Friday, July 28, 2006

Low Monthly Payment Key to Investing

Many people have emailed me lately with their woes of buying pre-construction dwellings a few months ago in hopes of grabbing a quick buck by flipping the dwelling once they go to settlement. In the heated market last year and previously, many a novice investor made a lot of money in this way. However, the warning given at that time that a buyers market could cause them much pain and financial suffering went unheeded by many and now they're paying for it.

In today's less fevered market (but still healthy in parts), many new homes are being placed on the market and the would-be investors/sellers are now homeowners without two things: the cash to go to settlement or a renter to make their monthly payment for them. They gambled that they would never have to go to settlement, instead, walking away with a lot of cash in return for being in line with deposit money a few months ago.

This is why when people ask me about a good place to invest, I do not point to the markets that have been moving upward for long periods of time and where they cannot cover their monthly payment with the fare market rent. If you want to build cash flow and seeking more money coming in each month than going out, then look for the long-haul principle of buy and wait.

Investors look for two ways to grow wealth: asset growth and cash flow. Hopefully, you can get both in the same property, but sometimes you have to settle for one or the other.

Eventually, a market will appreciate so much that the going rents won't pay for the monthly payment for the come lately investor. Thus, the investment creates a cash shortage each month -- which isn't necessarily bad. For instance, if your rent is $1,000 per month, but the mortgage is $1,200 -- the $200 monthly shortfall may be affordable and provide a good return on investment in the long haul, just like a good stock, if the asset is growing at a healthy rate.

For instance, if the property is appreciating at 10 percent and surpassing the $2,400 per year in payments you're having to make beyond the rental income through the year, then the asset growth builds your wealth and the renter makes the majority of the investment per month for you.

If you're looking to invest in short-term real estate, i.e., fixer upper to flip, then mortgage programs designed to create a low monthly payment may be the tool to use. These would be various adjustable rate mortgages (i.e., cost of funds index or Option ARMS) and interest-only mortgages.

Some of these type programs enable the investor/buyer to qualify for more property, control cash flow, and wait for property values to rise before selling/exchanging for a larger, more profitable investment over the next few years.

For instance, the 2/1 buy-down is making its way back into the market place. This is a mortgage that begins its interest rate 2 points lower than the fixed rate (4.5 percent in today's market), then moves up another percentage point the next year and then finally a fixed rate on the third to 30th years. This type loan was what I used on my very first mortgage. I was so excited to get a starting rate of 10 percent. By the time it increased to the 12 percent mark, fixed rate mortgages were headed downward and I refinanced to 7.5 percent (again, very excited at the time to have such a low rate).

Another adjustable rate mortgage popular with investors is the Option ARM., defines an Option ARM as a loan program with an adjustable rate mortgage "with added flexibility of making one of several possible payments on your mortgage every month, in order to better manage your monthly cash flow."

Again, this type loan provides very low monthly payments -- lower than those mortgages with fixed rate mortgages. The primary concern for any ARM and especially the Option, is the changing payment year over year. In particular for the Option ARM, you could find that while you're in the false security of having a positive cash-flow each month, your mortgage is increasing in value because you're paying the lowest allowed payment, which doesn't even pay enough interest to keep up with the mortgage. Thus, you would be in a negative amortization situation -- owing more than what you originally borrowed.

Before trying these mortgages -- get advice -- plenty of advice -- from a qualified, experienced mortgage professional who can explain all the benefits and liabilities (that means, dangers) of these programs.

Published: May 5, 2006

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