Real Estate Financing Knowledge is power. —Francis Bacon
In 1991, I made my first attempt at financing an investment property through creative means. With a lot of guts and a little knowledge, I made an offer that was accepted by the seller.
I tendered $1,000 as earnest money on the sales contract, then proceeded to try to make the deal work. I failed, lost my $1,000, but I learned an important les son a little knowledge can be dangerous.
I decided then to become a master at real estate finance. Financing has traditionally been, and will always be, an integral part of the purchase and sale of real estate.
Few people have the funds to purchase properties for all cash, and those that do rarely sink all of their money in one place.
Even institutional and corporate buyers of real estate use borrowed money to buy real estate. This book explains how to utilize real estate financing in the most effective and profitable way possible.
Mostly, this book focuses on acquisition techniques for investors, but these techniques are also applicable to potential homeowners.
Understanding the Time Value of Money In order to understand real estate financing, it is important that you understand the time value of money.
Because of inf lation, a dollar today is generally worth less in the future. Thus, while real estate val ues may increase, an all-cash purchase may not be economically feasi ble, because the investor’s cash may be utilized in more effective ways.
The cost of borrowing money is expressed in interest payments, usually a percent of the loan amount. Interest payments can be calcu lated in a variety of ways, the most common of which is simple inter est.
Simple interest is calculated by multiplying the loan amount by the interest rate, then dividing it up into period (12 months, 15 years, etc). Example: A $100,000 loan at 12% simple interest is $12,000 per year, or $1,000 per month.
To calculate monthly simple interest payments, take the loan amount (principal), multiply it by the interest rate, and then divide by 12. In this example, $100,000 × .12 = $12,000 per year ÷ 12 = $1,000 per month.
Mortgage loans are generally not paid in simple interest but rather by amortization schedules (discussed in Chapter 4), calculated by amortization tables (see Appendix A). Amortization, derived from the Latin word “amorta” (death), is to pay down or “kill” a debt.
Amortized payments remain the same throughout the life of the loan but are broken down into interest and principal.
The payments made near the beginning of the loan are mostly interest, while the payments near the end are mostly principal.
Lenders increase their return and reduce their risk by having most of the profit (interest) built into the front of the loan.
