Financing Real Estate Investments For Dummies

Financing Real Estate Investments For Dummies
Ralph R. Roberts
Real estate professional and coauthor of
Foreclosure Investing For Dummies
Chip Cummings
Real estate financing expert and author
Evaluate potential lenders
Maximize your cash flow
Finance through private lenders
Tap into government programs
Learn to:
Financing Real Estate
Making Everything Easier!
Open the book and find:
Real-world advice on financing
without tying up all your capital
How to get prequalified or
preapproved for a loan
Questions to ask your lender
Ways to avoid common beginner
How to protect your personal
assets from investment risks
Bargain-hunting hints for
low-cost loans
Strategies for surviving a credit
Ten pre-closing steps you must
Ralph R. Roberts is an internationally acclaimed real
estate agent, speaker, investor, and consultant. Chip
Cummings is a real estate lending expert, a Certified
Mortgage Consultant with more than 25 years of
experience, and a seasoned real estate investor. Roberts
and Cummings coauthored Mortgage Myths: 77 Secrets
That Will Save You Thousands on Home Financing.
$21.99 US / $25.99 CN / £15.99 UK
ISBN 978-0-470-42233-5
Business/Real Estate
Go to
for more!
Want to be a smart, successful real estate investor?
This no-nonsense guide contains everything
you must know to make the right choices about
financing your investments — from the various
options available and the impact on cash flow to
the tax implications and risk factors involved. You
also get tried-and-true tips for surviving a down
market and using current investments to finance
future ones.
A crash course in real estate financing
understand standard terms and concepts, learn the
various sources of investment capital, and gather
all essential facts and figures
Weigh your options — decide which type of
ancing is best for your circumstances and
incorporate it into your real estate investing plan
Finance residential properties — evaluate
idential loan programs, navigate the loan
application and processing, and handle the closing
Invest in commercial properties — know the
ferent property types, choose the one that meets
your investment goals, and discover unique sources
for financing
Tap into unconventional sources — discover the
s and cons of “hard money,” capitalize on seller
financing, partner to share risk and equity, and
invest on the cheap with no-money-down deals
Your practical guide to
scoring cash to fuel your
real estate investments
Financing Real Estate Investments
Spine: .576 in
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Financing Real Estate
by Ralph R.Roberts and
Chip Cummings with Joe Kraynak
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Financing Real Estate Investments For Dummies
Published by
Wiley Publishing, Inc.
111 River St.
Hoboken, NJ 07030-5774
Copyright © 2009 by Wiley Publishing, Inc., Indianapolis, Indiana
Published by Wiley Publishing, Inc., Indianapolis, Indiana
Published simultaneously in Canada
No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or
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ted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written per-
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Rest of Us!, The Dummies Way, Dummies Daily, The Fun and Easy Way,, Making Everything
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other trademarks are the property of their respective owners. Wiley Publishing, Inc., is not associated with
any product or vendor mentioned in this book.
For general information on our other products and services, please contact our Customer Care Department
within the U.S. at 877-762-2974, outside the U.S. at 317-572-3993, or fax 317-572-4002.
For technical support, please visit
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Manufactured in the United States of America
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About the Authors
Ralph R. Roberts, CRS, GRI, is a seasoned professional in all areas
of real estate, including buying and selling homes, investing in real
estate, and building and managing real estate agent teams. He has
been profiled by the Associated Press, CNN, and
Time magazine,
and has done hundreds of radio interviews. He has authored and
coauthored several successful titles, including
Flipping Houses For
Dummies, Foreclosure Investing For Dummies, Foreclosure Self-Defense
For Dummies, Mortgage Myths: 77 Secrets That Will Save You Thousands
on Home Financing, and Foreclosure Myths: 77 Secrets to Saving
Thousands on Distressed Properties!
(John Wiley & Sons); Protect
Yourself Against Real Estate and Mortgage Fraud: Preserving the
American Dream of Homeownership
(Kaplan); and REAL WEALTH by
Investing in REAL ESTATE
(Prentice Hall).
To find out more about Ralph Roberts and what he can offer you
and your organization as a speaker and coach, visit
For details on how to protect yourself and your home from real
estate and mortgage fraud, check out Ralph’s blog at
. And don’t miss the latest addition to Ralph’s family of
Web sites and blogs,, where Ralph offers addi-
tional information and tips on the art of flipping houses and invest-
ing in foreclosures and pre-foreclosures. You can contact Ralph by
emailing him at or calling
Chip Cummings, CMC, is a recognized expert in the areas of real
estate lending and e-Marketing, and is a Certified Mortgage
Consultant with more than 25 years in the mortgage industry and
more than a billion dollars in sales volume.
Chip has written hundreds of articles and appeared numerous times
on radio, television, and in various magazines including
Mortgage Originator, Real Estate Banker/Broker, and The Mortgage
. He is an experienced professional in all areas of real estate
financing, including residential and commercial mortgages, govern-
ment lending, regulatory and compliance issues. He is past president
of the MMBA (Michigan Mortgage Brokers Association), and is a
licensed mortgage broker and lender in Michigan.
As an international speaker, he has addressed groups and organiza-
tions of all types, and trains thousands of mortgage professionals
from around the country every year. Chip is a certified national
trainer for continuing education in more than 40 states, and has
served as an expert witness in state and federal courts. He is also
the author of
ABC’s of FHA Lending and Stop Selling and Start
Listening! – Marketing Strategies That Create Top Producers
(Northwind), Mortgage Myths: 77 Secrets That Will Save You
Thousands on Home Financing
, Foreclosure Myths: 77 Secrets to
Saving Thousands on Distressed Properties!
and Cashing In on Pre-
foreclosures and Short Sales
(John Wiley & Sons).
01_422335-ffirs.qxp 3/11/09 11:49 AM Page iii
Chip lives in Rockford, Michigan with his wife Lisa and three chil-
dren, Katelyn, CJ, and Joe.
To learn more about Chip Cummings, his many successful products
or how he can help your organization as a speaker or business con-
sultant, visit To receive a complimen-
tary subscription to his multimedia e-newsletter and online events,
check out You can also reach Chip by
emailing him at or by calling
Joe Kraynak ( is a freelance author who has
written and coauthored numerous books on topics ranging from
slam poetry to computer basics. Joe teamed up with Dr. Candida
Fink to write his first book in the
For Dummies series, Bipolar
Disorder For Dummies,
where he showcased his talent for translat-
ing the complexities of a topic into plain-spoken practical advice.
He then teamed up with Roberts to write the ultimate guide to flip-
ping houses —
Flipping Houses For Dummies and delivered encore
performances in
Foreclosure Investing For Dummies, Advanced
Selling For Dummies
, and Foreclosure Self-Defense For Dummies. In
Financing Real Estate Investments For Dummies, Joe assists Chip and
Ralph in delivering the ultimate guide to scoring some cash to fuel
your investments in real estate.
01_422335-ffirs.qxp 3/11/09 11:49 AM Page iv
From Ralph: To real estate investors and professionals who are
dedicated to supporting and promoting the American dream of
From Chip: To my assistant Debbie Forth who has managed to keep
me organized for the last 14 years, and to my wife Lisa who puts up
with all the crazy hours and remains my #1 fan.
Authors’ Acknowledgments
Thanks to acquisitions editor Lindsay Lefevere, who chose us to
author this book and guided us through the tough part of getting
started and to our agent, Neil Salkind of StudioB (,
who ironed out all the preliminary details to make this book possible.
Chad Sievers, our project editor, deserves a loud cheer for acting as a
very patient collaborator and gifted editor — shuffling chapters back
and forth, shepherding the text through production, making sure any
technical issues were properly resolved, and serving as the unofficial
quality control manager. Megan Knoll, our copy editor, earns an editor
of the year award for ferreting out our typos, misspellings, grammatical
errors, and other language faux pas-es, in addition to assisting Chad as
reader advocate — asking the questions we should have asked our-
selves. And, we tip our hats to the production crew for doing such an
outstanding job of transforming a loose collection of text and illustra-
tions into such an attractive bound book.
We also wish to express our appreciation to the National Association
of Mortgage Brokers, National Association of Realtors
, the Mortgage
Bankers Association of America, and the Michigan Mortgage Brokers
Association for their support and assistance.
We owe special thanks to our technical editor, Patrick Lecomte, for
flagging technical errors in the manuscript, helping guide its con-
tent, and offering his own tips, tricks, and insights from the world of
real estate financing.
01_422335-ffirs.qxp 3/11/09 11:49 AM Page v
Publisher’s Acknowledgments
We’re proud of this book; please send us your comments through our Dummies online regis-
tration form located at For other comments, please con-
tact our Customer Care Department within the U.S. at 877-762-2974, outside the U.S. at
317-572-3993, or fax 317-572-4002.
Some of the people who helped bring this book to market include the following:
Acquisitions, Editorial, and
Media Development
Project Editor: Chad R. Sievers
Acquisitions Editor: Lindsay Lefevere
Copy Editor: Megan Knoll
Assistant Editor: Erin Calligan Mooney
Editorial Program Coordinator: Joe Niesen
Technical Editor: Patrick Lecomte, MA, MBA
Editorial Manager: Michelle Hacker
Editorial Assistant: Jennette ElNaggar
Cover Photos: © Comstock Images
Cartoons: Rich Tennant
Composition Services
Project Coordinator: Patrick Redmond
Layout and Graphics: Melanee Habig,
Melissa K. Jester, Christine Williams
Proofreader: ConText Editorial
Services, Inc.
Indexer: Potomac Indexing, LLC
Publishing and Editorial for Consumer Dummies
Diane Graves Steele, Vice President and Publisher, Consumer Dummies
Kristin Ferguson-Wagstaffe, Product Development Director, Consumer Dummies
Ensley Eikenburg, Associate Publisher, Travel
Kelly Regan, Editorial Director, Travel
Publishing for Technology Dummies
Andy Cummings, Vice President and Publisher, Dummies Technology/General User
Composition Services
Gerry Fahey, Vice President of Production Services
Debbie Stailey, Director of Composition Services
01_422335-ffirs.qxp 3/11/09 11:49 AM Page vi
Contents at a Glance
Part I: Gearing Up for Financing
Your Real Estate Investments..............................7
Chapter 1: Taking a Crash Course in Real
Estate Investment Financing ..............................................................9
Chapter 2: Shielding Your Personal Assets from Investment Risks...25
Chapter 3: Gathering Essential Documents, Facts, and Figures.........43
Chapter 4: Scoping Out Prospective Lenders.......................................61
Part II: Financing the Purchase
of Residential Properties..................................77
Chapter 5: Finding the Residential Loan Program
That’s Right for You ...........................................................................79
Chapter 6: Bargain Hunting for Low-Cost Loans ..................................93
Chapter 7: Navigating the Loan Application and Processing ...........105
Part III: Financing the Purchase
of Commercial Properties................................127
Chapter 8: Picking the Right Commercial Property Type for You....129
Chapter 9: Exploring Sources of Financing
for Commercial Properties .............................................................149
Chapter 10: Securing a Loan to Finance
Your Commercial Venture...............................................................163
Part IV: Sampling More Creative
Financing Strategies ......................................173
Chapter 11: Financing in a Pinch with Hard Money
and Other Tough Options ...............................................................175
Chapter 12: Capitalizing on Seller Financing ......................................193
Chapter 13: Partnering to Share the Risk and the Equity .................207
Chapter 14: Profiting from No-Money-Down
and Other Creative Deals................................................................219
Part V: The Part of Tens..................................231
Chapter 15: Ten Ways to Avoid Common Beginner Blunders...........233
Chapter 16: Ten Steps to Take before Closing....................................239
Chapter 17: Ten Tips for Surviving a Credit Crunch..........................245
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Table of Contents
Introduction .......................................................1
About This Book .........................................................................1
Conventions Used in This Book................................................2
What You’re Not to Read............................................................3
Foolish Assumptions ..................................................................3
How This Book Is Organized......................................................3
Part I: Gearing Up for Financing
Your Real Estate Investments......................................4
Part II: Financing the Purchase
of Residential Properties .............................................4
Part III: Financing the Purchase
of Commercial Properties............................................4
Part IV: Sampling More Creative
Financing Strategies .....................................................4
Part V: The Part of Tens...................................................5
Icons Used in This Book.............................................................5
Where to Go From Here..............................................................5
Part I: Gearing Up for Financing
Your Real Estate Investments...............................7
Chapter 1: Taking a Crash Course in Real Estate
Investment Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Pumping Up Your Purchasing Power with Borrowed Money ...10
Minimizing your potential by owning
property free and clear ..............................................10
Maximizing your potential with
other people’s money.................................................10
Paying cash with borrowed money..............................11
Brushing Up on Basic Real Estate Financing Lingo ..............12
Identifying types of lenders...........................................12
Grasping different loan types........................................13
Brushing up on important legal lingo ..........................14
Pointing out mortgage concepts ..................................16
Examining equity ............................................................16
Looking at loan-to-value (LTV)......................................17
Distinguishing Investment and Home Financing...................17
Paying a premium for riskier investment loans..........17
Using quick cash to snag bargain prices .....................18
Accounting for taxes on your capital gains
(or losses)....................................................................18
Protecting your personal assets...................................19
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Exploring Common Sources of Investment Capital..............19
Tapping your own cash reserves..................................20
Borrowing from commercial lenders ...........................21
Obtaining a hard money loan........................................22
Financing your purchase through the seller...............22
Taking on a partner ........................................................22
Prepping to Meet with a Lender..............................................23
Gathering paperwork and other info ...........................23
Crafting a business plan.................................................24
Chapter 2: Shielding Your Personal
Assets from Investment Risks . . . . . . . . . . . . . . . . . . . 25
Understanding Why You Need to
Protect Your Personal Assets..............................................26
Limiting Your Personal Liability by Forming an LLC............26
Understanding the pros and cons................................27
Setting up an LLC............................................................28
Taking and securing title to real estate........................28
Eyeing Sub-S corporations and partnerships .............29
Transferring Personal Assets via Trusts................................30
Weighing the pros and cons of owning property
in another’s name .......................................................31
Gaining asset and tax protection
with an irrevocable trust ...........................................32
Considering real estate investment trusts (REITs) ....33
Staying Away from Promissory Notes
with Recourse Clauses .........................................................33
Opting for a nonrecourse loan......................................34
Negotiating the recourse clause...................................34
Avoiding cross-collateralization ...................................35
Steering Clear of Real Estate and Mortgage Fraud ...............36
Telling the truth on your application...........................37
Dodging predatory lenders ...........................................38
Saying “no” to inflated appraisals ................................39
Turning your back on cash-back-at-closing
schemes .......................................................................40
Avoiding illegal flipping..................................................40
Defending yourself against chunking schemes...........41
Refusing a builder bailout..............................................41
Acting with integrity: The golden rule .........................42
Chapter 3: Gathering Essential Documents,
Facts, and Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Examining Your Credit Reports...............................................43
Obtaining free copies of your reports..........................44
Checking your credit score ...........................................45
Inspecting your report for problems ...........................46
Financing Real Estate Investments For Dummies
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Repairing your credit and boosting your score..........47
Avoiding mistakes that can sabotage
your loan approval...................................................................48
Chasing Down Vital Paperwork...............................................49
Delving into your personal financial information.......49
Accounting for business income ..................................53
Documenting the property you plan to purchase......54
Show Me the Money: Identifying Sources of Ready Cash....59
Sources of cash for down payments,
closing costs, and prepaid items..............................59
Rainy day funds: Cash reserves....................................60
Getting Prequalified or Preapproved......................................60
Chapter 4: Scoping Out Prospective Lenders . . . . . . . . 61
Borrowing Directly from Banks...............................................61
Weighing the pros and cons..........................................62
Conventional loans.........................................................64
Subprime (nonconforming) loans ................................65
Dealing with a Middleman (or Woman): Mortgage Brokers ...66
Weighing the pros and cons..........................................67
Shaking the branches for a broker...............................68
Checking a broker’s credentials....................................68
Taking the Hard-Money Route through Private Lenders .....70
Borrowing from Uncle Sam: Government Loan Programs ......72
Financing through the Seller ...................................................73
Lease options ..................................................................73
Land contracts................................................................74
Teaming Up with a Cash-Heavy Partner.................................74
Opting for a limited partnership...................................75
Going the corporation route .........................................76
Part II: Financing the Purchase
of Residential Properties ...................................77
Chapter 5: Finding the Residential Loan
Program That’s Right for You . . . . . . . . . . . . . . . . . . . . 79
Understanding Why Finding the Right
Residential Loan Is Key ........................................................79
Choosing a Loan Type to Maximize Your Cash Flow............80
The power of OPM (other people’s money)................81
Interest-only mortgages.................................................82
Grabbing a hold of ARMs...............................................83
Hard-money loans: Private investors...........................85
Taking Advantage of Government-Secured Loans................86
Tapping the FHA for a loan............................................86
Viewing Veterans Affairs (VA) loans.............................89
Table of Contents
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Financing Real Estate Investments For Dummies
Considering REO loans ..................................................89
Tapping into state and local grants and loans............90
Digging up USDA Rural Development loans ................92
Avoiding the Prepayment Penalty Trap .................................92
Chapter 6: Bargain Hunting for Low-Cost Loans. . . . . . 93
Understanding How This Interest Thing Works....................93
Keeping simple with simple interest............................94
Grasping the concept of amortization .........................94
Telling the difference between the
interest rate and APR ................................................96
Exploring how adjustable rate mortgages work.........97
Paying interest upfront with points .............................98
Considering the Mortgage Term .............................................99
Accounting for Closing Costs ................................................100
Getting socked with origination fees .........................100
Forking over other fees................................................100
Examining the Good Faith Estimate ...........................102
Calculating a Loan’s Total Cost.............................................103
Chapter 7: Navigating the Loan Application
and Processing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
Completing Your Loan Application.......................................105
Walking through the parts of the loan application...106
Reviewing the lender’s disclosures............................108
Supplying the requested documentation ..................111
Signing a release of information .................................112
Following the Loan Processing Trail ....................................112
Getting up to speed on the underwriting process ...113
Obtaining an appraisal or AVM...................................113
Having the property inspected...................................114
Obtaining a survey .......................................................119
Navigating the Closing............................................................120
Keeping your attorney in the loop .............................120
Dealing with the preliminaries....................................120
Signing the documents.................................................122
Knowing your right of rescission . . . or lack thereof ...122
Dealing with surprises .................................................123
Financing Other Types of Residential Properties...............124
Digging up money for vacation properties................124
Financing investment properties................................125
Purchasing vacant land................................................126
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Table of Contents
Part III: Financing the Purchase
of Commercial Properties.................................127
Chapter 8: Picking the Right Commercial
Property Type for You. . . . . . . . . . . . . . . . . . . . . . . . . . 129
Estimating the Income Potential
of a Commercial Property..................................................130
Calculating effective gross income (EGI)...................130
Calculating Net Operating Income (NOI)...................131
Estimating the property’s true value .........................132
Projecting future profits with a pro forma ................133
Dwelling On the Thought of Multifamily Homes.................134
Two- to four-family homes...........................................135
Garden apartments.......................................................136
Large multifamily properties.......................................136
Crunching the numbers...............................................138
Buying and Renting Out Office Space:
The A-to-D Grading Scale ...................................................139
Investing in Retail Real Estate ...............................................140
Collecting your cut of gross sales...............................141
Comparing strip malls and convenience stores .......142
Running Your Own Hotel or Motel........................................142
Distinguishing between flagged
and unflagged properties.........................................143
Encountering income challenges................................144
Checking Out Industrial or Warehouse Properties.............145
Calculating income and costs .....................................145
Considering storage facilities......................................146
Exploring Mixed-Use Properties ...........................................146
Sampling Some Special Use Properties................................146
Restaurants and bars ...................................................147
Gas stations...................................................................148
Adult foster care...........................................................148
Chapter 9: Exploring Sources of Financing
for Commercial Properties . . . . . . . . . . . . . . . . . . . . . 149
Sizing Up Various Commercial Loan Programs...................150
Exploring the middle market (local
and national banks)..................................................150
Hitting up the private sector:
Hard-money lenders.................................................151
Financing Main Street property
with Wall Street money ............................................152
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Financing Real Estate Investments For Dummies
Pursuing Government Loans.................................................153
Financing housing and medical facilities
through FHA loans....................................................153
Tapping into economic development
funds and grants .......................................................154
Securing a loan through the SBA................................154
Harvesting investment capital through the USDA....156
Getting a hold of a CDBG .............................................157
Deconstructing Construction Loans ....................................158
Financing Fixes with Rehabilitation Loans ..........................158
Exploring Other Creative Financing Options ......................159
Borrowing from pension programs
and life insurance companies..................................159
Enlisting the services of venture capitalists .............160
Sharing the costs and the equity................................161
Participating in participation loans ...........................161
Taking on a partner ......................................................162
Considering other potential sources of capital ........162
Chapter 10: Securing a Loan to Finance
Your Commercial Venture. . . . . . . . . . . . . . . . . . . . . . 163
Deciphering the Broker-Borrower Agreement ....................163
Accounting for Upfront Fees .................................................165
Obtaining Third-Party Reports..............................................167
Verifying a property’s market value
with an appraisal ......................................................167
Plotting the perimeter with a survey .........................168
Inspecting the title........................................................168
Obtaining an engineering report ................................169
Getting a clean bill of environmental health.............169
Navigating the Closing............................................................170
Protecting yourself with title insurance ....................170
Insuring your property ................................................171
Attending to existing tenant rights.............................172
Part IV: Sampling More Creative
Financing Strategies .......................................173
Chapter 11: Financing in a Pinch with Hard
Money and Other Tough Options . . . . . . . . . . . . . . . . 175
Weighing the Pros and Cons of Hard Money .......................176
Perusing the pros..........................................................176
Considering the cons ...................................................177
Managing the Expense of a Hard-Money Loan....................179
Calculating points.........................................................179
Adding up the interest .................................................180
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Table of Contents
Subtracting the tax savings.........................................180
Paying back the loan sooner to save money.............181
Locating Local Hard-Money Lenders....................................183
Asking your broker for leads.......................................183
Networking through local investment groups ..........183
Perusing ads in local newspapers ..............................184
Searching the Web ........................................................184
Getting preapproval .....................................................185
Hitting Up Friends and Relatives for a Loan........................185
Grasping the pros and cons ........................................186
Identifying the moneybags in your circle..................187
Drawing up an agreement............................................187
Honoring securities laws .............................................189
Financing Fix-Ups with a Home
Equity Loan or Line of Credit ............................................189
Understanding home equity loans and LOCs ...........190
Maxing out your LOC ...................................................190
Applying for an LOC .....................................................191
Supplementing Your Financing with Credit Cards..............191
Eyeing the pros to credit card use .............................191
Choosing a credit card with low
interest and plenty of perks ....................................192
Chapter 12: Capitalizing on Seller Financing . . . . . . . 193
Buying Property on Contract with a Land Contract...........193
The ups and downs of buying
a property on contract.............................................194
Inspecting the title........................................................195
Beware of the due on sale clause ...............................197
The how-to: What you need to do ..............................197
Protecting yourself against fraud ...............................199
Renting to Own with a Lease Option Agreement................199
Grasping the fundamentals of a
lease option agreement............................................201
Using the lease to earn some cash.............................202
Dealing with the option................................................203
Paying Close Attention to the Forfeiture Clause.................206
Chapter 13: Partnering to Share the Risk
and the Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207
Differentiating between a Partnership
and a Joint Venture .............................................................207
Weighing the Pros and Cons of Partnerships......................208
Finding a Partner with the Right Stuff ..................................210
Scoping out prospective partners..............................211
Checking a prospective partner’s qualifications......212
Making sure your partner has what you need
and needs what you have ........................................213
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Financing Real Estate Investments For Dummies
Drawing Up a Partnership Agreement..................................214
Drafting the agreement ................................................215
Complying with the tax code ......................................217
Avoiding Common Pitfalls......................................................217
Chapter 14: Profiting from No-Money-Down
and Other Creative Deals . . . . . . . . . . . . . . . . . . . . . . 219
Financing Your Down Payment with a Second Mortgage ...220
Taking out an 80-20 loan ..............................................220
Disclosing your second mortgage ..............................221
Wholesaling for Fun and Profit..............................................221
Buying and selling options ..........................................222
Assigning a purchase agreement................................224
Selling the Tax Benefits ..........................................................226
Trading Spaces: 1031 Exchanges ..........................................226
Qualifying for a 1031 exchange ...................................228
Meeting the deadlines..................................................229
Selling Other Equitable Interests ..........................................229
Leaseholds and other rights .......................................229
Naming rights, air rights, and
other unimaginable stuff..........................................230
Part V: The Part of Tens...................................231
Chapter 15: Ten Ways to Avoid Common
Beginner Blunders. . . . . . . . . . . . . . . . . . . . . . . . . . . . 233
Focusing on More than Just a Low Interest Rate................233
Getting Preapproved ..............................................................234
Doing Your Homework: Property Research.........................234
Making a Reasonable Down Payment...................................235
Comparing at Least Three Good Faith Estimates...............236
Viewing at Least Ten Properties before Making an Offer...236
Checking Your Credit Score before Applying for a Loan ...237
Buying with Your Brain and Not Your Heart........................237
Monitoring the Pulse of Current Market Conditions..........238
Calculating the NOI and DSCR
on Commercial Properties .................................................238
Chapter 16: Ten Steps to Take before Closing . . . . . . . 239
Get and Review a Copy of the Appraisal..............................239
Review the Title Commitment
and Obtain Title Insurance ................................................240
Review All Closing Documents..............................................241
Review a Copy of the HUD-1 Closing Statement .................241
Get an Insurance Policy .........................................................242
Do a Walk-Through on the Property.....................................242
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Obtain Utility Final Readings and Schedule
the Transfer .........................................................................243
Review Updated Tenant Rent Roll ........................................243
Have Certified Funds or Wire Transfer Ready to Go..........244
Confirm Date, Time, and Location of Closing......................244
Chapter 17: Ten Tips for Surviving
a Credit Crunch. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245
Expand Your Search................................................................245
Choose Properties More Carefully........................................246
Focus on Foreclosures ...........................................................246
Look for Short-Sale Opportunities........................................247
Buy REO Properties................................................................247
Search for High-Equity Properties ........................................248
Shift from a Buy-Sell to a Buy-Hold Strategy .......................248
Team Up with Your Mortgage Broker...................................249
Offer Your Agent a Bonus.......................................................249
Partner Up and Get Creative .................................................250
Index .............................................................261
Table of Contents
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Financing Real Estate Investments For Dummies
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eal estate investing is an expensive habit. You need money to
finance the purchase, renovate your fixer-upper, and cover
the holding costs while you prepare to sell or rent the property.
The good news is that it doesn’t all have to be
your money. In fact,
the less of your own money you can use and the more you can
borrow, the bigger the return on your investment. Add the poten-
tial credit and market woes like the first decade of the 2000s, and
investing in real estate also becomes a bit more of an adventure.
Lining up financial resources well in advance of scouring the neigh-
borhood for investment opportunities enables you to pounce on a
bargain and gives you leverage in negotiating the price you ulti-
mately pay for a property. When you place an offer on a house and
other bids come in, the seller may accept your offer of thousands
of dollars less simply because you have the financing in place to
quickly close the deal. Ready cash also frees you to plan and begin
rehabbing the property immediately instead of waiting around for
sluggish loan approvals and credit checks.
If you’re thinking that you can’t possibly get your mitts on enough
cash to finance your venture,
Financing Real Estate Investments For
is the book for you. Here you discover the best sources
for investment capital and how to go about tapping into these
sources to fuel your next venture.
About This Book
This book isn’t a get-rich-quick guide to investing in real estate
or a guide or a tutorial on how to buy property with no money
down (although we do cover that topic).
Financing Real Estate
Investments For Dummies
delivers what the title promises — a
treasure map that shows you where to find sources of real estate
investment capital and guidance on how to dig it up.
Ralph and Chip are both seasoned investors. We’ve each built wealth
through investing in real estate — buying and selling fixer-uppers and
buying and renting out both residential and commercial property.
Although we have used our own money on occasion to finance our
purchases and renovations, we’ve primarily succeeded with the
use of other people’s money (OPM). Our grandmothers were our
first financial backers, but we’ve expanded our options since then.
03_422335-intro.qxp 3/11/09 11:50 AM Page 1
We have more than 50 years’ worth of combined experience in
buying and selling real estate and securing the financing to do it. In
this book, we share what we know with you, showing you how to
tap into loans from banks; mortgage companies; private lenders;
federal, state, and local government programs; and more. In the
process we cover financing for both residential and commercial
Conventions Used in This Book
Compared to other books on financing real estate investments,
Financing Real Estate Investments For Dummies is anything but con-
ventional, but we do use some conventions to call your attention
to certain items. For example:
Italics highlight new, somewhat technical terms, such as hard
and emphasize words when we’re driving home a
Boldface text indicates key words in bulleted and numbered
Monofont highlights Web addresses.
