Real Estate 049: (Guest Post) Thinking of getting a Home Equity Loan? Lets talk pros and cons!

As the real estate market continues to heat up in many of the major cities across the United States, Real Estate Investors may be looking for different ways to stay liquid and fund their next project. I have spoken about traditional lending, private lending, hard money, and retirement accounts on this blog. However, our guest writer Raúl Menéndez from Money.com talks about the pros and cons of obtaining a Home Equity Loan and how it can be used for various use cases.

Home Equity Loans Pros and Cons

“Equity is the amount you get after subtracting your mortgage balance from your home’s current fair market value. In other words, home equity is the figure that represents how much of that property you actually own. There are a few ways of accessing your home equity, but one of the most common and less risky ones is through a home equity loan.

Just like its name suggests, a home equity loan is a type of installment debt that allows you to borrow against your equity. With this type of loan, you borrow a certain amount at a fixed rate, which is then disbursed on a single-lump sum and is repaid through a series of regular monthly payments for a set period of time, also known as the “term.” By contrast, other options such as a home equity line of credit (HELOC) don’t give you a lump sum payment.

Since you’re using your home as collateral, interest rates tend to be much lower than those of unsecured debt, like personal loans and credit cards. The lower rate allows you to borrow a sizeable amount with comparatively low total interest. Also, these loans usually have fixed rates, so your monthly payments won’t fluctuate.

Home equity loans may also qualify for certain tax benefits if it’s used to make improvements to your house. In that case, you’d likely be able to deduct the interest on your loan payments from your taxable income, potentially reducing the amount you have to pay in taxes.

Finally, home equity loans are flexible in that you can use your lump sum payment for whatever you desire. Of course, that doesn’t necessarily mean that you should, but you have the freedom to use your funds as you see fit.

While a home equity loan can be beneficial in the right circumstances, it does have its potential drawbacks. One of these drawbacks is simply the fact that you’re taking on more debt. If you’re still making mortgage payments, you’ll have to add home equity loan payments to your monthly expenses.

That could limit your ability to borrow funds since many lending options have DTI requirements. If your total amount of monthly debt is above a certain percentage of your income, you might not qualify for certain loans. By securing your loan with your home as collateral, it does potentially put your home at risk. If you default on your home equity loan, it may mean losing your home.

As with many borrowing options, home equity loans have a full closing process, and that will mean fees. For that reason, it’s advised that you evaluate your current expenses and options to make sure the closing costs and fees are worth it. If you want to read more about these types of loans ad their advantages and disadvantages head over to Money's Best Home Equity Loans article to read more.”

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

Real Estate 048: 4 traits of successful real estate investors

For real estate investors who have recently taken the plunge and picked up rental properties, its very easy to be excited about this new venture and idea of financial freedom. My personal method of achieving success in anything I do is first seek out mentors and experienced investors who may have walked down a similar path, had failures, but overcame them to reach their goals. This way, I shorten the distance between a new and experienced real estate investor and also can save myself from costly mistakes. Below are 4 traits of successful real estate investors that I have met throughout my journey:

1. Continuous education

Knowledge is a powerful tool. Brandon Turner, Host of the BiggerPockets podcast frequently says, “you need multiple tools in your toolbelt to meet the needs of different problems that you will encounter as a real estate investor. To an investor who only has a hammer, every problem will appear to be a nail.” You will often hear from other investors that real estate is simply about solving other people’s problems. Whether it be buying a rental from a seller going through personal life issues, financial struggles, or a wholesaler who is looking to unload/assign their rights to a property, or an investor with a great deal but needs capital or a partner to walk them through the process. If you continue to educate yourself in this field you can become more creative with deals (e.g. seller financing, subject-to, land contracts, BRRRR, commercial financing, partnerships, syndication). Do your due diligence and become your own best adviser.

2. Maintain control of your investments

One thing that I really appreciate about real estate is that it is tangible, easy to understand, and you have control of your decisions. Prior to investing in real estate, I invested in stocks and bonds for over 7 years, and although I knew how to read financial statements, proformas, and general fee structure. I never once remember who my portfolio manager was, how exactly they are being paid and incentivized to take care of my hard earned cash. Nor did I understand the detail behind market fundamentals that drove a stock price up and down. As a direct real estate investor, I get to control who I work with in terms of acquisitions (e.g brokers, wholesalers, agents), rehabs (e.g. contractors), property managers, and lenders and the buck stops with me. These people have been coined the “core 4” by investor David Greene (check out his book “Long distance real estate investing” for more valuable information on investing out of state). Once I have my core 4 in place, you have more control in terms of running your numbers to fit your cash on cash criteria, as well as getting creative to create even more equity or cash flow (e.g. adding an extra bedroom or bath, going section 8 in certain markets, etc.)

3. Invest with the end in mind

A prudent investor will set goals and stick to his/her predefined criteria. Of course, you are free to update your criteria as markets change and you gain more knowledge into the subject matter at hand. However, do not get “trigger happy” and fudge the numbers to take down a deal. If you start compromising (e.g. 14% CoC → 9% CoC as this house is “well rehabbed”), it will become a slippery slope and you may find yourself holding a bag of loser rental properties that are difficult to unload in a downward market. Real estate is a long game, so think of your exit strategies whether it be 1031 exchanging into bigger, nicer neighborhoods, getting into multifamily apartments or private lending, you want to understand what you are purchasing instead of going for quantity in the short run. In other words, be a prudent, long-term value investor, never a get-rich-quick gambler, speculator, or flipper. Invest only in properties that make good financial sense the day you buy them.

