With the low mortgage rates and super-low housing prices, many investors who have fled the crazy stock market would like to invest in real estate. Most of us think we know something about real estate and, really, we do. After all, everyone lives in real estate of one kind or another. Owning your own home and owning a rental-producing asset are two different things, however. Let’s assume you are looking to purchase rental property for the first time. Let’s also assume that you will have the 30% or 20% down to invest and want to leverage your money to best possible advantage. What would be the best use of your money?
Single-Family or Multi-Family?
Many first-time investors automatically gravitate towards single-family homes. That’s what most people know best, so it makes sense. But, is that the best use of the available money? I would say no. On the same amount of land and often for the same price, it’s possible to purchase a duplex, a triplex or a quadruplex. That means for the same money, you will get double, triple or quadruple the rent. It also means that if one renter does not pay, you still are receiving half the rent, two-thirds or three-quarters. This will make quite a difference because you have to pay the mortgage and the expenses of the property every month whether you have tenants or not.
Therefore, all things being equal, which they never are exactly, my preference is to purchase a multi-family dwelling instead of a single family one. A fourplex is probably the most units a first-timer can handle. Beyond the fourplex also more complicated loans apply. An investor can even purchase up to a four-unit building with an FHA loan which requires only about 3.5% down plus another 3 to 4% in closing costs. Using such a loan puts the investor at a significant advantage due to the gain in leverage from the smaller down payment. Fixer or Repaired?
Many first-time investors naturally tend to look at fixer properties because they are cheaper than properties in good condition. If the investor is an experienced rehabber or in the construction business, then it might make sense to buy a fixer. As long as the buyer has experience, knows the cost of the needed materials, and can either do the work himself or can get it done at a reasonable price, integrated into the purchase price, then a fixer can be an ideal asset.
For everyone else, though, it’s really not a good idea. During the rehab, the investor is paying the mortgage but receiving no rent. Sometimes repairs take longer than anticipated. As a rule of thumb, rehabbing a property always costs more than anticipated. Besides the loss of rent, the investor should take into consideration the wear and tear on his personal psyche. Searching out reliable contractors and overseeing their work can be exhausting. For someone with a full-time job, the time lost to the new property can never be recovered.
Fully-Occupied or Vacant?
Another issue that investors have to consider is whether they want a fully-occupied or a fully- or partially-vacant building. Often, sellers are trying to get rid of properties which they have saddled with bad tenants or tenants not paying market rents. Asking for the rent roll and checking it carefully will show if the existing tenants are paying or not. A smart investor also has a good idea what the rents for the proposed purchase property ought to be. The purchase price should usually be a multiple of the yearly rents. Thus, if the yearly gross rents amount to $26,000, then the purchase price should be about 10-12 times the rent, or $260,000- $312000, depending on the market. In some markets investors will find properties for significantly less.
In the MLS listings, frequently the would-be investor will encounter “pro-forma” rents alongside the actual rents of the property. This means the seller has failed to keep his rents at market, so the potential or “pro-forma” market rents are included. That’s fine as long as the price of the property is calibrated on the actual, not the pro-forma, rents. Of course, usually sellers want to base their price on the pro-forma rents.
But, think about it. The new investor will have to approach the existing tenants with a hefty rent increase as a first introduction, not a good start. Some of the tenants will leave rather than pay more. Others will have to be evicted. Whatever happens, it will cost time and money for the new investor. Reasonably, then, the investor should not pay pro-forma prices.
If the investor feels confident that the current renters are paying close to market rents and have a good history of on-time payment, that is the ideal situation. On the other hand, there are good reasons to purchase a vacant property as well. The new owner will be able to thoroughly investigate each and every unit, which is usually not possible with tenant-occupied, making any repairs or cosmetic updates required. Plus, the new owner will set the deposit amount, the rent amount and the qualifications for the renter. Don’t want dogs? Want to check credit and do a background check? Want to limit smokers? Any of these are possible with a vacant building.
