When you are buying a property in a preconstruction process, you will have two times when you may consider financing:
1) When you go to hard contract; and
2) 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 Loans
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.
Dr. Chris Anderson is a co-founder of
http://www.GetPreconstructionDeals.com and is referenced in many venues including the New
York Times and USA Today. Download his free, 30+ page preconstruction investing ebook today at
Get Preconstruction e-Book
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