How does everyone here mostly buy there properties ?

Question

Cash ?

0 Down Financing ?

10 - 20 % Down ? ( Does anyone here do this ? )

Equity ?

Owner Financing ?

Anything else ? ......

John Worley · Answer

Ok, let's expand on this. To simply say that this is a dangerous loan product is not fair. The danger is not the product itself, it's in the lack of understanding of how the product works. Lack of understanding and a lack of financial planning for the future (and the natural decline of the housing markets) is what has led to the current level of foreclosures around the country today.

The Pay Option Arm, like Ryan stated, is an adjustable rate mortgage with a variety of payment options (in most case 3).

Option #1 is the full principal and interest payment (same as a 15 or 30 year fixed).

Option #2 is the fully indexed Interest only payment, where you are simply paying the interest generated that month for the loan (same as an Interest only Mortgage).

Option #3 is the minmal Interest payment (at a rate of around 1% to 3%).

For many home owners, how this third option works was either never explained to them or they chose to ignore it. The minmal interest payment option works like this:

EXAMPLE

Let's take the $250,000 mortgage that Steve brought up earlier. Let's say he's using a Pay Option Arm at 7.5% interest. His payment choices would look like this:

Choice #1 (full 30yr. P&I) = $1.748 
Choice #2 (Interest Only) = $1,563
Choice #3 (minmal Interest at rate of 2.5%) = $521

Now here's the catch. Regardless of whether you pay the interest only of 7.5% or the minmal interest of 2.5%, the loan is still generating interest every month at the fully indexed rate (in this case 7.5%) Choice #3, the minmal interest payment, does not cover the interest generated for the month.

So in this example, where does the additional $1,042 in interest go? You guessed it, right back into the principal. This is why this payment option is referred to as negative amortization. The lender will allow this increase in pricipal to continue until you reach a cap of anywhere from 115% to 125% of the original loan amount. So on this $250,000 mortgage, the minmal payment option could be used for 35 to 59 months before the lender will stop allowing it to be used. The risk you run when using this option month after month is that sooner or later you are going to outpace to the market value of the property and become upside down in your loan.

Ryan is correct in that if you are purchasing a house at market value and you can't cash flow with an interest only payment, then yeah you're proabley better finding a new deal and not using the Pay Option Arm. However let's say that our $250,000 mortgage is 90% LTV and the house is actually worth $275,000. Assuming that your housing market isn't in a decline, then you can rent the house for 12 months, pay the minmal interest payment and have the increased cash flow and then sale the house after the 12 months and still clear about $12,000 (minus your cost to sale). I know investors here around Atlanta that have using this stragety for years. They use the increased cash flow to increase their reserves, make other investments, etc.

So yes this is one of the best tools you can use for positive cash flow, as long as you understand it and know how to use it. For rental properties, how much you can use the minmal monthly payment option without hurting yourself is directly linked to how much equity you have in the property when you buy it. The better your equity position, the longer you can rent it and make the minmal interest payment without outpacing the market value of the home.

Ryan Webber · Answer

I buy 90% of my wholesale properties with a bank line of credit (no downpayment).  The others I use cash or hard money depending on the circumstances.  My rentals and notes I've used a mix of cash, hard money, commercial loans, and owner financing.

Tom McGiveron · Answer

i like that - "judgement of risk".

many people do not understand that at all.  when i first got into this - i was all NO MONEY DOWN and INTEREST ONLY  - and BUY FIX REFI RENT - blah blah blah...

to each his own i say - but really, no noob can make an educated decision WHEN THEY'RE NOT EDUCATED!

the problem, whether they want to admit it or not, is late night guru commercials.  i reviewed an entire package from cover to cover, watched every CD and i did learn quite a bit.  the first thing you learn is THIS IS NOT A GET RICH QUICK SCHEME...

buuuuutttt...in the commercials - it sure likes like it is!

people say, well face your fears and go for it...okay, sure - but first, let me learn a little about this BEFORE i go and plop down my credit, my savings and whatever little else i have on any old property just because i'm hard up to make become "financially free"...lol

that's an oximoron right there!

wake up!  you're never "financially free"...whether you're rich or not - you've still got to manage your money/investments/business - and when you retire - you've got to pass it on to someone who will continue your efforts - cuz you don't take it with you!!

educate yourself first - then make your mark.  give yourself a fighting chance.

Ryan Webber · Answer

A Pay Option ARM is an adjustable interest rate loan that you normally have atleast 3 payment options on.  You can pay the normal 30 year (or whatever your amortization is) amortization principal and interest payment, you can pay interest only, or you can actually have the option of paying a very low negative amortization payment.  A negative amortization meaning that you aren't paying enough to even cover the interest and you owe more on the principal as time goes.

Pay Option ARM's can be very dangerous, and in my opinion should only be done by experienced investors with plenty of liquidity.  ARM's in general can be very dangerous and then throw in there a negative amortization option, and you can get upside down very quickly.