Financing the purchase and renovation of residential properties,
such as homes, is quite different from financing the purchase and
renovation of commercial properties. You deal with different
lenders who use different methods for evaluating your loan appli-
cation and the property you’re planning to buy.
In this book, we cover both types of financing, but you should
know up front the differences between residential and commercial
Residential: One- to four-family dwellings classify as residen-
tial properties, which qualify for residential financing.
Commercial: Properties used to conduct business and any
rental properties designed to house more than four families
qualify as commercial real estate. Loan approval for these
properties hinges more on the property’s potential for gener-
ating sufficient income to make the payments than on the bor-
rower’s financial strength.
In addition, even though you see three author names on the cover
of this book — Chip, Ralph, and Joe — the “we” is usually Chip and
Ralph talking. Joe is the wordsmith — the guy responsible for
Financing Real Estate Investments For Dummies
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keeping you engaged and entertained and making sure we explain
everything as clearly and thoroughly as possible.
What You’re Not to Read
Although we encourage you to read this book from cover to cover
to maximize the return on your investment, we realize that in
today’s busy world you may have time to read only the information
pertinent to your situation. If so, you can safely skip anything you
see in a gray shaded box. We stuck this material in a box for the
same reason that most people stick stuff in boxes — to get it out of
the way, so you wouldn’t trip over it. However, you may find the
stories and brief asides uproariously funny and perhaps even
mildly informative (or vice versa).
Foolish Assumptions
We assume you already mastered the basics of investing in real
estate. If you haven’t, we encourage you to pick up a copy of either
(or both)
Real Estate Investing For Dummies, 2nd Edition, by Eric
Tyson and Robert S. Griswold, or
Commercial Real Estate Investing
For Dummies
by Peter Conti and Peter Harris (Wiley).
If you’re interested in flipping houses or focusing on foreclosure
properties, check out
Flipping Houses For Dummies or Foreclosure
Investing For Dummies
by Ralph R. Roberts with Joe Kraynak. If
you’re thinking of becoming a landlord, we strongly encourage you
to first read
Property Management For Dummies by Robert S.
Griswold. Not everyone has the right stuff to be a landlord, but if
you know what you’re getting into before you take on the role, you
can significantly improve your survival odds.
How This Book Is Organized
Financing Real Estate Investments For Dummies facilitates a skip-
and-dip approach. It presents the information in easily digestible
chunks, so you can skip to the chapter or section that grabs your
attention or meets your current needs, master it, and then skip to
another section or simply set the book aside for later reference.
To help you navigate, we took the 17 chapters that make up the
book and divvied them up into five parts. Here, we provide a quick
overview of what we cover in each part.
03_422335-intro.qxp 3/11/09 11:50 AM Page 3
Part I: Gearing Up for Financing
Your Real Estate Investments
When you become a real estate investor, you’re essentially building
a business; you should build it on a strong foundation. In this part,
we cover the basics, providing you with definitions of standard ter-
minology and concepts you’re likely to encounter, introducing you
to the various sources of investment capital, showing you how to
protect yourself against potential risks, and leading you through
the process of gathering all the documents and other information
you need to apply for financing.
In the process, we reveal the power of using OPM to gain leverage
and expose your own money and other assets to less risk.
Part II: Financing the Purchase
of Residential Properties
In this part, we explore the many residential loan programs cur-
rently available, show you how to compare different loan packages
to find the one that costs the least overall, and lead you through
the loan application process from filling out the forms to closing.
By the end of this part, you should have the financing you need to
start hunting for residential real estate investment opportunities.
Part III: Financing the Purchase
of Commercial Properties
In this part, we introduce you to the most common commercial
property types, so you can choose the type best suited to your
investment goals and evaluate the properties based on their poten-
tial for generating a positive cash flow. We take you on a tour of
some of the unique sources of financing available for commercial
ventures. Finally, we step you through the process of applying for
commercial real estate loans from application to closing.
Part IV: Sampling More Creative
Financing Strategies
In this part, you discover the pros and cons of hard money — cash
that’s generally easier but more expensive to borrow for purchasing
Financing Real Estate Investments For Dummies
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investment properties. We also show you how to finance the pur-
chase through the seller by purchasing properties on contract,
how to partner with an investor who’s cash heavy, and how to
track down no-money-down deals.
These options aren’t for everybody, but when you’re in the market
for investment properties and can’t get your hands on conven-
tional financing, these unconventional sources can be a deal saver.
Part V: The Part of Tens
The Part of Tens is the highlight of every For Dummies title, offer-
ing quick strategies, tips, and insights on whatever subject the
book covers. The chapters in this Part of Tens reveal how to avoid
the ten most common mistakes when financing real estate invest-
ments, which questions you should ask prospective lenders, ten
steps to take to prepare for your next closing, and ten strategies
for surviving a credit crunch.
Icons Used in This Book
Throughout this book, we sprinkle icons in the margins to cue you
in on different types of information that call out for your attention.
Here are the icons you’ll see and a brief description of each.
We want you to remember everything you read in this book, but if
you can’t quite do that, be sure to remember the important points
flagged with this icon.
Tips provide insider insight from behind the scenes. When you’re
looking for a better, faster, cheaper way to do something, check out
these tips.
“Whoa!” This icon appears when you need to be extra vigilant or
seek professional help before moving forward.
Where to Go From Here
Financing Real Estate Investments For Dummies is sort of like an
information kiosk. You can start with the chapters in Part I to
master the basics and then skip to Part II if you’re planning on
financing the purchase of residential property or Part III if your
focus is more on commercial properties.
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For a quick primer on financing the purchase of real estate invest-
ments, check out Chapter 1. Chapter 4 is a great place to start if
you’re not sure where to start looking for lenders — this chapter
touches on everything from banks and mortgage companies to pri-
vate lenders and partnering with others who have cash.
We do consider Chapter 6 required reading. All too often investors
get burned because they focus too much on interest rates and not
on other factors contributing to the overall cost of borrowing
money. This chapter offers a quick way to compare two loans side-
by-side to determine which one costs less over the life of the loan.
If you’re planning to invest in commercial properties, Chapter 8 is
also required reading. In this chapter, we show you how to evalu-
ate different types of properties the way lenders do it when you
apply for a loan.
If you’re looking for information on a very specific topic, flip to the
back of the book, where you can find a comprehensive index of key
Financing Real Estate Investments For Dummies
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Part I
Gearing Up for
Financing Your Real
Estate Investments
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In this part . . .
he key to scoring affordable financing and keeping a
bigger chunk of your after-tax profits from real estate
investments is preparation. By understanding the leverage
you can gain using other people’s money (OPM) to finance
your investments and having all your financial records in
place, you increase your odds of securing financing with
attractive terms and interest rates.
By understanding tax laws and loopholes before you get
started, you can lay the groundwork necessary to maxi-
mize your tax deductions and exclusions and keep more
profit for yourself. And by understanding the differences
between different types of lenders, you gain access to
additional sources of investment capital you may never
have considered.
In this part, we help you build your real estate investment
venture on a firm foundation so you have ready access to
cash while minimizing your exposure to risk.
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Chapter 1
Taking a Crash Course in
Real Estate Investment
In This Chapter
Gaining leverage with other people’s money
Deciphering key terms
Grasping the difference between a home and investment property
Discovering vital sources of real estate investment capital
Getting ready to meet your lender
re you eager to set out on the road to building wealth through
real estate? Although we hate to hold you back, we do dis-
courage you from moving forward without the proper preparation.
Our advice doesn’t necessarily mean, however, that you need to
read the entire book from cover to cover before you purchase your
first investment property.
Here, we provide a quick primer on real estate financing along with
what you need to do to secure financing for your real estate invest-
ments. We also provide a generous supply of references to other
chapters in the book where you can find more detailed information
on specific topics. So without further ado, let the real estate financ-
ing primer begin.
Don’t let negative economic and credit information dampen your
desire to invest in real estate. The best time to purchase real estate
is when prices are low. You can still find and secure financing; you
just may need to look and work a little harder and smarter to get it.
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Pumping Up Your Purchasing
Power with Borrowed Money
If you have any reservations about borrowing money to buy real
estate, you need to overcome those reservations by developing a
better understanding of leverage — using borrowed money to buy
more and better properties, thus improving your chances of earn-
ing bigger profits.
In the following sections, we show you why the goal of owning a
property free and clear isn’t such a smart move, reveal the secret
of leveraging the power of borrowed money, and explain how you
can offer “cash” for properties even when financing the purchase.
Although we encourage investors to borrow money to increase
their leverage, keep in mind that borrowing money can carry signif-
icant risks. As an investor, you can take action to minimize the
risks — by carefully evaluating your real estate market and proper-
ties under consideration, overestimating costs, underestimating
profits, developing realistic backup plans, and so on; however you
can never completely eliminate the risk. You have to decide for
yourself what an acceptable level of risk is.
Minimizing your potential by owning
property free and clear
For many Americans, paying off their mortgage early and owning
their home free and clear is the real American dream. Life would be
so much better if they didn’t have to deal with a house payment.
For real estate investors, however, owning property free and clear
means that valuable equity is locked up in those properties —
equity they can use to finance the purchase of other revenue-
generating real estate. Don’t get caught in the trap of thinking that
paying off a mortgage loan is a smart move — it may be a noble
goal, but it’s rarely a savvy strategy.
Maximizing your potential
with other people’s money
Other people’s money (or OPM for short) is money that you borrow
from other people to finance your investments. OPM isn’t much of
a secret. Assuming you own a home, you probably used OPM to
buy it. You may have put down 5 to 10 percent of your own money
as a down payment and then borrowed the rest.
Part I: Gearing Up for Financing Your Real Estate Investments
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In most cases, OPM helps you earn a profit. When you calculate in
the appreciation of the home, the tax savings it represents, infla-
tion, and other factors, you’re likely to earn more money off the
home than you pay out in interest over the life of the loan —
barring a major housing meltdown.
The same applies to your real estate investments. The more OPM
you can put to work for you, the more you stand to earn — as long
as your earnings from it exceed the cost of borrowing it. For more
info about OPM, check out Chapter 5.
Paying cash with borrowed money
In the world of real estate, cash is king. The buyer who shows up
with cash is in a significantly stronger position to purchase a prop-
erty and negotiate an attractive price and terms than a buyer who
shows up needing financing.
Chapter 1: Taking a Crash Course in Real Estate Investment Financing
Dealing with a major credit crunch
The mortgage meltdown, foreclosure epidemic, and global financial crisis that all
came to a head in 2008 led many real estate investors to believe that credit had all
but dried up. Banks were failing left and right, and the United States was forced to
step in with more than $1 trillion in economic rescue funds to keep cash flowing to
individuals and businesses that needed credit. Surely, real estate investors would
be the last on the list for cheap and easy credit.
Actually, the credit crunch didn’t put real estate investors out of business. In fact,
in many cases, it made conditions better for investors:
When the bubble burst, properties became much more affordable. Investors
could buy better properties for less money.
As millions of people worked through foreclosure, demand for rental properties
Financial institutions, eager to rid their books of empty, expensive, cash-sucking
foreclosures, became more willing to offer great deals. I (Chip) just had a client
pay $82,000 for a brand new property with a market value of about $275,000. The
bank had taken it back from a builder, was more than glad to just get it off the
books, and was willing to finance it with a 15-year loan.
A credit crunch doesn’t mean that financing disappears — it just means that you
probably need to look for it in some unusual places. Even FHA has investor financ-
ing with 25 percent down — and a lot of foreclosures they’re willing to deal on.
Throughout this book, we show you how to tap into these markets — credit crunch
and all.
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When we say cash is king, however, we’re not advising you to show
up with a suitcase full of money. We’re telling you to show up with
preapproved financing — a financial backer who can deliver the
cash on closing day. In other words, although you’re financing the
purchase as explained throughout this book, you’re still placing
yourself in a position to offer cash.
Brushing Up on Basic Real
Estate Financing Lingo
Throughout this book, we toss around some jargon common in the
real estate and mortgage lending industries. To the average con-
sumer, these terms may sound Greek, but we assure you that
they’re part of the English language. In the following sections, we
define the most common and often misunderstood of these terms.
Identifying types of lenders
The moneymen and -women you deal with when securing financing
for purchasing investment property play various roles in the
process. You need to know whom you’re working with:
Commercial lenders: They’re financial institutions rather
than individuals. They include banks, credit unions, mutual
savings banks, savings and loan associations, and stock sav-
ings banks. (Chapter 9 discusses commercial lenders in
greater detail.)
Private lenders: A private lender is any individual who loans
money outside the channels of institutional lending. This
person can be a friend or relative, such as your Aunt Mabel,
or an investor. Real estate investors often rely on private
lenders for access to investment capital when banks and
other financial institutions turn them down. (For more about
private lenders, check out Chapter 11.)
Mortgage banker: Mortgage bankers are financial institutions
that directly fund home loans and either service those loans
themselves (arranging and collecting monthly payments and
managing any escrow accounts) or sell the mortgages to
investors and contract out the servicing of the loans.
Servicer: The servicer is the institution contracted or
appointed to collect the monthly payments from the bor-
rower. They have to account for all payments and disburse-
ments and provide yearly statements showing all transactions
within a mortgage account to the borrower.
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Mortgage broker: Mortgage brokers are licensed by the state
to assist borrowers in finding mortgage lenders, comparing
loan programs, applying for mortgage loans, and securing
financing for purchasing real estate. They act as the eyes and
ears for many different mortgage lenders.
Loan officer: Loan officers work for mortgage bankers or bro-
kers to assist clients in securing financing for purchasing real
estate. They essentially do the same thing brokers do, but
they have to work for a licensed broker or lender.
Loan originator: Another name for a mortgage broker or loan
See Chapter 4 for more on these types of lenders.
Grasping different loan types
Throughout this book, we introduce you to various types of loans
for financing the purchase of real estate, including conforming and
nonconforming loans, jumbo loans, and hard money loans. In the
following list, we define the most common loan types and toss in
some additional information that you may find useful.
Conforming loan: A conforming loan is one that meets the cri-
teria set forth by Fannie Mae or Freddie Mac — the organiza-
tions that purchase the loans and then package them up to
sell on Wall Street. In general, to qualify for a conforming loan,
the borrower must
Show sufficient income to cover monthly payments.
Have enough cash for a down payment and reserves.
Have a good credit history.
For additional details about conforming loans and current cri-
teria, visit the Fannie Mae Web site at
Nonconforming loans: These include everything else outside
the Fannie/Freddie box. Sometimes referred to in the market
subprime or even exotic loans, they’re bought by other
financial companies or investment banks and packaged to be
sold to Wall Street investors. When the subprime market suf-
fers, as it did starting in 2008, far fewer of these types of secu-
rities make it to market.
Conventional loans: These loans are outside the sphere
of the government. In other words, they’re not FHA- or VA-
secured loans and aren’t underwritten by any government
Chapter 1: Taking a Crash Course in Real Estate Investment Financing
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Jumbo loans: As its name suggests, a jumbo loan represents a
lot of money — specifically, more money than you can borrow
under the limits of a conforming loan.
Hard money loans: Also referred to as bridge loans, they’re
typically short-term, high-interest loans that enable investors
to get their mitts on some cash in a hurry. You can expect to
pay several points upfront (a
point is equivalent to one per-
cent of the total loan amount) plus up to double the going
interest rate. (For more about hard money and strategies for
using it to your advantage, check out Chapter 11.)
Government loan programs: The government isn’t really in the
business of loaning money to homeowners and investors, but
it facilitates the process for lenders by insuring the loans — if
the borrower defaults on the loan, the government steps in to
cover any losses for the lender.
The two most common government loan programs are Federal
Housing Authority (FHA) and Veterans Administration (VA)
loans. But federal, state, and local governments also provide
loan programs to encourage investment in disaster areas and
neighborhoods that they’re seeking to develop. Within the
FHA and VA programs are some great hidden opportunities for
investors. (See Chapter 4 for more about specific government
loan programs.)
Brushing up on important legal lingo
Even though real estate deals are generally classified as financial,
they involve plenty of legalities, especially in relation to who owns
the property or has a stake in it. Although real estate–related legal
terms can fill an entire dictionary, you should have a working
knowledge of the following three:
Deed: A deed is a legal document that grants rights to a prop-
erty. Whenever you purchase a property, whoever is handling
the closing must file the deed with the county’s register of
deeds to make the transfer of ownership official. As the offi-
cial owner, you have the right to borrow against the property
and transfer your rights of ownership.
Be careful signing any deed, especially a
quitclaim deed (the
deed that allows a property’s owner to relinquish all rights to
the property). Real estate con artists often use the quitclaim
deed to hijack property from unwary owners. They may hide
a single page quitclaim deed in a stack of papers, fooling the
owner into signing the document without knowing what
they’re signing. Then, they run down to the register of deeds
and file the deed, making themselves the new owners, so they
can take out bogus loans against the property.
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Lien: A lien is a legal claim that a creditor holds against a
property in lieu of payment. Several parties can place a lien
on a property, including the lender who holds any first or
second mortgage, the county tax assessor (for unpaid taxes),
and contractors (if they financed the repairs or renovations).
As an investor, knowing who (if anyone) has a lien against a
property you’re purchasing and the monetary value of that
lien is important. All lien holders need to be paid in full upon
sale of the property. If the property has a lien against it that
the seller fails to disclose, you may become liable for paying it
when you take ownership of the property.
Promissory note: Whenever you borrow money, you have to
sign a promissory note pledging to pay back the loan in full
according to terms of the loan, which always specifies a dead-
line for full payment. Think of a promissory note as an IOU (as
in “I owe you” this amount of money).
The promissory note is your pledge to pay back the loan. The
mortgage or deed of trust names the property as collateral in
the event that you default on the loan.
Chapter 1: Taking a Crash Course in Real Estate Investment Financing
Who gets first dibs?
In the event of a foreclosure, certain liens take
over others, meaning
that when the property is sold at auction, certain lien holders are paid off first:
Tax lien: The proceeds from the foreclosure sale pay off any unpaid property
taxes first.
First mortgage: If any money from the proceeds of the sale remain, it pays off
the first mortgage or as much of the first mortgage as possible. This is also
referred to as a
senior lien.
Second mortgage: If the homeowner took out a second mortgage, any remain-
ing proceeds from the sale go toward paying it off. Any second (or third or
fourth) mortgages are also referred to as
junior liens
Construction liens: If money still remains, it goes to the next lien holders in order
of precedence.
Homeowners: After all the lien holders receive their cuts, the foreclosed-upon
homeowners get the remaining crumbs, which can actually be quite a chunk of
change if they had a lot of equity in the property.
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Pointing out mortgage concepts
When you take out a loan, the lender requires something of value
(collateral) to make sure it has something valuable to sell and
recoup its investment if you default on the loan. This collateral is
officially presented in the form of a mortgage or deed of trust
depending on the jurisdiction:
Mortgage: A mortgage is a contract between the lender and
borrower that gives the lender the right to foreclose on the
property in the event that the borrower defaults on the loan.
Deed of trust: A deed of trust is a mortgage contract that
places control of the deed in the hands of a third party — a
trustee. The trustee has the power to foreclose on the prop-
erty in the event that the borrower defaults on the loan.
The mortgage market is large and complex, but it consists of two
main divisions: a
primary and a secondary mortgage market.
Primary: This is the market in which you do business. It con-
sists of financial institutions that lend you money.
Secondary: This is the market where institutional lenders and
Wall Street investors converge. The primary lenders who actu-
ally loan money to homeowners and investors turn around
and sell the mortgages or deeds of trust to investors. This
gives the lenders more money to make available to borrowers.
Examining equity
Equity is the amount of money you’d have if you sold the property
today and paid off the balance due on the loan. More importantly,
as an investor, you can pull equity out of a property by borrowing
against it. This power enables you to put that equity to work for
you in other investments.
Thanks to the credit crisis in 2008 and 2009, the equity require-
ments to obtain financing are growing. Lenders are taking a closer
look at market values, especially in what they call
declining areas
areas showing a pattern of recently declining housing values. As an
investor, you should be doing the same thing. Be cautious when
calculating equity positions and profit margins.
Although we encourage investors to tap the power of equity, keep-
ing some equity in a property (especially the home you own) is a
good idea. Having equity to borrow against in the event of a finan-
cial setback may save you from foreclosure and bankruptcy.
Part I: Gearing Up for Financing Your Real Estate Investments
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Looking at loan-to-value (LTV)
The loan-to-value (LTV) is the ratio of the total loan amount to
the value of the property. If you’re buying a $200,000 home with
$40,000 down and applying for a $160,000 loan, the LTV would be
$160,000 ÷ $200,000 = 80 percent
Generally speaking, lenders want to see lower LTVs for investment
properties than for homes because a lower LTV provides more of a
buffer to cover the increased risks inherent in investment proper-
ties. Check out Chapter 3 for more about calculating the LTV and
how lenders use this number to evaluate risk.
Distinguishing Investment
and Home Financing
Your first real estate investment should be your own home. In fact,
if you don’t own your home, we advise you to put down this book
and pick up a copy of
Home Buying For Dummies by Eric Tyson and
Ray Brown (Wiley) first. Owning your own home carries the least
risk and the most potential tax benefits while bringing you up to
speed on the basics of real estate investing and ownership.
After you’ve purchased a home, you should have a fairly good
understanding of the mortgage loan application and approval
process. (We provide a refresher course in Chapter 7.) However,
real estate financing differs quite a bit when you take on the role of
investor rather than homeowner. You and the lender take on more
risk. As a result, you can expect to pay more for the privilege of
borrowing money. In addition, your borrowing strategy is likely to
change. In the following sections, we cover these differences in
greater detail, so you know what to expect before diving in.
Paying a premium for riskier
investment loans
When you invest in your own home, you literally have a vested
interest in making payments — if you don’t, you lose the roof over
your head. On the flip side, if you lose an investment property, it
may be painful, but it’s never
that serious, and lenders are well
aware of the difference. For them, investment loans are riskier
propositions. To mitigate the risk, they generally
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Require a larger down payment.
Demand a larger loan-to-value ratio. (See “Looking at loan to
value (LTV)” earlier in this chapter.)
Charge more interest upfront in the form of points.
Charge a higher interest rate.
Require proof that you have reserves or liquid assets available
in case things don’t go as planned.
The actions that lenders take to mitigate the risks and the interest
rates and fees they charge vary greatly depending on the borrower
and the deal that’s on the table. Just make sure you have all the
documentation and figures ready when you meet with your lender
for the first time, as explained in Chapter 3.
Using quick cash to
snag bargain prices
When you’re shopping for a mortgage to buy a home for your
family, you’re usually looking for a low-interest package, no or very
few points, and attractive terms. With investment properties,
trumps interest rate. In other words, access to cash is often
more important than the cost of the loan. To find out more about
the relative importance of cash flow and how to shop for loans
with the lowest interest rates and fees, see Chapter 6.
If the numbers work, what you pay in interest doesn’t matter.
Interest is just another expense. If you subtract all your expenses
and can still earn the profit you want, paying thousands of dollars
in interest over a relatively short period is acceptable.
Accounting for taxes on your
capital gains (or losses)
When buying and selling a primary residence, you don’t have to
think too much about the tax ramifications of the transactions. In
the United States, a huge chunk of any profit you earn from the sale
is usually tax exempt — up to $250,000 if you own the home your-
self or double that if you and your spouse sell the home.
However, when you’re selling investment real estate, any profits
are subject to capital gains taxes. During the writing of this book,
profits from real estate investments were taxed as follows:
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Long-term capital gains: 15 percent if you hold the property
for at least a year and a day.
Short-term capital gains: 35 percent if you sell the property in
fewer than 12 months from the date you purchased it.
Income tax: If profits from investing in real estate are your
sole income, the IRS may consider it your job and tax your
profits as income, complete with an additional 15 percent in
self-employment tax.
We’re not tax experts. Consult a CPA who has experience dealing
with real estate investors for details on how the government is
going to tax your profits and for suggestions on how to reduce
your tax burden. Your measure of success isn’t how much you
gross but how much you net. By reducing your tax bill, you can sig-
nificantly increase your net gain.
Protecting your personal assets
Just like most things worth doing, real estate investing exposes
you to risk. Perhaps the biggest risk is that you’re working with
borrowed money from lenders who expect you to pay it back. If
you make a lousy investment decision or an investment goes belly-
up despite your best efforts, lenders are going to do everything
legally possible to collect their money.
You also face the ever-present risk of litigation — having a dis-
agreement with a buyer, seller, tenant, contractor, or someone else
that eventually leads to a costly lawsuit.
Eliminating risk isn’t possible, but you can take several measures
to lessen the risk, including operating through an LLC, transferring
personal assets to someone else, or having a qualified attorney
cover your back. Check out Chapter 2 for more details.
Exploring Common Sources
of Investment Capital
You probably picked up this book because you want to start
investing in real estate, but you don’t know where to dig up the
cash to do your first deal. In the following sections, we show you
where to start digging.
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Tapping your own cash reserves
If you’re single, or you and your significant other are on the same
page about this real estate investing thing, cracking into your nest
egg to finance your investments may be the quickest way to get
your fingers on some investment capital.
It’s also the riskiest option, because if anything goes wrong — you
get laid off or fired, become too ill to work, or encounter unex-
pected expenses — you have fewer reserves to keep you afloat. In
addition, limiting yourself to your own resources also limits your
purchase power — you have to buy houses in a lower price range
and may not have sufficient cash to properly renovate the property.
A great way to ruin a relationship is to bet the farm on big profits
without the knowledge and complete agreement of your spouse or
significant other. If your investment doesn’t pan out (and even if it
does), the other person may take offense at not being consulted.
Even with these caveats, many beginning investors have gotten
their start by financing their own ventures — partially or in full.
And you want to know about these resources if you need some
quick cash in a pinch.
Clearing out your bank accounts
Having a few thousand dollars socked away in a savings account is
always a good idea, just in case you run into a cash flow problem. If
that house you bought and fixed up is taking a few months longer
than expected to sell, your little nest egg can help cover the pay-
ments until you find a buyer.
Use your savings as a reserve, not as your main mode of financing.
Having some cash to fall back on can save you in a pinch.
Borrowing against the equity in your home
As your home’s value rises and you pay down the principal, you
build equity. You can often borrow against this equity by taking out
a home equity loan or line of credit and then use the money for
whatever you want, including purchasing other real estate. The
recent credit crisis has made it harder to find these loans, but
they’re still out there for well-qualified borrowers.
We don’t recommend that you cash out all the equity in your
home, but if you have a substantial amount of equity, cashing out a
portion of it can help you come up with a down payment or cover
the cost of repairs and renovations. (For more about home equity
loans and lines of credit, skip to Chapter 11.)
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Financing investments through a self-directed IRA
More and more investors are choosing to set up self-directed IRAs
and other types of retirement accounts that enable them to invest
in real estate rather than in stocks and bonds. The reasoning: Real
estate often provides a better and sometimes even more secure
return on your investment.
With a self-directed IRA, you can buy and sell properties out of
your retirement account. Setting up a self-directed IRA, however, is
no simple matter. Typically, a trust company manages the money
and properties in the account, and all profits and losses from your
investments must stay in that account. Withdrawing money from
the account results in the same IRS penalties you have to pay if
you withdraw money from any type of retirement account.
Consult your financial advisor and accountant for details about
using a self-directed IRA to finance your real estate investments. If
a self-directed IRA isn’t an option, you may be able to borrow
money against your retirement account. Keep in mind, however,
that borrowing against your retirement savings places those sav-
ings at risk, as does any other investment.
Charging expenses on your credit cards
Maxing out your credit cards to purchase a car, clothes, electron-
ics, groceries, and other items that provide no return on your
investment is never a good idea. Using your credit cards to pur-
chase investment properties that offer a solid, relatively quick
return on your investment, however, can be a savvy (though risky)
financial move.
Consider credit cards a last resort to cover the costs of repairs and
renovations if financing is tight near the end of a project. With this
strategy, your investment activities can directly affect your per-
sonal finances, which increases your exposure to risk. For more
about this option, check out Chapter 11.
Borrowing from commercial lenders
One of the best ways to finance the purchase of investment proper-
ties is to meet with a qualified mortgage broker who can help you
find and evaluate various loan programs. These plans are often
your best deals — costing the least in upfront fees and interest.