Just Like The Lottery
Believe it or not, one bank has actually started offering automatic loan mods. No more reams of paperwork delving into intimate financial records of borrowers [treated more like beggars], no more waiting for six months, eight months and even more than a year to get an answer from the haughty banks. Finally, one bank, JP Morgan Chase, is automatically writing loan mod contracts for its underwater borrowers.
Yes, it’s true. Some Chase customers are getting loans mods, offering rate reductions, principal reductions or both–all without having to file the onerous paperwork. In one case cited by CNN Money, Chase surprised a Darrington, Wash. couple, who had tried, without success, to effect a loan mod with the very same bank, with a loan mod reducing their interest rate from 6.5% to 2.8% for five years and then a fixed 3.19% for the remaining 18 years of their loan, saving them $229 a month. For this couple, still suffering with job loss as well as an underwater house, it was just like winning the lottery.
Why Would Chase Offer Automatic Loan Mods?
Why would Chase be doing this? Is this a trick?
It’s not a trick. In fact, in accordance with the $25-billion mortgage settlement agreed to a few months ago by 49 out of 50 attorneys general, discussed in a previous post, Chase’s share of the payout burden is $4.2 billion. Because banks get “extra credit” for acting quickly and making their mods during the first year, Chase bit the bullet and decided to go ahead and make loan mod offers to thousands of underwater borrowers. In the past, contacting all these homeowners has proven difficult if not impossible. Many homeowners are so inundated with financial woes they no longer read their mail or answer the phone. Many underwater homeowners move out, anticipating a foreclosure.
Borrowers who receive the loan mod offers must, of course, sign the new contracts which typically would run for 5 years and then, most important, start making the new payments which are usually hundreds of dollars less than the previous amounts. Between March and June 2012, Chase claims that it has completed 3,086 loan mods, $359 million’s worth.
But, Isn’t The Housing Crisis Over By Now?
To understand how deep-seated this problem is despite the good news we’ve been hearing about home prices rising, look at what Chase, just one of the five major banks involved, says it still has to do: another 11,500 loan mods. I say, “Bravo,” to Chase for undertaking to honor the settlement. It is too bad, though, that the banks had to be forced by litigation to treat their borrowers like human beings. Makes you wonder what else we could get the banks to cough up if the federal government would just hold their feet to the fire just a teensy, weensy bit?
Rental Property: Amazing Tax Benefits
These days we hear a lot about the tax havens and tax loopholes available to high-income taxpayers and corporations, but most ordinary people do not understand the amazing tax benefits offered by owning rental property. In most cases, a “taxable loss” accrues from the rental which can offset ordinary income and thus the federal income tax bite. Of course, most people’s eyes glaze over at this point, so I’m going to make this as painless as possible!
Tax Savings For Middle-Income Earners
Not everyone is going to save tax money on real estate investments. Most middle-income wage-earners, though, will. First, let’s be clear. It takes a certain type of person to be a landlord as indicated in a previous post. So, looking at owning property to save money on taxes is, how do you say, bass-ackwards.
First and foremost, purchase a rental property with the idea of making money. Look for a property which will give you income after all the expenses are eliminated. This is cash-flow. Assuming you have such a property, how does it happen that even cash-flow properties can save you money on your taxes?
Rental properties generally show a “taxable loss” for many years after the purchase. This is true because, as in any business, you have the income from the rents, but then you can deduct all your expenses to come up with your net operating income. Your expenses include repairs, utilities paid, labor costs, property management or any of a vast variety of other expenses. Once you have your net operating income, then you can deduct any mortgage interest paid to arrive at the net income.
Rental Tax Saver: Depreciation
Now, here comes the good part for rental property--depreciation. You also get to deduct 1/27.5 of the building’s cost from your net income. This figure becomes your taxable income or, in many cases, loss. This is how even a good, cash flowing property can manage to be a loss for tax purposes. It is also how an investment property can help reduce ordinary income because this “loss” is deducted from the owner’s wage income and can often substantially reduce income tax owed.
There is a hitch, naturally. If losses are over $25,000 and ordinary income is over $100,000, then the taxpayer may not be able to deduct the whole amount due to Passive Activity Loss Limitations. Still, the taxpayer does get all other ordinary deductions and may well substantially reduce the amount of tax owed. Owning real estate is one of the best tax strategies allowed by the current tax code. Anyone earning any kind of money really should consider investing in rental property, whether residential, multi-family or commercial.