In my opinion if you can't cash flow with a normal loan, then its not a good deal.  There are so many deals out there, I hate to see people compounding their problems with a dangerous loan on a bad deal.

John Worley · Answer

I'm not trying rebuke you here Ryan. I agree with what you are saying. A borrower can get into trouble using the Pay Option Arm. Just ask any of the millions of primary home owners in this country who are finding out the hard way. My contention is that the reason a borrower gets into trouble is not so much the product, but a lack of understand of how the product works, a lack of understanding about the financial process or even basic econmics, and a lack of financial discipline.

Make no mistake about it, the Pay Option Arm is not for the average homebuyer. Not by a long shot. This product requires that you have:

-an understanding of how the product and the finacial process works.
-a particular financial goal. (If your goal is to simply own a house, then go get a nice safe 15 or 30 year fixed loan)
-a sense of strong financial planning 
-good financial discipline

The majority of homeowners in this country don't have these things (especially the last two).

All homeowners, but investors in particular, have to start educating themselves as to as many aspects of the real estate business as possible. For investors, the ablity to accuratly read market data and sales comps or to understand the ends and outs of several different loan programs (and how they can work for the different investment situations) are absolutely necessary for surviving in this business.

Investors need to always remember that this is a business. You have to treat it as such. If you are into real estate investing then you need to spend at least 50% of your time teaching and training yourself; continuing to learn on a daily basis the ends and outs of this business. And I'm not talking about just going out and buying into some guru's mircle system. I mean go down to your local real estate school and take some of the same courses that appraisers, mortgage brokers, and real estate agents take. Find active people in each of these three professions and ask questions. If you are unwilling to do that then you simply need to get out and go find something else to do because you will not last and in most cases will end up losing everything you have.

No successful businessman walks blindly into his business and relys on other people to make him a success.

Ryan Webber · Answer

I understand John, and I think I was being a little short.  I just see so many people get into financial trouble in this business because of a lack of financial responsibility.  I just wanted to make sure that people understand both sides to the puzzle.  Improperly weighing the risk/reward factor and not understanding money management are two factors that I see new investors get broke on very commonly.  I think I am just very motivated for people to understand what can go wrong and not just what can go right, so that they can adequately prepare for things when they do happen.

I had to learn some of these lessons the hard way.  I made it through it and eventually thrived, but there were times when my business' survival was at stake because of my lack of proper judgment of risk.

Ryan Webber · Answer

The thing about a Pay Option ARM is that it allows you to get upside down on a house like MANY people do on a car loan.

Loaded guns CAN BE very dangerous.  Now I agree that loaded guns are not always dangerous in a stable minded, responsible, experienced person's hand, but when you put a loaded gun in a child's hand it becomes very dangerous.  So I would like to reiterate that Pay Option ARM's CAN BE very dangerous, and in my opinon should only be done by EXPERIENCED investors with plenty of liquidity (or equity as JWorley pointed out).  Even a loaded gun in an experienced rifleman's hands can be the source of a lifetime of regret and sorrow.

Leveraging in general entails significant financial risks, and combining creative options with leverage magnifies those risks.  Be sure to be responsible and conservative in your risk/reward factoring, and don't fall into the trap of trusting someone else's decisions or loan ratios for your financial security.

Saying that reminds me of a local wholesaler that doesn't know a good deal when he sees one.  He calls his hard money lender and asks him if he will loan on it.  If the HML determines that he will loan on the property then the wholesaler will buy it.  He is trusting the HML's judgment on the loan worthiness of the property to determine if it's a good deal or not.  Now the HML is an experienced investor and is assuredly going to protect his principal with plenty of equity in the deal, but the problem is that the wholesaler completely relies on the lenders judgment.  I wouldn't frown on this so much if the wholesaler hadn't been in business for a couple years and still hasn't figured out what a good deal is.

Take your business serious, and have the diligence to learn and apply the principles of business that will make you successful.  Understanding what a good deal is or is not and understanding the uses of different types of financing are essential to be successful in this business.

N/A N/A · Answer

Whats a Pay Option Arm ?

John Worley · Answer

Steve,

I find that one of the best tools for positive cash flow on rentals, even when you are dealing in the ball park of $250K, is the Pay Option Arm. These can be done to 90% LTV with mininum monthly interest rates starting around 2.5%. The $250K mortgage you mentioned would be about $520/month under this program.

N/A N/A · Answer

many people do not think of the exit strategy....
are you going to sell it within 2 years.... (try for ARM, or interest only)

are you going to flip it in a month or so... (try hard money or 100% finance)

Is it positive cash flow you want to keep for a long time...(then a fixed 30 or 40 year is the way to do)

the quicker you want to sell it....put less cash
the longer you want to keep it....put more cash

thanks goodluck to you

sunsmicro