Private mortgage option - 20% down. Good idea?

Question

Hello all,

New to the forums.  I have the opportunity to purchase a home via private financing.  Terms: Downpayment - 20%  Interest - appx 5%  Time - 20 yr

The person providing the financing is allowing me to purchase any home he signs off on with the above terms.  My limit is 250k.  He will not contribute any more than 200k.  Financier is a friend of mine, we've spoken with an attorney, and worked out most of the details.

Reason I'm looking at private financing as opposed to conventional:

The main reason is income history.  I own a small business, and have been operating it now for 2 years (2014 being our 3rd year in business).  My income last year was $4k.  This year I'm on pace to do much better (at least 50k), but as we all know, the self-employed are difficult to lend to.  Also my credit history isn't super (was foolish at 19), but it's at 655 and rising. So I think it's reasonable to say that I probably won't qualify for a loan for at least a year, more likely 2.  I haven't applied for a loan yet, as my mortgage broker friends tell me with my income that I probably shouldn't bother.

Additionally, I feel, and so do a number of people more familiar with the real estate market in Fort Collins, that we are headed for a large appreciation in values and rents, especially around campus.

Thanks to an inheritance, a 40-50k down payment isn't a huge deal.  I'm looking at properties in the 180-250k range, close to campus (Colorado State) that would make a good rental in 1-2 years.  I've found one that my broker and I are going to look at, and hopefully pursue: http://www.coloproperty.com/listing/details/1035402

I guess I'm just wondering: is this crazy?  Am I an idiot?  Should I keep renting and in 2 years get something with a much lower down?  Is anyone else more familiar with the rental market in Northern Colorado?

Account Closed · Answer

Hi @Sam Sorden , those sound like good terms and I agree with you about the Fort Collins market so I don't know if waiting 2 years is a good idea. I am tagging @Mark  Ferguson as he is very familiar with the NoCo rental market.

Kim Smith · Answer

Hello,

When you make a down payment, you risk losing that money if you can't make the house payments and end up in foreclosure. When you make a down payment of less than 20 percent, you must buy mortgage insurance.

Blake Stevens · Answer

Sam,

You're general idea is pretty decent.  Buy a house, hopefully fix it up, create some value, move and rent it out.  That is why I got in to real estate in the first place the people I know that actually are secure did this sort of strategy throughout their life compared to stock market investing or some other method.

So the idea really isn't bad.  It's not that great of an investment when you compare it to what really good investors get on this site.  But their are many investors that would just buy that house you mentioned near campus and think of it as a great rental when in reality it's a bit mediocre.  But if appreciation does happen it works out well.  If it doesn't you kind of tread water.

Here is an analysis of appreciation by my Realtor James Orr http://jamesorr.com/appreciation/  I don't believe in investing just for appreciation but if it does happen in generally dwarfs cash flow on total returns for a rental property so their is something to a Bruce Norris market timing style to try and predict the market and look for appreciation but that is really hard to do in real estate the same as stocks.

I wouldn't lock yourself in to being around campus, see if you could get more house for your money somewhere else in town.  If you are near CSU you won't have vacancies but you will get a lot of wear and tear and you will have more tenant headaches.

You're plan isn't bad but it's not great, you could improve by keeping renting yourself and getting a better cash flow rental in Greeley.  Or do like Dev Horn recommended and take that money and fix and flip some properties.  Or broaden out your search to find a house in town with a better rent to value ratio.

The other major thing is that you want to make sure you plan to be in the area a long time.  If you buy with those numbers planning for a rental you won't have margin to higher a property manager if you move out of town.  I also wouldn't count on a refi, the private loan has pretty good terms and you never know what financing will be available in the future.

To recap it's not going to be the best investment ever made but if you execute your plan you'll probably end up way ahead of most Americans in the long run.

Dev Horn · Answer

Sounds to me like you have your own source of OPM which offers considerably better terms than using hard money.  I like it.