Today’s real estate market offers amazing opportunities for anyone thinking about investing in real estate. Mortgage rates are incredibly low, values are lower than they have been in many years and rents have not dipped. Want to discuss rental property? Call me anytime.
The horse has already bolted out the barn door, which the mortgage industry is now nailing firmly shut. Due to the banks’ foolhardy loans during the “bubble years”, home prices and loan values are now at an all-time low, but few are able to benefit. The reason? Those who want a home loan today need pristine credit. That means a FICO score of 750 to 775. Since the nation’s median score is 711, that means fully half the population would not qualify for a new home loan even if the 20% down payments were no problem.
Because of the new, much tighter loan qualifying guidelines, the terrific bargains out there will have to remain a tantalizing, but forbidden treat for potential buyers. In the past before the current crisis, a FICO score of 700-725 was considered “solid”, a good risk for the bank. FICO scores range from 300 to 850. Freddie Mac and Fannie Mae, two government agencies, are now covering about 75% of the mortgage market and, according to data just released pursuant to the Dodd-Frank financial-services legislation, have approved borrowers with 750 to 775 for 75% of their mortgages when in 2005 that high a FICO accounted for just 5% of approvals.
Paying close attention to credit reports is now, more than ever, of prime importance for would-be home owners. Having a score below 750 does not make getting a mortgage approval impossible, just more expensive. Besides the 20% down payment required for conventional mortgages, a 730, for instance, would cost an extra .125 percentage points per year. Between 700 to 725, previously an un alloyed approval, the borrower will pay an extra quarter percentage point. Below 680, it gets harder to find an approval and, of course, costs more.
Those who already own their homes and are looking to tap into today’s great loan rates will face similar obstacles. The banks will look for the higher credit scores, adequate income and what is now increasingly difficult to come by–at least 20% equity in the property. The rules for refi really are little different from those for first-time buyers. Cash-out refis also are subject to stringent approval guidelines as home values are still dropping or wildly gyrating in many areas. And, unlike the past, no one seems to have much faith in the future any more.
These days with 30% of those with mortgages under water and foreclosures coming left and right, it’s easy to forget that 50% of all American homes have paid off mortgages. That’s right–50%. Though some may quibble that means huge amounts of untapped equity that could be used elsewhere more productively, for the average homeowner paying off the mortgage means peace of mind, safety and security in an unsafe and insecure economy.
Pay Off The Mortage Faster
Paying off the mortgage is a good thing, but how can a homeowners get it done faster than the 15 or 30 years of payments outlined in their mortgage documents? Many routes to mortgage-free living exist, most almost painless.
One simple method involves refinancing the property. Despite the millions suffering from plunging home values, others still have plenty of equity. If you estimate that you have at least 20% equity in your home, refinancing is a good options. It makes sense even if your present rate is 5% or 6% as current rates are hovering closer to 4%. A good rule of thumb is–if you can save 1% in mortgage interest than it is worthwhile to refinance. And, if you can afford it, it might make greater sense to refi into a 15-year mortgage which will save you more than half the interest costs of a 30-year mortgage.
Another simple method of paying off your mortgage faster is to make bi-weekly payments. That way if your payment on, say, a $300,000 mortgage at 5% over 30 years is $1610 per month, you could break this up into two payments a month of $805. Because a year has 26 weeks, paying biweekly will have you making 13 payments and by the end of the year, you will have made an extra payment. You could also, of course, make a whole extra payment any time during the year. Or you could divide one payment of $1610 by 12 and pay an extra $134 per payment. The savings can be substantial. In the above example, according to this nifty calculator from bankrate.com, a homeowner could shave 5 years off his 30-year loan and over $50,000 in interest charges. Not bad.
Do Banks Charge A Fee?