For more about finding commercial lenders, check out Chapter 4. If
you’re investing in residential property, Chapter 5 reveals the vari-
ous residential loan programs to choose from. If you’re buying
commercial property, turn to Chapter 9 for guidance on choosing
the right loan program.
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Don’t confuse “commercial property” with “commercial lender.” A
commercial property is any property that isn’t a one- to four-family
residential dwelling. A
commercial lender is an institution (as
opposed to an individual) that loans money. In other words, you
can use a commercial lender to finance the purchase of residential
investment property.
Obtaining a hard money loan
When banks and other financial institutions turn down your
requests for investment capital (or you don’t have the time to con-
vince them that a deal is pure gold), consider borrowing money
from a hard money lender, as explained in Chapter 11.
One of the main advantages of a hard money lender is that the
person is likely to accept the property you’re buying as all the col-
lateral needed to secure the loan, so you don’t have to place your
home at risk.
Financing your purchase
through the seller
Property owners who are eager to sell and don’t need all the cash
at once are often willing to finance the purchase themselves. This
tactic enables them to profit in two ways — by selling you the
property for more than they paid for it and collecting interest from
you. Seller financing take either of the following forms:
Land contract: A land contract is like a mortgage, except the
seller acts as the bank.
Lease option agreement: A lease option agreement is like a
rent-to-own deal — you lease the property for a specified
period, at the end of which time you have the option to buy it.
For more about seller financing, check out Chapter 12.
Taking on a partner
Whenever you don’t have something (like money, skills, time, or
talent) to accomplish a particular goal, you can acquire those
skills, buy or hire them, or create a partnership with someone who
already has what you need. If you have something someone else
needs and they have what you need, you have what it takes to form
a mutually beneficial relationship. For details on how to partner
with someone who has the cash you need, check out Chapter 13.
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Choose a partner as carefully as you choose a spouse. Partnerships
often end when one person scams the other or disagreements arise
over who’s putting more into the projects and who’s getting more
out of them. Have your attorney write up a contract, complete with
a prenuptial type agreement stating how all the assets will be
divvied up in the event that you part company.
Prepping to Meet with a Lender
Walk into a bank empty-handed and explain to the loan officer that
you need a loan to start investing in real estate, and we can almost
guarantee that you’ll be laughed out the door. Before you even
think about meeting with a prospective lender, get all your ducks in
a row. Copy all the financial documents lenders are going to ask for
and construct a fairly detailed plan on how you’re going to profit
by investing in real estate. This section gives you an overview of
what you need to do before visiting your lender. Chapter 4 pro-
vides complete in-depth info.
Gathering paperwork and other info
Before approving your request for a loan, lenders want to know
whether you’re good for the money — how likely you are to make
the monthly payments and pay back the loan in full. For investors,
this means two things:
You’re in pretty good financial shape right now and have a
fairly clean credit history.
The property you’re planning to buy is more than worth the
money you’re borrowing to pay for it, and (if you’re going to
be renting out the property) it will generate sufficient income
to more than cover all your expenses along with the monthly
To verify your creditworthiness for yourself and be sure you have
all the documents and other information your lender requires, stuff
a folder full of a copy of each of the following items:
Credit reports from all three credit reporting agencies
A net worth statement (assets – liabilities = net worth)
A debt ratio statement (ratio of what you owe to what
you own)
Last two months’ bank statements
Last 30 days’ pay stubs
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Last two years’ federal tax returns and schedules
Statements of any business income
Appraisal or comparative market analysis for the property
Cash flow analysis of the property
Loan-to-value ratio of the property
Zoning information for the property’s location
City and county records for the property
Crafting a business plan
Real estate investors often scoff at the idea of creating a business
— a detailed presentation that shows how an investor plans
to purchase a specific property and earn a profit from it. Investors
often just want to buy and sell and rent out property and make a
lot of money — that’s the plan. They don’t like to think of them-
selves as pencil-necked pencil pushers. If they feel in their gut that
a property is a solid investment, that’s good enough for them.
At least that’s the false image that many people have of investors.
The most successful investors, however, do the math. They crunch
the numbers. And if the numbers don’t work, they don’t do the deal.
Do your homework. Do a comparative market analysis of the prop-
erty to make sure it’s worth what you think it’s worth. If you’re
buying rental property, check the rental history of the property —
the owner’s tax records showing income and expenses. Craft a
business plan showing exactly how this property is going to be a
revenue generator.
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Chapter 2
Shielding Your Personal
Assets from Investment Risks
In This Chapter
Grasping the need to cover your assets
Investing as a corporation to reduce your exposure to risk
Assigning ownership of certain assets to others
Avoiding collateral and cross-collateral damage
Dodging real estate and mortgage fraud
unny thing about lenders — when you borrow money from
them, they expect you to pay it back. To ensure repayment of
a loan, the lender usually requires that you sign a promissory note
and a mortgage or deed of trust. The
promissory note is your per-
sonal promise to repay the loan in full. The
mortgage or deed of
names certain property as collateral for the loan.
If you happen to
default on the loan (fail to make payments as stip-
ulated), the lender has the right to
foreclose (sell your property to
the highest bidder). If the lender can’t sell the property for at least
as much as you owe on it, it may be able to sue you for the differ-
(deficiency) in jurisdictions that allow deficiency judgments.
As an investor, you want to limit the assets that the lender has the
right to seize in lieu of payment. If you fail to make payments on a
loan you took out to purchase an investment property, for exam-
ple, you want to make sure that the bank can’t take possession of
the home you live in, other businesses you own, or other assets,
such as your car. To prevent the lender from going after personal
assets and other business assets as payment, you need to
those assets — keep them legally and financially separate from
your investment properties. In this chapter, you discover various
strategies for doing just that.
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It’s a jungle out there. Fraud is more common in the real estate
industry than most professionals are willing to admit, so in this
chapter, we also show you how to protect yourself against becoming
a victim or unwitting accomplice to real estate and mortgage fraud.
Understanding Why You Need to
Protect Your Personal Assets
As an investor, you’re a small-business owner, but you’re also an
individual who may have a spouse and a family to support. You
probably have a home, a car, one or more personal bank accounts,
a retirement account, and other valuables that you’ve worked very
hard for a long time to accumulate. You want to build even more
wealth by investing in real estate, and you’re willing to take some
risks, but can you live with losing everything you now own?
The correct answer is (or should be) “no.” No, you shouldn’t risk
everything you now own to invest in real estate. Why? We can
think of two very good reasons:
You don’t want to or have to risk everything. You can protect
some or all your assets from risk by following the advice we
offer in this chapter.
If your investment goes belly up, you can recover much more
quickly and perhaps even pursue future investments by hold-
ing on to more of your current assets.
In any investment, you should try to limit your exposure (both
financially and emotionally) to the individual deal. You’re investing
your time and talent and perhaps a little of your own money. In
addition, you’re the one who’s taking on the burden of managing
the project, dealing with hassles, and worrying about whether your
investment is going to eventually turn a profit. All the lender is
doing is putting up the money, so let the lender step up to the plate
and take the
financial risk. That’s the price it pays for being able to
do business with you.
Limiting Your Personal Liability
by Forming an LLC
Businesses form corporations for any number of reasons, but one
of the primary reasons is to establish the business as a separate
entity. If, for example, you do business in your own name, you
become personally liable for anything that happens in the course
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of doing business. If someone decides to sue you over something
related to your business, all your personal belongings are at stake.
By setting up a corporation, you essentially create a fall guy who
takes the blame if something terrible happens. A customer can sue
your corporation to the point of bankruptcy, and in most cases,
you can simply walk away with your home, your car, and your per-
sonal savings and belongings all intact.
One of the best and most popular corporate entities for real estate
investors is the
limited liability company or LLC. By forming an LLC,
you limit your exposure to risk to the company, so it can fold with-
out negatively affecting your personal finances.
In the following sections, we provide guidelines on setting up an
LLC and managing your investments through it. For details about
creating and managing an LLC, check out
Limited Liability
Companies For Dummies
by Jennifer Reuting (Wiley).
Understanding the pros and cons
On its surface, an LLC appears to be the best of all possible busi-
ness entities, and in some ways it really is, but prior to taking the
plunge, consider its potential advantages and disadvantages.
An LLC offers the following benefits:
Generally requires less paperwork and fewer hassles: Small
business owners who form S-corps often get frustrated pre-
tending that they’re some huge corporation — filing all sorts
of forms, holding or pretending to hold corporate meetings,
and keeping a record of each meeting’s minutes. With an LLC,
you avoid most of that nonsense — at least the meetings and
the minutes.
Provides greater protection: Operating as a sole proprietor-
ship leaves you completely vulnerable to lawsuits and other
legal claims against your personal assets. An LLC provides the
same sort of protection you can expect under the corporate
Allows you to dodge the passive income bullet: If too much
of your income from real estate holdings is classified as
, the IRS could convert your Sub-S into a C-corp (a regular
corporation), exposing you to double taxation. With an LLC,
you can do a
pass-through, in which your real estate earnings
pass through the company and are treated as personal
income so that the company isn’t taxed separately, as well.
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Although an LLC offers the protection of limited liability, it does
have a couple of its own limitations, as well:
If a member of the LLC dies or goes bankrupt, the LLC is dis-
solved, whereas a corporation can continue to exist as long as
it has shareholders.
All properties within the LLC are exposed to risks associated
with the other properties held in the same LLC. In other
words, someone trying to collect money for one of the LLC’s
properties can go after the other properties to collect pay-
ment. For this reason, limiting the number of properties held
in any one LLC is a good idea.
Setting up an LLC
Anyone with a free weekend, a computer, and an Internet connection
can set up an LLC (although we recommend that you use an attor-
ney). You download the forms, fill them out, and submit them to
your state commerce department, secretary of state, or bureau of
corporations. Although each state has slightly different procedures
to follow and forms to complete, you should be able to find all the
instructions and documents you need on your state’s Web site.
Go to your favorite online search engine and type in “corporation”
followed by the name of your state — for example, “corporation
Arizona” (without the quotation marks). This search should bring
up a link to the department in your state that handles LLCs and
You can set up most LLCs on your own for very little expense and
paperwork, but we encourage you to consult with an attorney. A
savvy attorney can ensure you’ve set up your corporate shield in a
way that makes it less vulnerable to being pierced. You may also
want to hire an accountant to manage the finances for the com-
pany and ensure that any taxes that come due are paid on time.
The choice of which state you form your corporation in is of
utmost importance, especially in terms of how you’re taxed.
Delaware, for example, is very corporation-friendly, which is why
you see so many financial institutions, especially credit card com-
panies, centered in Delaware. Discuss the options with your
accountant and attorney.
Taking and securing title to real estate
When you have an LLC in place, perform all business transactions
in the name of the LLC rather than in your own name. Whether
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you’re taking out a loan, signing a purchase agreement, or putting
your John Hancock on closing papers, make sure your LLC is listed
as the responsible party and that you’re signing as a representative
of the company.
Accomplishing this task is fairly easy on your part because other
people are usually in charge of drawing up the paperwork. All you
need to do is instruct the person (real estate agent, closing agent,
loan officer, or whoever is handling the paperwork) to prepare it in
the name of the LLC.
Unfortunately, on conventional loans with conventional lenders for
typical one- to four-family dwellings, getting a loan in the name of
the LLC is nearly impossible, but you can still have the LLC
hold the
property, providing some protection from personal liability. You
have an easier time taking loans out in the name of the LLC when
purchasing larger properties (5+ units) and commercial deals.
If you can’t take title in the name of your LLC, move the property
into the LLC as soon as practical. You can do this by using a
claim deed
— typically a one-page legal document that enables you
to deed the property to another individual or business entity. You
simply sign the quitclaim deed, specifying that the LLC is the new
deed holder, and then file the quitclaim deed with your county’s
register of deeds. Your attorney can supply you with a quitclaim
deed that’s valid in your county.
Follow your attorney’s advice carefully, because this strategy can
trigger a
due-on-sale clause, in which case you would need to pay
back the loan in full immediately. The IRS allows investors to trans-
fer real estate for estate-planning purposes, so you’re in the clear
as long as you follow the rules.
Some LLCs choose to perform certain transactions under an
assumed name — a name that differs from that of the company. We
strongly discourage the use of assumed names in real estate trans-
actions, because they provide little, if any, protection for you.
Always transact your investment business under the LLC’s name.
Eyeing Sub-S corporations
and partnerships
Although we recommend LLCs for most investors, a Subchapter S
corporation (or Sub-S for short) is a viable alternative. A Sub-S is
an actual
corporation (as opposed to a company) that chooses not
to pay taxes on earnings but instead have those earnings pass
through to the shareholders so they pay taxes on them. It’s
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another way of dodging the double-taxation bullet (taxing the cor-
poration as well as the individual shareholders).
A Sub-S can also provide you with a great measure of protection
and allow for other deductions and a wider variety of activities
than are possible under an LLC. For example, a Sub-S allows you to
partner with other business entities in addition to individuals.
If you plan on partnering up with another investor, you need to for-
malize the relationship by forming a partnership, as we discuss in
Chapter 13. A
partnership is simply a business entity in which the
members agree to work toward a common goal. You need to have a
written agreement in place that stipulates how the partnership
functions, who’s responsible for what, and how assets are to be
divided should the partnership dissolve. The partnership itself,
however, provides you with little or no protection. You still need to
set up a corporation or an LLC for protecting your personal assets
and those of your partner(s).
Transferring Personal
Assets via Trusts
As an investor, you’re a business owner, and most responsible
business owners keep their business and personal finances sepa-
rate. You can be sued by anyone at any time, and you want to pro-
tect your family and personal assets as best as possible. An
excellent way to accomplish this is to place your personal assets
under someone else’s name or into a separate entity — a
Consider the following options:
Transfer personal assets to your spouse, one of your children,
another relative, or a designated third-party administrator
such as an attorney or financial planner.
Shift your assets into a trust — a legal device you as an indi-
vidual place your assets in for the benefit of others, such as
your family.
Investors often spend a great deal of time and effort building
wealth only to see the fruits of their efforts chipped away by unjus-
tified lawsuits and taxes. By holding your assets in an estate or
trust, you not only protect them against legal claims, but you can
also reap substantial tax benefits. Sophisticated investors often
use multiple business entities (including LLCs and other corporate
structures) to manage their assets and protect them from a variety
of risks. As you acquire more properties, consider employing a
similar strategy. For more about estate planning, check out
Planning For Dummies
by Jordan Simon and Brian Caverly (Wiley).
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In the following sections, we address the advantages and disadvan-
tages of placing your assets in someone else’s name and assist you
in deciding which option is best for you.
Weighing the pros and cons of owning
property in another’s name
Investors and business owners often protect assets by placing
them in the name of a spouse or other relative. Before you make
this move, however, you need to have a firm grasp of the pros and
cons to protect the property.
Some investors hold some investments in their own names, and
some in the name of their spouses. This strategy increases the
number of properties you can finance (by getting around Fannie
Mae and Freddie Mac limits on the number of residential proper-
ties/mortgages you can hold) and also enables you to diversify
your assets and limit liabilities.
A real estate investor, for example, may choose to have her spouse
listed as the sole owner of their home, car, and other big-ticket
assets and then take out loans and the title to investment proper-
ties in her own name only. If she defaults on a loan, she can lose
the investment property, but the family home and car are safe.
So, what’s the catch? Placing assets in someone else’s name can
increase your exposure to several risks:
You lose some control over those assets. If all your personal
assets are listed in your husband’s name only, for example, a
divorce may leave you at a severe disadvantage.
You may affect your kids’ future financial aid. If you own
property in the name of your children, the value of that
property can influence the financial aid calculations should
your children decide to attend college and require financial
You may encounter tax consequences. Putting assets in the
names of your children may also trigger gift tax requirements
or estate tax issues.
You’re at the mercy of that person’s legal issues. If the
holder of your assets becomes disabled or runs into his own
liability issues, your assets can get tied up for a long time in
the legal wrangling. Bankruptcy, insolvency, or even death
(and the subsequent probate) can turn the best of plans into a
financial fiasco.
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Placing assets in someone else’s name can be a bit of a hassle, but
it usually doesn’t cost all that much. For example, you can head
down to the bureau of motor vehicles and change the name on the
title for any vehicles you own for a small fee. Likewise, you can use
a quitclaim deed to assign ownership of a property for a small
recording fee. Before you do, however, consult your attorney or
accountant to find out about all the ramifications of transferring
ownership of your properties because the laws and procedures
vary from state to state.
Gaining asset and tax protection
with an irrevocable trust
Trusts are the most versatile tool for transferring title of assets
without tax implications or increased risk, but they have some lim-
itations. We encourage you to discuss your situation with a quali-
fied estate planner who can assist you in weighing the potential
benefits and drawbacks of different options and then set up the
trust for you.
Trusts come in two flavors — revocable and irrevocable. A
trust is one you can change or terminate during your lifetime.
irrevocable trust is one that you can’t change or dissolve — as
grantor (creator of the trust), you no longer own the assets held in
trust. The trust does. An irrevocable trust benefits you in two
important ways:
Because you no longer own the assets, they’re protected
against any legal actions taken against you.
The property and its appreciation are outside of your taxable
estate, allowing you to avoid paying estate taxes on the value
of your holdings.
Both revocable and irrevocable trusts protect assets from probate,
but only irrevocable trusts can eliminate estate taxes.
The ultimate way to protect assets is to hold them in an offshore
asset protection trust, but we’re not advising that you do that. The
next best thing is to have your assets owned by a Sub-S or LLC and
then have the shares of the corporation owned by an irrevocable
trust — this is the fortress of U.S. asset protection. The IRS frowns
upon any sort of tax optimization scheme, particularly the offshore
variety, so before employing any such scheme, consult a tax
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Considering real estate investment
trusts (REITs)
Real estate investment trusts (or REITs for short) give small
investors a way to pool their assets and own investment real estate
as a group. REITs offer investors three significant benefits:
Investors can diversify their real estate holdings by owning
pieces of multiple properties.
Instead of purchasing a
$200,000 property, for example, a small investor can own a
$10,000 share in 20 properties, spreading the risk.
Small investors can afford to buy into higher-end real
REITs allow minor league investors to play a smaller
role in the major leagues, because it costs less to buy in.
REITs simplify the transfer of ownership to different
Instead of selling the property, you simply transfer
If you have an LLC with 100 or more investors, consult your attor-
ney for assistance in setting up a REIT, to ensure that it meets all
the requirements, including the following:
Your REIT must have at least 100 shareholders. Why 100?
That’s just one of the rules.
You must distribute at least 90 percent of your REIT’s taxable
income. In other words, at least 90 percent of the profits earned
by the assets in the REIT must flow through to shareholders.
Ninety five percent of your REIT’s income must come from
financial investments (including real estate, securities, and
annuities), with 75 percent of that total coming from real estate
(net profit from sale of assets, rent/lease payments, and so on).
Staying Away from Promissory
Notes with Recourse Clauses
Promissory note is a fancy term for an IOU. Whenever you borrow
money, the lender almost always requires that you sign a promis-
sory note promising to pay back the money under a set of specific
conditions, including the
term (amount of time you have to pay the
loan in full), interest rate,
principal (total amount you borrowed),
and payment amount of each scheduled payment.
Promissory notes usually include a
recourse clause stipulating that
the person signing for the loan is pledging individual assets as
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additional collateral to secure the loan. If the loan goes bad, the
lender can then come after the borrower’s personal assets to
recoup any losses.
In the following sections, we explain nonrecourse loans (the most
desirable option), discuss what you need to do if your contract has
a recourse clause, and point out the risks involved in
alized loans
— loans that enable the lender to lay claim to prop-
erty other than the property the loan was used to purchase.
Opting for a nonrecourse loan
If you’re trying to borrow money for a potentially lucrative invest-
ment, a recourse loan may be your only option, but in most cases,
you want a loan that places only the property you’re financing at
risk — a
nonrecourse loan.
Nonrecourse means that the property stands on its own. Fail to
make your payments, and all you stand to lose is the property you
borrowed the money to buy . . . and your pride. Borrowers typi-
cally use nonrecourse loans for financing the purchase of larger
commercial-type properties, where the lender understands that
the real value is in the property and the income it generates. If a
$15 million loan on a hotel goes bad, the lender knows he can’t
shake enough quarters and nickels out of you to pay it back.
Instead, he can get the money out of the property.
In some cases, lenders allow you to buy into a nonrecourse clause
by paying a higher interest rate or agreeing to other terms that are
more favorable to the lender. It never hurts to ask, but on smaller
properties, you can usually count on having to agree to some sort
of recourse clause. (See the next section for more on how to nego-
tiate this recourse clause.)
Any type of fraud, misrepresentation, or misappropriation of funds
in respect to the loan or the property — such as claiming that the
building generates more rental income than it really does — can
void the nonrecourse clause and give the lender the right to come
after your personal assets.
Negotiating the recourse clause
Although we suggest you go the nonrecourse route as often as pos-
sible, some contracts require a recourse clause. Fortunately, this
clause is usually negotiable. A lender typically doesn’t remove it
entirely, but you may be able to negotiate a recourse clause that
limits your liability. Ask your loan officer or broker whether any
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options are available. Following are some areas that may be open
for negotiation:
Property limitations: You may limit the recourse, for exam-
ple, to other real estate holdings in your LLC, thus protecting
your personal residence and other assets.
Time limitations: You may be able to place a time limitation
on your liability; for example, if you make payments on time
for five years, your personal liability is released.
Partial recourse: This provision limits your liability to a cer-
tain percentage of the loan or a certain amount (less than the
full amount). Partial recourse can also limit the lender’s abil-
ity to collect only under certain conditions.
Almost every residential loan (for one- to four-family investment
property) requires personal recourse. Just make sure you under-
stand the limitations and options. When signing a promissory note,
make sure that the recourse clause is limited to the assets you’re
willing to put at risk.
Avoiding cross-collateralization
To protect their money, lenders like to know that you have plenty
collateral — anything of value that they can take from you and
sell to get their money back in the event you’re unable or unwilling
to pay back the loan. When the housing market is thriving and
property values are on the rise, lenders tend to accept the prop-
erty you’re financing as collateral on the loan. If you don’t make
your payments, they can foreclose, sell the property, and get back
all or nearly all their money.
Chapter 2: Shielding Your Personal Assets from Investment Risks
Your recourse to recourse loans
I (Chip) once had 16 doctors who went in together on a commercial building as an
investment. The bank wanted a full recourse loan on each of them, which would
have given them a total of 1600 percent coverage on the loan. We negotiated for a
10 percent personal recourse on each investor, which still provided the lender with
160 percent coverage. We were also able to eliminate personal liability after five
years of satisfactory payments.
The moral of this story is this: Don’t accept what the lender offers as a final offer. As
long as you’re a serious investor with a solid plan in place, you can usually negoti-
ate more attractive terms with the lender.
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On riskier investments — when property values are declining or
the property’s value is close to the amount being borrowed or a
large loan is being taken out to purchase multiple properties —
the lender may want to
cross-collateralize the loan. With cross-
collateralization, two or more properties act as collateral for a
single loan. If you fail to make payments on the loan, the lender
can foreclose on other properties to collect the amount due.
For the investor, cross-collateralization exposes other properties to
the liabilities of one. Stay away from these types of loans if at all
possible. You can’t always avoid cross-collateralization, but we
encourage you to at least try. Otherwise, you may lose a good
income property just because one of your other properties is a dog.
Steering Clear of Real Estate
and Mortgage Fraud
Wherever you find money, you find crooks — con artists deter-
mined to score some quick cash. As a real estate investor, you’re
vulnerable to real estate and mortgage fraud in any or all of the fol-
lowing three ways: as a target, as a perpetrator, or as an unwitting
accomplice. And all these roles can ultimately undermine your
long-term success, not to mention your reputation.
Part I: Gearing Up for Financing Your Real Estate Investments
Cross-collateralization nightmare
Several years ago, I (Chip) had a friend who had a great idea for a retail clothing
store. Couldn’t lose, or so he thought. Unfortunately, his overconfidence led him to
be careless in borrowing money for his new venture. He allowed the loan he
secured to buy the building to be cross-collateralized with the store’s inventory and
many of his personal assets.
A sharp downturn in the market transformed his dreams to dust in a mere 18 months,
but the worst was yet to come: The lender not only foreclosed on the building and
took his inventory but also went after his home, car, boat, and retirement fund. The
financial strain eventually ended his marriage.
Any investment that’s worth pursuing usually involves some risk, but going all in
when you don’t really have to is folly. By avoiding the cross-collateralization trap,
you limit your risk to the new investment.
No investment is a sure thing. Protect yourself from unforeseen and unfortunate
circumstances as much as possible.
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In the following sections, we describe the main types of real estate
and mortgage fraud, to empower you to steer clear of scams and
schemes that can get you into trouble.
Ignorance of the law is no excuse for breaking it. Unfortunately,
ignorance is as rampant as fraud in the real estate industry. Many
real estate professionals may try to convince you that something
illegal is okay because everybody does it or because these are “vic-
timless crimes.” However, as we’ve seen from the mortgage melt-
down beginning in 2008, homeowners and investors ultimately pay
the price. For more about real estate and mortgage fraud, check
Protect Yourself from Real Estate and Mortgage Fraud: Preserving
the American Dream of Homeownership
by Ralph R. Roberts and
Rachel Dollar (Kaplan Publishing).
Telling the truth on your application
A huge percentage of real estate and mortgage fraud could be elim-
inated if everyone in the industry, including investors, would work
together to ensure that all the information on loan applications is
complete and accurate.
Buyers and those who assist them often think that accuracy is
optional, but the loan application, the 1003 (commonly referred to
as a ten-oh-three, or officially as the Uniform Residential Loan
Application), clearly states, just above the space for your signa-
ture, the following:
Chapter 2: Shielding Your Personal Assets from Investment Risks
Refusing to play a role in fraud for housing
Fraud for housing used to be the most common type of real estate and mortgage
fraud and the most “harmless” (although still illegal). It consists of lying on a loan
application so you can purchase a home to live in – as opposed to “fraud for profit,”
in which you’re committing fraud to obtain money.
When you’re acting as an investor, you’re at a pretty low risk of becoming a perpe-
trator of fraud for housing because you’re not buying the property to live in it.
However, you may be at risk for becoming an accomplice if you’re trying to sell a
property to buyers who are having trouble qualifying for a mortgage loan.
If prospective buyers are having trouble qualifying for a loan to buy the property
you’re selling, they may just not be able to afford the payments. Don’t try to “help”
them by encouraging them to lie on their loan application or by referring them to a
loan officer who’s known for bending the rules.
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I/We fully understand that it is a federal crime punishable by fine
or imprisonment, or both, to knowingly make any false state-
ments concerning any of the above facts as applicable under the
provisions of Title 18, United States Code, Section 1001, et seq.
What constitutes a
false statement? Here’s a list of what may be
considered false:
Stating or providing false records that you’re employed some-
where you’re not.
Stating or providing false records of income.
Providing false identification.
Boosting your credit score by piggybacking on someone else’s
better credit.
Falsifying ownership of assets, either by stating that you own
items you don’t or by renting assets. (Some disreputable com-
panies allow you to rent assets, so you appear to own more
assets than you really do.)
Failing to disclose a silent second. A silent second is a separate
mortgage typically taken out to cover the down payment. As
we discuss in Chapter 14, taking out a second mortgage to
finance the down payment is okay, but not disclosing it is ille-
gal. It creates the false impression that you’re more financially
secure than you really are.
Dodging predatory lenders
Although lenders are often the victims of mortgage fraud, they may
also be guilty of committing fraud and are even more frequently
guilty of lending practices that prey on uninformed borrowers.
Whenever you’re applying for a loan, keep one hand on your wallet
and one eye out for the following questionable and perhaps illegal
lending practices:
Charging you higher-than-normal loan origination fees (includ-
ing points).
Encouraging you to bend the truth on a loan application, so
you can qualify for a loan you would otherwise not qualify for.
Having you sign a blank loan application and then filling in the
details for you later.
Refinancing your mortgage repeatedly within a short period of
Selling you a high-cost, high-interest loan when you would
qualify for a low-cost, low-interest loan.
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Adding products or services such as credit life insurance to a
loan without adequately informing you about the need or cost
of these products or services. Watch out for hidden (undis-
closed) fees.
Selling you products or services that are nonexistent or offer
no benefit.
Convincing you to borrow more than you can reasonably
afford to pay back.
Pressuring you to accept high-risk loans, such as balloon-
payment loans, interest-only mortgages, subprime or
adjustable rate mortgages (ARMs), and loans with high
prepayment penalties.
Selling high-interest loans based on ethnicity or nationality
rather than your credit history and financial situation.
