Banks? We Don’t Need no Stinking Banks – Unconventional Financing Fundamentals

By Karen Davis and Jeff Smith, Mentors in the Houston Office

There are many reasons (erroneous we believe) why people don’t want to get involved in real estate investing. However, if you do want to get involved, there is no reason why you can’t.

Most people who hesitate to get started are afraid at some level. And most often the hurdle is fear of the unknown. Are you familiar with the acronym false evidence appearing real? There are many people who don’t take action because of what they believe is the truth; yet a belief doesn’t really have to be true to prevent a person from moving forward. We hope to show you why your situation is not unique, that you can invest in income producing real estate, and how you too can get started earning passive those income streams today.

Some common fears are “I don’t have enough money”, “I don’t have enough time”, “I don’t have credit” or “I’m just too afraid”. If your inaction is a result of one or a combination of these excuses…there is a solution for you. Since financing is a frequent question we get as real estate investing mentors, we will look at the various methods of financing property not just in today’s market but in any market.

Mortgage Brokers and Bankers are the Cheapest, Easiest (Except for Cash)

Wait a minute! First you say that we don’t need banks and then turn around and say that they are cheaper and easier! Isn’t that a contradiction? Yep. If you have excellent credit, can afford to buy properties with 10 – 20% down, and meet some other miscellaneous qualifications (i.e. debt to income ratio, cash reserves, w-2 income from somebody else’s company) then you will have fewer fees, a more understandable offer (to the loan officer and real estate agent), and as a result a larger pool of properties from which to choose. If you are not in a position to take advantage of the benefits of conventional financing the very first thing that we want you to address is, “Why not?”

There is a reason or reasons, usually due to some pattern of behavior and the consequences for this can be bad credit and/or no money. Recognize that these are NOT PERMANENT conditions and take steps to position yourself differently. If the issue is money, learn to live within a budget that includes at least a 10% contribution to your investment decisions. If the issue is credit, start keeping your promises again, make good on the broken ones, and visit the LUI Vendor Directory for some referrals on companies that can help with credit restoration and ongoing strategies. Every instance where we have missed an opportunity to invest in the “deal of the year” is because we were over-extended by breaking the basic rules of budgeting laid out in the book, “The Richest Man in Babylon,” by George Clason (this book is included in our Free Real Estate Investor Starter Kit).
Sometimes though the reason is because you already own so much real estate that your FNMA Form 1003 Loan Application runs out of boxes (you have now literally thought outside the box), and you’ve confused the loan officer so you don’t qualify. Whatever the reason is, YOU ARE NOT STUCK—you just have to work harder.

In this market the traditional banks are not lending to just anyone anymore. A good credit rating doesn’t even guarantee you’ll get a loan. In the past because derivatives of mortgage products created a false sense of security among secondary market note investors, banks were lending to just about anyone who wanted a loan even though most of them (both the lenders and the borrowers) knew that the resulting payments could not be sustained through maturity. Subsequently many borrowers who were creditworthy then had trouble refinancing due to new regulations in the appraisal rules. Unfortunately as is too often the case when a government intervenes in the private economy, good intentions actually compound the problem which was the case here. Further complications resulted from stricter underwriting guidelines and tightening credit markets.

So where does this leave those of us who buy distressed properties and turn them into clean, functional, safe rental properties that working families can afford? Del Walmsley the founder of Lifestyles Unlimited Inc., explains this with a metaphor. “If you squeeze a balloon on one end what happens is the other end gets bigger.” There are lots of ways to get creative so don’t limit yourself by not doing your homework. Just because the funding sources that were readily available in the past are not as readily available doesn’t mean that you are out of the game.

Establishing Your Financing Plan is the 2nd Action Step

The reason all of this is so important is because once you’ve taken the first step of surrounding yourself with other success-minded people in an educational environment, your very next action step is to secure funding for your investment properties. Do not ignore the next suggestion even if you think that or even know that you won’t qualify: visit with a mortgage professional who understands financing investment properties to familiarize yourself with and to determine what it will take to position yourself to use their products—remember Dr. Stephen Covey’s advice to begin with the end in mind. You may even be surprised at how bankable you might already be. Additional benefits of this meeting will include ascertaining what you can afford to buy, discovering and correcting inaccurate credit report entries before you enter a contract with an approval deadline, and most importantly, some of the data that you need to evaluate your rates of return is related to the costs of money, like down payment, closing costs, and interest rate.

Sources of Funding

Having expressed our thoughts regarding the virtues of traditional financing strategies, some deals (and as established above, buyers) however are better suited for an alternative financing strategy. Plus, we think that it is in your best interest to get started right away regardless of your circumstances.

