Falling real estate prices may have you thinking it’s a great time to apply the Golden Rule of wealth creation — buy low, sell high.
It’s always good advice, but deceptively simple because it assumes you have money available to snap up under-priced assets.
Today, prospective real estate buyers are faced with the opposite problem they had a few years ago. Then, credit was easily obtained but bargain-priced properties were scarce. Now, deals abound, but debt is hard to secure.
Of course, not everyone’s having trouble. A borrower with excellent credit, high income, few debts, and a large down payment typically has little trouble getting a loan. Applicants who don’t meet those criteria, however, are finding they need creative strategies to secure loans in today’s credit-constrained environment.
If you’re interested in profiting from the down market — either as an owner-occupant or investor — the following five tips may make it easier to finance your next property.
1. Scrutinize personal resources:Take an orderly approach. See how much you can borrow right now. Are there assets you can sell (a car, a boat, that old baseball card collection) that would boost your down payment? Can you tap equity from another property? Could friends and family members help with the financing or co-sign a loan? If so, keep in mind that there are ways to formalize these agreements — such as through Virgin Money USA, which sets up payment schedules and interest rates — and thus lessen the risk of strained friendships and familial relations down the road.
2. Get down to business:Considering the challenges most people face financing just a first or second home, how do serial investors keep getting loans? A big part of their success stems from presenting banks with a compelling business case for why an investment will succeed. “The lender wants to know that you’ve got a viable deal on the books that will make sense over a long period of time,” says Frank Gallinelli, founder of RealData, a real estate software company, and author of several investment books. For investment properties, prospective buyers need to demonstrate that the cash flow from the building — the rent minus mortgage, tax and maintenance costs — will cover the costs of ownership over many years, says Gallinelli. Even buyers who intend to live in the home would be well-advised to consider cash flow should they plan to resell or rent the property in the future.
3. Call on your Uncle Sam:The federal government actively promotes homeownership, often extending financing to people who don’t qualify for traditional bank loans. Such programs generally don’t serve investors. For buyers who intend to move into the home, however, government-sponsored options abound.
The Federal Housing Administration runs the largest program — offering mortgage insurance to cover loans up to a fixed amount (previously set at $417,000, but recently raised to $730,000 in some areas under the 2008 federal economic stimulus package). “The beauty of FHA is because we are protecting the lender from risk of loss, the lender is able to make loans to borrowers with riskier credit profiles,” says Meg Burns, director of the FHA’s Office of Single Family Program Development. Burns estimates that three-fourths of FHA borrowers are first-time homebuyers.
- The Veterans Administration Home Loan Program, which provides mortgages to veterans
- The Department of Housing and Urban Development’s Teacher Next Door Program, which helps teachers buy homes
- The Department of Agriculture’s Rural Development Housing & Community Facilities Program, which extends financing to low-income buyers in rural areas.
4. Try an alternative lender:If securing a down payment is your primary obstacle to buying a home, an alternative lender can be a worthwhile option. That is, if you can stomach the rates and repayment schedules.
So called “hard money” lenders — who provide financing at above-market rates to needy borrowers — can provide cash when banks won’t. They’re not always easy to locate, however. Borrowers can try calling mortgage brokers and asking for referrals to these lenders, or look for their ads in newspapers or other publications with real estate listings. Also, hard money lenders are best used sparingly. Even a bargain property, when financed at above-market rates, can quickly turn into a burden.
Another fast-growing alternative source of funding is the so-called “peer-to-peer” loan market. Prosper.com, which operates a Web site through which people borrow from and lend to one another, provides loans at rates that CEO Chris Larsen says are typically 3 percent to 5 percent below what credit card companies would charge.
With loans ranging in size from about $1,000 to $25,000, Prosper isn’t a place for financing a mortgage. However, as banks grow more reluctant to extend mortgages to borrowers without up-front cash, members are using the marketplace for down payments. “It’s a very fast equity builder, if you can handle the payments,” says Larsen, who says Prosper probably works best for homebuyers with higher incomes, since loans get paid back within three years.
5. Split it up:When financing a whole building proves too difficult, try getting part of one. That’s what buyers in high-priced markets like San Francisco are doing. With a local median home price of just under $600,000, most prospective property buyers in the San Francisco Bay Area can’t afford a standard condominium, let alone a single-family home. High costs have led to the rise of an ownership structure called a tenancy-in-common, or TIC, in which homebuyers purchase a share of a multi-unit building. Typically, buyers either share a mortgage or take out individual loans. This unorthodox approach commonly results in units selling for below-market rates. The split-it-up technique is by no means limited to expensive urban areas. In communities across the country, buyers find that while they may not be able to independently finance a single-family home, splitting a duplex or other multi-unit property can be affordable.
Don’t force it
If no one wants to lend to you, there may be a good reason. Perhaps the property you covet isn’t the great buy it first seemed to be. Damage discovered during a site inspection, deteriorating local real estate market conditions, or a purchase price that’s higher than what you can realistically afford are all sound reasons to walk away even from what seems like a screaming deal.
Much like bargain-hunters at a post-holiday clearance sale, real estate investors in beaten-down markets are eager to scout for deals. After the initial enthusiasm wears off, however, investors, just like shoppers, may start to wonder if there’s a reason why certain items wound up on the deep discount rack.
“Yes, the market is down, and yes, there is potential for deals,” says James Wiedemer, a Houston-area real estate attorney who specializes in foreclosures. “But I think buyers get carried away with the idea that they can buy some nice little foreclosure at 20 percent below market. It’s hard to get something below market.”
Joanna Glasner is a freelance writer in California.