With the advent of 90%-100% LAV loans on investment properties, many investors are taking the opportunity to finance or refinance their properties at a higher percentage of value than normal. Many are taking cash out at the closing, and many are choosing to pay close to retail for properties that qualify for this financing, on the theory that a no money down deal is a good deal, even if it only cash flows a little. Smart investors avoid the temptation (and the strong come-ons by mortgage brokers) to do this. Here’s why:
1. You can’t “dump” properties in an emergency. I get calls from landlords in this position literally every day. Like from a guy who paid $78K (full value) for a rental last summer and got a purchase money loan for $76K. Now his tenants are driving him crazy and destroying the place, and he wants to sell now. He can’t sell to an investor, because he’s over-leveraged, and he can’t sell to a homeowner, because his tenants have destroyed the house. Or from the lady who bought a $100,000 duplex for $59,000…but then got a 2nd mortgage for another $50,000. She took cash out, spent it, and now can’t afford to sell the pain-in-the-rear property.
2. You can’t get consistent cash flow. I got a call yesterday from the owner of a 3 family who got a 2nd mortgage a few years ago to take some cash out. Now the city’s on his back and he wants to sell…but the 2 payments total more than the property would gross fully rented. Unless he pays off the 2nd of $20K, he won’t be able to sell.
3. You’ll pay an arm and a leg in the long term. Check out the difference in total interest payments between a property financed at 80% of it’s value vs. 100%, and you’ll see what I mean.
There’s nothing wrong with having no money in a property—as long as your total debt is less than 80% of the retail value. Borrowing more may make you feel richer in the short term, but it’s a recipe for disaster.
by Vena Jones-Cox