I’ve talked to a lot of real estate investors recently about the 100% mortgages and Interest Only mortgages that have become rather popular over the past few years as housing prices have become arguably over-inflated in various markets across the US.

Recently, I read an article from one “seasoned” real estate investor, who made it a point to note that paying more than the property was worth was probably “okay” if you could get the owner to finance most of it for you. I couldn’t disagree more, especially in the real estate market that I think we will experience over the next couple of years.

So, I thought my first article of 2006 might be on…

Reasons why YOU SHOULD NOT OVER-FINANCE your real estate:

1. What if you need to sell? If you pay full price for a property or overpay through 100% or greater financing, you may find selling extremely difficult and could have a large potential loss. Say you buy a duplex for $250K, when based off of the income and expenses it’s worth only about $180K (I use this example because there is on for sale in my area with these same characteristics). You buy it, and go to closing which costs you another $5K, and then find yourself in a situation where you need to sell (bad tenants that won’t leave and are destroying the property, you hate landlording, you can’t afford the upkeep, you are loosing money each month because your expenses are exceeding your rental income, etc.). What are the chances that another investor is going to come along and rescue you? You have now backed yourself into a corner and may have further losses from the ongoing ownership or a potentially big loss from selling for significantly less than you paid.

2. Little, no, or negative cash flow. If you over-finance then your net cash flow suffers. Your net cash flow in simple terms is your income from the rentals, minus your expenses to run the property, minus your finance payments. The more financing you carry (mortgages, etc) the less cash flow you potentially have at the end of the month. If you say that you don’t mind breaking even, that tells me you haven’t been a landlord and had to deal with rental property issues for very long. It also tells me that you haven’t thought about what happens if you cash flow is negative (tenant doesn’t pay, taxes go up, etc). When you are in a little, no, or negative cash flow situation, your property
suffers. Think about it. If you don’t have sufficient cash flow, where does that routine maintenance to clean the gutters, paint the porch or clean the heater come from? How about when the water heater goes, or the roof leaks? Even if you are buying a property, banking on price appreciation, bad cash flow is bad cash flow in my opinion.

3. Higher financing costs. Call you local lender and ask what the interest rate and closing costs are to buy a $250,000 property if they finance 60%, 70%, 80%, 90% or 100% of the property’s sale price. I’ll bet you see a significant difference, especially at the higher lending levels. The more risk the mortgage company has to take on, the higher the financing costs to you in the form of higher interest rates and closing costs. The higher you debt payments, the lower your cash flow. Reread point #2 if you don’t remember why that’s bad.

4. Over-financing is a sign of desperation. Remember, patience is a virtue… practice it often. Are you looking to find good real estate DEALS, or are you looking to take on a lot of risk for little gain? Hopefully, you answered that you are looking for good deals. Good deals are not bought when you are willing to do the deal at any price. They generally happen when you are negotiating with a level head and the seller is more motivated to sell than you are to buy. If you need to overfinance the property to do the deal, this may be more a sign of desperation on your part than a smart business decision.

You can probably sum it up like this: “The right amount of leverage can help you succeed, too much leverage can devastate you.”

If you are looking for a simple, practical, step-by-step guide to buying rental properties, you should consider purchasing How to Buy Your First Rental Property and Beyond. I wrote this book for readers who are looking to build a solid rental property business, but don’t know how to start or how to evaluate properties. Avoiding over-financing is just one of the considerations that you need to be aware of when venturing into the rental property business. Thorough my book (and website www.HowToBuyRentalProperty.com ) I show you how to reduce your risk and increase your chance for profit and success!

I hope you have a prosperous and blessed 2006…

Regards,
Steven A. Boorstein
Landlord/Rental Property Owner
Author, How To Buy Your First Rental Property and Beyond
www.HowToBuyRentalProperty.com