Always obtain three or more quotes from different companies
before choosing a loan and compare the quotes carefully (see
Chapter 6 for details). Doing so enables you to see any hidden loan
costs more clearly. When applying for and closing on a loan, read
the documents carefully to make sure the information is accurate
and complete.
Saying “no” to inflated appraisals
One of the main instruments that real estate con artists use to ply
their trade is the
inflated appraisal — a document showing that a
property is worth significantly more than its true market value. By
obtaining an inflated appraisal (forging one or paying off a crooked
appraiser), the con artist can create equity in a property where
none exists.
As an investor, never try to sway the opinion of an appraiser or
allow a loan officer, real estate agent, or anyone else to convince
you to go along with a deal that involves an inflated appraisal.
Also, be careful about overpaying for a property whose value has
been artificially boosted by inflated appraisals. You can protect
yourself by ordering your own independent appraisal before pur-
chasing a property. Find an appraiser in the area who has a solid
gold reputation and plenty of experience in the market you’re
buying into. Don’t let the seller or seller’s agent recommend an
appraiser. You pay a few hundred dollars for your own appraisal,
but it can save you from making a mistake costing tens or even
hundreds of thousands of dollars.
We also recommend against using online appraisals or computer-
ized valuation models. You want a real live person, a qualified
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appraiser who knows the local market, to physically inspect the
property and provide you with an educated estimate of its market
value. There’s really no substitute.
Turning your back on cash-
back-at-closing schemes
One of the most prevalent forms of fraud, particularly when the
market is down, consists of providing the buyer with
cash back at
. The buyer agrees to pay more for the property than it’s
worth and obtains an inflated appraisal showing that the property
is actually worth the purchase price. The seller agrees to raise the
asking price and kick back the excess money to the buyer at clos-
ing. Many people think these arrangements are okay, but don’t be
fooled — cash back at closing is illegal. Protect yourself:
Don’t offer buyers cash back at closing or any other “perks”
that the lender is actually financing, including “free” furniture,
a cruise, upgrades, and so on.
Don’t accept cash back at closing, even if it comes in some
other form, such as “free” furniture, upgrades, rebates,
refunds, or anything else that’s actually being paid out of the
loan amount.
Avoiding illegal flipping
Flipping houses, as described in Flipping Houses For Dummies, is
perfectly legal. You buy a house below market value, fix it up, and
then sell it for a profit. However, another type of flipping is clearly
illegal. It consists of buying a property, typically a dilapidated
house, at well below market value, doing a few cosmetic repairs to
make it look nice, and then selling it for much more than its true
market value.
As an investor, avoid illegal flipping. In addition to breaking the
law, this type of flipping ruins your long-term success. Illegal flip-
pers may score some quick cash, but they quickly ruin their repu-
tations and often end up in legal trouble. It’s not worth it.
To avoid becoming the victim of an illegal flip, always check the
recent sales prices of similar homes in the same neighborhood to
make sure the asking price of the property you’re about to pur-
chase is realistic. Make sure you’re the one choosing the home
inspector and the appraiser. If the seller offers to handle this for
you, politely decline the offer.
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Defending yourself against
chunking schemes
Real estate investors often become the targets of con artists
through what is commonly referred to as a
chunking scheme. The
con artist dangles a quick-cash, no-hassle investment opportunity
in front of the eager investor and offers to take care of all the
details. The investor only has to put up the cash or sign the papers
for the loan that to finance the deal.
The organizer promises to place renters, collect the rent, make the
mortgage payments, and so on, and tells the investor that the rental
payments will cover the mortgage and maybe even earn a little
extra cash each month. The investor can sell the property at any
time and profit from it because the property is sure to appreciate.
The truth behind the deal is that the properties are usually over-
valued, the renters don’t exist, and the con artist never intends to
make the mortgage payments. Investors are left with dilapidated
homes, unpaid mortgages, and destroyed credit.
The best way to avoid getting sucked in by a chunking scheme is to
plug your ears when you hear someone pitching a no-risk, no-
hassle way to earning riches in real estate. Quite frankly, such
deals don’t exist. Do your homework. Visit the property and
inspect it with your own two eyes. Oversee the management of the
property. Don’t let someone else “handle all the details” because
they probably intend to handle you out of your money.
Refusing a builder bailout
Builders who become overextended may try to dig themselves out
of a financial hole by selling homes (or whatever they’re building)
before completion to unsuspecting buyers. In some cases, the
builder eventually completes the project. In other cases, he may
take the cash and leave the buyer with an unfinished building or
even a vacant lot.
When banks finance new construction (see Chapter 9), they don’t
give the builder all the money at once. They set up an account that
the builder draws from during the building process. The bank
wants to make sure the project is completed, so it ties the cash
draws to success and to certain milestones. When those mile-
stones are completed, the bank can then free up the money to pay
for the supplies and services. For example, if the rough lumber
needed for a project costs $28,000, the bank would give the builder
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a draw for $28,000, which would then flow to the lumber company
after the framing was complete. The lumber company would then
sign a waiver of lien, acknowledging payment and freeing up its
claim to the property.
When a builder becomes strapped for cash, he may try to get the
money sooner by employing any of the following strategies:
Falsifying inspection reports
Submitting fake certifications of work performed
Fooling the inspectors by removing items from some buildings
and installing them in others to make it appear as though
progress is being made
Selling an incomplete property to the buyer
The best way to avoid builder bailout scams is to choose a rep-
utable builder and refuse to close on the deal until you have the
building thoroughly inspected by a professional inspector of your
Acting with integrity:
The golden rule
Far too many investors succumb to the temptation to commit
fraud because they’re in a hurry to make a quick buck. All these
“investors” eventually fail because they tarnish their own reputa-
tions and damage the very industry that puts money in their
The best way to achieve long-term success as a real estate investor
is to make a commitment to follow the golden rule — treat others
as you would want to be treated. You can still earn a handsome
profit in real estate by purchasing properties legitimately and set-
ting a fair price when you sell. You don’t have to break or bend the
laws to be successful. You just need to do your homework.
Part I: Gearing Up for Financing Your Real Estate Investments
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Chapter 3
Gathering Essential
Documents, Facts,
and Figures
In This Chapter
Obtaining, checking, and correcting your credit history
Gathering all the facts, figures, and documents you need
Keeping track of where all your money’s coming from
Telling the difference between prequalification and preapproval
enders aren’t exactly tripping over themselves to lend money,
especially in the recent credit debacles of the mid-2000s. They
want to know who they’re lending it to, for what, and how and
when they’re going to get paid back. They usually operate conserv-
atively, weighing the risks before quoting you a price. If they see
your venture as too risky, they may reject your loan application
outright. If they believe you’re in a strong position to pay back the
loan in full, they may offer you financing at lower interest rates to
win your business. If they see you as a moderate risk, you may
receive financing at higher rates.
In any event, the lender wants to see how you look on paper — the
value of what you own, how much you owe, how much you earn,
your credit history, and so on. Before you even think about applying
for a loan, gather all the documents and information that lenders are
likely to request. This chapter leads you through the process.
Examining Your Credit Reports
Good credit is gold. Without it, you have access to your money
only. With it, you can put other people’s money to work for you.
Whenever you apply for a loan, the lending institution performs a
credit check — a background check to make sure that you’re not up
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to your gills in debt, that your income covers expenses, and that
you pay your bills on time. They examine your credit history (doc-
umented by the three major credit reporting agencies), bank state-
ments, pay stubs, W-2s, tax forms, and other financial records.
To ensure success at obtaining loans, become proactive in ensuring
your credit history remains unblemished. Check your credit report
every three months or so, correct any errors, and take steps to
improve your credit rating, as instructed in the following sections.
No irregularity is too small to correct. (Checking your own credit
report doesn’t negatively affect your credit score as can too many
credit inquiries from prospective creditors. Check your credit history
regularly, but keep loan and credit card applications to a minimum.)
The following sections show you how to obtain, review, and cor-
rect your credit report. We also offer suggestions on how to
improve your credit score.
Obtaining free copies of your reports
As of September 1, 2005, the Federal Trade Commission (FTC) man-
dated each of the three major credit reporting companies provide
you with a free credit report once every 12 months (a total of three
free credit reports per year). These three major national credit
reporting bureaus contain slightly different information about your
credit history, or what’s called a
credit report or credit profile.
To obtain your free credit report, do one of the following:
Submit your request online at
Phone in your request by calling toll-free 877-322-8228.
Download the Annual Credit Report Request Form from www.
(click the link to request your
report through the mail), fill it out, and mail it to Annual
Credit Report Request Service, P.O. Box 105281, Atlanta, GA
Some banks offer free credit reports, so consider checking with
your bank or credit union, too.
If you already obtained your three free credit reports this year
and want something more recent, you can order a credit report for
less than ten bucks from any of the following three credit report
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Equifax: 800-685-1111 or online at
Experian: 888-397-3742 or online at
TransUnion: 800-916-8800 or online at
Financial institutions may not file reports with all three agencies.
To obtain a complete credit history, order a three-in-one report
that contains data from all three agencies. All three agencies offer
these three-in-one reports.
Checking your credit score
To give your credit rating an air of objectivity, credit reporting
agencies often assign you a
credit score that ranges roughly
between 300 (you never paid a bill in your life) and 900 (you
borrow often, always pay your bills on time, and don’t carry any
huge balances on your credit cards). A “good” credit score is 700
or above. A “great” credit score is anything higher than 780.
Your credit score determines not only whether you qualify for a loan
but also how much you’re qualified to borrow and at what interest
rate. A high credit score enables you to borrow more and pay less
interest on it. A high score can also lower your home and auto insur-
ance rates so keeping a close eye on your score is important.
Chapter 3: Gathering Essential Documents, Facts, and Figures
Credit score stats
Credit reporting agencies rely on one or more statistical models to determine your
credit score. One of the most popular models is the Fair Isaac Company (FICO) rating
system. The credit company assigns numerical values to particular pieces of data
in your credit history, such as the length of your credit history and the various types
of interest you’re paying. They then plug these numbers into the statistical model,
which spits out your credit score. It’s basically a numbers game that weighs the
data on your credit report in the following manner:
35 percent of the score is based on payment history
30 percent is based on outstanding debt or how much you currently owe
15 percent is based on the length of your credit history or how long you’ve been
10 percent is based on recent inquiries on your report (whenever a lending insti-
tution requests a report)
10 percent is based on the types of credit, such as mortgage or credit card interest
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Although the law requires each credit agency to supply you with
one report annually, it doesn’t require them to provide your credit
score. When you’re getting your free report, you can choose to pay
extra to include your credit score.
Inspecting your report for problems
When you receive your credit report, inspect it carefully for the
following red flags:
Names that are the same as or similar to yours, but aren’t you.
Relative with the same name; for example, a father (Senior) if
you’re Junior.
Addresses of places you’ve never lived.
Aliases you’ve never used, which may indicate that someone
else is using your Social Security Number or the credit report-
ing agency has mixed someone else’s data into yours.
Multiple Social Security Numbers, flagging the possibility that
information for someone with the same name has made it into
your credit report.
Wrong date of birth (DOB).
Credit cards you don’t have.
Loans you haven’t taken out.
Records of unpaid bills that you either know you paid or have
good reason for not paying.
Records of delinquent payments that weren’t delinquent or
you have a good excuse for not paying on time.
Inquiries from companies with whom you’ve never done busi-
ness. (When you apply for a loan, the lender typically runs an
inquiry on your credit report, and that shows up on the report.)
An address of a place you’ve never lived or records of accounts,
loans, and credit cards you never had may be a sign that some-
body has stolen your identity. Yikes! Contact the credit reporting
company immediately and request that a fraud alert be placed on
your credit report. For tips on protecting yourself against identity
theft and recovering from it, check out
Preventing Identity Theft For
by Michael J. Arata, Jr. (Wiley).
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Repairing your credit and
boosting your score
If you have a credit score of 700 or higher, pat yourself on the back.
You’re above average and certainly qualified to borrow big bucks
at the lowest available rates. Anything below about 680 sounds the
warning sirens that you need to dispute errors on your report or
repair your credit as quickly as possible. This number is the point
at which lending institutions get out their magnifying glasses and
begin raising rates and denying credit.
If your credit rating dips below 700, take steps to improve it, such
as the following:
Dispute any erroneous items on your credit report.
Disputing a claim doesn’t always result in a correction, but
you can add a paragraph to your report explaining your side
of the story.
Apply for fewer loans and credit cards. When you apply for a
loan or credit card, the lending institution typically orders an
inquiry that shows up on your credit report. Evidence that
you’re applying for several loans or credit cards in a short
period of time can make you appear financially desperate.
Pay off your credit card balances, if possible, or at least
enough so the balance is 50 percent or below your available
credit limit.
Doing so shows that your credit isn’t maxed out.
Paying off high-interest credit card balances is always a good idea,
but don’t start consolidating loans and closing out accounts. Having
four open accounts with a balance of $1,000 each on a $5,000 credit
limit looks better than one account with a credit limit of $5,000 and a
$4,000 balance. Why? Because of something called
credit utilization
your total debt relative to the amount of credit available to you.
Keeping your credit utilization below 80 percent (preferably below
60 percent) improves your score.
Avoid credit enhancement companies on the Web that claim to
provide seasoned credit within 90 days. Law enforcement authori-
ties are shutting down these sites on a regular basis. Legitimate
credit counselors can help you repair your damaged credit, but it
takes some work and a little belt-tightening. Quick fixes are typi-
cally fraudulent fixes. For additional tips on boosting your credit
score, check out
Credit Repair Kit For Dummies, 2nd Edition, by
Steve Bucci (Wiley).
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Avoiding mistakes that can
sabotage your loan approval
After you apply for a loan, resist the urge to make any life-changing
decisions that negatively affect your current financial status. Major
changes can undermine your efforts to secure a loan, so follow
these sage do’s and don’ts:
Do stay married: Divorce drains your emotions, energy, and
finances. It cuts your assets in half and increases your liabili-
ties, obliterating your chances of securing a loan.
Don’t apply for other loans or credit cards: Any last-minute
inquiries that pop up on your credit report can be a red flag
that cautions prospective lenders.
Do avoid buying big-ticket items: Buying an expensive vehi-
cle can sink a deal. If you must have the vehicle, buy, fix, and
sell the investment property first, and then purchase the vehi-
cle with your profit.
Don’t make any major purchases on credit: This advice goes
for a car, furniture, health club membership, big-screen TV,
and any other purchase that can throw off your debt-to-
income ratio (see “Calculating your debt ratio” later in this
Don’t cosign for any loans: No matter what your relationship
with the borrower is (or how badly your son, daughter, or
long-lost uncle needs the money), don’t cosign a loan. Doing
so exposes your credit history to potential blemishes when
others fail to make their payments.
Don’t withdraw or move substantial amounts of cash: If a
prospective lender looks at an account expecting to see $10,000,
and it shows a $50 balance, you have some explaining to do.
Do pay your bills on time: Records of unpaid bills and delin-
quent payments can get back to prospective lenders. If you
have a stack of unpaid bills, pay them now. If a bill is due on
the 1st and you pay it on the 15th, you can avoid the late fee.
Paying it before the 30th typically keeps the late payment off
your credit report. But any bill payment after the due date is
considered late and qualifies as
slow pay, which lenders can
figure into their formula assuming they know about it.
If your financial situation changes between the application and the
time of closing, you’re legally obligated to inform the loan officer
and lender of the change.
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Chasing Down Vital Paperwork
You can approach a loan application in one of two ways: Either
show up with all the paperwork, facts, and figures in hand or con-
sult with a lender first and find out what she needs. The first
approach is best, because it demonstrates to lenders that you’re
well organized and are committed to providing them with every-
thing they need to do their job.
However, in order to come prepared to your lender, you must know
which paperwork you need for the meeting. In the following sec-
tions, we reveal the information and documentation most lenders
are going to require to process your loan application.
Delving into your personal
financial information
Unless you plan to borrow money solely against business assets,
lenders are going to want to know everything about your personal
finances — the value of everything you own, the total you already
owe on other loans and credit cards, your monthly and annual
income, monthly bills, and so on. And they’ll want documentation
to back up all those figures.
The following sections show you how to calculate some of these
important figures, including your net worth and debt ratio, and list
the documentation required to prove the amount of cash you have
and the monthly and annual income you earn.
Calculating your net worth
Most people in real estate and banking know their own net worth.
Asking folks in these circles, “What’s your net worth?” is about as
natural as asking them their name. When we ask most consumers
to estimate their net worth, however, they look puzzled, as if we
had asked them for the square root of pi. They simply have better
things to entertain themselves.
Net worth is simply whatever money you would have if you sold all
your stuff and then paid off all your debts, including your taxes.
Officially, the equation goes like this:
Net Worth = Assets – Liabilities
A strong positive net worth indicates that you
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Own more than you owe
Don’t borrow more than you can afford to pay back
Can pay off a loan by liquidating assets, if needed
Pay your taxes on time
Probably know more about net worth than you realize
To prove to a lender that you’re net worthy, follow these simple
steps to calculate your net worth:
1. Jot down a list of your assets and liabilities.
The tough part is identifying assets and liabilities.
Following these steps are lists of common assets and liabili-
ties, which can help you identify yours.
2. Total your assets.
3. Subtract your liabilities.
The next time someone asks, “What’s your net worth?”
you’re prepared to answer.
The following lists of items may stimulate your brain cells and help
you identify different examples of assets and liabilities.
Home: If you sold your home today, what could you get for it?
If you recently had an appraisal, use that number, assuming
the appraiser assigned it an honest value.
Other real estate: If you have a vacation home or other real
estate, consider how much you could get for it if you sold it
Car: The blue book value (current value), not what you paid
for it.
Savings account: Whether you have $5 or $50,000, it counts.
Checking account: The current balance as recorded in your
check register. No cheating. If you just wrote five checks that
haven’t cleared yet, you don’t really have that money.
Retirement savings: 401(k), IRA, SEP, or other account that
you don’t dip into for your daily living expenses.
Investments: Stocks, bonds, and mutual funds that aren’t part
of a retirement account.
Jewelry, antiques, and artwork: If you’re not sure what this
stuff is worth, have it professionally appraised. People often
think that their stuff is worth much more than it really is.
Furniture: If you sold all your furniture at an auction or
garage sale, what could you get for it?
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Cash value of life insurance: If you have term life insurance,
it’s worth $0. If you use a life insurance policy as an
investment, how much is it worth today?
If you don’t have it, don’t count it. The money you stand to inherit
when Aunt Millie kicks the bucket doesn’t count.
Now for the painful part — liabilities. These are items such as the
Mortgage principal: The amount you owe on your house
today and on any other loans you’ve taken out on the house.
Car loan: How much would paying off your car loan today
cost? Write it down.
Student loans: If you’re paying off any student loans from
your old college days or are named as a cosigner on any of
your kids’ student loans, record the amounts as liabilities.
Credit card debt: Dig out your credit card bills and tally up
the total you currently owe on them.
Taxes owed: Do you owe any back taxes or property taxes?
Total the amount.
Personal loans: Did you borrow $5 from the neighbor to buy
candy from the neighborhood kids? Write it down.
You may be able to obtain most of the liability information you
need from your credit report, as discussed earlier in this chapter
in the section “Examining Your Credit Reports.” However, if you
know that you have a debt that doesn’t appear on the credit
report, be sure to include it in your calculations.
Calculating your debt ratio
Almost every lender examines your debt ratio, so you should know
what it is before the topic ever comes up. Your
debt ratio is how
much you pay out in monthly bills compared to your gross
monthly income. Generally speaking, you can estimate your debt
ratio by dividing your total monthly payments (on loans and credit
cards) by your total monthly income:
Debt Ratio = Total Monthly Payments ÷ Total Monthly Income
Your total monthly payments apply only to payments on loans and
credit card balances, not for other expenses like groceries, gas, or
clothing. They include payments on long-term debts, such as a car
loan or student loan payments, alimony, child support, or a bal-
ance you carry on one or more credit cards. Debt ratios come in
two flavors:
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Back-end debt ratio: The back-end ratio consists of your total
debt payments (including your house payment with home-
owner’s insurance and property taxes) divided by your
monthly income. According to the Federal Housing Authority
(FHA), your back-end debt ratio should not exceed 43 percent.
Front-end debt ratio: The front-end debt ratio (also called the
housing ratio) consists of your house payment alone (includ-
ing property taxes and insurance) divided by your total
monthly income. According to the FHA, your front-end debt
ratio should not exceed 31 percent. If your total gross house-
hold income is $6,000 per month, for example, your house
payment alone should not exceed $1,860.
Gathering bank statements
Almost all lenders are going to ask for copies of the most recent
two months’ bank statements, so they can see how much cash you
have in savings and checking, determine whether you have a
healthy cash flow, and check for any activity that looks out of the
ordinary (such as large deposits or withdrawals that can’t be
explained by other documentation). Make a copy of your two most
recent bank statements — whether you receive statements
monthly or quarterly.
On the copies, take a black magic marker and mark out the
account numbers to prevent others from gaining unauthorized
access to your accounts.
Tracking down your pay stubs and W-2s
If you work a regular job, you probably get a paycheck every week
or two that shows your gross pay, your deductions (state and fed-
eral income tax, Social Security, and so on), and what’s left — your
net pay. Most lenders want a full month (30 days’ worth) of consec-
utive paycheck stubs — not one from last week and another from
two months ago; they need to be the most recent and consecutive.
They should also show your year-to-date (YTD) earnings.
Most lenders also want to see proof of previous years’ income. Of
course, they can obtain this evidence by looking at your previous
two years of federal income tax returns, but many lenders also like
to see your W-2 forms, so be sure to make copies of these as well.
If you don’t have a regular job, skip ahead to the section
“Accounting for business income” to find out which records you
need to supply to prove your business income.
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Gathering tax returns and schedules
Every lender requires you to submit along with your loan applica-
tion your federal income tax returns. Make sure you provide copies
of your two most recent federal income tax returns. Copy the com-
plete federal tax return, including all schedules and attachments,
not just the first two pages of the return. Include
everything — don’t
leave something out just because you don’t think it’s relevant.
You don’t need to supply your state income tax returns unless state
grants or subsidies are involved in the transaction or financing.
Pulling up other useful documents
If you follow the instructions in the previous sections, you now
have all the major facts, figures, and documentation you need
related to your personal finances. However, additional documenta-
tion may also be useful (and necessary) in determining whether
you qualify for a particular loan. Your lender or broker may need
the following:
Any documents that support your income, such as employ-
ment contracts with step increases; union benefit agreements;
notes receivable; real estate earnings; earnings from trusts,
estates, or settlements; or documentation showing major lot-
tery winnings.
Property income, including GAI (Gross Annual Income) from
rents; storage fees; fees for facilities, such as clubhouse,
pools, satellite TV, cable, laundry, or Internet; parking or car-
port fees; pet income; income from signage; a percentage of
tenant sales (for retail commercial properties); and so on.
Documentation of any unusual liabilities (or the exclusion of
them), such as major reimbursed business expenses, person-
ally guaranteed business loans (appearing on your credit
report), or old loans that you’ve paid off but that haven’t
cleared from your report.
Create copies of any documentation that supports your claims of
assets, liabilities, and income. Prospective lenders may request
specific documents, but gathering everything you have available in
advance makes your job that much easier later on.
Accounting for business income
If you don’t have a regular job or you have income (or losses) from
a business, you need to supply proof of your income or loss:
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Some of this documentation may already be included in your
federal income tax returns. Be sure to include
all schedules
(C’s E’s, K-1’s, and so on) so that the lender has an accurate
picture of each of your investments and business holdings.
If you own 25 percent or more of any company, corporation,
or LLC, provide copies of each entity’s federal returns for the
past two years.
To provide more recent data, produce a report showing YTD
income and expenses for the business. You can produce such
reports fairly easily by using a business or personal finance
program, such as Quicken or QuickBooks. If you have an
accountant, ask the accountant to produce a report for you.
Documenting the property
you plan to purchase
Your gut feeling that a particular property is a great investment
may be enough to convince you to sign a purchase agreement, but
it’s rarely enough to convince lenders to finance the purchase. You
need to have a plan in place for how you’re going to profit from the
investment, complete with fairly realistic estimates concerning the
costs and revenue potential.
Many novice investors view the loan application process as a big
hassle that just gets in the way of their vision and profits. However,
by forcing you to think ahead, the process actually protects you
from making bad investment decisions. As an investor, you should
only purchase a property to make money or create future wealth,
and you should be able to show how an investment will further
those goals before you ever sign a purchase agreement.
In the following sections, we show you how to estimate and
document the profit potential for investment properties.
Obtaining an appraisal or comparative market analysis
As a real estate investor, your goal is to discover properties that are
likely to generate profits. Basically you don’t want to pay more for
the property than it’s worth. To help in your calculations, get your
hands on a
comparative market analysis or appraisal. Your real
estate agent can provide you with a comparative market analysis
that shows the probable value of the property in relation to similar
properties that have sold recently or are currently on the market.
You want to keep your eyes open for property that’s likely to make
you profits in one or both of the following two ways:
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Income from sale: You’re looking to buy low and sell high or
legally “flip” the property. For more about flipping properties,
check out
Flipping Houses For Dummies.
Rental income: You’re planning a buy-and-hold strategy, in
which your rental income covers (or more than covers) your
expenses until you decide to sell the property (hopefully for
more than you paid for it).
If you want something more formal and more detailed, you may
consider hiring an appraiser. A qualified appraiser can evaluate the
market value of the property (to assist in estimating your potential
income from selling it) or evaluate the income of the property by
using a Net Operating Income (NOI) formula (see Chapter 8).
When you’re just checking out some properties, bringing in an
appraiser may be premature (and an unnecessary expense). Most
investors rely on their own market knowledge and perhaps their
agents’ insight to estimate the property’s value. The appraiser
enters the picture just prior to closing to confirm that the property
is worth the price you’re paying. However, if you’re seriously consid-
ering a property and are questioning your instincts, you may want to
hire an appraiser for a second opinion before moving forward.
The seller whose property you’re thinking of buying may already
have had an appraisal done, in which case, you may be able to
review it just by asking. (Don’t place blind faith in the seller’s
appraisal — use it only to confirm or question your own evaluation.)
Looking ahead to potential resale value and repair costs
When you obtain an appraisal, the appraiser usually takes into
account the property’s current condition. If you plan to flip the
property for a quick profit, estimate the market value of the prop-
erty after repairs. What’s a realistic price you think you can get for
the property after fixing it up? Your real estate agent should be
able to help you come up with a realistic value.
You also need to estimate your total costs for the project, includ-
ing the cost of repairs and renovations, holding costs for the dura-
tion of the project (the total you plan to spend on loan interest,
property taxes, loan interest, and utilities), and the cost of selling
the property (any real estate agent commissions and closing fees).
Overestimate costs and underestimate the final sale price, so you
have a bit of a buffer. For details about making well-calculated
investments when flipping properties, check out
Flipping Houses
For Dummies
by none other than Ralph and Joe, two of your
esteemed authors (Wiley).
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If you’re planning on holding the property for several years rather
than doing a quick flip, you still need to consider the potential
future value of the property. For example, if you’re buying into a
neighborhood where home values are on the rise, then paying close
to the appraised value of the property may make sense. The ques-
tion you need to answer is this: How likely is it that I will more than
recoup my investment when I finally decide to sell the property?
Performing a quick cash flow analysis
One of the best ways to build wealth in real estate is to purchase
property and hold it indefinitely. During the time you hold the prop-
erty, you profit in three ways:
The property appreciates, gaining in value.
Renters pay down your principal (the amount you owe on the
You get a tax write-off for any expenses you incur relating to
the rental property.
Of course, your profit hinges on the assumption that you earn
more in rent than the property costs you in expenses (including
taxes, insurance, landlord-paid utilities, repairs, and improve-
ments). In short, you (and your lenders) want to make sure that
that your investment delivers a positive cash flow so you’re not
losing money.
The formulas for calculating cash flow (or NOI) are fairly basic:
If those formulas look like Greek to you, read on:
GAI is your Gross Annual Income; simply calculate your
yearly income from all possible sources (rent, carport, laun-
dry, storage, parking, and so on).
VAC is a vacancy allowance; use a minimum of 5 percent of
the GAI to allow for vacancy (periods when you have no
EGI is your Effective Gross Income — the total workable rev-
enue you see from the property. Another way of looking at it is
that this is the amount of money you have on hand to cover
your property’s expenses.
TOE represents your Total Operating Expenses; this figure
includes all the costs to operate the property, except the loan
payments. It includes maintenance, taxes, insurance,
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management, landscaping, landlord-paid utilities, office
expenses, and so on.