4. Use leverage to create wealth

Many successful investors will tell you the one word that build them their wealth: leverage. Leverage can come in many forms such as other people’s money (e.g. banks, private lenders, hard money lenders), other people’s time (e.g. wholesalers, brokers, contractors), and lastly, other people’s knowledge (e.g. partners, mentors). You may run into student’s of Dave Ramsey’s teachings who proclaim debt is bad and you should make purchases all cash. However, this advice, while safe, is not going to get you to financial freedom anytime soon. There is a reason why Dave’s teachings focus on saving your first $1K, creating reserves, debt snowball methods, and budgeting to create a better financial future. I agree the aforementioned strategies are important if you are heavily drowning in consumer debt. The debt I am referring to relates to good debt, which is used to create assets that positively cash flow. There is a difference between a person who has $5k on their credit card from purchasing clothing, jewelry, and the latest electronics and pay a minimum balance with 22.58% interest vs an investor who obtains a 80K loan at 6% interest amortized of 30 years for a rental property in the midwest that cash flows $350/month after all expenses and debt payment.

I personally have debt on my personal residence as well as my 10 other rental properties. However, my 10 rental properties all cash flow positive a minimum of $200/unit and my primary residence was used to obtain a HELOC (home equity line of credit) that creates even more cash flow through the use of leverage. By simply using leverage, I have been able to add $100K to my net worth during the past year and this is all through use of other people’s time, money, and knowledge. Let other people’s money work for you, reduce your risk, and make you wealthy.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

Real Estate 047: Finding a Lender to Finance your Rental Properties

Now that you have learned about the benefits of real estate, how to identify a market, analyze a deal, and applying different strategies, it's time to understanding the financing. As David Greene mentions in his book “Long-Distance Real Estate Investing”, there are a “core four” you need in your real estate team that is comprised of the deal finder, the property manager, the contractor, and the lender. Today we will be discussing the lender and their role in financing your deals.

Before you start looking for properties, it's important that you receive pre-approval from a potential lender to understand your buying power. This will also give you a leg up on the competition because it shows the seller you are a serious buyer who is capable of closing. In a hot market, a pre-approval is a minimum requirement to get your foot in the door and have your offer be reviewed.

When you are looking to build a relationship with a lender, you may come across direct lenders as well as mortgage brokers. In short, direct lenders are actual lenders such as banks and credit unions that will have in-house underwriting and review your documents themselves. On the other hand, mortgage brokers will connect you to different programs that they have build a network around and be an intermediary between you and the final lender from start to finish.

There are pros and cons to using direct vs a broker as a direct bank may have more flexibility in terms of removing some of their own underlays as well as the convenience of dealing with on shop when doing multiple loans across your portfolio. On the other hand, brokers are able to shop around rates with different banks and also become your advocate in terms of trying to get you the best deal possible. In addition, you may come across complex deals that the direct lender you have worked with in the past is unwilling to lend on. This is when the mortgage broker can speak with multiple banks in hopes to find a lender who will loan you the money.

Finding a lender will vary depending on where you want to invest as well as your asset class. For the purposes of this discussion, we will assume that we are seeking residential mortgages for 1-4 unit rental properties in the state of Missouri. As your lender needs to be licensed in the state in which your property is located, it may benefit you to find a national lender who has the license and knowledge to lend in most if not all 50 states. To find a lender, you can ask your investor network, Biggerpockets forums, and local real estate property managers and agents, you may notice names being repeated as lenders who have a high reputation for being investor friendly and closing deals are sought after.

Once you have identified the lender you would like to work with, it's important that you ask them good questions to ensure that you understand one of the core members of your core four. Remember that you do not have to “impress” them as they too are trying to earn your business. Some lenders do not like to work with investors, a quick interview is also a good way to measure how responsive the lender may be and also see if they are investor friendly.

When you are obtaining a Fannie Mae (conventional) mortgage, banks have to adhere to certain rules and regulations set by the government agency, however banks can have their own “overlays” and rules (e.g. maximum 4 properties per person vs 10), so it's important to be able to identify the differences between Fannie Mae’s requirements and the bank’s additional overlays. It may be disadvantageous for an investor to work with a bank with multiple overlays which restrict the investor from scaling their portfolio. Below are some basic questions you may want to ask your potential lender:

1. How many loans do they close per month (understand the bank’s volume and experience. A bank doing 35 loans a month may know how to navigate complex situations vs a bank doing 3 loans a month as they will have seen more unique cases).

2. What type of loan programs are available? (e.g. Owner Occupied, Non-Owner Occupied, VA, FHA, Conventional, Portfolio, Delayed-Refinance)

3. What states are you licensed to operate in?

4. What are your minimum and maximum loan amounts

5. What paperwork is required, Debt to Income (DTI), Debt Coverage Ratio requirements?

6. What are current interest rates for a FICO score of XXX?

7. What fees are involved (administration, closing costs, etc.)

8. What is your average time to close?

9. What is the maximum number of loans per person?

10. What are the reserve requirements per loan, do you help investors with planning for multiple loans?

The answer to these questions will vary from lender to lender and I would recommend you interview at least 5 lenders to understand the differences and similarities across the market. Once you have selected a lender you would like to work with, you will need to submit the paperwork required to get pre-approved. This will result in a hard inquiry and briefly lower your credit score, so make sure you are ready to purchase a home in the near future. Once you are pre-approved, you are ready to make an offer on a property.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!