FHA Mortgage, Interest Rates and Marketing

Investors want the highest possible return on their investment; this is the goal and mark of a successful endeavor. After all, low monthly payments equate to a higher cash flow. And the higher cash flow, the higher the return on your investment. But then delightful little fees and payments begin to sneak into the equation, and pretty soon you’re hardly breaking even or even taking a monthly loss. While in some cases a slightly negative cash flow is tolerable (long-term investments with high appreciation, for example), many investors try to avoid a negative cash flow.

One fee that bites into monthly cash flow is PMI or Private Mortgage Insurance. This typically affects investors who borrow more than 80% of the property’s sales price. You see, in the eyes of a lender, such borrowers are relatively risky. To offset risk, the lender charges a fee, PMI, which covers the bank if the borrower defaults on their loan. This insurance, charged to the entire loan amount, can be as high as 1.5%–depending on loan type and down payment amount.

However, there is a way–called piggy backing–to avoid paying this particular fee. Many lenders offer “piggy back” loans, which are loans where two separate mortgages are lumped together. It goes like this: A mortgage is assigned, with market interest rates, for 80% of the sales price. But the borrower requires more money so a second loan is also taken out to cover the remaining needed funds. This second loan is called the piggy back loan, and the interest on this smaller loan is much higher than the first because it is the last lien to receive funds if the borrower defaults. What makes piggy back loans so attractive is that the higher interest is only charged to the smaller loan.

Piggy backing works well for many and can lead to significant savings. But really do your research here, because piggy backing is not always the right option for every investment. In some cases PMI payments are relatively small and will cost less than the high interest associated with piggy back loans. Now, if you do the math and see that both the PMI payments and the piggy back payments are incredibly high, it’s probably time to revisit your strategy and consider making a larger down payment if possible.

Banks have got to protect themselves, and I understand that–our market depends on it. But wouldn’t it be nice, just daydreaming a bit, if there were no such things as transaction fees, closing fees, or interest rates. Especially interest rates.

“Here you go Mr. Jones. You can just have this loan without any of those unnecessary costs. No interest fees or anything. Just bring the money back when you can.”

This unrealistic dialogue could never happen–it’s not how our market works. Interest, in particular, isn’t about to disappear. Many real estate investors have come to recognize interest rates as one of the largest expenses associated with this type of investing.

Simply put, interest can be defined as the price you pay to borrow money from the bank; you’re renting a large sum of money from the bank with a relatively small down payment and interest is the price you pay for leveraging.

But there are ways to lower your interest rate–though, eliminating it all together is nothing short of impossible. Those who can make a 10% down payment, who have decent credit scores, and who can prove their income/assets are more likely to be quoted a lower rate. And you can always pay Discount Points; these are fees paid up front and based on the amount you’re borrowing.

The way it works is like this: The more you pay up front in such fees, the more you can buy down your interest rate. Try to get at least three quotes from your lender, each with different amounts of discount points including maximum amount of discount the lender allows. Keep in mind that the first couple of discount points paid will most greatly affect the interest rate; additional points after that might not be beneficial considering how little they affect the interest rate.

So, while we can’t alter the banking system into an interest fee establishment, we can do our best to ensure the lowest interest rate possible for our real estate investments.

Healthy competition has a way of pushing us to excel. For example, I always run faster if I’m with a friend versus running along. Well, healthy competition in the market has the same sort of effect. One place this is clearly visible is in the real estate market. Consider a bidding war and what this means for the seller; you have five people who are all competing or bidding for the same property and that competition drives the selling price up drastically.

Well this same idea can be seen in other facets of the real estate arena as well, namely, when deciding what amount of money to put down on a property. There are all sorts of beliefs when it comes to this topic, and many of the different notions have validity in their own way. Some will say to put no money down and take the 100% financing route while others recommend putting anywhere from 5 to 20% down.

I recommend making a 10% down payment. Any investment property loan requiring less than this percentage is called a “niche” loan, and fewer lenders offer such programs. This means less competition between lenders and so the costs and interest rates are relatively higher. These borrowers are considered more of a risk after all, and as a result, their cash flow and return will suffer.

But most lenders do offer a 10% down investment property loan. There is more competition between lenders over borrowers who can make this down payment amount, and that equals better loan programs with lower interest rates. Isn’t healthy competition great? A borrower who can offer 10% down appears less risky to the lender, and, in light of the subprime lending meltdown, lenders looking for low-risk borrowers more than ever. Monthly payments for such borrowers will be lower, which makes for a greater return and cash flow.