Mortgage Brokers

One of the best outcomes of the retraction in the mortgage market is that it forced mortgage brokers to get creative and make contact with private note investors. They have created their own private loan programs that are exclusive to their company. Because these note investors plan to actually invest for their own portfolios and do not intend to sell the notes that they create on the secondary mortgage market to Fannie Mae or Freddie Mac, or anyone else, they do not need to conform to external rules. There are many new programs now available with some attractive features. One of our favorites is the prearranged refinance from a rehab loan into a blanket mortgage with the refinance value based on a county appraisal district’s tax assessment.

Creating Your Own Private Bank (Karen’s favorite)

No money and/or bad credit? Here’s an option for you (again, if you’re in this situation, make sure you know why and take the necessary steps to correct this). Due to the stock market and other low yield investments, there are plenty of individuals out there who are willing to invest their money in you instead. Think about how much interest is earned in a money market account. We’ve seen banks advertise 1.19% to as high as 2.71%. Now think about all the people who’ve lost money in the stock market or their IRA. If a person stands to earn 10% to 18% on a secured mortgage instrument and they’re confident in your investing skills, then you just found a private lender.

By definition a private lender is an individual with whom you can negotiate directly on a personal basis to borrow money. In other words, these people lend money at a higher interest rate than they can normally receive using conventional investing institutions like banks and conventional investment vehicles like stocks, bonds, CDs, mutual funds, and money market accounts. The great thing…the alternative that you offer is secured by local rental real estate. Key concept for the private lender: S E C U R I T Y. The reason is because if you do not perform (a.k.a. make your payments) and the lender doesn’t earn that 10% to 18% on the note, then he forecloses and earns a much, much higher return.

Where can you find people like this? All over. Private lenders come from all walks of life. Some don’t know enough about buying small income properties but they have extra cash they want to invest. Now, don’t expect to walk up to people and ask “Can I have some of your money?” If you expect this to work, you’re in for a rude awakening. Finding a private lender involves networking, building credibility, getting educated and having a portfolio. A fantastic place to meet note buyers is at Lifestyles classes on self-directed IRA’s. Entrust and Newman Asset Managementboth teach classes on investing IRA funds in this manner.

Hard Money Lenders

If your credit isn’t the greatest but you’re working to bring it up to par, a hard money loan may be something to look into.

Hard money lending is institutionalized private lending where the primary consideration for qualification of the financing is the subject property or collateral. The property in question must meet certain requirements before being considered. For example, some hard money lenders will only lend a percentage of the loan-to-value usually 65%. In other words, if a property is purchased for $70,000 (including expenses) and it’s worth $100,000, the borrower will have to come up with $5,000 out-of-pocket, which is the remaining balance, paid with personal funds.

Hard money loans are short term mortgage products at higher interest rates. Additionally, hard money lenders might charge between 2-10 points (a percentage of the loan) as an upfront fee. Because of the expense and the term, a demonstrable, probable exit strategy is essential for success.
Please not that if your exit plan is to refinance into a conventional product then the hard money lender will want to qualify you for the exit loan. If your exit plan is a sale of the property, then as put by Tom Kenney, President of ISB Capital, “we will certainly be more sensitive to loan to value, so insist on a deeper discount when negotiating with the seller.”

Partners

Our colleague Alfonso Munoz, LUI Houston Mentor humorously noted that nearly every call he fields as a mentor for Lifestyles Unlimited begins with the same qualifying statement, “I’m calling to get your take on this, because my situation is kind of unique.” For whatever follows though, that statement regarding exclusivity of circumstance is false. Andrew Carnegie said it a hundred years ago: it’s all been done before, go find those people and imitate them. You very likely do have something to offer as the illustration below shows, so one, use whatever asset(s) that you have to your advantage, and two, there is someone else, as alone as you may feel, who has taken the exact scenario that you are facing, and triumphed.

Real Estate Management Hierarchy

A simple example would be if you have management skills (or can contribute “knowledge,” following the chart above) but no money or credit, then partner with someone who has what you’re looking for and wants what you have. Put some quantifiable value to each partner’s input (for each of the asset columns above, for example), and divide profits (and hopefully not losses) accordingly. This is just one illustration of how to partner and buy investment property now.

