Billions of dollars of wealth up in smoke since 2006...

However, the zero down conventional loans are now gone, and lenders are requiring anywhere from 5-20% down on conventional mortgages, depending on the type of property.  So for those who are still looking for limited cash out of pocket, there are other roads that you must follow. 

The most common loans with limited cash down are:

1)  VA loan: 

If you or your spouse are a current or past Veteran of the Armed Services, Reserves, or National Guard, you can qualify for a Veterans Administration (VA) loan with no money down.  Historically, this has always been a great benefit to veterans who did not have a lot of money saved. 

However, one disadvantage of this type of loan is that you must pay a funding fee, which currently is 2.15%.  The funding fee is intended to enable the veteran with the VA loan to contribute toward the cost of the benefit, which reduces the cost to the taxpayer.  The funding fee is very often added to the loan amount, so that the loan becomes greater than the sale price of the home.  This creates a situation of negative equity for the buyer which will last until the principal is paid down to below the present value of the home.

Veterans who are receiving VA compensation for service-related disabilities and surviving spouses of veterans who have died in service or from service related disabilities are exempt from paying the funding fee.  The maximum VA Loan, until the end of 2011, is $729,750.  There are some other eligibility requirements that are related to the length of your military service. 

VA loans are for owner occupants only, which means that you can not use a VA loan to purchase investment property.  However you can always live in the home for a few years, and then move out and turn it into a rental property.  For more information about the specifics of a VA loan, consult with a qualified mortgage lender.

2)   FHA loans: 

An FHA loan is a loan that is insured against default by the Federal Housing Administration (FHA).  FHA does not lend the money, they simply insure the loans.  The purpose of FHA is to promote home ownership for people who do not have a lot of money.  Almost anybody can get an FHA loan, providing that you have reasonable debt to income ratios and decent credit.  A few years ago, the FICO score needed for FHA and VA was only 580.  Recently, however, lenders have tightened standards and raised the minimum scores needed on both loans to 620.

A few months ago, FHA also raised the down payment necessary for an FHA loan from 3% to 3.5% (although, a borrower is permitted to receive the down payment money as a gift from a family member).  At one time the down payment could also have come from a non profit organization that participated in Down Payment Assistance Programs, such as Ameridream.  However, at the moment, the Down Payment Assistance programs have been eliminated by the Federal Government.  Ameridream has been fighting this decision through the courts for many months.

Most recently, the Obama administration has proposed that the $8,000 first time home buyer tax credit may be used as partial money towards the down payment.  But the buyer must put some money up as well.  These complicated rules are still being worked out. 

One disadvantage of FHA loans is that they require Mortgage Insurance Premium (MIP), which is 1.5% of the loan amount, and is paid by the buyer at closing.

Presently, the maximum FHA conforming loan limit is $417,000, but in higher cost areas this can be adjusted to 115% of local median prices, not to exceed $625,000.  FHA is quite lenient as well.  If someone has lost a home to foreclosure, they are permitted to buy another home with an FHA loan as little as three years later.  The interest rates on FHA are very close to those of the conventional loans.

As with VA loans, you can not use an FHA loan to buy investment property.  However, you are allowed to buy a duplex, providing that you live in one side of the duplex, while renting the other side.  Similarly to the VA loan, you can also buy a home with an FHA loan, live in it for a few years, and then rent it out.  However, you can not have two FHA loans at the same time, so your next home will have to be purchased with conventional financing.

Keep in mind that with a small down payment comes a larger monthly payment of principal and interest.  For example, on a $150,000 loan, with zero down, at 5% over 30 years, your principal and interest payment will be $805.23 a month.  But put down 5% on that same $150,000, and your payment drops to $764.97 per month.  The $40 savings per month may not seem like much, but over 30 years it adds up to over $7,000 in reduced interest payments.
 

Mr. Piggy is happy to save $7,000 over time...