That’s why it’s so important to seek out healthy competition in real estate; it benefits the borrower.

Life can be a lot like the real estate market; one minute everything’s going right, and the next, things seem to stall and sputter.

Many who invested in real estate properties during the nationwide boom (2001-2005, give or take a year for varying markets) were successful–for a time. We all heard the success stories or got to tell them from personal experience. Made 20k , 50k, or more in a year. Several of these moneymakers bought properties without an ounce of research and saw their property appreciate at an unusually rapid pace. Not surprisingly, real estate investors emerged from every corner. If so-and-so can do it, why shouldn’t I try it out? Gurus were formed, classes written, a lot of people made a lot of money.

But then things began to stall and sputter. Extreme markets must adjust because markets are efficient by nature; demand and supply had become extremely unbalanced. To compensate, areas experiencing the most rapid appreciation rates gradually began to stall. The era ended and several once-enthusiastic real estate investors found new endeavors to pursue.

So what about investing in the current market? Is investing in real estate just some trend of the past? In my opinion, (forgive my predictability) no, real estate is not a forgone investing option. Moneymaking opportunities are still available, but a lot of the luck out there is not. Simply put, rapid appreciation on a widespread scale isn’t happening in the current market.

Research must replace luck.

Normal appreciation rates are out there, anywhere from 3-7%. And, speaking on a local level, there are still rapid appreciation zones in areas with high demand. However, even if appreciation rates are conservative, you can still make money by holding that property for a longer period of time (20 years, for example). A long-term hold allows you to ride out localized dips in the market, reaping a big payday once you do sell the property. While this approach is considered archaic and a bit old school, it’s proved lucrative for many real estate investors.

In the third grade I was assigned my first research paper. After a few minutes of thorough thought, I picked my topic–kangaroos; they could jump, they were exotic, and they had a pocket. My mom took me to the downtown library and pretty soon there were four books about the delightful animal in my bag. Next came the color-coordinated note cards, and then writing the paper as well as the bibliography. When it was all presented to my teacher–bound and crisp–I had never been so proud; I had become a kangaroo expert.

I tell you my kangaroo story to encourage even the least research-minded person; if a third grader can do it than so can you. And anyone who plans on becoming a serious and successful real estate investor needs to prepare for a healthy helping of research.

There are two major areas where I recommend seriously researching. (Now, you don’t need to use color-coordinated note cards. Those are optional). The first area is when assembling your real estate investing team: a property manager, real estate agent, and mortgage broker–this one’s important because it also equals the right type of loan. Each of these individuals is crucial to your overall success so take the time to thoroughly research here. Ask other investors if your part of a club or network. Once you find one team member, ask if they know other professionals to fill in the other two slots. Conduct a thorough phone interview asking a diverse set of questions. And always interview more than one professional for each of the three slots.

The second area worthy of thorough research is location. That’s pretty much a given; even non-real estate investors recognize the value of location. But few people give this area the attention it deserves. Check and see if there are any major renovations planned for certain parts of the city. Is the downtown going to undergo a major makeover? If so, surrounding property will rapidly appreciate.
Check schools. Check crime rates. All of this is available to you through the Internet or by making a phone call. And ask reputable professionals–preferably someone from your own team–about local market trends. What property types sell the fastest? Which appreciate faster? If the cat had been a real estate investor, then curiosity wouldn’t have killed it.

If you have the right team and the right location, you could bind and present your investment with the highest degree of pride.

I was having lunch with a friend the other day (eating some delicious bow-tie pasta) when he asked me, “Do you consider yourself a dreamer or doer?” Interesting question, right? I responded with some sort of non-committal answer, the kind that avoids having to choose between two options.

“Well, I’m a doer who likes to dream.” After all, who wants to be considered a boring doer, someone who’s not exciting enough to dream? And, what merit is there in simply dreaming up plans but never taking the initiative to act? My friend was just making interesting conversation, but his question got me thinking. And the more I thought about it, the more pleased I was with my answer.

Any successful real estate investor is indeed a doer who likes to dream, because every decision made or property invested, started as a dream. A major bridge from do to dream in such endeavors is the mortgage broker–the funds provider. Few people have the necessary means to invest in property without borrowing the funds to make it happen. And even people that do have that kind of money often opt for some sort of financing plan.

