I have heard many questions over the years from investors about whether or not it is really possible to buy real estate with no money down. The most frequent questions I get are from mortgage brokers and realtors. Since mortgage brokers are by definition trained to fund a loan based on bank requirements like 20% down payments, then by definition anything else seems to be beyond the scope of their possibilities. It has been my experience that many real estate professionals including real estate agents and mortgage brokers do not seem to understand the concept of no money down deals.
What Is No Money Down?
Firstly, the definition of no money down does not mean no money down. It simply means none of YOUR money down. It could be Uncle Bob’s money, the sellers’ money, or a loan from Aunt Sally. It could also be a credit line, a private investor, hard money lender or anyone else for that matter. It is very important to understand this concept.
Now, if you were to purchase a house and put down 20% which you borrowed from your relative, then you would have purchased the house with no money down. You can call it 100% financing or whatever you want to call it. As far as the bank is concerned you put down 20%.
However there is a problem with that since as many mortgage brokers will tell you, banks want to know the source of the funds. When they see that the funds are borrowed and that you have “no skin” (your own money) in the deal then they will reject the loan.
So, what is an investor with no cash going to do to get around this problem? The solution is to borrow ALL of the money to purchase the house for cash. Paying all cash means you will be able to buy the house at a substantial discount. And if your discount is more than 20% below market value then you will be able to pay off the borrowed money when you refinance and then you will own a property with no money down.
Let’s assume that you can borrow the money from your rich uncle Bob. If you borrow from Uncle Bob all of the cash to pay cash for a property then you can be a cash buyer. Being a cash bash buyer is very rare and by being a cash buyer you are able to make offers on bank owned REO properties at a substantial discount to market value.
Using Other People Money
But Uncle BOB is not going to feel comfortable loaning you money to buy a house unless there is substantial security for him. Since traditional banks loan money at loan to value (LTV) ratios of 70% – 80%, Uncle Bob might be especially cautious and only agree to loan money at 60% LTV. Is this risky for him? Well it is less risky than conventional mortgages that are funded by banks.
Why is it less risky? Well firstly, conventional banks loan based on a mortgage application, a credit score and an appraisal. But Uncle Bob is a little smarter than the average bank. He can actually go out to the property and inspect it himself. Banks don’t do this.
They hire appraisers. And we all know how well that turned out for them in the last financial crisis. What is Uncle Bob’s risk if he loans you the money at say an LTV of 60%? Well not much really. If you don’t pay him then he can file a foreclosure lawsuit just like the banks do and he can get the property back from you. Now if the property is really worth $100,000 and he only loaned you $60,000 then he should be quite happy to own a $100,000 property for $60,0000. So like I said. Not much risk to Uncle Bob.
But Uncle Bob is going to need to have enough knowledge of real estate to feel comfortable that if you don’t pay him, and he gets your house that he will have a deal. Uncle Bob is going to do his own comparable sales comps and is not going to rely on an appraiser. Uncle Bob is going to spend days or even weeks investigating the property compared to the 60 minutes that an out of state loan officer looks at a file. If Uncle Bob is convinced that your deal is a good deal, then he is going to loan you the money.
If you are paying him 10% interest and the bank is only paying him 1% then Uncle Bob will make a lot more interest loaning you his money to buy real estate than he will leaving his money in the bank. If Uncle Bob has done his homework and understands private lending then he will only fund a deal at 60% loan to value ratio or less. What this means, is that if he thinks the house is worth $100,000 he will only loan you $60,000 and no more.
Your challenge as an investor will be to find a $100,000 house that you can buy for $60,000. Being a cash buyer will make your job much easier because 99% of the buyers that are competing with you will be looking to purchase a home with a mortgage and will not be able to make a cash offer. Cash buyers are able to buy properties directly from banks for as little as 50 cents on the dollar. This is a once in a lifetime opportunity.
When you find a deal the mechanics will work like this:
House is worth $100,000
You purchase for $60,000
Uncle Bob loans $60,000
Money out of pocket $0
So start looking for Uncle Bob or anyone else that you know that has money who could be your private lender. Then once you have an investor lined up begin looking for wholesale real estate deals that you could purchase for cash. Typically these deals are going to be either bank owned properties or short sales that the bank is willing to sell quickly at a discount to a cash buyer.
I have so much to share with you real estate investors. Let’s pick up with how to “Profit From A “No Money Down” Deal” on part 2 of this real estate investing training article – “Is It Possible To Buy Real Estate With No Money Down?”