Finding a down payment!

[Kelly Madden]

My husband and I are trying to get into REI here in Florida. Turns out that the guidelines are SUPER stringent. (Through a lender) Minimum down payment is 20%, no gifts allowed for help, closing costs are also out of pocket. We're just starting out and haven't won the lottery, so we're having trouble finding it without totally draining our savings (which wouldn't be smart). Advice is MORE than welcome!! Thank you!!

[Jon Holdman]

Well, the reality is that buying rentals is real estate investing. And to invest you need cash. 20% down for investment properties is actually on the lower end. 25%-30% isn't unusual. That's still better than buying stocks, bonds or bank CDs. Those all require 100% "down".

Also keep in mind that if you end up needing to sell, about 10% of the sales price will go to commissions, selling costs and concessions to the buyers. So, if you put 20% down, prices fall by 10% and you're forced to sell, you'll walk away with nothing. The banks want that protection.

You're wise to consider the need for cash reservers. Rentals have a way of waking up once in a while and saying "I'd like $3000 today, please." And they pretty frequently seem to call and say "I'd like $300 today."

And don't fall for the "cash flow = rent - PITI". Banks use the formula "cash flow = (75% * rent) - PITI". A slightly more conservative rule of thumb is "cash flow = (50% * rent) - P&I"

But I think you're asking how you can get into the rental property business with less cash out of pocket. One key method is some sort of owner financing. Get the seller to carry a note for the purchase rather than getting a bank loan. This works best if the seller owns the house free and clear. But it can work if they have an existing loan. If they give you a new loan, that's a "wrap" because the new loan warps the existing one. Or, you could do a "land contract", which is like a car loan. The seller keeps title to the property, you make payments. When you complete the contract, you get the title. Or you could buy "subject to" where you buy the house and take over the payments on the existing loan. Or you could buy with a lease option. That's where you lease the property (giving you possession) and also buy an option on the property (which gives you the right to purchase at a future date.) If you in turn lease out the property, that's called a "sandwich lease option". There's significant risk with many of these. In particular, if you buy without paying off the existing loan you violate the "due on sale" clause in the loan. That gives the lender the right, but not obligation, to call the loan.

Ways to come up with more cash include:
- Borrowing from a 401k account (puts your retirement at risk)
- Borrowing against existing property (puts your existing property at risk if the rental goes bad)
- Selling stuff
- Cutting spending and increasing saving

Yet another approach is to buy a property using hard money. That's short term investor financing. Rates are very high - 15% and four points is typical around here. You buy a dumpy property with hard money. Fix it up, lease it out. Then, after (typically, sometimes less) a year, you refinance with a bank into a more conventional loan. If you get the right deal (difficult), you can do this with less cash out of pocket than 20-25%. But finding a really good deal is very hard, and this is an expensive approach that will result in a higher debt load on the property than a regular purchase.