Financing is one of the most crucial and misunderstood parts of real estate investing. People go to all sorts of work finding the right property for their investment (researching market trends, renter needs in the area, etc.), but they do not apply the same diligent research when finding the right mortgage company and broker.

So, here’s a nudge in the right direction.

When considering financing options, always remember that different loan programs are better for different investor needs. There are quite a variety of loans out there and a competent loan officer should be able to match your needs to the right loan. Competent, of course, being the key word in that little sentence. If your loan officer is below par it doesn’t matter how great the company or loan programs, because part of the process is being matched with the appropriate loan.

And I recommend working with at least two capable loan officers from two different companies. Be upfront with both officers by letting them know you are working with multiple firms. This dose of competition will help you secure the best rates. Also, make sure your mortgage company is licensed in multiple states and has experience and expertise in investor financing.

When you find the right mortgage broker you’ll experience the momentum that comes with moving from dream to do.

Real estate agents are a valuable resource to any real estate investor wishing to build a team of professionals. Just like a property manager provides you with sound understanding of the rental market, a real estate agent provides info on the local sales market from both the seller and buyer’s perspective. They tell you which properties have the best resell value, what market trends are like, and which areas are hot for buying and selling.

While they provide you with plethora information, keep this in mind: a real estate agent is not a real estate investor. They won’t coach you on investing strategies, because that isn’t their job. They will help you buy and sell properties–that is their job. Now, one of the ways a realtor does this is by using the Multiple Listing System, or MLS. This electronic database shows properties for sale in a specified area, how long they’ve been for sale, property details, and any recent price reductions.

Length of time on the market and price reductions are both valuable indicators to the savvy investor; they can help you determine the motivation level of the seller. For example, if the property has been on the market for 12 months and had a few price reductions, then the seller might be getting anxious/motivated. Real estate investors should look for such sellers, since they are more likely to negotiate.

Of course, to get the most for your investment, you need to be working with a real estate agent who is a skilled negotiator. Not all agents or comfortable in bidding volleys. Some realtors are timid or hesitant to make low offers; instead, they urge buyers to offer unnecessary full-price bids. But a real estate agent with a good attitude towards negotiating jumps on the opportunity to get their investor the lowest possible price.

Well, if you can combine all the good qualities I’ve mentioned in this little blog and find them in one realtor, hold onto that agent with both hands. They will be one of your most valuable team members and worth their weight in equity.

I cannot water ski. I’ve tried it countless times–one day an entire afternoon was spent attempting this impossibility. I can, however, tube. Probably because this requires no skill other than hanging on for dear life, the kind of hanging that leaves your hands throbbing for a bit afterwards.

But I don’t tube alone. I fall off after about 30 seconds if I don’t have someone else on the tube with me, balancing the weight on spiraling turns. And it’s far more enjoyable when someone else is out there with you.

Well, I think there’s a real estate lesson to be learned through my lake leisure experiences. Just like tubing is more successful and fun with others, so is real estate investing. Many of the successful real estate investors out there, credit their lofty achievements to teamwork. They recognize the value of help when taking such a huge financial venture.

These savvy investors do the research, and take the time to handpick a team of successful professionals working together with a common goal.

One such professional is a property manager.

A property manager (their title explains their job duties quite nicely) manages the property for the investor/landlord. While the definition is short and straightforward, a property manager is responsible for quite a lot. They find an ideal property matching the needs of renters in the area; they also find quality renters and act as the liaison between tenant and investor.

If you want excellent renters, however, make sure you’re working with an excellent property manager.

A quality property manager is committed (after all, this is a relationship). Ideally, it’s great to find a manager who can commit for the length of time you plan to hold the investment. It’s also helpful to find a professional who does this sort of thing on a full-time basis. Many property managers simultaneously work as selling agents, but I recommend working with one who exclusively manages properties.

To find property managers in your area, browse the Internet or phonebook. Look up real estate agencies with separate divisions for property management or even a firm completely dedicated to managing investment properties. Regardless of which avenue you choose, many of the property managers you’ll interview are licensed real estate agents–this is a requirement in most states.

So, applying a lake lesson to real estate investing, I recommend going it with a team. And, as covered above, one crucial team member is the property manager. They are, after all, the connection between you and your renters, and as such, they should be friendly and easy to get a hold of. When you find the right manager (or tubing partner), treat them with the respect and professionalism they deserve.