Some banks are offering this biweekly mortgage payments as a service with a setup fee of several hundred dollars. Citibank, for instance, charges $375 for the “convenience” of taking this money out of your checking account and then dings you again when you make the payment. Most banks, including Citibank, will allow you to make extra payments for free. It is possible to make this payment yourself, but it pays to check with the bank first as your bank may just deduct the payment from principal and then still expect the regular payment.
High-Interest Credit Cards First
Making this extra payment can save the homeowner in this example, for instance, 5% so it does not make sense to put the money into the mortgage if you have outstanding balances on credit cards charging interest rates of 6% or above and certainly not the 29% charged by some cards. Pay off those high-interest cards first and then start working on the mortgage.
Finally, in Obama’s plan the federal government is doing something to stem the tsunami of foreclsoures and short sales. It’s trying to keep property values from decreasing further. It’s trying to keep families in their homes.
Even as President Obama was announcing his plan, he acknowledged that it would be just a drop in the bucket. Think about this: the plan offers $75 billion in federal money to help homewoners, mainly by providing incentives to lenders.
Today, one in 10, that’s 10% of all home loans are right now facing foreclosure. It’s estimated that by the end of 2010 at this rate fully 25% of all homeowners will be underwater. That’s closer to $500 to $600 trillion in home loans.
The refis will not be too much help in California because we’ve lost too much value, though they may help in other areas. The loan modifications may help and the Obama team has said that any bank which has accepted TARP or any bailout money MUST do loan mods and good ones.
Still homeowners must have income to do a loan mod. So, if a homeowner has lost a job or has been unemployed for more than a short time, I don’t see lenders offering anything–short sale.
Lately, I’ve been seeing an ad on TV featuring a women who says she gave up her job so she could take care of her mother when she realized she was “failing”. She says she talked to her bank and “worked it out”. This would be laughable if it weren’t so villanous. Calling your bank and telling them you can’t pay your mortgage or only part of it will accomplish only one thing–a faster foreclosure notice. They will definitely tell you to pay whatever you have and to pay the bank first before other items in your budget, probably even food. That’s what I’ve been seeing out in the field. Despite all the bailout money, as we’ve all noticed, banks have gotten more hard-nosed, vicious even, not less.
Wow, I’m glad I got that off my chest. I didn’t realize how much I despise banks, especially the big ones. It seems Obama and his team have already learned the banks will have to be forced to do anything at all to help homeowners.
Called the Home Ownership Stability Initiative the heart of Obama’s plan really is the loan modification. As we have all heard, some homeowners are facing payments jumping thousands of dollars a month as adjustable loans readjust. Many homeowners are paying 50% or 60% or more of their income in mortgage payments while the value of their proerties is tumbling.
This plan aims to modify loans for those who qualify at 31% of income. Notice, that just like refinances, modifications require income. That’s the first qualification: income sufficient to pay the modified mortgage.
Until now, banks have been reluctant to offer loan modifications to homeowners who, whatever struggles they were having, remained current on their mortgages. Most banks refused outright to help such borrowers. This plan changes that and makes loan mods available to those who are current in their home loans as well as those who are behind in their payments.
This is important because it allows those who have not missed a payment to maintain their credit. As we all know, often a few dings on the credit and a missed mortgage payment is a major ding, have a cascade effect. Credit card companies find out and jump up rates on credit card debt. It becomes much harder to get any credit at a decent rate, etc.
Let’s say, for instance, that the borrower is paying 43% of his income for his mortgage. He applies for a loan mod and the lender brings the payment down to 38% of his income. Then, the government [Freddie and Fannie] and the lender bring the loan down by equal contributions [3.5% and 3.5%] to 31% of the borrower’s income. That mod stays in place for 5 years. At the end of that time, the rate would be gradually increased to the rate at the time of the loan mod.
Also, and this is important, the government would reinburse the lenders who agree to bring down the principal. Bringing down the principal: all underwater borrowers’ dream and their lenders’ nightmare. Until now, it’s been the rare lender who would touch that principal.