NOI is your Net Operating Income; this number represents
your profit on a yearly basis, assuming you pay
cash for the
This formula works for
all buy-and-hold properties. It shows you
and your lenders how much you can afford to pay monthly for the
financing. We look at calculating those numbers in Chapter 8.
Calculating the loan-to-value (LTV) ratio
The loan-to-value (LTV) ratio is a mathematic representation of how
much you owe on your home compared to its appraised value.
Banks use LTVs to justify lending money to high-risk borrowers.
Even if you have a low credit score and a history of paying your
bills a little late, a bank may be willing to cut you some slack and
approve your loan if your LTV ratio is low. In other words, the more
equity you have in your home, the more likely the bank will
approve your loan.
For example, if your home appraises for $250,000 and you owe
$200,000 on it, the LTV is $200,000 ÷ $250,000, or 80 percent.
Anything below 80 percent is considered great and often qualifies
you to borrow more money at a lower interest rate.
Be realistic and know how much you can really afford to borrow.
Don’t cause yourself stress and future problems by trying to stretch
your finances too thin. If after you do your calculations it looks as
though you can’t afford to borrow more money, don’t. Check out
some of your other options instead, as we explain in Part IV.
Obtaining zoning information
Most counties or cities zone properties for specific uses, usually to
keep businesses out of residential districts or vice versa. Before
you purchase a property, find out how it’s zoned so you know
about anything that could restrict the way you use the property.
Check with the local city or county assessment or building
inspection office regarding the following:
How the property is currently zoned
Any plans to change the zoning for this area
Whether your intended use of the property fits the current
and any new zoning restrictions
Whether the property is subject to changes in zoning require-
ments; some properties have “grandfather” clauses that allow
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them to operate without being subject to changes in the zoning
requirements, but these clauses may expire when ownership of
a property changes
Pulling city and county records
When you’re investing in real estate, knowledge is power; the more
you know about a property before you buy it, the less likely you
are to encounter nasty surprises later. The info you gather may
also improve your chances of obtaining financing to purchase and
restore the property. One way to obtain additional information is
to research the public records.
Call the city or county assessor’s office or the County Real Estate
Mapping Division (every county has one) and find out how to
access the parcel maps, aerial maps, tax records, building records,
zoning or building appeals, violations, and ownership records. The
county has to make all these documents available to the public.
Many cities and townships post their records and even property
histories online.
If you notice any red flags in the property records, such as a build-
ing code violation, address them before you purchase the property
and they become
your headache. In many cases, liabilities for viola-
tions and/or discrepancies (such as boundary lines, easements,
riparian rights [relating to a body of water], natural resource claims,
and so on) reach back to only a certain number of previous owners.
You don’t want to get stuck on the hook for someone else’s problem
from long ago.
Part I: Gearing Up for Financing Your Real Estate Investments
Zoning fiasco
If you think that zoning restrictions are something you can deal with later, think
again — they may just deal with you later. Several years ago, I (Chip) bought a
property without thinking too much about zoning restrictions and grandfather
clauses. I planned to use the property pretty much the same way the owner before
me used it. Because no grandfather clause was in place that would expire when
I took ownership, I figured I was safe.
Unfortunately, a different type of grandfather clause was in place — one I hadn’t con-
sidered. The clause stated that if the property burned down,
could be built in
its place. The lot would have to remain vacant regardless of how it was zoned!
Fortunately, the building didn’t burn down when I owned it, but getting insurance
was tough, and I was severely limited in what I could do with the property. It was
zoned for multifamily, but I had to convert it back to single family to get the Certificate
of Occupancy that’s required before you can lease the property.
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The “cleaner” the package, and more documentation you have, the
more valuable the property becomes — and the easier to sell later
on. Get your ducks in a row early on so that problems don’t cause
expensive delays later.
Show Me the Money: Identifying
Sources of Ready Cash
When you’re applying for a loan, the lender will ask you to do one
important thing: “Show me the money!” Where will you get the nec-
essary cash for the down payment, the closing costs, the pre-paid
items, any repairs or inspections, any third-party fees, or commis-
sions? Do you have sufficient cash reserves to cover unexpected
expenses or income shortfalls?
You need to be able explain and document those sources of avail-
able cash, as we discuss in the following sections.
Sources of cash for down payments,
closing costs, and prepaid items
Although you can usually count on financing the major portion of
the purchase price, you probably need to pay some closing costs
and other expenses out of pocket. Your lender wants to know up
front where the money’s going to come from. The money can come
from just about any source, as long as you have documentation to
prove the money exists:
Checking and savings accounts
Retirement accounts
Money from the sale of other properties
Refinancing or selling other assets
New loans
Documentation can include bank or other financial statements,
sales receipts, HUD-1’s from the sale/refinance of real estate, loan
agreements, and credit card statements.
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Rainy day funds: Cash reserves
On most transactions, lenders want to know you have reserves
cash set aside to cover the cost of unpleasant surprises. Simple
transactions may require two to three months’ cash reserves of the
monthly payment or principal, interest, taxes, and insurance (PITI).
More-complex transactions may require reserves for construction
allowances, credit losses, tenant improvements, and replacement
reserves (for example, for new refrigerators or stoves in apartment
units). The lender establishes the reserve requirements, and different
lenders have different guidelines for calculating minimum reserves.
The more reserves you have, the better. Even shaky loans get
approved based on a borrower having strong reserves.
Getting Prequalified
or Preapproved
You’re always in a stronger position to purchase a property at an
attractive price if you have cash or financing in place when making
your offer. Cash is king. Financing is queen. Having to secure
financing is about a
2. Because you’re reading a book on financing,
we can safely assume that, like most investors, you don’t have
enough cash on hand to purchase investment properties. The next
best option is to prequalify or obtain preapproval for a loan:
Prequalification: Prequalification means a lender or broker has
reviewed your financial records and determined that you would
probably qualify for a particular loan. The lender performs some
basic calculations to determine whether your front-end and
back-end debt ratios meet the FHA qualification requirements.
Preapproval: Preapproval is a more formal, final step in which
the lender obtains all the borrower’s documentation and
underwrites the loan — without a property. With preapproval,
the lender agrees to finance the purchase of an investment
property up to a certain amount. As long as the property
complies with the lender’s standards, the loan is a done deal.
Gaining preapproval puts you in a much stronger position to nego-
tiate. To the seller, it’s almost as good as cash. Preapproval is also
much better for you as a borrower because it insulates you from
changing market conditions. You can move quickly on a property
and lock in an approval even if credit tightens and interest rates
rise. (Chapter 7 leads you through the loan process so you can do
everything necessary to obtain preapproval.)
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Chapter 4
Scoping Out Prospective
In This Chapter
Hitting up banks for a loan
Getting a broker to do your legwork
Exploring the private sector
Financing through the seller or your Uncle Sam
Joining forces with a cash-endowed partner
o pursue your dream of owning some investment property, you
need some start-up cash. Sure, you can shake all the money
out of your piggy bank and cookie jar, but that probably won’t
score you enough cash to finance your first major acquisition. You
need serious cash — probably at least 100 grand — and you don’t
want to have to go through the neighborhood loan shark to get it.
If you haven’t shopped for money before, you may have the mis-
conception that the answer is simple — just head down to the
bank. But as we reveal in this chapter, you have many more
options from which to choose. If the bank won’t loan you the
money or offer you a decent deal, maybe someone else will.
In this chapter, we introduce you to the money lenders, including
bankers, brokers, and some less-conventional sorts. You may be
surprised at the variety available. In later chapters, we get into the
nitty-gritty of actually asking for the money.
Borrowing Directly from Banks
You don’t need a treasure map to locate huge stores of cash. At
just about every major intersection in every town or city, you can
find a bank chock-full of greenbacks. Unfortunately, depending on
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market conditions, your friendly neighborhood bank may not be as
eager as you might expect to give you the combination to the vault.
But is a bank the best place to go for a loan? Maybe, maybe not. In
the following sections, we weigh the pros and cons of financing
through a bank and examine the types of loans banks typically
offer. After reading through these sections, you should have a
pretty clear idea of what banks can and can’t do for you as an
Weighing the pros and cons
Financing your investments through a bank, particularly the bank
you use to manage your personal finances, may seem like the perfect
solution, at first. It’s probably convenient, you already know some of
the people, and you feel comfortable doing business with them.
Don’t dismiss any source of financing without first exploring it.
Before you head down to your bank to apply for a loan, however,
weigh the pros and cons of borrowing from a bank. You may dis-
cover that a bank is the perfect solution for your financing needs
or that the perfect solution isn’t so ideal after all.
Financing your real estate investments through a bank, especially a
local bank, offers several perks, including the following:
Security and reliability: Federally insured banks are generally
dependable institutions, although even the most solid institu-
tions are vulnerable to bankruptcy.
Convenience: Banks typically have many branches, which can
give you access to convenient locations when you need assis-
tance or a quick draw from a line of credit to act on an invest-
ment opportunity.
Portfolio lending: Smaller financial institutions, including
banks and credit unions, may be more open to holding loans in
their own portfolios rather than selling them to bigger banks
or mortgage companies. This allows them to be more flexible
on interest and terms. However, portfolio lending is usually
available only for short-term (less than three years) loans.
Community Reinvestment Act (CRA) goals: Banks may be
required by federal law to lend money for certain projects
(including residential and commercial properties) within their
immediate geographical area. A lucrative rehabilitation invest-
ment project can get the green light just because of the bank’s
CRA requirements. (For more about the CRA option, check out
Chapter 9.)
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Insights and guidance: Local banks understand the local real
estate market. They’re aware of trends and market conditions,
and can provide a great deal of insight into the viability of an
investment property in a specific area. Your banker may just
develop into your own personal real estate investment advisor.
Preferential treatment: Although the world may seem to be
becoming more impersonal, relationships still count, espe-
cially when dealing with money. As you develop a relationship
with people at the bank, especially loan officers and execu-
tives, you place yourself in a stronger position to negotiate
more affordable loans.
Improved access to REO properties: When a bank forecloses
on a mortgage, it often takes possession of the foreclosure
property and transfers it to its Real Estate Owned (REO)
department, which then tries to sell the property. If everyone at
the bank knows you as a trustworthy investor, you may have a
better chance of obtaining good deals on these properties.
During economic slowdowns, when credit usually tightens, REO
(or bank-owned) properties become more available. In addition,
because banks get stuck holding so many of these properties, they’re
often willing to finance purchases. Through careful negotiations, you
can not only buy properties at great prices but also have the bank
finance them. For more about this strategy, check out Chapter 17.
Although banks offer a host of valuable benefits, they also come
with a few drawbacks, including the following:
Limited financing options: Unlike brokers, banks don’t help
you shop for loans. They can offer you the loan programs
from their own menu only. They may not even offer certain
loans (such as government loans) for particular types of prop-
erties. A
mortgage broker can provide more options by work-
ing with dozens of banks. Check out “Dealing with a
Middleman (or Woman): Brokers” later in this chapter.
Possible complications: Many banks broker their loans out
(sell them to other lenders or institutions), so you end up
dealing with another lender anyway without reaping any of
the benefits of working through a broker, such as a faster,
hassle-free closing.
Possible loan processing delays: Many banks rely on hourly
employees to handle loan transactions. As a result, they have no
financial incentive to wrap things up quickly. Mortgage brokers,
on the other hand, are paid only when the loan closes. They’re
typically paid on a straight commission for producing the loan,
so they have an added incentive to see that it closes quickly.
Chapter 4: Scoping Out Prospective Lenders
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Conventional loans
Banks typically deal in loans that are considered conventional or
conforming — meaning the loan conforms to all the requirements
of Fannie Mae and Freddie Mac (see the nearby sidebar).
Conventional loans are the bread and butter of residential real
estate financing, particularly for homeowners but also for
investors. With conventional loans, you can always be sure that
Capital is available.
Loan costs and interest rates are generally attractive.
Interest rates among lenders vary only slightly because the
money is coming from Wall Street through Fannie and Freddie.
Because conventional loans are primarily intended for consumers
borrowing money to purchase a home, plenty of information is
available on how to find the best deals on conventional mortgages.
For more information, we recommend
Mortgages For Dummies, 3rd
Edition, by Eric Tyson and Ray Brown (Wiley). To separate mort-
gage fact from fiction, check out our book
Mortgage Myths: 77
Secrets That Will Save You Thousands on Home Financing
Conventional loans are also available for investors, although they
tend to cost more and be more restrictive — with a loan-to-value)
usually no higher than 75 percent and 1 to 1.5 points. (For more
about LTV, see Chapter 3. For information about points, refer to
Mortgage broker or loan officer?
You’re likely to hear plenty of industry lingo bandied about, but the first two terms
you need to sort out are “mortgage broker” and “loan officer.” A
mortgage broker
is a licensed company or professional who assists clients in finding and arranging
financing through lenders. Brokers are regulated by the state. A
loan officer
simply be an individual who works on behalf of a licensed lender or mortgage broker
to facilitate the process. Some states license the individual loan officers as brokers.
For all practical purposes, a loan officer offers the same services as a mortgage
broker but is required by law to work for the licensed broker or lender. It’s sort of like
going into your doctor’s office and seeing a nurse practitioner — sometimes the
practitioner offers better advice than the doctor even though the practitioner isn’t
licensed to practice medicine.
Of course, you’re usually better off working directly with an experienced broker, but
if you find a great loan officer, you may do just as well or better.
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Chapter 6.) As an investor, keep in mind that having access to cash
is often more important than the cost of gaining access.
Subprime (nonconforming) loans
Subprime loans (also known as nonconforming loans), are the bad
boys of the mortgage lending industry. At least that’s what many
people were led to believe during the great mortgage meltdown in
the late 2000s. Due to some irresponsible underwriting by lenders
and irresponsible borrowing on the part of consumers, subprime
loans did contribute to the mortgage meltdown, but that doesn’t
make them all bad. They do serve a useful purpose when used
Subprime loans are everything that Fannie Mae and Freddie Mac
aren’t. Although some subprime loans known as Alt-A loans can go
through Fannie and Freddie, most don’t. (An
Alt-A loan or alterna-
tive A-paper
loan is one for which the approval is based primarily
on the borrower’s lower credit score, or other situations such as
self-employment, that increase the risk of repayment.) Instead,
subprime loans are usually available through other institutional
investors, pension funds, insurance companies, various large and
small mortgage banking firms, and even individuals.
Chapter 4: Scoping Out Prospective Lenders
Fannie and Freddie who?
The question is more like “Fannie and Freddie what?” Fannie Mae is actually a nick-
name for the FNMA, or Federal National Mortgage Association. Freddie Mac is a
nickname for FHLMC, or Federal Home Loan Mortgage Corporation.
Both organizations do pretty much the same thing — they purchase residential mort-
gages and then convert the mortgages into securities for sale to Wall Street investors,
indirectly financing the purchase of homes. In other words, they sort of act as the
middlemen between banks and Wall Street investors. The end result is that they make
money readily available for the purchase of homes and other real estate.
Although both institutions began as government-chartered, private companies,
they’re now controlled by the government as a result of the problems they ran into
during the mortgage meltdown that started in 2008. While we were writing this book,
it was still too early to tell whether the end result would be a consolidation, merger,
or something else entirely, but whatever happens, Fannie and Freddie should essen-
tially function the same way but with more restrictions.
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Instead of Fannie and Freddie setting the qualifications for these
loans, the market and individual investors lay down the rules and
decide what’s available and to whom. As a result, they can offer a
much greater variety of loan packages that appeal to niche markets
and address specific needs, such as the following:
Limited-documentation loans make it easier for investors who
don’t have the necessary financial documents (tax returns,
pay check stubs, and W-2s) to qualify for loans.
Hybrid adjustable rate loans can help investors with short-term
financing and cash flow by providing flexibility in interest rates.
Rehabilitation programs can open doors to investors by
funding special projects or development in certain areas.
Subprime loans have some drawbacks, particularly if the borrower
doesn’t fully understand the terms, which can be complicated. When
shopping for any loan, make sure you’re working with a qualified and
trustworthy professional who can clearly explain your options and
the ramifications of choosing a particular option. In short, know what
you’re getting into before signing on the dotted line.
One of the main drawbacks of subprime mortgages is that certain
programs can disappear overnight as the appetites of Wall Street
investors and consumers change. Numerous creative subprime loan
packages emerged leading up to the mortgage meltdown, and many
of these options disappeared as soon as loan defaults shot up.
Dealing with a Middleman (or
Woman): Mortgage Brokers
A mortgage broker is sort of like a real estate agent, but instead of
helping you find the right house, the broker helps you find the
right loan. Ideally, a broker sits down with you to determine what
you’re planning on using the money for and then assists you in
selecting the lender and loan package that best meets your needs.
Through a broker, you gain access to dozens of financing options
as opposed to the limited few you may find with a local bank.
In the following sections, we discuss the pros and cons of working
through a broker and then show you how to find brokers and
research their credentials and references.
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Weighing the pros and cons
As you probably already guessed, we think that most investors can
benefit by shopping for loans through a broker — a good broker,
that is. In the following sections, we list the reasons why. To give a
balanced perspective, we also list a couple of reasons why you
may not want to use a broker. Furthermore we give you clues to
uncovering a good broker and what you can do to verify the broker
is reputable and the right choice for you.
Mortgage brokers offer a host of benefits for fueling your real
estate purchases and development, including the following:
Better selection: A broker has access to many different
lenders, each of whom may offer several different loan pack-
ages, so you’re more likely to find a loan that meets your
unique needs.
Bargaining power: Mortgage brokers can negotiate fees and
terms with large lenders and play one off the other to negoti-
ate the best deal on your behalf.
Marketplace knowledge: Brokers are more in tune with new
and creative financing programs and options. When new pro-
grams become available, they’re often the first to know.
Although mortgage brokers specialize in the mortgage lending indus-
try, many are also very knowledgeable about the real estate market in
their area. In addition, a well-established broker is likely to have con-
nections with other investors, local bankers, real estate attorneys,
and so forth. Take full advantage of what your broker has to offer.
Mortgage brokers are sort of like doctors and lawyers — if you find
the right one, you have no reason not to use a broker. However,
finding and keeping a qualified broker who’s dedicated to serving
your needs can be quite a challenge. Watch out for the following:
Lack of experience: Many brokers may not be experienced
enough or large enough to deal with the right lenders. You can
spend a lot of time researching and checking credentials and
references before you find a great broker.
High turnover: Brokers can disappear overnight. Becoming a
broker doesn’t require a huge capital investment, so brokers
often come and go. After a long search, you may find a top-
notch broker only to discover that several months later the
person is no longer in business. You may end up losing time,
money, and a valuable resource.
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Shaking the branches for a broker
Although you can certainly flip through the “Mortgages” section of
the phone-book ads or search the Internet for “mortgage brokers
any town, your state USA” to find brokers in your area, these meth-
ods don’t focus in on the highest quality prospects. The best way
to find qualified, experienced mortgage brokers is to search
through the people who actually borrow money to finance their
real estate investments — real estate investors.
Obtain referrals from investors in your area, so you know the
broker has experience working with investors and has provided
satisfactory service to at least one person. Most investors will also
tell you which brokers to avoid.
If you don’t know other real estate investors in your area, you have
some work to do. Join a reputable real estate investment club such
as the Rental Property Owners Association (RPOA) and start net-
working. (Search the Web for “rental property owners association”
followed by your state.) You can pick up plenty of market knowl-
edge just by attending meetings and talking with people who’ve
been there and done that.
Checking a broker’s credentials
Ideally, a mortgage broker works on your behalf to find you the
best deal. Unfortunately, brokers don’t have a
fiduciary (legal finan-
cial) responsibility to you as the borrower. As a result, some bro-
kers may try to sell you on a loan that brings them a higher
commission rather than provide you with a better deal. This is why
finding a trustworthy broker who has a stellar reputation is so
In the following sections, we show you how to do your own back-
ground check on mortgage brokers, verify their credentials, and
interview the top three candidates.
Doing a background check
After you have a list of possible candidates, start trimming that list
to three finalists by doing a background check on each candidate:
Check the National Association of Mortgage Brokers (NAMB)
Web site at to make sure the broker is a
NAMB members follow a strict code of ethics, tend
to be more dedicated to the profession, and are required to
take continuing education courses.
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Search the Internet for the company’s or individual’s name.
If the candidate has a bad reputation, dissatisfied clients are
likely to post something about it on the Web.
If the company or individual has a Web site or blog, visit the
site and explore.
Make sure the broker deals in both conven-
tional and subprime loans. The more established brokers also
offer government loans, including Federal Housing Authority
(FHA) and Veteran’s Administration (VA) loans. (Check out the
section “Borrowing from Uncle Sam: Government Loan
Programs” later in this chapter for these types of loans.)
Visit your state’s Web site and verify that the broker is
licensed in your state.
If you can’t find your state’s Web site,
call the licensing board in your state capital. All 50 states have
licensing requirements for mortgage lenders. Some states have
licensing for individuals as well. Check for any administrative
actions or sanctions, or complaints (many complaints aren’t
public unless the department of licensing takes action). You
may also want to check your state attorney general’s Web site.
Check the Better Business Bureau (BBB) for any complaints.
Start at the national Web site’s home page at (,
which can direct you to the Web site for your local branch.
Contact your local chamber of commerce to determine
whether the broker is a member in good standing.
Being an
established member of the local business community is
always a big plus.
Contact each broker who’s made the first cut and obtain
three references from investors and three references from
real estate agents the broker has worked with.
(Make sure
the real estate agents are well-established in the community,
not just part-timers.) Call the references and ask about their
experience working with the broker.
Don’t just go with the broker who has the largest ad in the phone
book or the local newspaper. Check their credentials with the state
licensing board, the BBB, and the state attorney general’s office for
complaints and/or regulatory actions or sanctions.
Interviewing the top candidates
After you’ve chopped your list of candidates down to three, call to
set up an interview with each of them. During the interview, be
sure to ask the following questions:
How long have you been in business? You’re looking for
someone who’s been a broker for at least a couple of years.
How many transactions do you process in a year? Good bro-
kers average at least 40 to 50 transactions per year. Someone
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who processes way fewer than average may lack motivation.
A broker who processes way more may not be careful enough.
What percentage of your transactions are conventional,
non-conventional, and government loans?
Brokers generally
deal with far more conventional loans, but look for a broker
who has experience with all three types.
What percentage of your transactions are investor loans?
Brokers who do a substantial percentage of their business
with investors are usually a better choice than those who
exclusively serve consumers/homeowners.
How many lenders do you work with? Generally speaking,
the more the merrier. The more lenders the broker has access
to, the wider the selection of loan packages.
What’s your specialty? Just as real estate agents specialize in
certain types of homes, mortgage brokers specialize in certain
types of loans (such as government loans, first-time home
buyers, construction loans, and so on). Choose a broker who
specializes in the types of loans that best fit your investment
strategy. (See Chapters 5 and 9 for descriptions of different
residential and commercial loan types.)
What are your application fee requirements? Determine how
much money the mortgage broker charges upfront at the time
of application and what those fees are applied toward.
Compare costs among the brokers and make sure they’re
applying any fees to real services rather than pocketing them
as extra money.
What’s your policy on locking in interest rates? Does locking
in a rate cost extra? How long does the rate remain locked?
How soon before closing does the rate have to be locked?
What’s your refund policy for cancelled loan applications?
Some brokers actually charge upfront fees up to $1,000 or
more if you cancel a loan application. You’re better off know-
ing about it now than when you need to cancel an application.
During the interview, make sure you get along with the broker and
that your personalities match up pretty well. If this is a good fit,
you’ll be working together for some time. You want somebody you
can get along with.
Taking the Hard-Money Route
through Private Lenders
Hard money is called “hard” for a reason — it’s hard to get, hard to
pay, and generally costs more than your average loan. Hard money
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comes from individuals or small groups of private investors who
like to obtain a high return on their money and are willing to take
some additional risk in order to get it.
Because hard money costs more, you may wonder why anyone on
earth would even consider it. Just like any other type of invest-
ment method, hard money has its upsides and downsides. Hard
money offers several benefits:
More financing options: You gain access to cash you may not
be able to get through a conventional lender. Hard money
loans typically cost more in points upfront and interest, but
the terms can be more flexible than with conventional loans.
More collateral options: Hard-money lenders often accept the
future value (after renovations) of a property as collateral, so
you don’t have to borrow against other assets, like your home.
More flexibility: You can often close the transaction faster, with
less paperwork, and even set up a separate escrow account
with a hard money lender to pay for repairs and renovations.
Less intrusion into your business: Banks tend to be more
intrusive, wanting more information about the business oper-
ation than a hard money investor does. The hard-money
lender sets a lower LTV requirement, so you have less equity
risk from the start. Even so, hard-money lenders do want to
know the plan for repayment and see a business plan if it’s
contingent on a business tenancy arrangement.
On the flipside, hard money does have a few significant drawbacks:
Higher cost: Sometimes gaining access to cash, whatever the
cost, is good investment decision — as long as you account
for that cost in your calculations and can still turn the profit
you want.
Lower ratios: Another disadvantage of hard-money loans is
that the LTV’s (loan-to-value ratios) are typically lower. For
example, instead of being able to borrow 80 to 90 percent of
the value of the property, you may only be able to borrow 65
to 75 percent. However, hard-money lenders are often willing
to make the calculations on the future value of the property.
For more about using hard money to finance your real estate
investments, check out Chapter 11.
Hard-money lenders may be more willing to negotiate with
investors, especially investors who have a solid track record. Some
lenders, for instance, may charge three or four points upfront to
reduce their exposure to the risk of an early default but then agree
to refund one or two points when you’ve paid off the loan.
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Borrowing from Uncle Sam:
Government Loan Programs
The housing market plays an important role in driving the econ-
omy, so the U.S. government does what it can to support this key
industry. One of the primary support mechanisms are government
(or government-secured) loans made available to first-time home
buyers. If you’re like most Americans, you probably used an FHA
(Federal Housing Administration) or VA (Veterans Administration)
loan to purchase your first home.
Through the FHA, the U.S. Department of Housing and Urban
Development (HUD) also offers loans to homeowners and
investors to assist in rehabilitating properties. Government loans
are designed to help the marketplace in areas where the private
sector can’t. After Hurricane Katrina, for example, several govern-
ment programs came to the rescue, encouraging investors to assist
in rebuilding the damaged areas. Special grants and state and fed-
eral loan programs gave investors access to cash that the banks
and private sector wouldn’t or couldn’t offer.
In most cases, the government steers clear of lending money
directly to homeowners and investors. Instead, the government
secures the loans. If the borrower fails to pay back the loan, the
government steps in, picks up the tab, takes the property, and tries
to sell it to recoup its loss. Additionally, most government programs
are limited to owner-occupied properties.
As a homeowner, you’re already aware of some of the benefits that
government-secured loans offer homeowners, but government
loans can also benefit investors in two important ways:
Understanding government loans can enable you to flip the
property to a buyer down the road. For example, the
Neighbor Next Door loan
(GNND) enables qualified buyers
(including teachers, law-enforcement professionals, and fire-
fighters) to purchase certain HUD homes with only a $100
down payment, or even some HUD repo’s at half price;
help an owner rehabilitate a property, pay for additions,
and even purchase new appliances. Using the GNND loan and
a 203k loan, a qualified investor can actually buy a home for
half its market value with a $100 down payment and then sell
it several years down the road to earn a handsome profit.
You may be able to purchase government-owned properties
directly (usually those foreclosed on due to nonpayment of an
FHA or VA loan) and finance the purchase through the govern-
ment agency.
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For more about using specific government-sponsored loan pro-
grams to finance real estate purchases and rehabilitation, see
Chapter 5.
Financing through the Seller
Before most homeowners can pack up and move, they have to sell
their homes and pay off their current mortgages so they can afford
to buy their new homes. Homeowners who’ve paid off their mort-
gages or have sufficient cash available, however, don’t need the full
purchase price upfront. They can sell you the home and
the purchase. In other words, the seller becomes the bank.
If a seller is willing and able, you can often purchase the property
on contract through a lease option agreement or a land contract.
The contract takes the place of the mortgage document that most
buyers sign when they close on a house. In the following sections,
we explain how these contracts work. For more about the pros and
cons of financing through the seller and the nitty gritty of how to
harness the power of seller financing, check out Chapter 12.
Lease options
A lease option agreement is sort of a rent-to-own deal. You rent the
property from the owner for a fixed period (usually no more than a
few years), at the end of which time you have the option to buy the
property. Normally, the seller requires some sort of down payment
(often less than a typical mortgage lender requires), which should
be applied to the purchase price, along with monthly rent equiva-
lent to about 1 percent of the purchase price.
