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When you are buying a
property in a preconstruction
process, you will have two times
when you may consider
financing:
-
When you go to hard
contract; and
-
When (if) you close on the
property.
In this article, we are going to
look at both of these types of
financing.
At the time of going to hard
contract, you will have to put
down anywhere from $1,000 to 30%
of the project, with 20%
typically being the norm when
this article was written. For
many projects, all of this money
does not have to be in the form
of cash but can be a letter of
credit instead.
So let's look at an example.
Suppose you wish to acquire a
preconstruction condo price at
$350,000. If 20% is required,
then this implies that you will
need to bring $70,000 to this
deal at the hard contract
stage. Of course, if you bring
this in cash, then you have tied
up that amount of money for the
duration of the construction
project.
What many investors do is obtain
a line of credit from their
local bank. Depending upon the
credit history of the investor,
equity in other projects and
their home, and many other
considerations, the bank may be
able to approve either a secure
or unsecured line of credit for
you. Now, you simply put down
some (or zero) cash towards the
hard money contract and then the
bank provides a line of credit
for the remainder.
If an investor uses lines of
credit, or home equity loans, or
any other leveraging techniques,
they must be careful since if
things do not work out as
expected, then they may suffer a
devastating loss. We always
encourage any investor using
large amounts of leverage to
thoroughly educated themselves
on any possible risks before
undertaking such an activity.
After construction is complete,
if the property has not been
flipped, then investor must
close the deal and make the
balance payment. You must
prearrange for taking a loan or
mortgage to make the balance
payment needed for closing the
deal, because if you fail to pay
and close the process, you will
lose your down payment.
Taking a loan for balance
payment for your preconstruction
project is an easy job (if you
have good credit) because the
lenders or financial
institutions would take your
condo as collateral for the
loan. However, before taking
the loan for closing a
preconstruction purchase, you
must make yourself aware about
the different choices available
for financing.
Before you decide on the exact
financing, you really have to
decide on your exit strategy for
your investment. Your
considerations become:
-
Do I want to hold or flip?;
-
If flipping, do I want to
hold for at least one year
for tax reason or flip
immediately;
-
Do you want to hold for
equity appreciation; or
-
Do you want to hold for
cashflow generation
While each of these subjects is
much too complex for this
article, let's look at some of
the financing options that might
fit the bill. These include
§
30-Year Fixed
Interest Mortgage
§
Adjustable Rate Mortgages
§
Interest Only
§
Home Equity Lines
Of Credit
So let's briefly review each of
these.
30-Year Fixed Interest
Mortgage
The 30-year fixed rate house
mortgage was a favorite house
mortgage option of the
yesteryears because it assigns
predictability to cost of
purchasing. The 30-year fixed
rate mortgage is probably the
best finance option even these
days because it has low monthly
payment and you enjoy a
never-changing monthly payment
schedule. For this loan, you are
making payments towards
principle and interest.
Adjustable Rate Mortgages
Like the 30 year mortgage, these
loans typically stretch over a
period of 30 years but have a
variable interest rate. The
attraction is that the interest
rate is lower initially than a
30 year fixed. As an example, a
3 year ARM (fixed for 3 years),
has an interest rate today that
is about 1% point lower than the
30 year fixed. If your plan is
to hold for less than 3 years,
this might be an excellent
option. Hunt around to find the
length of the ARM and the
interest rates that make the
most sense for you.
Interest Only Mortgages
The interest only loan is
reasonably new on the scene and
can also provide a VERY powerful
tool for investors to keep their
monthly payments low. In this
case, you pay interest on the
loan for a period of time after
which you then pay interest +
principle. During the interest
only period, you can save a
considerable amount of money on
your monthly payment. Of course
at the end of the interest only
period, your payments will go up
sharply since you have a smaller
time window over which to repay
the total principle.
Home Equity Lines
Another possible option is to
use home equity lines. The
attraction of these financing
vehicles is that you can get
very low interest payments.
Unfortunately, these loans are
tied to some pretty volatile
measures of interest rate and
can adjust on a MONTHLY basis so
make sure you do your homework.
It may be possible to use these
loans on your primary residence
or on the new investment
property itself.
So no matter what options you
decide for financing, there is
two major requirements: 1) know
your goals for exiting and 2)
find a good mortgage broker who
can guide you through the wide
range of options. |