Sellers (Jeff’s favorite)

Buying properties with owner financing (where the seller takes payments as opposed to a lump sum from you or your lender) is available for anyone, with or without credit ratings. The last time our real estate agent looked up listed properties on the local Houston area multiple listing service in which the seller indicated that they would consider some form of owner financing, she found over 900 listings. These strategies include various styles of options, wrap-around mortgages, and “subject-to” strategies. This was just a few weeks ago that this search was done. Many more sellers than that haven’t even been asked by their agents if they would consider owner financing, but might do so if you offered a reasonable interest rate.

With the continued tighter underwriting requirements for conventional real estate loans, owner finance offerings are becoming more and more commonplace, even on the MLS. Vendor attorneys in all 3 Lifestyles Unlimited offices have taught classes on this topic and the event in the Houston office was video recorded and available for members to view by logging in the videos section of the members’ hub.

Get Started!

With any type of financing, there are advantages and disadvantages that must be analyzed. No matter what you do, careful planning and drafting in any type of situation can prevent problems. If you are considering alternative financing and want to get started we recommend getting a mentor.

With all this being said, what is holding you back? Achieve the goals you have put off for way too long … Today. Fear will keep you from being successful and before you know it another year has passed. Nothing will change unless you change your perception in what you believe.

Take action. Write down your goals. Be aware of your financial and credit situation. Have the confidence that you can succeed. But most importantly, get educated and find a group of peers who are successful real estate investors to guide you in your business ventures. If you’d like to learn more about our model for those ventures, register for a Free Introductory Workshop by calling 866.945.6565.

Comments

  1. Jeff Smith says:

    Randy – it is a searchable field for agents. Consumer access on har does not have this option.

  2. Great article. I used a hard money loan from a LUI vendor for my last purchase because I have exceeded the 4 house FNMA limit and I’m currently working on the refinance. Even with the 12% loan I still generate $230/mo positive cash flow.

    I am perplexed by your comment on the 900 owner finance listing found on MLS. I have looked over HAR in an attempt to locate this information and don’t see any indication of any FSBO listing, owner finance options or a way to access this information. Is this prepriotory information just for agents?

    Randy

  3. Excellent ideas! My favorite is the Hard Money deals right now.

  4. Chris Robinson says:

    I could not have written this article better myself. lol In fact, I was getting ready to write something along the same lines, since the wife and I are putting together deals right now using private lenders. The private individuals that we are working with are very excited about getting great returns on their money and we are excited about not having to pay tons of fees and huge interest rates. Private money also allows us to move very quickly on a deal….it is just like buying with cash…just not your own cash.

    There are always opportunities to find a solid investor that can put your money to work for you. We are always looking for private lenders to fund our quick flip deals as well as our long term rental deals. We can help you with the entire process of using your money as a private lender. Just give us a holler.

  5. I qualified for hard money loan in July and was told I I qualified for the exit loan. Nothing change between the time in July up unitl the refi time with my financials. So be careful in what lenders tell you. You might want to have two vendors lined up that can qualify you to get out. You can’t imagine the compounding problems this one little statement, “Sure I can get you out the backend” can cause.

  6. Good Info

  7. I red your article on hard money loans, and I want to clarify what happens when you refinance to conventienal:
    you buy a house 70k hard money finaced (65k financed and you put 5k out of pocket) ARV 100k you fix it, rent it and then want to refinance.
    You now have a house that is worth 100k and you refinance it to conventional; do you need to put any money down at that time or can you refi the whole amount (65k)?

  8. Dailyestate says:

    if the house is worth 100k and the bank will give you 80% LTV, then you have 80k. If you hard money loan is only 65k, then you actually have 15k minus closing cost. You should walk away with money. Unless you want a lower nore

  9. Good point David. Always make sure you have multiple avenues for financing (on both the front and back ends) when structuring your business plan. You never know what things may change that you have no control over.

  10. Chris Robinson…I read your input from earlier and I could use some guidance from Chris or really anyone as to how I can locate private investors in the Houston area.

    I have been in the new home construction business as a sales professional for a major builder based in Houston. Sorry..can’t mention names but you would know them. I have lots of home construction knowledge but I am having trouble locating Private investors in the Houston area. Hard money lending will not work for me due to a divorce several years ago.

    I had an individual who was going to back me but told me today that he won’t be able to for several months. Which means I may lose out on two deals that I have a contract on. The only problem is now I can’t give them a proof of funds letter to take the purchase to the closing table

    Any guidance would be appreciated.

  11. I would love to get some information on the private lenders and understand how the program works.

  12. Karen Davis says:

    The first step is to attend a free introductory workshop in your area and learn how others are doing deals just like this. Are you here in Texas?

  13. I could realy use some help locating money in west virginia for quick flips and bridge loans. Any help would be greatly appreciated! thanks

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