A lease option agreement can be a great way to finance the pur-
chase of an investment property, assuming you’re working with a
seller who deals aboveboard, and you have a great plan in place
for obtaining cash or alternative financing by the time your option
to buy the property rolls around.
So how does a lease option work? The monthly payment consists
of rent plus some additional money that’s applied to the purchase
price. In other words, if the going rate for rent on the property is
$1,000 per month, you may have a monthly payment of, say, $1,500
with the extra $500 being added to your down payment. This
ensures that you’re building equity in the property during the lease
part of the agreement, and it provides the seller/lender with some
security in the event that you back out of the deal.
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Make sure that the lease option agreement is very specific regard-
ing the application of payments and terms of exercising your
option. Otherwise, you may lose a lot of money in rent that you
assumed was being applied to the purchase price or lose your
option to buy on some minor technicality. Have a qualified real
estate attorney look over the agreement before you sign it, and
make sure you understand it completely.
Land contracts
With a land contract (also called a contract for deed), the seller
essentially functions as a bank, so you’re cutting out the middle-
man. In most cases, you handle the transaction through a rep-
utable escrow company. The deed is held in escrow, and you make
payments to the escrow company. When you’ve finally paid the
loan in full, the escrow company releases the deed to you.
Land contracts are often win-win situations, benefiting both the
seller and the investor:
The seller profits not only from the sale of the property but
also from the interest the buyer is paying. They earn invest-
ment income generated by an asset they know and love —
their own real estate.
The investor benefits by not having to pay a lot in closing
costs and being able to obtain a loan without having to jump
through hoops for a bank or mortgage company. With the
increased cash flow, an investor can obtain more properties
by using this strategy.
Make absolutely sure that payments are handled by a servicing
company —
not by the seller — and that the deed is placed into
escrow. The last thing you want is to make payments for seven
years, only to find out that the underlying mortgage wasn’t paid,
the property has a tax lien against it, and the seller is nowhere to
be found to sign off on the deed! Been there, done that, not going
back for seconds.
Teaming Up with a
Cash-Heavy Partner
Successful partnerships begin with individuals whose needs and
offerings complement one another — in other words, when one
partner has what the other needs, and vice versa. People who have
plenty of cash often don’t have plenty of time, talent, and motivation
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to purchase, renovate, and manage real estate, and they really don’t
have to — they can hire someone else to do it for them. This is
where you come in as an investor. You have (or should have) the
know-how. All you need is the money.
In the following sections, we introduce you to various ways to
structure a partnership that typically work well in real estate. In
Chapter 13, we go a little deeper to show you how to partner with
the right individual(s).
Opting for a limited partnership
A limited partnership is called “limited” for a very good reason —
the liability protection (none) and tax benefits (insignificant) of a
partnership are very limited. Legal actions against one partner can
lead to actions against all partners, and each partner can be held
personally liable for actions of the partnership as a group. In other
words, if you’re going to partner up with someone, you really need
to form the partnership inside the protective bubble of a corpora-
tion, as discussed in the following section.
Limited partnerships do offer a few benefits. They’re
Easy to set up
Simple to manage for the few involved parties
You can set up a limited partnership with two or more people
(including yourself) on a per-property basis or to invest in multiple
properties. Just make sure you have all the terms of the partnership
in writing. The agreement should address the following three areas:
Partner responsibilities: Spell out what each partner is
responsible for — supplying capital, finding and buying real
estate, making repairs and renovations, marketing and selling
the property, and so on.
Profit sharing: Specify how profits from the real estate ven-
tures are going to be split.
Dissolution: Stipulate how you’re going to divide any cash
and other assets if you decide to dissolve the partnership
later. Yeah, we know — when forming a partnership, the last
thing you want to think about is the possibility that it will end,
but it’s better to come to an agreement now when you’re
friends than later when you’re at each others’ throats (hope-
fully, that doesn’t happen).
Chapter 4: Scoping Out Prospective Lenders
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Part I: Gearing Up for Financing Your Real Estate Investments
Have an attorney draw up the partnership agreement and explain
the terms to everyone involved. Each partner should have his own
legal representation to ensure that his interests are protected.
If you’re forming a corporation, a partnership agreement is still
very useful in clarifying each partner’s responsibilities. If you
decide not to use a written agreement, at least make sure that your
corporation papers clearly explain how distributions will be
applied — usually determined by shareholder percentage of own-
ership and disclosed on the K-1 (the tax schedule showing the total
annual payments, deductions, and credits to the shareholder).
Going the corporation route
Even if you happen to form a partnership with one or more other
individuals, managing your partnership as a
corporation offers
additional benefits in terms of taxes and liability protection. You
have three options here:
LLC: A limited liability corporation (LLC) limits your exposure
to risk. If someone takes legal action against the corporation,
your personal assets are protected. For most investors, we
recommend forming an LLC, as discussed in Chapter 2.
Sub-S corp: A Sub-S corp (short for Subchapter S corporation)
also limits your exposure to risks and allows for pass-through
taxation (unlike a C-corp). With
pass-through taxation, the cor-
poration’s profits pass through to your individual income tax
return, avoiding
double-taxation (in which both you and your
corporation are taxed). Only individuals, not other business
entities, can own a Sub-S corp, and the corporation can have a
maximum of 75 shareholders. With a Sub-S, you run the risk of
the IRS forcing it into C-corp status (described in the following
bullet) if the corporation shows as having too much
(income you don’t really do anything to earn, such as
rental income, that’s taxed at a lower rate than
earned income).
C-corp: A C-corp (short for Chapter C corporation) also limits
your personal liability, but we don’t recommend going the C-
corp route for most real estate investors. First, you need to
have at least 75 shareholders or establish a real estate invest-
ment trust (REIT), as discussed in Chapter 2. A C-corp also
exposes you to double-taxation, which can really take a bite
out of your profits.
A Sub-S corporation is simple to establish and file for, but make
sure to file for the Sub-S election with the IRS right away after form-
ing the corporation. For more about forming and managing a cor-
poration, check out
Incorporating Your Business For Dummies by
The Company Corporation (Wiley).
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Part II
Financing the
Purchase of
Residential Properties
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In this part . . .
hen most folks buy a home, they’re usually best off
to look for a 30-year fixed-rate mortgage that keeps
their payments low and steady and allows them to pay off
the loan in a reasonable amount of time. When you’re
financing real estate investments, however, cash flow
becomes much more important. You usually want to use as
little of your own money as possible, so you have cash on
hand to cover other investments and unexpected expenses.
This part gives you the tools to secure the financing you
need to start hunting for residential real estate investment
opportunities. In this part, we explore the many residential
loan programs currently available, show you how to com-
pare different loan packages to find the one that costs the
least overall, and lead you through the loan application
from filling out the forms to closing.
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Chapter 5
Finding the Residential Loan
Program That’s Right for You
In This Chapter
Understanding why choosing the right loan is so crucial
Focusing more on cash flow than on loan costs and interest
Checking out what your government can do for you
Dodging prepayment penalties
onsumers have hundreds of different residential loan programs
to choose from, including zero-down-payment programs, 40-
and 50-year terms, interest-only loans, and complicated adjustable-
rate mortgages that can double your payment overnight! In addition,
investors may have access to government financing through rehabil-
itation loans, renaissance loans, and even grants for redevelopment.
With so many types of loans and other financing to choose from,
how do you pick the type that’s best for you as an investor?
This chapter introduces you to the most common residential loan
types, explains how each program works, and guides you in choos-
ing the right type of loan for your investment needs.
The market is in constant flux, so new mortgage programs are con-
stantly being introduced while obsolete programs are being phased
out. In writing this chapter, we’ve tried our best to provide informa-
tion that’s detailed enough to be useful, but general enough to
accommodate market changes.
Understanding Why Finding the
Right Residential Loan Is Key
You’re not the only one who wants to earn a buck off real estate.
Lenders want to earn their keep, too, so they charge all sorts of
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interest, fees, and penalties. As an investor working through one of
these lenders, you have two primary goals:
Gain access to cash. You need cash to do deals. Check out the
following section, “Choosing a Loan Type to Maximize Your
Cash Flow” for more information.
Pay as little as possible for access to that cash. After all, the
more you pay in interest, fees, and penalties, the less money
you walk away with at the end of the day.
In order to meet these two goals, you want to locate the right resi-
dential loan. To help you know what’s available, throughout this
chapter we roll out a veritable smorgasbord of loan types so you
can home in on the type that sounds best for a particular deal.
Another key to locating the right loan is to examine
all the pros
and cons of each available loan before making a selection. We
cover this important step in Chapter 6.
When searching for the right residential loan, you also need to know
the difference between residential and commercial loans.
mortgage loans finance the purchase of properties that people live
in — single-family homes, multifamily dwellings, apartment buildings,
condos, and co-ops.
Commercial loans finance the purchase of prop-
erties that house businesses. With residential loans, lenders typically
examine the ability of the
borrower to make payments and eventually
pay back the loan. With commercial properties, lenders give more
weight to the
building’s ability to produce sufficient income. (See Part
III for more about financing the purchase of commercial properties.)
Choosing a Loan Type to Maximize
Your Cash Flow
When most folks buy a home to live in, the main ingredients they’re
looking at in a mortgage loan are interest rate,
term (number of years
to pay off the loan), and monthly payment. They want a monthly
mortgage payment they can afford without paying an exorbitant
amount of interest over the life of the loan.
As an investor, your needs are different. Your primary goal is to gain
access to cash, even if you have to pay more to gain that access.
The interest rate, terms, and payment matter only as they relate to
your all-important cash flow. As a result, the criteria you use for
comparing loans are likely to differ a great deal from the criteria
you use to select a mortgage for a primary residence.
Part II: Financing the Purchase of Residential Properties
Part II: Financing the Purchase of Residential Properties
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We toss the term cash flow around quite a bit and even use it as a
verb, as in “Wow, this property really cash flows!” So what is cash
flow, exactly?
Cash flow simply means that the property is bringing
in more cash than is going out each month. If your property is losing
money, it has a negative cash flow . . . and you have problems.
When you’re more focused on gaining access to financing than
worrying about the cost of financing, your options suddenly multi-
ply. You can begin to consider loans that you would otherwise dis-
miss outright as costing too much. In addition, you can begin to
explore a host of options that aren’t available to the average home-
owner, such as rehabilitation loans.
In the following sections, we show you how cash flow enables you
to leverage the power of using other people’s money to finance
your investments and introduce you to a few types of loans that
can maximize the cash you have available for investments.
The power of OPM (other
people’s money)
One of the secrets to maximizing your investment profits is to use
as little of your own money and as much of other people’s money
(OPM) as possible. By using OPM, you stretch your investment
dollar — you can buy more and better properties and increase
your profit potential as a result.
Whenever you finance the purchase of a property, rather than paying
cash with your own money, you’re using OPM. Throughout this book,
we reveal various sources of OPM, including bank loans, government-
secured loans, hard-money lenders, small-business loans, and so on.
We introduce the concept of OPM here, so you have a better under-
standing of why you want to borrow money (rather than using all
your own money) to purchase real estate. After you grasp the
concept of OPM and understand the leverage it gives you, you’re
better prepared to begin evaluating the sources of OPM.
The magic of using OPM is in the numbers, as the following
examples reveal:
You invest $100,000 cash to buy, renovate, and sell a house for
$120,000. You just made a 20 percent profit ($20,000 profit
divided by your investment of $100,000 equals 20 percent).
You invest $20,000, borrowing the other $80,000 to buy, reno-
vate, and sell a house for $120,000. You just made a 100 percent
profit ($20,000 profit divided by your investment of $20,000
equals 100 percent).
Chapter 5: Finding the Right Residential Loan Program
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In these examples, you earn five times more profit percentage-wise
by using other people’s money, even though you earn the same
profit in terms of dollar amount. You may argue that you still end
up with $20,000 in your pocket either way. But say you have $100,000
to invest, as in the first example. Instead of buying one property with
$100,000, you can divvy it up into $20,000 chunks to buy five $100,000
properties (borrowing $80,000 for each). You now control $1,000,000
worth of real estate and when you sell the properties, you earn
$20,000 each for a total profit of $100,000!
Borrowing money is always risky, but you have to take some risk.
Throughout this book, we show you ways to reduce the risk, but
unforeseen events can undermine the best-laid plans. As a real
estate investor, you need to decide for yourself whether the poten-
tial benefits outweigh the risks.
The following sections reveal some loan types that can free up
more of your own money and maximize the use of OPM.
Interest-only mortgages
An interest-only loan is just what it sounds like; if you take out an
interest-only loan for $100,000, in two years, after making 24 interest-
only payments, you still owe $100,000. Sound like a bum deal?
Part II: Financing the Purchase of Residential Properties
Did I overpay for that loan?
Several years ago, I (Chip) obtained a mortgage for a two-family duplex at 9.50 per-
cent interest, and paid 3 points to get it. The market rate for mortgages was about
6 percent at the time, and qualified home buyers were usually able to secure a mort-
gage without paying any points. Most people would have thought I was crazy.
Was I?
Crazy like a fox, maybe. I needed a loan to purchase an investment property, and
because the property had been severely neglected and in disrepair, the type of loan
I needed wasn’t readily available in the marketplace. Without cash, I couldn’t do the
deal, so I was willing to pay a premium to gain access to the cash I needed. It was just
a short-term solution until I could make some repairs to the point that the property
became eligible for more-conventional (and less-expensive) financing. But the cash
flow made it very attractive (and profitable) — even at the higher interest rate.
When financing real estate investments, you have to remember to stop thinking like
an average homeowner and start thinking like an investor. Put your investor cap on
when examining the terms and make sure the cash flow works for the property
you’re planning on buying.
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It may be, if you plan on living in your home for 15 years and the
value of the home doesn’t appreciate significantly. But if you’re
using the loan for a quick flip, it may be perfect. You pay off the loan
in full right after you sell the house. In the meantime, you have more
investment capital to put toward renovations or other properties.
The key to using interest-only loans wisely is in making sure the
property provides a positive cash flow — enough revenue to more
than cover all your costs, including the monthly interest you’re
paying, and the value of the property is stable or rising. When
considering interest-only loans, be aware of the following:
Most interest-only loans are adjustable rate mortgages (ARMs),
so carefully check the adjustment period, index, margin, and
cap. (For more about ARMs, check out the following section.)
Rarely is an interest-only loan interest-only for the life of the
loan. Read the fine print to determine when and how you
must pay the principle. Some loans require a lump-sum pay-
ment three to five years down the road. They suck you in with
low monthly payments early and then sock you with huge bills
later. This fake-out may be devastating to the average home-
owner, but if you know about it and plan for it, an interest-only
loan can be your ticket to a profitable investment property.
Nobody can judge a loan type as good or bad without considering
how the investor uses the loan to finance the investment. If a no-
interest loan frees up some cash so you can complete the repairs
and renovations on a property more quickly, the fact that your
entire payment was going only toward interest matters very little.
Grabbing a hold of ARMs
Adjustable rate mortgages (ARMs) have interest rates that fluctu-
ate. You may take out a loan for 5 percent and find yourself paying
8 percent the following year. Even so, ARMs can play a valuable
role in your investment strategy. They’re often easier to qualify for,
and if you can sell the property or refinance the loan before the
rate jumps, you may be able to avoid any huge increases in interest
and payments.
As was revealed during the great foreclosure crisis that began in
2008, ARMs are risky business for most homeowners. Tight credit
can undermine your plans to sell or refinance. In the meantime,
your monthly payment increases could make the property un-
affordable. Realize that when you take out an ARM, you’re taking a
gamble. To minimize your exposure to risk, figure out the worst-
case scenario and plan accordingly.
Chapter 5: Finding the Right Residential Loan Program
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When shopping for ARMs, examine the following factors to deter-
mine the worst-case scenario:
Initial interest rate: The interest rate when you sign for the
loan. This is usually a
teaser rate to make the initial payments
more attractive.
Adjustment period: The frequency at which the rate can go
up or down. This is typically one, three, or five years but can
also be months rather than years.
Index: ARMs are tied to an index that typically rises or falls
based on government lending rates. Ask which index the lender
uses, how often it changes, and how it has performed in the
past. Several indexes are considered standard, including the
Treasury index, the London InterBank Offered Rate (LIBOR),
the Cost of Funds Index (COFI), the Prime Rate, various T-Bills,
and the Fed Funds Rate.
The Treasury index is always a little safer and secure and is the
most common. Take some time to look up whatever index your
lender uses, and make sure you can find it in
The Wall Street
(the financial rates section) or a similar publication.
Margin: The percentage above the index that the lender
charges — think of it as a markup. For example, if the index
is at 3 percent and the margin is 2 percent, you pay 5 percent
interest. If the index rises two percentage points to 5 percent, you
pay 7 percent interest. The margin remains the same through-
out the life of the mortgage.
Cap: The highest interest rate the lender can charge, no matter
how high the index rises. So if the lender sets the cap at 9 per-
cent, you never pay more than 9 percent interest, no matter
how high the index goes. The lender likely will quote a yearly
cap and a lifetime cap as, for example, “2/6”, which means the
rate can go up 2 percent per year (or per adjustment), and
6 percent over the life of the loan.
Make sure you understand all the possible adjustments that can
take place and calculate the payments under a worst-case sce-
nario. Plug this number into your
pro forma calculations (your pro-
jections) to make sure that your property will still cash flow under
the worst of circumstances. We can’t stress enough the need to do
your homework, and possibly consult your highly qualified and
trusted mortgage broker before selecting an ARM.
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A hybrid loan is a combination of an ARM and a fixed-rate loan.
With a hybrid term, the interest rate remains fixed for a certain
number of years, after which time the rate is adjustable. For exam-
ple, with a 3/1 hybrid, the interest rate remains fixed for 3 years
and then becomes an adjustable-rate loan in which the rate can be
adjusted every year. A 2/28 hybrid has a fixed interest rate for the
first 2 years and then adjusts each year for the next 28 years.
These types of loans are better suited for situations in which you
plan on holding the property for at least a couple of years before
selling it and you’re fairly certain that interest rates won’t drop
over the next couple years. If you’re planning on selling the prop-
erty quickly, an adjustable rate mortgage with a low introductory
interest rate may be a better choice. (See the previous section for
more on adjustable rate mortgages.) On the other hand, if you plan
on holding the property for longer than a couple of years, a fixed-
rate mortgage may be more appealing.
The main advantage of a hybrid over a straight ARM is that it pro-
vides, at least for a time, a guaranteed fixed interest rate, which
can help you establish more reliable cash flow projections for the
duration of the fixed-interest term. You still need to be careful,
however; hybrid loans can turn into time bombs if your projections
are based on unrealistic assumptions. An unexpectedly steep jump
in the interest rate can quickly create a negative cash flow.
Hard-money loans: Private investors
When easy money is unavailable (money from financial institu-
tions), you can always turn to
hard-money lenders — private
investors who offer loans that typically charge several points
upfront, use higher-than-average interest rates, and require pay-
ment in full after only a few years.
Why would any investor in her right mind even consider a hard-
money loan? Because you gotta have cash to do a deal, and some-
times hard money is the only money you can get your hands on.
For more about financing your real estate investments with hard
money, turn to Chapter 11.
Chapter 5: Finding the Right Residential Loan Program
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Taking Advantage of Government-
Secured Loans
You may be able to hit up your rich Uncle Sam for a loan to finance
your real estate investments (refer to Chapter 4 for more on how
government loans work). Although the government rarely loans
money directly, especially to investors, it often secures loans so
lending institutions can make the money available without exposing
themselves to huge risks. (If a borrower defaults on a government-
secured loan, the government pays the difference and sells the
home to recoup at least part of its loss.)
Although many government loans are available only to finance
the purchase of
owner-occupied properties (properties that the
borrower/homeowner is going to live in), in some cases you can
also use these programs to finance the purchase, repairs, and
renovations of investment properties.
In the following sections, we describe a host of government pro-
grams that may be available to you depending on your investment
strategy and the property you’re planning to purchase. We
also show you how to go about tapping into these government-
sponsored resources.
Tapping the FHA for a loan
Although the Federal Housing Authority (FHA) works with mort-
gage lenders to make loans available primarily to first-time home
buyers, some FHA programs are open to investors. These loans can
directly benefit you by providing government-secured financing for
investment properties, especially if you’re investing in residential
real estate and multifamily housing. The FHA is the federal govern-
ment’s way of promoting the American Dream of homeownership.
As an investor, these programs can also benefit you indirectly —
you can often use FHA loans to assist prospective buyers in financ-
ing the purchase of an investment property you’re selling. One of
the biggest obstacles preventing first-time buyers from purchasing
a home is their inability to qualify for a conventional mortgage.
FHA loans make qualifying much easier for them.
If you’re working with a well-qualified mortgage broker (see
Chapter 4) who has experience working with investors, she can
direct you to FHA loan programs that you may be able to qualify
Part II: Financing the Purchase of Residential Properties
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for as an investor. The same is true if you’re working directly with a
lender who handles FHA loans.
To get more information about FHA loans and other programs
straight from the source, visit the FHA Web site at,
where you can find information about the Good Neighbor Next
Door program (described in Chapter 4), special loans for financing
the development of multifamily housing and medical centers,
streamlined FHA mortgages, 203(k) loans, and much more.
If you decide to sell a property you own, you can often attract
more buyers if you advertise that you accept FHA financing. Also
offer to put prospective buyers in touch with your mortgage broker,
who can help them determine whether they qualify for an FHA loan.
In addition to helping the buyers, your broker can screen out any
looky-loos (casual browsers) who may not be able to afford the
If you’re looking to invest in residential real estate, you may be
able to turn to one of the following FHA loans. Check carefully
(your lender or broker can assist you) because they have strict
FHA 203(b) loans
FHA 203 loans are designed for first-time homebuyers and people
who don’t have a lot of money for a down payment. Investors can
utilize these loans to help their potential buyers finance the pur-
chase of their residential real estate, or to acquire and occupy a
multifamily property. (You’d have to occupy at least one of the
units in a multifamily property.) During the writing of this book,
FHA 203b loans
Are available only for owner-occupied, one- to four-family
Allow borrowers to obtain a loan for up to 96.5 percent loan-
to-value (LTV)
, meaning they can purchase a home with a
down payment of as little as 3.5 percent of the property’s
market value
Are assumable for a new purchaser, meaning the owner can
get out from under the loan by arranging to have a buyer pick
up the payments
FHA offers another program that you may find useful as an investor:
streamline refinancing. This program enables you to lower your
interest rate on a previous FHA loan with low or no out-of-pocket
costs faster and with less documentation than most other refinance
loans. For example, if you purchased a home with a $100,000 FHA
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loan as a home buyer a couple of years ago, moved out, and now
use the home as an investment property, you may be able to refi-
nance at a lower interest rate through this program. Even better,
you can refinance all the way back up to the original loan amount
(about $100,000 in this example) without obtaining a new appraisal,
and roll all costs into the new loan — including any points you may
pay to lower the rate.
Title I loans
Title I loans are available only for owner-occupied properties to
enable homeowners to finance the cost of repairs and renovations
up to $25,000.
Title I loans are great for investors who want to flip the property
they’re living in but don’t have the cash on hand to bring the prop-
erty up to market conditions. In a situation like this, you can use
the Title I loan in either of the following ways:
Take out the Title I loan yourself to pay for repairs and
renovations before placing the property on the market.
Place the home on the market as is (at a lower asking price)
and let potential buyers know about the Title I loan they can
take out to cover the cost of repairs and renovations after
they take possession.
FHA 203(k) loans
FHA 203(k) loans are similar to Title I loans in that they’re avail-
able only for owner-occupied properties and they allow the owner
to finance the cost of repairs and renovations. The difference is
that 203(k) loans allow the cost of
major repairs to be combined
with the purchase price of the property.
This program is ideal for investors who want to purchase a property,
live in it while they’re making repairs and renovations, and then sell
it. Just make sure you don’t overimprove the property and improve
yourself right out of a profit. Also, your intent has to be to live in the
house for at least 12 months as a primary residence.
For example, if a home is worth $100,000 now but would be worth
$150,000 all fixed up, you can obtain an FHA 203(k) loan for the
full $150,000 upfront, take your time completing the repairs and
renovations, and then sell the property after you’ve lived in it for
at least 12 months total.
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Multifamily loans
For larger residential properties, FHA does offer a multifamily pro-
gram that allows investors to purchase and rehabilitate apartment
complex–type properties. You can often combine the FHA loan
with other government grants or subsidies for improvements, tax
credit, or rental payments such as the Section 8 program.
You can find out more about FHA programs for multifamily housing
through HUD’s Web site at
Viewing Veterans Affairs
(VA) loans
As one of the perks for serving in the military, the U.S. Department
of Veterans Affairs (VA) offers veterans zero-down financing to pur-
chase owner-occupied one- to four-family properties. If you’re a
veteran, these loans are often the best deal in town. As an investor,
you can often leverage the power of VA financing when you decide
to sell a property — these loans give you access to another pool of
potential buyers.
Although VA loans are generally available only to veterans, even
investors who aren’t veterans can often obtain VA financing to pur-
chase foreclosure properties that the VA owns.
Any mortgage broker or lender who handles VA loans can assist
you in determining whether you qualify for one of the programs. Your
broker may also be able to work with any prospective buyers (if you
decide to sell the property) to determine whether they qualify for
a VA loan, which may make the property more affordable to them.
For more about VA loans, visit the VA’s Web site at
and then click “Benefits, Home Loans.”
Considering REO loans
Real Estate Owned (REO) property is typically property repos-
sessed by the bank after foreclosure. The bank now has to sell the
property to recoup the remaining portion of the unpaid debt. With
government-secured (FHA and VA) loans, the government agency
that secured the loan gets stuck with the property.
Ideally, the government or bank that owns the REO wants someone
to show up with cash and buy the property, but sometimes eager
cash-heavy investors are few and far between. To add a little extra
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motivation, the owner of the REO property may offer to finance its
purchase, sometimes offering very attractive deals and perhaps
even the ever-elusive no-money down deal. These deals can be
ideal for an investor because you can pick up the property at a
great price
and secure attractive financing in one fell swoop.
To obtain an REO loan, first find one or more properties that you
want to purchase from a bank or government agency and then con-
tact that agency and ask whether it’s willing to finance the purchase.
Experienced investors who have a proven track record of getting
(and keeping) bad loans off the books have a better chance of
obtaining this sort of financing. After all, the government or bank
doesn’t want to have to foreclose on the same property again.
For more in-depth information about REOs, check out our book
Foreclosure Investing For Dummies (Wiley).
One of the best times to pursue REO’s is when the housing market
is in a slump and foreclosures are on the rise, as we discuss in
Chapter 17.
Tapping into state and
local grants and loans
State and local governments often identify certain target areas
(such as rundown downtown districts, renaissance zones, and
other areas in need of a pick-me-up) for redevelopment. They then
offer incentives — usually in the form of state or local grants or low-
interest loans — to get investors like you involved in pitching in.
State and local grant and loan programs rarely get you
all the
money you need to purchase and rehab a property. They’re
intended as add-on programs, typically used in conjunction with
other loans. Here we describe the most common types of state and
local programs you’re likely to find:
State housing development authorities: Meant to encourage
redevelopment in areas like Detroit or areas hit by disasters
such as hurricanes, state housing development authorities
often sell bonds to make money available to both homeown-
ers and investors. They also fund special first-time home
buyer programs and foreclosure rescue grant programs.
Renaissance zones: Great for investors, renaissance zones are
areas that federal, state, and/or local governments have
declared tax-free (or tax-lite) to encourage development. In
these zones, investors can secure loans with significantly
lower monthly payments, sometimes saving hundreds or
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thousands of dollars per month. It’s like getting an interest-
free loan, which dramatically increases your cash flow.
Economic development department: To encourage develop-
ment within certain areas, many larger cities have economic
development departments that provide tax breaks, invest-
ment funding, capital expansion funds, construction, or reha-
bilitation grants to projects within their district.
Grants and specific use loans: States, local governments, and
some nonprofit agencies often provide loans or grants for
improvement projects — such as health care facilities,
women’s shelters, and emergency housing — designed to add
value to specific areas.
If your property is located in an area flagged for development or
meets the state or local program’s criteria, contact the state hous-
ing development authority, the city housing agency, and any non-
profit housing agencies to find out about available funds and what
you need to do to qualify.
Start researching at the top — HUD’s Web site at Here
you can search for information by state, find out about economic
development programs and grants, type in the address of a property
to determine whether it’s located in an enterprise zone, and dis-
cover other community networks and programs that can assist you
in rebuilding communities while earning a profit for yourself.
