In your efforts to create as much financial leverage as possible, you’ll want to use other people’s money whenever you can. And one of the best ways to use other people’s money is to obtain a mortgage from the seller of any investment property.
Beware late night infomercials!
Now, unlike the drivel that is shoveled out in all those late night television infomercials on making riches in real estate – it is incredibly difficult to find owners willing to extend a personal mortgage on their property. They would need to already own the property outright (in which case they could extend you a large first mortgage). Or if they only have an existing small first mortgage on the property, you could obtain a first mortgage from a bank, then get a smaller second mortgage from the owner after his first mortgage has been paid off at the closing from the proceeds of your first mortgage.
Unfortunately, both scenarios are terribly rare to find. Those infomercials make it sound so easy, but you’ll be spending most of your waking hours trying to locate that rare breed – the owner who is a) undervaluing his property for sale, b) owns the property outright, and c) is so secure financially himself, that he can offer a personal mortgage without needing the proceeds of the sale of his property to purchase his next home. A rare breed indeed.
Ask for it…
That said, there are many instances where you can realistically garner a small second mortgage simply by asking. And every little bit of other people’s money helps in increasing your financial leverage.
In addition, I have found there are times, after crunching your numbers properly, where buying a rental property at market value (or even a little above market value) can make sense if the owner is willing to give a large first mortgage at incredibly good terms – an interest rate far below market rates and/or monthly payments based on very long amortization periods (30 years or more).
In this scenario, the cash flow may look spectacular because your monthly payments are so low relative to a regular “hard money lender’s” (ie., your bank’s) rates. But keep in mind it will take some time for the property to “make back” the differential in the value you’re overpaying in absolute terms to get it. So plan on holding the property for a long time horizon if you go this route. And make sure there are no early balloon payoffs required in this type of personal owner-financed mortgage. Or at the very least, make sure the balloon payoff date is set far enough into the future (for example, a minimum of ten years) in order for you to recoup the differential in value.
Owners willing to finance – and the property value trade-off
Also keep in mind that the owner who is truly desperate to sell, wants out immediately, and will make all sorts of concessions on price to do so – is usually not able to offer any kind of financing on his property. So just be aware of this trade-off when locating your next investment property. A property priced at or slightly above market value may have an owner who is willing to extend credit in the form of a first mortgage, or even a small second mortgage. (But be sure to ask!) Whereas a property that looks like a steal – and is priced well and/or below market value – these are the properties that will always be hardest to obtain owner financing for. It doesn’t mean you shouldn’t still ask if the owner is willing to consider financing – but just don’t be surprised in the least if they immediately say no way.
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