3)  Hard Money Loans:

Once upon a time in home flipping, crazy America, circa 2002-2006, these fixer upper loans were very popular with investors who had either mediocre credit, little cash, or both.  Although each hard money company is different, in general most will loan money based upon the after repaired value (ARV) of the property.  Hard money companies do their own appraisal to determine what that ARV will be, and then they loan the investor 65-70% of that amount.

So, for example, let's say an investor finds a handyman special that appears to be below market value, with an asking price of $70,000.  (S)he calls the hard money lender, who sends someone out to appraise the property within 24 hours.  The hard money lender determines the ARV to be $110,000.  The investor makes an offer of $57,000, and after some negotiation, the investor and seller agree to a sales price of $62,000.  The hard money lender is willing to lend 65% of the ARV, or in this case, $71,500.

Sounds great, right?  No money out of pocket for the investor, and they even receive $9,500 more than the sales price.  But not so fast.  Hard money lenders generally charge very high closing costs and 4-5 "points" (each point is 1% of the loan amount) on a deal.  So points alone on a $71,500 loan could be as much as $3,575.  By the time all the closing costs and points are paid, the investor may have very little money left to make the necessary repairs to the home.

Additionally, hard money lenders will often charge interest rates of 12-15%, and there is usually a "balloon payment" (the total loan is then due in full) within two years.  So one either needs to re-sell the property quickly, or to re-finance it later on.  Renting the property makes no sense, as the high interest rate will more than likely create a negative cash flow for the investor.

Over the years, I have seen several investors go belly up by taking these loans and not being able to re-sell right away.  The monthly payments of double digit interest rates killed any chance of them being able to make a quick profit.  A sizable percentage of them eventually felt as if they had sold their soul to a certain party you may have heard about before...

 

"Acme Hard Money Lenders, have I got a HOT deal for you!"
 

Now having made my joke, to be fair to the hard money lenders, let me add that they do provide a high risk service to those who want it, and deserve to be fairly compensated for the numerous risks they assume.  There are also a lot fewer of these lenders today than there were four years ago, as many of them were forced out of business by declining home values and investors who foreclosed on their properties they could not sell.

Although I have included them here as one of the options for purchasing real estate with limited cash, in general, for the reasons given above, I will NOT recommend hard money loans to my investor customers, nor to you, the Tycoon Report readers.

 

4)  Home Equity Line of Credit (HELOC)

If one has sufficient equity in their primary residence, or even in other investment properties, a home equity line of credit, aka HELOC, is another way to obtain cash for a second home or investment property.  However, remember that a HELOC is in essence a second mortgage on your home.  So I would certainly not recommend it for speculative investments, as you could find yourself out on the street. 

At one time, you could borrow about 80% of your total equity on a HELOC.  However, these days the banks are being a bit more stingy, as their fears of declining home values have materialized.  Furthermore, with many home owners now having less equity, or even no equity in their homes anymore, the banks have begun to limit any further draws on already granted HELOC accounts in which the equity has collapsed.

The use of leverage when buying with limited cash, is one of the greatest benefits of buying real estate, whether it's for a primary residence or for investment property.  However we must keep something in mind.  While buying properties with limited money down will provide the greatest return on investment during times of appreciation, it will also smack you upside the head with a large percentage loss when property values decline. 

For example, if you put down $10,000 on a $285,000 home (3.5%), and the property appreciates to $300,000, your ROI is $15,000 divided by $10,000, or 150%!  One could argue that you are paying interest during the time of appreciation, and that brings down the ROI, but what if the property were a rental and the tenant paid your mortgage during that time?

On the other hand, if the value of the home declines from $285,000 to $270,000, you now have a huge percentage loss, even if you have been renting the home during that time.

5)  Uncle Tony:

And speaking of being smacked upside the head, if all else fails and you don't qualify for VA, don't want a hard money loan, and can't get an FHA loan or HELOC, there is always your Uncle Tony.  You might have to sell him on the property idea and perhaps give him a "taste" of your investment.  But if you think the hard money lenders have high interest rates, wait until you hear what Uncle Tony charges!
 

 

See you next week!