To find state-level programs, head to your state’s housing authority
Web site. To find it, use your favorite Web search tool to search for
your state’s name followed by “housing authority.” Your county,
city, or town may also have its own housing authority, so use the
same strategy to search for it. The Public Housing Directors
Association (PHDA) also has a directory of members, which you
can access by visiting and clicking the “Housing
Authority Websites” link.
Chapter 5: Finding the Right Residential Loan Program
REO financing in action
The first foreclosure I (Chip) ever purchased was a vacant two-family dwelling,
which I bought for $500 down and simply had to pay the balance of the previous
loan. The seller, the Bank of Florida, financed the purchase over a five-year term. No
qualifying, no closing costs!
We can’t guarantee that a bank or government agency will be willing to finance the
purchase for you, but it’s certainly worth a try. You never know if you never ask.
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Many mortgage brokers who are approved by their State Housing
Development Authority can also provide valuable assistance.
Digging up USDA Rural
Development loans
To encourage development of rural areas the USDA offers its own
financing through Business and Industry (B&I) loans, discussed in
Chapter 9, and rural development (RD) loans. As an investor, you
don’t qualify for the RD loans designed for residential home
buyers, but these loans can benefit you indirectly if you buy and
sell property in rural areas. Prospective buyers who can’t obtain
financing elsewhere may qualify for an RD loan.
For more about USDA loan programs to encourage rural develop-
ment, visit
Avoiding the Prepayment
Penalty Trap
When a bank loans you money for 30 years, it’s counting on the
fact that you’re going to be paying interest to them for a long time.
They have invested a certain amount of time and energy in origi-
nating that loan and need time to be able to make a profit off their
investment (just like you do). The bank also doesn’t want you refi-
nancing with another bank a year or two down the road and cut-
ting them out of the deal.
To discourage you from refinancing, and to help keep their initial
costs low, the bank may try to slip a
prepayment penalty clause into
your mortgage. With this clause, if you refinance and try to pay off
the loan early, you have to pay a stiff penalty — sometimes thou-
sands of dollars.
When shopping for mortgages, be sure to ask whether the mortgage
loan has any prepayment penalties and then read the mortgage
carefully before signing it. Prepayment penalties typically apply for
up to the first three years of the loan but can extend to longer peri-
ods on larger investment properties. If you have to refinance later,
you don’t want a prepayment penalty getting in the way.
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Chapter 6
Bargain Hunting for
Low-Cost Loans
In This Chapter
Grasping interest rates concepts and calculations
Understanding the term term
Exploring closing costs and how they affect your wallet
Figuring the bottom line — the total cost of a loan
hether you’re borrowing money to buy a place to live in or
invest in, you’re not just buying real estate — you’re also
buying money to finance the purchase. You’re a consumer buying a
product — in this case, a loan program — and you need to compare
costs and benefits just as you do when you make any major
purchasing decision.
Your goal is to find a loan that costs you the least amount of money
over the life of the loan and requires monthly payments that you
can afford and that ensure positive cash flows (as discussed in
Chapter 5). The monthly payment part is fairly easy to figure out —
lenders have to tell you what your monthly payments are going to
be upfront. Determining how much it will cost you over the life of
the loan, however, is a little trickier.
In this chapter, we show you how to shop for loans to find the one
that costs the least and is best suited to your investment goals.
Understanding How This
Interest Thing Works
Banks and other lenders primarily earn their money by charging
interest on loans — a certain percentage of the principal owed on
the loan (
principal is the amount you owe on the loan). Well, that’s
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certainly easy enough to understand, especially if you’ve pur-
chased any big ticket item like a car or a house on credit.
In practice, however, interest can get pretty complicated. Lenders
may choose to collect interest upfront in points, calculate your
rate as simple interest, amortize the loan, or even play a game of
“moving target” by adjusting the interest rate over the life of the
loan. In the following sections, we sort out the complexities that
surround interest rates and explain the essential jargon you’re
likely to encounter in plain English.
Keeping simple with simple interest
Simple interest is simple because you can usually calculate the
amount of interest you need to pay in your head or with a very
basic calculator. The formula goes like this:
× Interest Rate = Annual Interest
You can then calculate your monthly interest by dividing by 12:
Annual Interest ÷ 12 Months Per Year = Monthly Interest
For example, say you borrow $100,000 at 8 percent interest:
× .08 = $8,000 interest per year
$8,000 ÷ 12 = $666.67 interest per month
Because the formulas calculate only the interest owed on the loan,
simple interest is perfect for interest-only loans. (Check out Chapter 5
for the ins and outs of interest-only loans.) Unless you’re dealing
with interest-only loans or smaller loans, such as home equity loans
or lines of credit, you’re unlikely to encounter simple interest. Most
loans use more complicated methods to calculate interest.
Grasping the concept of amortization
If you ever looked at an amortization table or tried to set up your
own spreadsheet to calculate amortization, you probably ended up
bleary-eyed from trying to figure out how anyone could possibly
have devised such a convoluted system for calculating house pay-
Amortization is a method for calculating the retirement of
debt that applies significantly higher portions of early payments
toward interest and significantly higher portions of later payments
to pay down the principal.
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The mathematicians who devised this system had a method to their
madness. They were attempting to create a system to provide for
constant loan payments over a fixed period. The system also had to
account for interest on the loan and the fact that each payment
reduces the principal owed on the loan, which ultimately results in
extinguishing the loan. In other words, they set some lofty goals.
Explaining how amortization works in theory is way too compli-
cated, so consider the following example: Say you owe $100,000 at
8 percent interest over a 30-year term. The following steps show
you how to calculate amortization and determine the amount of
interest due for each payment:
1. Determine the total monthly payment due.
This step is the most mathematically complicated. To figure
your payment, plug the numbers into the following formula:
Chapter 6: Bargain Hunting for Low-Cost Loans
iP i
A is the total monthly payment, i is the periodic interest
P is the principal, and n is the number of periods (pay-
ments over the life of the loan). The
periodic interest rate is
the annual interest rate divided by 12 months. The
of periods
is the number of years times 12 months.
Using this formula, your monthly payment on a $100,000 at
8 percent interest over a 30-year term comes to $733.76.
Yep, this is why everyone uses a loan calculator or a spread-
sheet instead of doing the math by hand, but we think you
should know where the numbers are coming from.
2. Calculate how much of the payment is interest by using
the same formula you use to calculate simple interest.
Your payment consists of interest plus a reduction in the
loan balance (principal). Here’s that formula:
× Interest Rate ÷ 12 = Monthly Interest
So, in this example, your interest on your first payment is
$666.67: $100,000
× .08 ÷ 12 = $666.67
3. Subtract your interest payment from your total payment
to figure out how much principal you pay off.
Your first monthly payment of $733.76 breaks down like this:
Total payment of $733.76 – $666.67 in interest = $67.09 of
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4. For the next payment, subtract the amount you paid
toward the principal from the total.
$100,000 – $67.09 = $99,932.91, so this figure is the number
you use when you figure your next payment.
5. Repeat Steps 1 through 4 for each subsequent payment.
Based on the calculation in Step 4, the interest portion of
your second payment is $666.22:
× .08 ÷ 12 = $666.22
With this payment, $67.54 goes toward principal, and with
each subsequent payment you end up paying more toward
the principal and less toward interest. This pattern continues
until the entire balance is paid off in 360 months (30 years).
If you have Microsoft Excel, select File
New and check the tem-
plates on your computer to determine whether your version of
Excel comes with an amortization schedule. If it does, you can click
it and click OK to create a new loan amortization schedule. Just
plug in the loan amount, term, and interest rate, and Excel does the
rest. If your version of Excel has no amortization template, you can
download a free one and other real estate finance–related templates
from Microsoft’s Office Web site. Go to,
click the Templates tab, click in the search box, type “amortiza-
tion,” and press Enter. You have several results to choose from.
Telling the difference between
the interest rate and APR
Most people know that the interest rate and the annual percentage
rate (APR) differ, but few people understand how they differ. The
interest rate reflects the simple cost of the money you’re borrowing.
APR is designed to reflect the total cost of the loan, including
any loan origination fees and prepaid costs. As a result, the APR is
higher than the simple interest rate.
Why use an APR? Congress designed the system back in 1974 as a
way to enable consumers to more easily compare the actual costs
associated with the loans. It sort of functions as a consumer pro-
tection tool, helping borrowers compare apples to apples in the
world of personal finance.
For example, say you came into my (Chip’s) office and I quoted you
a 30-year mortgage loan for $200,000 at 6.50 percent. You talk to
another loan officer who offers you the same deal at 6.25 percent.
On the surface, you think this is a no-brainer — paying one-quarter
percentage point less is going to save you money over the life of
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the loan. However, what if I’m charging zero points (points are pre-
paid interest; see “Paying interest upfront with points” later in this
chapter), and this other guy is charging three points (in this case,
$6,000)? Now it’s not such a no-brainer.
Which deal is better? All other factors (loan origination fees and
any other costs) being equal, mine is, and you can quickly see by
looking at the APR:
APR on 30-year fixed mortgage $200,000 at 6.50 percent with
zero points: 6.5 percent.
APR on a 30-year fixed mortgage $200,000 at 6.25 percent with
three points: 6.626 percent.
What makes my deal even more attractive is that if you were to pay
off the loan in less than 30 years (highly common, especially for
investors), you’d save the $6,000 you would have paid in points to
the other guy.
You can find several APR calculators on the Web by searching for, you
guessed it, “APR calculator.” One of our favorites is at
Exploring how adjustable
rate mortgages work
Adjustable rate mortgages (ARMs) are mortgage loans with interest
rates that can fluctuate (rise or fall). During the mortgage meltdown,
many unsuspecting homeowners got burned by ARMs they probably
never should have been placed into. Although this has given ARMs a
bad name, they’re actually very useful, particularly for investors, as
long as you use them strategically.
Not all ARMs are created equal, though. Several factors influence
the best-case and worst-case scenarios of how low or high the inter-
est rate can go, including the initial interest rate, the
(how often adjustments can be made), the index (the base
interest rate you pay), the
margin (the lender’s markup on the
index), and the
cap (the highest rate the lender can charge). We
explain these factors in greater detail in Chapter 5.
For example, say you take out an ARM to purchase a property that
you’re almost certain you can renovate and sell within a year.
Taking out an ARM with a rate that stands to rise at the end of one
or two years could be a reasonable gamble. And if you can get the
ARM for a lower interest rate than the going rate for fixed-rate
mortgages, the ARM can actually save you quite a bit of money.
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Of course, taking out an ARM always carries some risk. Being
“almost certain” you can sell the property within the year for more
than you have in it is no guarantee. Whenever you invest in any-
thing, you need to assess the risk/benefit ratio for yourself and
determine just how much risk you’re willing and able to take on.
Paying interest upfront with points
Plenty of lenders, particularly hard-money lenders, charge interest
upfront in the form of points. (Hard-money lenders are private
lenders; check out Chapter 11 for more on using these types of
lenders.) So what are points? One
point is equivalent to 1 percent
of the total loan amount, so for every $100,000 you borrow, a point
costs you $1,000. A point on a $200,000 loan costs $2,000.
So why do lenders use points? Lenders typically charge points for
one of the following reasons:
To lower the interest rate: When you choose to pay interest
upfront, the lender may reduce your interest rate, so you pay
less interest with each payment.
To get the money upfront: If you pay back the loan quickly, the
lender earns enough for taking the time to process your loan.
When you pay interest upfront to lower the interest rate, you may
not see a net savings for several years. You can calculate the break-
even point to determine whether you’ll actually save money by
paying upfront for a lower interest rate. The
break-even point is the
payment period at which you’ve saved enough money with the
lower interest rate to pay the cost of the points:
1. Start with the cost of the points.
Two points on a $100,000 loan cost $2,000.
2. Determine your monthly savings per payment as a result
of the lower interest rate.
To do this, simply subtract the monthly payment at the
lower interest rate from the monthly payment at the higher
rate. In this example, assume you’re saving $50 per month.
3. Divide the cost of the points by the monthly savings.
In this example, you divide $2,000 by $50, which equals 40.
Your break-even point is at 40 months. If you plan on keeping
the property for more than 40 months, you’ll save money
paying points. If not, it costs you more to pay points.
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Of course, it gets more complicated when you take taxes into con-
sideration, but this gives you a general idea of how points work.
Another reason you may want to pay points is so you can qualify
for a larger loan, because the points you pay lower your monthly
payment. Does paying points make sense? That depends. Crunch
the numbers yourself. For example, a $100,000 loan at 7 percent
interest over 30 years with zero points requires a monthly payment
of $665.30. The same loan at 6 percent with 2 points would cost an
extra $2,000 upfront but lower the payment to $599.55 — a monthly
savings of $65.75. At that rate, breaking even on the upfront cost
would take just under 31 months, but the investor would likely be
able to claim a tax deduction for the costs, depending on his tax sit-
uation. In this case, paying points is an okay deal.
Although some people say they never pay points, and others rec-
ommend doing everything you can to lower the interest rate, points
really have no
never or always. Sometimes you have to pay points
to gain access to the cash you need to do the deal, as we explain
in Chapter 5.
Considering the Mortgage Term
When investing in residential real estate and looking for a low-cost
loan, you need to take a close look at the mortgage term. A lender
often quotes the mortgage
term in years; for example, you may
have a 15- or 30-year mortgage. However, for payment purposes
you calculate the term on a monthly basis — 12 payment periods
per year over 30 years equals a total of 360 months or payment
periods. A 15-year mortgage has 180 payment periods.
Understanding the term is important because it ultimately affects
how much money you end up paying for the loan over the life of
the loan. For your average homeowner, a shorter term can pay div-
idends. Pay off a $200,000 loan in 15 years rather than 30, and you
save a whopping $155,437.
However, as an investor, you have a different perspective. Investors
like longer terms because they increase a property’s cash flow, giving
them more cash to do more deals. For example, payments on that 15-
year mortgage would cost in excess of $467 more per month. That
would significantly reduce monthly profit on any rental property and
give you much less money to work with on other deals.
As an investor, the longer the term, the better.
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Accounting for Closing Costs
Every major newspaper has a financial section where banks, bro-
kers, and other lending companies post their interest rates and
often the points (prepaid interest) they’re currently charging.
Although this financial information gives you a general comparison
of the going rates, it really doesn’t help investors or home buyers
comparison shop. These figures usually don’t mention other costs
associated with the loan, such as the loan origination fee, discount
points, processing fees, paperwork fees, and junk fees. (For more
about junk fees, see “Forking over other fees” later in this chapter.)
When comparison shopping for loans, you need to take these fees
into account. In the following sections, we explain the most
common closing costs you’re likely to see.
Getting socked with origination fees
The loan origination fee is what the lender or broker charges you
as a service fee for processing your loan. They’re usually calcu-
lated the same way as points are — as a percentage of the total
loan amount and charged as a cost to the borrower. For example, a
1 percent loan origination fee is 1 percent of the total loan amount,
or $1,000 for every $100,000 you borrow.
Although most lenders charge a maximum of 1 percent, the loan
origination fee is always negotiable. Sometimes, all you need to do is
ask the loan officer to reduce the fee. In other cases, you may need
to mention that Julie Swanson on the other side of town is charging
less. For more tips on negotiating, check out
Negotiating For
by Michael C. Donaldson and David Frohnmayer (Wiley).
Although you may not consider the loan origination fee part of the
loan, you should always include it in your calculations of the total
cost of the loan. This strategy enables you to more effectively
comparison-shop for the best deal.
Forking over other fees
Points and loan origination fees are only a couple of the legitimate
expenses you can expect to see on a Good Faith Estimate (GFE) or
HUD-1 (see the next section). Other legitimate fees include the
Appraisal fee
Closing or escrow fee
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Credit report fee
Flood certification fee
Lender fee (negotiable)
Recording fees
Reserves for paying taxes or insurance
State tax/stamps
Title insurance
Underwriting fee (negotiable)
Some lenders include a
processing fee, which is fairly standard but
usually negotiable. (This fee covers the time and effort invested in
handling the paperwork, along with any copy or printing costs.)
You can usually figure out whether any of these fees is exorbitant
by comparing a few Good Faith Estimates from other lenders.
Although we like to think of brokers and bankers as being trust-
worthy professionals, some are less forthright than others and are
infamous for padding their closing fees with what the industry
junk fees. One time I (Chip) was surprised to find an “e-mail
fee” of $35 tacked onto my closing statement. Upon inquiry, I was
told that this amount was what the title company charged to e-mail
the documents over to the lender. How ridiculous! I was able to get
it removed in about 45 seconds. Here are some other more
common junk fees to watch out for:
Chapter 6: Bargain Hunting for Low-Cost Loans
Administration fee
Affiliate consulting
Amortization fee
Application fee
Bank inspection fee
preparation fee
Document review fee
Express mail fee
Funding fee
Lender’s attorney fee
Lender’s inspection fee
Messenger fee
Notary fee
Photograph fee
Settlement fee
Signup fee
Translation fee
Junk fees can also be inflated costs of standard fees. If the going
rate for overnight fees is $75, for example, and one lender tries to
charge you $150, ask why.
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Examining the Good Faith Estimate
By law, your broker or lender is required to provide you with a
detailed breakdown of all the costs associated with the loan (resi-
dential, not commercial loans). Lenders typically provide a Good
Faith Estimate prior to processing your residential loan application
and then a HUD-1 statement at closing detailing the actual final
costs. (The
Good Faith Estimate is a list of projected costs to the
borrower, while the
HUD-1 breaks down all the actual costs that the
seller and buyer are responsible for paying at closing.)
If the lender doesn’t provide a Good Faith Estimate upfront, ask for
one and make sure it’s legible and understandable. Some lenders
like to use fine print and shading to conceal what they’re really
charging and then give you a copy of the copy of the copy of the
faxed original to make it completely unreadable.
Costs, particularly the loan origination fee and points, shouldn’t
change dramatically from what’s on the Good Faith Estimate to
what you see on the HUD-1 at closing. If you notice any change,
bring it up at the closing table and don’t sign the papers until any
issues are resolved to your satisfaction and in writing. See Chapter 7
for more about covering your back at closing.
Part II: Financing the Purchase of Residential Properties
Are Good Faith Estimates standardized?
When you start shopping for loans, you’re likely to see all sorts of Good Faith
Estimates, each of which categorizes its expenses differently and assigns each
expense a different name. All these differences can make it difficult, if not impossi-
ble, to compare estimated closing costs.
Fortunately, the federal government is stepping up to deal with this issue. On
November 12, 2008, HUD announced several new mortgage rules to help consumers
shop for lower-cost home loans. One of the new rules requires that starting on
January 1, 2010, lenders use a standardized GFE. The new three-page GFE benefits
borrowers in two ways:
When all lenders start using the form, the standardized model enables borrow-
ers to compare costs line by line without having to decipher different names for
the same charges.
The new GFE contains line-item references to the same amounts on the HUD-1,
making it easier to spot any changes between the estimated charges on the
GFE and the actual charges on the HUD-1 at closing.
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Calculating a Loan’s Total Cost
Your bank or mortgage broker is likely to lay out a virtual buffet of
loan types for you to choose from: fixed-interest, adjustable rate
mortgage (ARM), interest-only, and others. We describe the pros
and cons of these loan types in Chapter 5. If you’re still unclear
about the benefits and drawbacks of a particular loan program, ask
the bank representative or your mortgage broker lots of questions.
Don’t get too caught up in the various loan types. For people buying
houses they plan to reside in for 30 years, loan type is a big factor.
For real estate investors, particularly those who plan to sell the
property or refinance the loan within a couple of years, the cost of
the loan over the life of the loan becomes more important. To com-
pare loans and find the best bargains, take the following steps:
1. Start with the amount the bank charges you upfront in
loan origination fees, points, and other fees.
When performing these calculations, include all points, but
realize that not all points are created equal. Lenders can
discount points, defined by some states as the legal
cost associated with reducing the interest rate for a bor-
rower. Lenders can also charge points as a fee (for exam-
origination points) that don’t reduce the borrower’s
interest rate.
2. Multiply the monthly payment times the number of
months you plan to pay on the loan.
3. Add the two amounts to determine your total payment.
4. Total the amount of each payment that goes toward
paying the principal of the loan.
Your lender can tell you how much of each payment goes
toward principal.
5. Subtract the total you determined in Step 4 from the total
in Step 3.
The result is the total amount you can expect to pay for the
loan over the life of the loan.
To save yourself some time performing these calculations, check
out the mortgage payment calculator on our Mortgage Myths Web
site at (
Say that you’re considering two loans, each for $100,000. You plan
on using the loan to buy and renovate a home over two years and
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then sell it and pay off the remaining principal on the loan. You
have a choice between a 30-year, fixed-rate mortgage at 6 percent
or a 30-year, interest-only loan at 5 percent. Look at the 6-percent,
fixed-rate mortgage first:
Loan origination fee and discount points: $1,000.00
Monthly payment of $599.55
× 24 months: $14,389.20
Total payments (fees plus monthly payments): $15,389.20
Total paid toward principal: $2,531.75
Total cost of loan (payments minus $12,857.45
principal paid):
Here are the numbers for the 30-year, interest-only loan at 5 percent:
Loan origination fee and discount points: $1,000.00
Monthly payment of $416.67
× 24 months: $10,000.08
Total payments: $11,000.08
Total paid toward principal: $0.00
Total cost of loan: $11,000.08
As you can see, even though you’re not paying down the principal
on the interest-only loan, over the life of the loan, you pay about
$1,700 less. In addition, the interest-only loan has much lower
monthly payments, freeing up cash to use for renovations and
other investments.
As a general rule for
quick flips (buying and selling a property in
less than a year’s time), opt for loans with low (or no) closing
costs, low (or no) discount points, and low interest rates. Avoid
any loans that have early-payment penalties.
Don’t forget to account for cash flow and tax benefits that may be
available. A lender may charge you $3,000 in points, but if you can
write off a portion of that mortgage interest on your taxes, it may
end up costing you less than $3,000. Also, always remember that
having access to financing is often more important than the cost of
that financing. Crunch the numbers to get the lowest-cost loan
available, but don’t beat yourself up if you have to pay more than
average — as long as you can walk away with a decent profit and a
positive cash flow.
One more, very important word of caution: Always factor in a
margin of error to account for the unexpected.
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Chapter 7
Navigating the Loan
Application and Processing
In This Chapter
Filling out a loan application
Tracking your paperwork through the approval process
Gathering ’round the closing table
Getting a loan to finance investment-based residential property
ssuming you own the home you live in, you’ve already filled
out at least one loan application and have been through one
closing. Whether you did everything correctly is another question,
but at least you have a general sense of how the process works.
As the buyer of a residential property and the borrower, you have
the most papers to sign — papers dealing not only with the prop-
erty you’re buying but also with the loan you’re taking out to
finance the purchase. Faced with mountains of documents to sign,
borrowers (even seasoned investors) often give the paperwork a
cursory check at most before signing on the dotted line. This care-
lessness can be a big mistake, however, leaving you open to sign-
ing up for something you never really agreed to.
In this chapter, we review the closing process in greater detail and
show you how to avoid many of the traps that ensnare even the
savviest real estate investors.
Completing Your Loan Application
Filling out a loan application isn’t exactly rocket science, but it
does call for some careful attention to detail. The application
requires specific and accurate financial details that enable your
loan originator (broker or loan officer) and your lender to properly
evaluate your current financial situation and your ability to make
payments and repay the loan. In addition, the lender provides you
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with specific information, by way of lender disclosures, about the
loan program and its costs.
In the following sections, we show you how to complete the loan
application, review the various disclosures, supply the additional
documentation your lender needs to process your application, and
sign a release of information, so your lender can confirm the infor-
mation you supply.
Walking through the parts
of the loan application
In order to be able to accurately complete the loan application,
you first need a good grasp on what the form comprises.
Everything in your loan application package revolves around the
Uniform Residential Loan Application — a five-page, fill-in-the-blank
form that requests all sorts of information about the property
you’re buying and your financial situation. Although your loan orig-
inator actually prepares the form for you, go through the process
yourself first so that you can gather the necessary information
ahead of time and see for yourself what the lender looks at to
determine whether you qualify for the loan.
The Uniform Residential Loan Application is commonly referred to
as the
FNMA (Fannie Mae) 1003 application or simply the Ten-Oh-
To download the form, visit
and click the link for the desired
version — the blank form or an interactive version you can type
your own entries into.
The form consists of ten sections:
I. Type of Mortgage and Terms of Loan: Basic information
about the loan, including the type (FHA, VA, Conventional,
Rural), total loan amount, interest rate,
term (number of
months), and amortization type. Your loan originator can
supply this information. Refer to Chapter 6 for details about
II. Property Information and Purpose of Loan: Description of
the property (including its location) and how you plan to use
it: as a primary residence, secondary residence, or investment
property. This section also covers whether the loan is for new
construction or refinance, how the title will be held, and the
source of the down payment and any closing costs.
III. Borrower Information: General information about you,
including your name, address, previous address, Social
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Security Number, marital status, number of children (if any),
and so on.
IV. Employment Information: Information about your and any
coborrower’s employment, including names and addresses of
the most recent three employers, dates of employment, and
monthly gross income. The lender wants to know the past two
to five years’ history.
V. Monthly Income and Combined Housing Expense
Information about monthly income including
base pay, bonuses, overtime, commissions, dividends and
interest, and rental income, along with housing expenses that
include any monthly rent, existing home loan payment (princi-
pal and interest), property taxes, mortgage insurance, home-
owners’ association fees, and so forth.
VI. Assets and Liabilities: The value of what you own (assets)
and how much you owe (liabilities). Assets include balances
in checking and savings accounts, stocks and bonds, the cur-
rent cash value of any life insurance policies, vested interest
in retirement funds, the value of any real estate you own, and
so on. Liabilities include any current loans you have, credit
card debt, alimony or child support payments, and job-related
expenses (including child care).
VII. Details of Transaction: Overview of the financial aspects
of this particular loan, itemizing the costs and sources of
financing. Costs include the purchase price, cost of alterations
and improvements, cost of land (if purchased separately),
refinance costs (debts to be paid off through the refinance),
closing costs, cost of mortgage insurance, and so on. Sources
of financing include the loan itself, closing costs paid for by
the seller (if any), cash from the borrower, and other sources.
You may need to consult your loan officer and others involved
in the transaction to gather all the information you need.
VIII. Declarations: Yes/no questions for you and your co-
borrower (if applicable) to determine whether past or present
situations may affect your ability to make payments and pay
the loan. Questions include whether you have any outstand-
ing judgments, whether you’ve declared bankruptcy or
suffered foreclosure, whether you’re obligated to pay child
support or alimony, and so on.
IX. Acknowledgement and Agreement: Here is where you
sign, acknowledging that the information in this loan applica-
tion is correct to the best of your knowledge and that you and
any coborrower are knowingly entering into this agreement
with the lender.
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X. Information for Government Monitoring Purposes:
Information that enables the government to track statistics on
mortgages and homeownership relating to race and ethnicity.
The information also enables the government to enforce any
antidiscrimination rules and regulations.
As an investor, you know that the more prepared you are, the more
quickly you get things done. The same is true with financing. By
having all the necessary information at your fingertips, you can
work with your lender (or loan officer) to complete your loan
application in a matter of minutes.
Although you may be tempted to fudge the facts on the Uniform
Residential Loan Application, don’t do it (or allow anyone else to
do it for you). Lying on a loan application is all too common, but
it’s also a felony. The rules are ultimately meant to protect you. If
your net assets are too small to qualify for the loan, for example,
then having your application rejected protects you from a poten-
tial financial nightmare. See lenders as your partners, not your ene-
mies. For more about dodging the real estate and mortgage fraud
bullet, turn to Chapter 2 for more info.
Reviewing the lender’s disclosures
In the Declarations section of the 1003 (see the previous section),
you and any coborrower must answer several disclosure questions
as a way of “coming clean” about your current financial situation.
Your lender also must commit to a certain level of transparency
regarding its practices and the loan you’re applying for. For example,
by law, a lender can’t play some cruel game of bait-and-switch on
you by dangling an attractive set of numbers during the application
process and then sticking you with a real stinker of a loan at closing.
Be sure to examine the lender’s disclosures carefully before signing
on the dotted line, as explained in the following sections. At the
closing, make sure the lender adheres to whatever those disclo-
sures stipulate. (For more about closing, skip ahead to the section
entitled “Navigating the Closing.”)
Program disclosures
Regardless of the loan program, be sure you fully understand the
program disclosures (the terms of the loan agreement) before you
sign anything. If you don’t understand how a particular type of
loan works, keep asking your mortgage expert questions until you
fully understand what you’re getting yourself into.