Now, lenders have incentives. If they modify a current loan,servicers receive $500 and lenders [investors] $1500. Borrowers have incentives, too. Every year a borrower stays current in the new mod, he receives $1,000 for up to 5 years. This is clear incentive to help those “good” borrowers who have made tremendous efforts to pay their mortgages during this current crisis and by dint of great sacrifice maintain their credit. Obama’s plan clearly tries to help these people while at least partially answering the persistent critique that responsible homeowners received no help while the irresponsible were being bailed out. Obama’s plan specifically says speculators or flippers cannot particpate.
This, of course, brings up another issue: small investors who own rental properties, especially single family homes or condos, are suffering, too, but seem to be eliminated from this program. Apparently, that is the case except for rental property that was originally a principal residence. So, if you are renting out the condo or 2-bedroom house you bought as your first home before you bought your current residence, then you may be able to participate.
Final details of this plan are supposed to be released this week. The Treasury Department says it will issue clear guidelines for all lenders to follow in doing loan modifications. That would be a relief. At the moment, it’s a free-for-all out there. Some lenders are very cooperative; others refuse to do anything. There’s no doubt we need to do something even if it means helping those who have not, shall we say, been the most prudent in their financial choices. If we don’t the fallout is just too terrible to contemplate.
In an earlier post, Short Sale v Foreclosure, we saw the difference between a short sale and a foreclosure, but there is another option for a distressed homeowner. This is the Short Payoff. This option makes sense only under special circumstances.
What’s the difference between Short Sale v Short Payoff?
In our current real estate environment, short sales are becoming more common. A short sale occurs when the lender or investor agrees to accept an amount less than actually owed on the property. The lender sells the property “short.” In this case, it’s up to the homeowner, usually using a real estate agent, to market and sell the property. The new buyer usually gets a bargain. The previous homeowner gets out from under an unmanageable mortgage by giving up the house.
In order to qualify for a short sale, generally speaking, the homeowner must demonstrate a verifiable long-term hardship rendering him unable to pay the mortgage. These days, many homeowners, especially those who bought within the last several years or those who refinanced and took big chunks of equity out of their properties, becoming “upside down” in their home loans or owing more than the home is worth. Now, more and more often, these homeowners are also doing short sales.
So far, this doesn’t sound like such a bad deal. The house I bought loses value, so I sell it at current market rates and the lender takes the loss. Well, true, but the homeowner no longer has a home. And, the former homeowner will probably be a renter for several years to come as his credit report’s FICO score will immediately drop by about 300 points. The newest loan guidelines from Fannie Mae and Freddie Mac specify that after a short sale, a prospective borrower must wait for 2 years to qualify for any FHA- or government-backed loan.
So, what’s the alternative that will NOT damage credit to such a degree?
That option is called a Short Payoff. It also carries some tough restrictions. If the homeowner is upside down by a smallish amount, say $10,000 to $50,000, depending on his financial perspective, he might try to negotiate a short payoff with his lender. In this scenario, the lender agrees to release the lien, his interest in the property, allowing it to be “conveyed” or sold to a new owner. The lender agrees to accept less than the amount owed on the property to release the lien, thus “short payoff,” However, in return, the former homeowner signs a promissory note for the difference or some of the difference agreeing to “pay off ” this unsecured line of credit according to the terms of the note.
To do a Short Payoff, the mortgage must be current, the borrower must have great credit, and must demonstrate the ability to pay off the debt. The upside of this situation? The former homeowner keeps his great credit and can purchase another home or anything else he desires.
When is a Short Payoff appropriate? A homeowner might request a short payoff when the home has lost value dramatically or even just enough to make it impossible to sell, and he does not have the ability to pay the large amount to get completely out of the property.
Not all lenders will allow for a Short Payoff; however, you will never know if you never ask.
Of course, the advantages of short Pay-offs are the borrower are able to move out of the property and get on with his life, there SHOULD receive no negative feedback on the former homeowner’s credit.
If for some reason down the line, the borrower’s ability to pay changes and cannot pay on the note, the credit ramifications are significantly smaller.
For further clarification of the entire short sale, foreclosure and short payoff differences, I have just posted an E-Book, Should I Short Sale My Home or How To Survive the Worst Real Estate Market in History, available as a free download, on my website. Plus, it appears in Links to the right of this post.