With a great funding partner like that and decent capital on hand, I would just think about doing more deals and acquiring more units, faster.  The real benefit of leverage (using OPM) is it multiplies what you can do with your own capital.  Everything makes sense to me here except the sitting in the units 1-2 years yourself....

Sam S. · Answer

@Joel Owens

I pay $1000 for a 2 bed 2 bath.  About 7 blocks from my potential property.

I agree with what you said about holding onto the inheritance for business use.  The total inheritance was in the neighborhood of 100k, so I'll have plenty left over for business use, should I so decide.  Fact of the matter is, the point we're at now, I don't see much good to come from dumping 50k into the business.  We could really ramp up marketing, hire a few more guys, get 2-3 more crews going, but I don't think we have the infrastructure to support that right now.  We're still expanding, but I've found that we can do that with the profit we're already making, and I'm comfortable with the salary I take right now.

Albert Bui · Answer

Another angle I always look at personally to consider that down payment money as business capital. All business capital whether person or business use has opportunity cost so while you're saying you can live with 1500 gross rent against your 1220 PITIA (full payment monthly future projection at 6% 30 year AM) There is opportunity cost that is compounding on top of each other each year. The question I would have for you would be, have you defined your min return for your capital when its deployed? If so, what is that total rate of return from all sources? Then comes the contingency planning, how liquid is your money, and your exit strategy.

Bringing clarity to what your goals are will make it super easy for you to make a decision.

Joel Owens · Answer

Sam how much are you paying in rent RIGHT NOW?? You have to be living somewhere so what is that costing??

If you are paying the same or close to it in rent now then really all you would be doing is trading a rental property for one you live in that has growth potential.

As a pure investment no it's not the best but if you are paying rent now anyways close to that at least you would be growing equity with pay down and have some tax benefits.

Having 50k for an inheritance is huge and you might want to hold onto that for growing your business. Once you put down the down payment it will be very hard to get liquid again even if the property goes up in value as lenders just strongly dislike the self employed. Not all cases but lenders have a chip on their shoulder because you don't fit into a little box with a pretty bow for them.

I often think it's comical when a lender see more strength in a Wal-Mart worker pulling down 10 bucks an hour than a business owner making huge bank with cash enough to pay the mortgage for years. The Wal-mart worker lives paycheck to paycheck and could lose their job and be foreclosed on next month.

Mark Ferguson · Answer

@Sam Sorden your cash flow is not the rent minus the piti.  You have to factor in vacancies, maintenance and management expenses.  Even if your vacancies and maintenance are 10% each of rent that leaves you negative with cash flow again. And that assumes you refinance your current loan at those terms in 2 years which may or may not be possible.

I not trying to be a downer, but that is why most investors will not buy rentals that do not meet the 1% rule and many want to see much better numbers than that. If you are buying the home just as your personal residence that is a different story, but it may not work well as a rental in the future.

Sam S. · Answer

Thanks everyone for advice.  It's probably my fault this thread got a little convoluted.  I initially was talking about my financing.  Then I began talking about a property I'm considering putting an offer on.  The property is a 4 bed, 2 bath listed at 230k.  Since it does have 4 qualifying bedrooms, I could potentially rent it out for more than $1500.

@Mark Furguson:

The property is going to be my primary residence.  I will keep it as a rental upon moving, ideally re-financing to improve cash-flow.  I like looking at it from a rental perspective.  I agree that purchasing rentals in Fort Collins is probably not a great idea.  Prices are definitely high.  However, if I refinance in 2 years at 6% for a 30 year term, payment would be $1070 + $150(taxes + insurance) = 1220.  Even if I could only rent it for $1,500, that's cash-flow that I can live with.

@Aaron Montague :

No I cannot build in my price range, much less in my price range and in my target area.

Mark Ferguson · Answer

@Sam Sorden

That is why I don't buy rentals in Fort Collins.  I don't know how anyone makes money with the price to rent ratios.  If you are not making money with the house as a rental why are you buying a rental there?  Buying a rental just to buy a rental is not good business.  It has to make you money and hoping rents or prices will go up is a recipe for disaster.