For example, some loan programs are straightforward. If you’re
taking out a 30-year mortgage at 7.5 percent interest, the lender
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has very little to disclose about the program itself. On the other
hand, more-complicated loan programs may require that the
lender provide an additional disclosure. With adjustable rate mort-
gage (ARM) programs, for example, the lender must notify you of
the index it uses, the margin associated with the loan, and how and
when the lender calculates changes to your interest rate. For more
about ARMs, including the roles that the index and margin play,
check out Chapter 5.
The disclosure may also contain a hypothetical example showing a
brief history of changes and how your rate may have changed
under that program if you had a loan with those terms. (For more
about ARMs, including the roles that the index and margin play,
head to Chapter 5.)
Good Faith Estimate
For all loan types, your lender is required by law to provide you
with a ballpark figure of all the costs associated with this loan in
the form of a
Good Faith Estimate (or GFE, in industry lingo). The
GFE provides a complete breakdown of all the costs associated
with the loan you’re applying for, including the loan origination fee,
appraisal fee, and underwriting fee. Only by comparing GFEs can
you get a good feel of what’s normal and what’s excessive in the
market. Although the lender must supply the GFE to you within
three days of receiving your application, most lenders offer the
GFE prior to the application.
Ask for the GFE in advance, so you don’t waste time applying for a
loan you have no intention of following through on. In fact, obtain a
GFE from at least three lenders so you can compare the programs
and their costs. Watch for
junk fees (unfair charges), as discussed
in Chapter 6. If any of the costs on the GFE look out of the ordinary,
ask about it.
Truth In Lending statement
The Truth-In-Lending disclosure (TIL) gives you a reflection of the
true cost of the loan, including the interest rate and fees. In short,
the TIL makes it easier for you to comparison-shop for loans.
One of the key items on the TIL is the
annual percentage rate
as discussed in Chapter 6. The APR shows you how much
interest you’re really paying on a loan if you include the upfront
costs in your calculations. For example, say you’re comparing the
following two loans:
$100,000 30-year fixed rate loan at 7 percent interest with
finance costs of $5,000
$100,000 30-year fixed rate loan at 8 percent interest with
finance costs of $4,000
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With numbers like these tossed about, comparison-shopping
becomes almost impossible. At first glance, the second loan may
seem like the better deal, costing $1,000 less upfront, but if you
look at the APR, you get a different picture:
The first loan has an APR of 7.52 percent and costs you
$251,485 over the life of the loan.
The second loan has an APR of 8.44 percent and costs you
$274,723 over the life of the loan, or $23,238 more than loan one.
The TIL also discloses any late-payment fees associated with the
loan, whether the loan has any early-payment penalties, and the
proposed payment schedule. If the loan is an ARM loan, it may illus-
trate what will happen to the payments as the rate starts to change.
The TIL is a great tool for taking a quick look at which loan among
several is the best deal, but it doesn’t provide enough information
to evaluate specific costs associated with a particular loan. Use it
in tandem with the GFE.
Real Estate Settlement Procedures Act (RESPA)
RESPA standardizes closings for residential real estate transactions
in order to clamp down on any funny business that may occur at
closing. According to the act, all closings must use a HUD-1 form to
disclose the costs of the loan and show where all the disbursed
funds are going.
Take a copy of your GFE to the closing to compare the fees dis-
closed on it with the fees actually being charged according to the
HUD-1. This practice is one of the best ways to catch any discrep-
ancies between what your loan originator told you and what it’s
actually charging you.
RESPA also controls certain actions of settlement providers such
as the closing agent, and service providers (including the title
insurance provider, credit company, and appraiser) to prevent
them from working together against the best interests of the con-
sumer (as in the case of price-gouging or kickbacks). Section 8 of
RESPA has two important components:
The first part prevents a lender from overcharging for settle-
ment services and keeping the difference. For example, if the
appraisal costs $400, the lender can’t charge you $600 and
pocket the extra $200.
The second part prevents lenders and service providers from
accepting or offering kickbacks for referral business — for
example, a lender can’t refer a specific appraiser and then
accept part of the appraiser’s fee as a reward.
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RESPAs provisions cover all aspects of services, companies, and
individuals, including title companies, attorneys, and real estate
HOEPA — Section 32
The Home Ownership and Equity Protection Act (HOEPA) is an
amendment to the
Truth In Lending Act (TILA) to protect homeown-
ers from paying excessive fees and interest. HOEPA is part of TILA
but stands alone in its application; Congress passed these two sep-
arate acts:
TILA covers all residential loan transactions (one- to four-
family units), whether they’re owner-occupied or investment
properties. It doesn’t apply to commercial loan transactions.
HOEPA, also referred to as “Section 32” or “high-rate, high-fee
loan disclosures,” applies to residential owner-occupied
dwellings for purchases and refinances. It includes one- to
four-family owner-occupied properties (which could be a
multiunit investment property in which one unit is occupied
by the investor). It also applies to anyone you sell the property
to. HOEPA doesn’t apply to pure investment properties or
commercial loan transactions, but you should always be aware
of it so you know what’s considered fair in terms of fees.
Under this regulation, lenders must warn borrowers if APRs exceed
10 percent of the comparable Treasury yield (which means
Treasury securities having a similar period of maturity, such as 30
years), or if the deal’s total points and fees exceed 8 percent of the
loan amount.
Most lenders don’t offer loans that fall under Section 32, including
to investors, so this regulation usually isn’t an issue. Just be aware
of these restrictions and limitations to make sure you’re working
with a lender who plays by the rules.
Supplying the requested
In order to review your loan application, your lender needs some
supporting documentation that verifies the information you sup-
plied. Gather the following documents:
Federal tax returns (with all attachments and schedules) for
the past two years
W-2s from the past two years
30-days’ worth of paycheck stubs
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List of real estate owned, complete with income and expenses
Any and all supporting documentation for assets and liabili-
ties listed on the Uniform Residential Loan Application (bank
statements, credit card statements, divorce decree, retirement
earnings statements, and so on)
Make a copy of each document in the list and place them neatly in
a folder labeled with your name and contact information. You can
then hand the entire package (the copies, not the originals) over to
your loan originator at your next meeting.
Signing a release of information
Providing your loan originator with a loan application package is
like submitting a resume for a job — it paints a picture of you on
paper, but it may not be an accurate portrait. To make sure the
information is factual, your loan originator needs to verify it in the
real world, usually by checking independent sources such as
employers, banks, and even providers of government benefits.
Most lenders require that you sign a
borrow authorization form,
which gives them permission to check your credit and independ-
ently verify any information you provide for this transaction.
Before you sign the release, read it carefully to make sure it covers
only this transaction. You don’t want to give anyone carte blanche
to poke around in your financial affairs whenever they want.
Additionally you may be asked to sign an IRS Form 4506 or 8821 for
verifying tax return information. These forms are standard, but make
sure you don’t sign blank ones — make the lender fill out the years
covered, or else it can go get your tax returns from six years ago.
Following the Loan
Processing Trail
After you supply your prospective lender with a completed loan
application and supporting documentation, all you can really do is
wait. During this time, you may be wondering what the lender is
doing, whether you need to be doing something, and how this
whole loan application process is going to unfold.
To prevent anxiety from overtaking you, the following sections lead
you through the course of a processing and keep you posted on
the possible outcomes.
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Getting up to speed on
the underwriting process
You may be under the illusion that right now an accountant is comb-
ing through your loan application and supporting documents for
proof that you’re worthy of a loan. The fact is that nowadays com-
puters actually do the initial screening. The information you provide
is entered into an
automated underwriting (AU) system, which per-
forms a preliminary evaluation and spits out the conditions and doc-
umentation requirements of the loan.
The AU system can’t deny your loan application. It can only place
your application in one of the following three categories:
Accept/Eligible: This category is the best; it means that
you’re approved for the loan, subject to certain conditions.
Those conditions show up on the
findings report and must be
part of the file for final approval. The loan officer or processor
obtains the necessary documents as requested and then sub-
mits the complete file to the underwriter to review for accu-
racy. The file is already approved at this point, so they’re only
looking to make sure you’ve submitted and signed each of the
required supporting documents and disclosures.
Accept/Ineligible: This category indicates that the loan is
approved but is ineligible for purchase in the
(Fannie Mae or Freddie Mac). For example, it may be a
jumbo loan, where the loan amount is outside the upper limit
of what Fannie and Freddie can purchase. Many investors still
use AU systems and approve/buy these loans anyway.
Refer: This category is also typically known as a dead deal. An
underwriter still has to review the file before it can be denied,
but loan files that fall in this category don’t come with the same
lender guarantees against loan losses, so the lender has no
incentive to take on the additional risk of approval. Unless the
loan can be repackaged and resubmitted to obtain a different
AU result, the deal is likely DOA.
Don’t let a dead deal get you down. Even if you can’t obtain a loan
from traditional sources, you can usually find other means of
financing your investments, as we explain in Part IV.
Obtaining an appraisal or AVM
One of the first things any lender wants to know is whether the
property you’re buying is worth the money you’re borrowing to
pay for it. Actually, it wants to make sure the property is worth
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more than the money you’re borrowing so that if anything prevents
you from paying back the loan, the lender has something of suffi-
cient value to sell and recoup its investment.
To assess the value of a property, the lender orders an appraisal,
Automated Valuation Model (AVM) report, or both and usually
charges you for it as a part of the cost of processing your loan.
This appraisal isn’t something you order — the lender wants to be
in charge of picking an objective appraiser.
Expect to pay the full price for an appraisal, even if the property
was recently appraised. Old appraisals can’t be recertified no
matter how recent they may be.
Appraisers generally take one of the following three approaches
when performing an appraisal:
Sales comparison: This most-common form of appraisal for
residential properties compares the property to similar,
recently sold properties in the same vicinity. The appraiser
can then adjust her estimate by accounting for differences
between the comparable homes and depreciation.
Income approach: This method is used for income-producing
properties, such as rental units. The appraiser compares simi-
lar properties in the same market to determine how much
income the appraised property is likely to generate.
Cost approach: This method is commonly used to establish
the value of a unique property or properties in areas where
few comparisons are available. The appraiser determines the
value of the land and
improvements (the building on the land)
and then subtracts for depreciation.
An appraisal that uses the income approach is likely to cost a little
more than a market-comparison appraisal, but not a whole lot
more. If the lender tries to charge you hundreds of dollars more
than you’d be paying for a standard appraisal (for a typical owner-
occupied residential dwelling), find out why.
Having the property inspected
Whenever you make an offer on a property, make the offer contin-
gent upon the property passing inspection, and then have the
home professionally inspected. (This action is more for your pro-
tection than the lender’s. Lenders usually don’t require an inspec-
tion, even on government-secured loans.) This contingency
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ensures that you don’t get stuck holding the bag on any of the
following big-ticket items:
Damaged foundation or other structural anomalies
Electrical wiring problems
Broken sewer lines, poor plumbing, or aging septic systems,
especially if the house has been vacant for some time
Leaking, nonfunctioning, or nonexistent gas lines
Poorly functioning furnace or central air conditioning units
Leaking or ramshackle roof
Termite damage
Health hazards such as lead-based paint, toxic mold, radon
gas, asbestos, and hazardous insulation
In the following sections, we show you how to track down a profes-
sional home inspector and ensure that you obtain a thorough
Hiring a qualified home inspector
If you decide to hire an inspector, you can crack open the phone
book and find listings for dozens of home inspectors in just about
any area of the country. Finding a qualified home inspector, how-
ever, is a challenge. So where do you start? Ask the following indi-
viduals for referrals:
Your real estate agent or other real estate professionals you
By networking with homeowners, investors, and col-
leagues, real estate professionals know the best service
providers in the area. Ask them for references to the best
inspectors. If one inspector’s name pops up on several lists,
you’ve probably found a winner.
The National Association of Certified Home Inspectors
(NACHI) Web site:
NACHI is a nonprofit agency that works
toward educating and ensuring the quality of home inspec-
tors. Its Web site at features an online referral
service that you can search to find certified home inspectors
in your area. Make sure the inspector you hire is NACHI-
certified — meaning the member has performed at least 250
inspections and passed two written proficiency exams.
Friends, family members, and colleagues: Gather referrals
from people you know and trust. Using an inspector who’s done
a satisfactory job for someone you know usually delivers better
results than choosing someone blindly.
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Your town’s building inspection department: Most towns have
building inspectors who examine buildings as they’re being
constructed or renovated to ensure that they adhere to the
local building codes. In some cases, you can hire the town’s
building inspectors to perform your inspection for you. They
tend to be more thorough, and they’re well versed on local
building codes. The inspectors often show up as a team that
typically includes a plumber, an electrician, a heating and air
conditioning specialist, a builder, and someone who specializes
in zoning. You get a thorough inspection and a complete write-
up for about the same price as you’d pay a private inspector.
Better Business Bureau (BBB): Although the BBB has a policy
of not recommending certain businesses, it does offer a tool
that enables you to search for BBB-certified businesses in
your area. Start your search at, where you
can enter your ZIP code to skip to the Web site for the nearest
BBB. You can then click the Find an Accredited BBB Business
to start your search.
When you have a few leads, contact your candidates and ask them
the following questions:
Are you certified, licensed, and insured? Certification and
licensing ensure that the inspector has the basic qualifica-
tions for the job. Insurance covers any serious defects he may
How long have you been a home inspector? Length of serv-
ice is often, but not always, a good indication of experience
and expertise. Someone who’s been in the business for 10
years probably has more experience than a person who’s just
getting started.
How many homes have you inspected? “One or two” isn’t the
answer you’re looking for. A busy home inspector is usually
busy because she’s good.
What did you do before becoming a home inspector?
Someone who’s a retired carpenter or home builder is proba-
bly a better candidate than, say, a burned-out English teacher.
Do you have references I can call? If the inspector has a
good track record, people don’t hesitate to provide positive
Do you recommend remedies or simply identify problems?
Look for an inspector who’s had experience in construction.
Someone who not only points out problems but also recom-
mends repairs and renovations is a good choice.
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How much do you charge? Most inspectors charge a flat fee
of a few hundred bucks — more or less depending on the size
of the home and the complexity of the inspection. As you
interview candidates, you can get a pretty good idea of the
going rate for a typical home inspection in your area.
After you gather answers and information from all your candidates,
make a decision. Sit down with your list and identify the inspector
who has the best experience and credentials of the bunch but
doesn’t charge an exorbitant fee.
Attending the inspection
Although attendance isn’t mandatory, you should show up for the
inspection prepared to take notes. Your notes should include the
Possible structural defects: The inspector will point out
cracked foundation walls, weak roof trusses, or shifting foot-
ings or joists. These problems can be extremely costly and
can kill a deal quickly.
List of functional defects: Examples include a furnace that no
longer functions or is leaking carbon monoxide, or a toilet that
doesn’t flush. These are critical repairs that have the most
impact on your ability to resell the property or lease it out.
List of potential environmental problems: An example
includes insulation that contains asbestos or ground on the
lot that’s been contaminated by a local industrial plant. These
can be costly to fix.
List of cosmetic defects: These include divots or dents in the
walls, peeling paint, and other defects that just look bad.
They’re less-serious stuff.
Anything else the inspector points out: These may range
from minor issues, such as a leaky faucet, to more major
issues, such as a stained ceiling that may be a sign of some-
thing more serious, but the inspector can’t gain access to the
area above the ceiling to check it out.
If you’re note-taking challenged, consider carrying a digital recorder
with you during the inspection. Just don’t forget to turn it on.
Requesting repairs
With your list of property defects in hand, highlight the ones you
expect the seller to repair and then have your agent present the
list to the seller or seller’s agent. The seller agrees to make all
repairs, refuses to make all repairs, or agrees to make only some of
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the repairs. It’s up to you to decide whether you want to move for-
ward with the deal.
For any repairs you’re willing to take on and other renovations to
improve the property, obtain estimates from independent contrac-
tors to determine approximate costs. Get three bids from licensed
professionals, including the time estimated to complete the work,
as well as the lead time needed to schedule the work.
Don’t get your inspector involved in providing estimates or doing
any repairs or renovations to a property. This creates a conflict of
interest, which is prohibited on government-insured loans.
For additional details on how to determine whether a property is
likely to be a profitable investment, check out Ralph and Joe’s
Flipping Houses For Dummies (Wiley) and Real Estate Investing For
2nd edition, by Eric Tyson and Robert S. Griswold (Wiley).
When you’re estimating the costs of repairs and renovations, keep
in mind that as soon as you take possession of the property (at
closing), you’re responsible for the holding costs on the property
when repairs are being done. (
Holding costs are the expenses you
incur when the property is just sitting there — they include the
monthly mortgage payments, insurance, property taxes, and utili-
ties.) By planning your repairs and renovations prior to closing
and lining up contractors to begin work as soon as possible after
closing, you can slash your holding costs.
Testing the water
You may not need to test the water as a condition for obtaining
loan approval, but if the system is served by a well, get the water
tested for your own protection. Your county health department or
an independent lab can perform the required tests, but you need
to collect the water:
1. Get a clean bottle from the lab or your county health
2. Go to the water faucet farthest from the well source.
3. Let the water run for at least five minutes.
4. Fill the bottle and label it as instructed.
5. Have the sample tested right away.
The lab usually returns the results within a couple of days and
lets you know the chemical makeup, including minerals
and any detectable E. coli in the water.
If the property is serviced by a community well, request
maintenance records.
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I, Chip, usually steer clear of properties serviced by community
wells. I also avoid properties on which the well is located in a
crawl space or basement. These pose financing risks, and any
eventual buyer will be limited in financing options.
Having the septic system inspected
If the property relies on a septic system, have a qualified septic
contractor inspect the field, saturation levels, and estimated
remaining life of the system. These systems can be very costly to
Also, research the pumping records with the owner and the county
(usually the county health department), and check with the county
on the age of the system and its maintenance history. The county
should have records of when the system was installed and a pump
card that shows when it was last pumped out.
If the system is more than 10 years old, we highly recommend that
you have a qualified professional perform a
perk test. This test
makes sure the septic field is draining properly and isn’t saturated
(a situation that indicates a short remaining life).
Obtaining a survey
Your lender will request a survey on the property, regardless of the
size of the parcel, even if it’s a
platted lot (a lot with boundaries
shown on a map). To insure the transaction, the title company
requires a survey or certification of an existing survey. Surveys
come in two types:
Boundary survey: This type illustrates where the property
lines are and is usually sufficient for a platted lot, because the
parcel’s boundaries have already been recorded.
Stake survey: With this type the surveyor actually goes out
and places or finds metal boundary stakes to certify the
actual boundary lines of the parcel. The stake survey is
slightly more expensive, but it’s the better choice for water-
front property, irregular parcels, and properties with a
and-bounds description
(commonly found in a deed).
Walk the property with the owner to be sure you know where the
boundary lines are, and ask questions about any easements or
encroachments that may exist. If the owner/seller has a copy of the
previous survey, obtain a copy so the surveyor can recertify it
instead of performing a new survey — you may save a few bucks.
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Navigating the Closing
Although the closing (or settlement) is the final step in the real
estate transaction, it can feel a little anticlimactic. You and the
other participants in the transaction have completed your work.
Now you’re simply meeting to sign off on the deal you’ve all agreed
to and shuffle the money around to the appropriate recipients.
Even though the process may seem like an afterthought on a long
journey, you really need to stay on your toes to avoid any last-
minute mishaps. In the following sections, we show you how to
ensure that the closing proceeds smoothly without any glitches
that can negatively affect your bottom line.
Keeping your attorney in the loop
A good real estate attorney can keep you from spending thousands
of dollars later to clean up a mess that you can easily avoid now.
Get your attorney involved sooner rather than later in the
following ways:
Make sure your attorney reviews the purchase agreement
before you make an offer.
Consider working with your attor-
ney to develop a boilerplate purchase agreement you can use
for all of your transactions, so your attorney doesn’t have to
review it every time.
Have your attorney present during any sensitive or unusual
If you’re not completely comfortable with some-
thing the seller or seller’s representative is saying, consult
your attorney before giving a final response. Backing away
from something you agreed to, even verbally, can make your
attorney’s job more difficult later.
Ask your attorney to review the closing papers prior to the
closing date.
Have the company handling the closing supply
you with copies at least three days in advance.
Get your attorney involved early. She probably won’t be able to
help you after the closing; even if she can, it’ll cost you a whole lot
more than if you had corrected the errors
before you signed the
Dealing with the preliminaries
Closings usually proceed smoothly as long as you have all the
parts in place prior to closing. In the following sections, we show
you how to prepare for your next closing.
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Hiring a title company
Closing is pretty easy, at least from your perspective. In most
cases, your agent or the seller’s agent selects a title company, and
the title company does the rest — gathering all the essential paper-
work, making sure everyone shows up to the closing on time, and
then routing the closing documents around the table to make sure
everything gets signed.
The title company also provides title insurance — your only pro-
tection from future claims against the property, including old co-
lien holders (other parties that claim rights to the
backside deals (private negotiated or unrecorded agree-
ments) with neighbors, and a whole host of other potential prob-
lems. Approximately a month after closing, the title company
sends you a complete policy. Store it in a safe place — in addition
to providing you with a record that you have title insurance, the
policy can earn you credit toward the next policy when you sell or
refinance the property.
Never ever purchase a property without title insurance. Without
title insurance, you can lose your entire investment overnight. One
way this can and has happened is when a scam artist sells a prop-
erty he doesn’t own. The con artist waits until the owners are on
an extended vacation and uses a phony deed to transfer the prop-
erty into his own name. He then lists and sells the property and
takes off with the cash. If you happen to have bought the place,
and you don’t have title insurance, when the rightful owners return
from vacation, you lose the property, but you still owe on that loan
you took out to buy it.
Under RESPA (Section 9), you as purchaser have the exclusive
right to select the title insurance provider. We encourage you to go
with one of the national agencies or one of their agents — someone
with a solid reputation in the marketplace. In addition, larger com-
panies have several offices, making dealings more convenient
when closing time arrives.
Request an
insured closing letter, indicating that the title company
is insured for handling the transaction. This document provides
you with the assurance that if the closing company mishandles
anything, you don’t get stuck with a bill for its mistake.
The title company disburses funds on investment properties imme-
diately upon the close of the transaction. Request a copy of each
disbursement check for your records.
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Reviewing the documents in advance
You have the right to review any closing documents at least 24
hours prior to closing (preferably three days before closing, so
your attorney has time to review them, too). As soon as you’ve
chosen a title company, contact the company and let your repre-
sentative know that you want a copy of the closing packet as soon
as possible so you have time to review the paperwork.
Check the mortgage, deed, note, HUD-1 closing statement, and all
other documents for spelling or calculation errors, and make sure
the figures on the HUD-1 match up with those on the Good Faith
Estimate. If anything looks odd, call the title company and have
your issues addressed
before closing.
Insuring the property
Several days prior to closing, meet with your insurance provider
and review coverage options for the property you’re about to pur-
chase. Let your agent know the closing date so he can prepare a
policy for you in advance of the closing.
Make sure you obtain a
policy and not just an insurance binder (a
promise to insure) — some lenders don’t accept binders.
Signing the documents
Be prepared to sign a lot of documents during closing (and no, you
can’t use a rubber stamp!) You have to provide a picture ID (such
as a driver’s license). The closing agent witnesses and notarizes
your signature many times during the closing.
Request a complete copy set of all
signed documents (not just
blank ones) and keep them in a safe place just in case you need
them in the future. In the court of real estate law, only signed docu-
ments count, so be sure you get a copy of the signed documents
showing what you and the seller agreed to.
Knowing your right of rescission . . .
or lack thereof
The right of rescission is a federal law that gives you three days to
change your mind on financial deals. It protects consumers from
high-pressure sales tactics. Commonly called the “cooling-off law,”
it also allows you to back out of refinance deals on owner-occupied
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As an investor, don’t count on the right of rescission to protect
you. It doesn’t apply to the purchase agreement — after you sign
the agreement, your offer is binding. In addition, the right applies
only to owner-occupied residences, not investment properties.
Dealing with surprises
The key to dealing effectively with surprises at closing is to not
have any surprises. In the following sections, you discover some
prevention maneuvers that ensure a smooth closing.
Rate changes
Your interest-rate lock agreement is only as good as the loan offi-
cer who gave it to you. You have nothing in writing to say that the
person actually locked in the rate with an investor or that the
terms of your application didn’t change just enough to allow (or
require) the loan officer to place it with a different lender-investor
or a completely different loan program.
At least two days prior to closing, confirm your interest rate and
program with the loan officer. If you had been floating the interest
rate, he will require you to lock it in at least three days prior to
close so that he can prepare the documents. If it’s not what you
agreed upon, hold out until you’re satisfied with the rate and
terms. You won’t be able to change them after the closing.
Term changes
Confirm the terms of your loan (including index, margin, and start
rate for an ARM loan) prior to the closing. Your loan terms should
remain fixed unless something major occurred between the time of
your application and the closing, but ask anyway. You don’t want
any surprises.
Chapter 7: Navigating the Loan Application and Processing
Dodging disaster
How would you like to purchase a property and have it burn down the next day with-
out having insurance to cover it? I, Chip, almost had that happen to me. However,
the property actually burned down a day
closing. Fortunately, the previous
owners hadn’t cancelled their policy prior to close, or it would have been a real
mess. We had to wait for the property to be rebuilt before we could close on the
transaction — a delay of five months!
The moral of this story: Obtain an insurance policy before closing. Don’t leave the
property uninsured for even one minute — too many things can happen.
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If rates improved since you obtained loan approval, or the prop-
erty numbers no longer meet your expectations, you may consider
changing loan programs in order to maximize your cash flow. Just
remember that any changes you make now cancel out the rate and
terms you locked in. Even a slight change can jeopardize your lock,
giving the lender an opportunity to charge extra fees and interest,
so be careful.
Other unexpected events
Once in awhile, other events throw a wrench into the proceedings —
and they’re completely beyond your control. The seller may have a
change of heart, the title company may require additional docu-
mentation to insure the title transfer, you may have to get lien
waivers, and so on. Take it all in stride — and prepare for a delay.
We’ve had lots of closings slightly postponed while someone fixed
a glitch, so keep your schedule (and that of your contractors) a
little loose.
You’re dealing with professionals, and they’re programmed to get
any problems resolved as quickly as possible. If anything sounds
too strange or flat-out made up, simply ask your attorney to call
the title company or closing agent. That usually gets the process
back on track pretty quickly!
Financing Other Types of
Residential Properties
Most of the information in this chapter relates to financing the pur-
chase of primary residences. Variations arise, however, when
you’re financing the purchase of other types of properties, includ-
ing vacation and investment properties and vacant land. The fol-
lowing sections introduce the variables you can expect and show
you how to deal with them.
Digging up money for
vacation properties
If you’re in the market for a vacation property or second home,
expect the financing requirements to be a lot tighter, the interest rate
and costs to be higher, and the down-payment requirements to be
greater, with many lenders requiring at least 20 to 25 percent down.
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Due to the higher costs, you may want to consider purchasing a
fractional ownership, in which you share the property with several
parties. This can be a great way to invest in higher-end properties
located in expensive markets. You can usually find a loan officer
who specializes in these types of loans.
Banks and other more traditional lenders rarely handle loans for
fractional ownerships, so you have to go through a specialized
group of finance companies. Shop around carefully for one that
specializes in this type of financing, and make sure that you have a
solid agreement with the other parties involved. Make absolutely
sure that your real estate attorney reviews all the paperwork and
that you fully understand what you’re getting yourself into.
A management company often makes all the arrangements, but
make sure you understand your obligations as an owner and how
the parties plan to share the income and expenses of the rentals or
the burden of expenses when the rentals are vacant? For more
information, check out
Second Homes For Dummies by Bridget
McCrea and Stephen Spignesi (Wiley).
Financing investment properties
Lenders approach the financing of residential investment properties
(dwellings you rent out) more carefully than they do financing the
purchase of primary residences. As a result, you need to adjust
your expectations and approach to financing these properties in a
different way as well. We cover the main differences that come
with these properties in the following sections.
Options for financing residential investment properties are some-
what limited. Expect interest rates, costs, and the down-payment
requirements to all be higher. Often, lenders require a minimum of
25 percent down.
Shop around for a lender that offers several options for investment
properties, and be careful of extra fees. You should have to pay
only an additional 1.5 to 2 points above a normal owner-occupied
transaction. Check out Chapter 4 to find out how to shop around
for lenders.
Before approving a loan for any income-producing property, your
lender wants to know whether it promises a positive cash flow. Of
course, you want to know this, too, so before you even submit an
offer, perform a complete cash flow analysis of the property, as
explained in Chapter 3. Do the math before you do the deal, and if
the return on your investment is less than you’d earn by investing
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