Financing for investment properties can be risky, and it can end up costing you BIG if utilized incorrectly.
A whole new generation of real estate investors is being set up to fail — for the benefit of the big banks. Are you falling for the con? How do we beat them?
Battles often rage in the BiggerPockets Forums between those who detest the idea of any debt out of principle versus those who insist that you can’t get ahead financially without using credit and borrowing from big financial institutions — and who see failing to borrow as being small minded and foolish.
So is there some way to find balance in using leverage that will allow individuals to scale their finances quickly? What factors should real estate investors be savvy to now?
The Biggest Scam in History
Looking back at the financial crisis of 2008, many might consider it the most massive con in the history of our planet. Millions lost their homes — and still are losing them. Then the banks that loaned the money to pump up the market (and who simultaneously crashed it) began taking those homes for pennies on the dollar!
Then they began renting and selling them back at higher prices, with new loan fees.
If you haven’t yet, you’ve got to watch:
This has proven to be a game so profitable that it may prove irresistible not to repeat it.
What to Watch Out For
What I’m watching out for now includes:
- How affordable properties are for regular people
- The amount of middlemen adding multiple layers of fees to investments
- The return of no money down
- Home buyers falsely claiming properties to be investments to borrow more money
- New investors taking out adjustable rate loans and lines of credit in the face of rising interest rates
I’ve seen the aftermath of mass over-leveraging, so I’m carefully watching the data so I am never caught short.
Do You Really Know How Much You’re Paying for That Property?
Conspiracy theories aside, borrowing money from mortgage lenders can be extremely costly. There can be benefits of buying more properties faster. However, investors must be clear on how much of their profits are being lost to the bank when borrowing.
Check out Bankrate’s closing cost calculator to see how much average closing costs are in each state. This is at least a couple thousand dollars straight out of the profit. Then there are normally extra taxes on money borrowed, as well as additional mandatory insurances, which can run into the thousands of dollars range.
Then look at the interest:
On a $250,000 loan, with a 6% interest rate over 30 years, borrowers will pay $289,595.47 in interest alone. That’s enough to buy a second property cash!
How to Win
Over-leveraging is risky. No question about it. That is true for individuals and countries alike. It’s also true that without any leverage, the average individual and family is going to have an incredibly tough time trying to get ahead and experience growth without taking on too much risk. And clearly borrowing big digs deep into any gains you make. So what’s the solution?
I’ve personally chosen to take a page out of The Intelligent Investor and Warren Buffett’s playbook. That means winning the long game by investing consistently in good properties, in good markets, at fair prices, which are throwing off positive cash flow.
I’ve also watched closely how Buffett has used leverage. This is increasingly through capital partners and by investing alongside others who share his values. He has done this in real estate and for his largest and most profitable deals. In other words, individual investors can get together with those who share their values and investment philosophy to control well diversified portfolios of income-producing properties. That provides strength, reduces risk, and minimizes expenses in order to maximize the bottom line.
Big banks have one mission. That is to make as much money as possible, at any cost. All too often the small investor is the victim of that. Right now, they appear to be repeating many of the same old moves. Leverage is needed. Even borrowing can sometimes be necessary and beneficial. However, I am afraid that many aren’t doing the math on what they are losing and may be putting themselves at risk.
Investors: How do you ensure you’re using leverage in a safe way to grow your portfolio?
Let me know what you think with a comment!