I need help with finance basics

6 Replies

OK. I have been listening, learning, reading, and dreaming. I am very close to looking for that first deal, but one thing that I seem to have limited knowledge on is financing. So I am just gonna throw some random scenarios out there and please let me know which ones I seem to have a solid grasp on and which ones I'm totally missing:

I get the basics (I think)...I could get a loan from a mortgage company for 3.5% down and then pay X amount per month for the next X amount of years. I buy a house for 120k, put down $4200 and pay roughly $800 a month, then hopefully rent that property for $1200 a month. Effectively, providing myself with $400 of cashflow (minus any expenses of course [and in my mind only $200/month just to cover the 50% rule]). 

Next, lets say I go to a private lender. He gives me $60,000 to be paid back with 10% interest in let's just say 6 months. Am I going to have to pay that person X amount each month or do I just give said person $66,000 at the end of the term?

In the case of BRRRR, if I get a loan for 100k from a private lender with the same terms as above. Be nice to just give back 110,000 at the end of X amount of months. Find 80k home, put 20k into it and rent out the new house for 1300/month. Now, I have a cashflow of $1300 a month coming in because I am paying the 110k back later. After say three months, I refinance with a mortgage company and get the house appraised at 150k. Bank wants 20% down, effectively giving me 80% of the appraised price. So, 80% of 150k is 120k. I give my private lender their 110k, keep 10k for myself and continue to earn the $1300/month, correct? Plus the three months of $1300/month is mine as well.

Ok, in the case of getting several people to invest in me. Lets say I have 4 people who want to give me money. Say, 50k each for a total of 200k. These people just want me to take their money and go make them more of it. How do I pay those people back? Lets say I use the 200k to go out and buy 3 homes, do a little refurb and get them on the market for rentals. That is three homes bringing in a cashflow of $1300 each (lets just say they are similar). That is $3900 coming in each month. So...would I just set up a fund that pays each of these investors monies each month until the total plus whatever % we agree on is reached? This is where I am really fussy. And is there any compound interest happening? And if so...what is compound interest and how does it work? If I am paying each person $500 each month ($2000 total) I should effectively have a cashflow of $1900 each month to hopefully save and invest back into the business. But I guess, then you just find more investors and do it all over again. 

Sorry for such a long post/question, but I want to really wrap my head around this because this is really the core of my ability to succeed. I not only need to know how to finance my own deals, but I need to be able to approach would-be investors and be able to explain to them in detail how this will work and why they should invest with me. Not to mention not getting my head taken off by a bad deal/finance situation. 

Hi @Preston Miller , see my answers below to your questions in order:

1) Yes in theory you can do that.  In reality, no you can't do that specific scenario. 3.5% down loans are almost exclusively done as an FHA owner-occupied loan. This means you have to LIVE IN the property to qualify for this very low down-payment loan. This can be applied to people purchasing multifamilies and living in one unit and renting out the others (maximum of a four unit building). This is called house-hacking. There's a lot of great articles about it. However the important piece to note is that you MUST live in one of the units for at least one year.

2) Unless you can negotiate some fabulous deal, yes you have to pay them back monthly.  Its obviously to your benefit to pay them back at the end... but the lender makes the decisions here and they want to get paid as frequently as possible as soon as possible, so they typically schedule monthly payments plus the total loan balance at the end of the term.

3)  That would be nice... but like mentioned above.  Lenders want to minimize risk and get their money back as quick as possible... so you can expect to pay monthly to that lender plus the balance of the loan at the end of the term.  If this means you're taking out a more conventional mortgage, then you get to start making payments to that lender (hopefully) at a lower interest rate!

4)  This concept is called "syndication".  You're pooling funds from multiple sources to be able to afford something that everyone couldn't do individually.  This however, is a very complex and advanced subject and I'd STRONGLY advise you to not even think about touching other people's money until you've done multiple deals of your own and have put your own money on the line.  Naturally other people don't want to risk their money with someone inexperienced, so they'll want to see your track record as well.  In this case, just like with borrowing money from a private money lender or a bank, these investors will want to see their money paid back over time.  There are a variety of different ways this is done, but frequently, investors get paid back a "preferred" rate of return and then usually some extra bonus if the property is performing better than expected.  These returns might occur monthly, quarterly, or annually.  It all depends on how you structure your deal and what they agree to.  Again, do NOT do this until you have a lot of experience.  

Hope this help!

All great questions Preston. This was all new to me a few months ago as well. 

I would say your cash flow equation is way too basic. You need to factor in vacancy, anticipating for repairs, insurance, property management, etc. I STRONGLY suggest you watch one of Brandon's Webinars where he does a few live examples of this. The 50% rule is just a guide and can be very innacurate depending on insurance rates and property taxes in your area. 

Next, interest is annualized. In your example you would owe 6k if you held it for the entire year. If you move quicker, you would pay whatever fraction of the year you took to pay your lender back. If they allow you to pay them back at the end of the project with Jo payments in between that would be ideal. 

When paying friends who invested, same as you owing someone else or the bank. If you raise 100k from a friend, the faster the move, the less interest you owe. If it takes exactly 100k you owe your buddy 110k. Take just six months? 105k

Hope that was helpful in conjunction with the gentleman who answered before me. 

@Matt Lefebvre , thank you so very much. I really appreciate the help. I know that I am just a few key points away from hurting myself or nailing this thing and no, I will not touch anyone else's money until I am well on my way and have a ton of experience. That is a very important point. I just want to make sure I have as much education in this subject as possible. The FHA - owner occupied was a solid point as well. I forgot about having to live in it. Again, thanks for the info!

@Ernesto Hernandez Yes! Thank you for that reminder about the annualized interest.  

And yes, my formula for the holds was super basic. I totally get that when its all said and done, cashflow would be way less. I would be super disappointed if I was counting on those numbers up there, wouldn't I! 

In my actual business plan, I am going to go with a 100% rule until I have enough money established to deal with any issues that may arise. I don't plan to take a check, so to speak, from the holds. I want that money to build. I will be keeping my day job until there is enough steam in the engine to keep me going. I plan to have some flips in there that will help bolster my day job until Real Estate becomes my day job. :)

@Preston Miller , regarding "compound interest", it depends on the arrangement you have with your clients. Do they require the interest paid to their account after each year? (In which case, you don't have to pay them compound interest. Each year would be just the same). Or, if they give you continuing control of their $50k x 4 outlay (ie. You become their bank), then yes, you'd owe them their agreed (say 7%?) interest after one year, but because they're leaving that 7% interest with you, the following year you'd owe them 7% interest on that 7% interest, as well - compounding each year! [The higher the agreed interest, the faster it compounds!]

$200,000.00 x 7% = $14,000.00 interest the 1st year. $214,000.00 x 7% = $14,980.00 interest the 2nd year. $228,980.00 x 7% = $16,028.60 interest the 3rd year. See how that's compounding?...

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