick sale” market value of the property…that is – what the property will fetch today – not three months from now after you’ve fixed it up. Another potentially scary cost to take into account are points (up front interest charges). Typically, they can run anywhere between 4 to 8 percent of the total mortgage amount.”

Swimming with the sharks

So is a hard money loan for you?  Well, that depends…mostly on your ability to perform under financial pressure.  And believe me, there will definitely be more financial pressure utilizing the services of a hard money lender than a commercial bank.  I’ve written in a prior article that “as a borrower, the hard money loan is definitely not for the faint of heart. You should already be comfortable taking on more debt, especially of the short term variety. You should also be well aware of investment property mortgagesthe consequences in case of default. The hard money lender takes on the increased risk of borrowers with less-than-stellar credit. For this, they are able to charge exorbitant interest rates, with onerous terms, and even more Draconian conditions if the borrower defaults.
A mature, responsible investment property investor/borrower should not be scared off by the terms of a hard money loan. They realize they can use the leverage to their advantage to help grow their real estate holdings. And they enter into hard money investment property loans with eyes wide open.”  So you really need to ask yourself, “am I of the right temperament for such an endeavor?”  If the answer is yes, then by all means, jump into the ocean…and keep swimming fast…
photos courtesy of hardmoneylendersutah.com, trustdeedinvestment.org, toonpool.com, ocasturkiye.com, todaysfacilitymanager.com, credit-realtybiznews.com, socalfools.org
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Filed Under: Featured, Financing Property Tagged With: define hard money loan, hard money, hard money definition, hard money lenders, Hard money loan, Hard Money Loans, money lenders, money loans

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