How to Buy Property With No Money Down

For those of you that have seen Richard Davis and Trademark Properties on The Real Estate Pros (formerly known as The Real Deal and Flip This House), you know he’s one of the best there is. The guy is a genius, and has built a very impressive company by solely focusing on South Carolina (up to this point). A major difference between him and the average real estate investor is the availability of acquisition assets. We use this to illustrate one of the main roadblocks for beginner investors compared to their professional counterparts. That’s why finding a way to buy property with no money down, especially in the current state of affairs in the “credit crunch” we find ourselves, is like finding a nugget of gold. It’s invaluable.

Prior to the subprime meltdown, there was a plethora of options available to an investor that wanted to buy property for no money down. Aside from various 100% straight financing options, the most popular mortgage package was the 80/20 (or sometime, 85/15) loan. The 80/20 loan was actually two loans - a main (first) mortgage for 80% of the purchase price, and a second mortgage (sometimes set up as a home equity loan) for the remaining 20% of the purchase. Those two together made up 100% of the purchase, and after rolling the closing costs into the purchase price, any investor with good credit could purchase a property for no cash out of their pocket. We’ve used this loan package ourselves many times.

Fast forward to the present, in the aftermath of the subprime mess. 100% straight financing is scarce at best, and basically completely out of the question for investment property. Additionally, the mortgage lender my company typically uses informed us only last month that 80/20 loans are no longer available to fund investment property through his particular mortgage company. Because of what we’ll discuss below, we haven’t gone out and shopped for mortgage companies still offering 80/20 financing packages on investment properties, but it’s at least safe to say that they are definitely more rare now than ever. So where does that leave real estate investors, especially those looking to renovate and flip properties with no money down? Simple answer: the rehab loan.

The Rehab Loan

The rehab loan is an offshoot of the much more typical “construction loan.” A construction loan is the loan used when a builder builds a house. The way a construction loan works is that it starts with a lump sump disbursement, usually called an acquisition loan, which is used to acquire the land upon which the house will be built. Then, in accordance with previously submitted building plans, the builder can draw upon the remaining amount of the loan as needed, to pay for various parts of the construction. In the end, the acquisition loan and all the various intermittent disbursements, or “draws,” are encompassed in an “end loan,” leaving one mortgage on the house. If a builder is building the property, and then selling it (versus keeping it as a model home), the end loan is unnecessary, as they just pay off the various loans once the property is sold. Otherwise, the end loan becomes the actual mortgage on the property, and resembles any other standard mortgage.

A rehab loan works much the same. Like a construction loan, there is an initial disbursement which acts as the acquisition loan, but instead of just buying the land, you are using it to purchase the entire property. Then, in accordance with a previously submitted statement of renovation plans and estimated costs, as you spend money renovating the property, you submit receipts to the bank for reimbursement, up to the planned on amount. Then, when the renovation is done, you either sell the property, or you wrap everything into an end loan, which leaves one mortgage on the property. The beauty of the rehab loan is that you don’t have to spend your own cash to renovate the property. Additionally, there’s a way to utilize the rehab loan to purchase, carry, AND renovate a property for no money down. This is where it gets interesting.

The Formula

First things first, if you haven’t read How to Still Make Money in Real Estate, do it right now. You need to know whether a property is as good deal before you spend the time to further figure out how to make the rehab loan get you in with no money down, and you need to understand the legend and supporting calculations from that article in order to follow the rehab loan equation below. Having read that article, you know we like equations. Every aspect of real estate investing should involve some sort of equation. With the market as it is today, things are tighter than ever. The only way to manage this tightness, and to mitigate the risks, is to track things economically, almost scientifically. So there’s an equation we’ve worked up to assist with using the rehab loan to invest in real estate with no money down.

Before we get into the equation, let us first explain summarily how it works. The bank requires that you explain to it what you intend to do to the property, in detail. The bank then takes that information and has its appraisers estimate what the future market value of that property will be once those renovations are done (this is called the “Finished Appraised Value”). The bank then calculates backwards from there, and loans up to a maximum of 80% of that Finished Appraised Value (some banks loan only 70% of this amount, others do up to 90% based on credit and debt to income ratios). So, generally speaking, in order to find a deal that can include all out-of-pocket costs (acquisition, closing costs, renovation costs, and carrying costs), you need to find a property with a purchase price, renovations costs, and etc. that are less than 80% of the finished appraised value. Conceptually, it’s pretty easy, but the equation makes it more clear. So here we go:

[(Y + Z + CC + ZY) / (.8 * FAV)]  <  1.0

Legend

Y = Purchase Price
Z = Renovation Costs
CC = Carrying Costs
ZY = Closing Costs
FAV = Finished Appraised Value

Once you input the values into the equation, the end result is easy to interpret. As long as the calculation comes out at 1.0 or less (preferably .95 or less), then you’re in the clear for the rehab loan. Notice that, in comparing this to the Investment Decision Equation, this equation is a lot more simple. Because it must fit within the 80% of Finished Appraised Value benchmark, a lot of the additional considerations aren’t necessary. This does not mean, however, that the other equation should not be completed. In fact, as we said earlier, it should precede this equation. Think of these equations as filters. For example, you see a property that interests you. You run it through the first filter, the investment decision equation, to determine if it’s a good deal. If it is, and you intend to purchase and renovate it with no money down, then you must run it through a second filter, the rehab loan equation.

Even though the formula is pretty straightforward, let’s run through a quick example. Say you scout a property that you can purchase for $100,000. With $5,000 in closing costs, $5,000 in carrying costs during renovation, and $30,000 in renovation costs, you would need a rehab loan in the amount of $140,000. Let’s further say that after the renovations you do (maybe adding a bedroom or two, a bathroom, etc.), the Finished Appraised Value would be $200,000. Let’s run the equation:

[(Y + Z + CC + ZY) / (.8 * FAV)]

[($100,000 + $30,000 + $5,000 + $5,000) / (.8 * $200,000)] = .875

Because the calculation resulting from this example equals .875, this deal will work, and is therefore ripe for a rehab loan.

Conclusion

The rehab loan is an excellent way to fund a renovation/flip with no money down. Now, obviously, qualifying limits for this loan, including 70% vs. 90% of the FAV on the loan, are unique to each lender, so checking in detail with your lender is key before putting in the leg work and beginning to scout properties. The purpose of this article is to provide you with the tools to understand this type of loan (most lenders do NOT advertise this loan, and only discuss it when asked about it directly), and to give you a head start into what you need to know when working with this loan and scouting properties to fit into it. Feel free to take the equation and modify it as necessary in accordance with your lender’s rehab loan parameters. Putting a potential project through both the investment decision equation and the rehab loan equation will assure you’re well on your way to real estate riches. There’s no time like the present, so get started! And, as always, GOOD LUCK!!!