Interest-only loans & real estate investing

In the US there is a lot of debate about mortgages and the various options presented to people. The discussion tends to be a bit of a muddle. The poster child for bad loans is sub-prime. Lumped in together are ARMs and the focus of this post, interest-only loans. Throwing the baby and out with the bath water seems to be the order of the day.

Interest-only loans mean that the borrower is effectively renting the money from the bank. Like any renter they need to pay monthly and at the end they need to return to the bank the money provided.

In the UK, lenders recommend interest-only mortgages for all BTL property. As some might already recognize, BTL is the term used in the UK to refer to rental property. Why should investors only use interest-only mortgages? The banks feel that an investor is holding the property to make money. Both from the rental income and the possible capital appreciation in the future. Paying down the loan balance for an asset that is likely to rise seems to trap capital in the property when that cash can be better used elsewhere. Holding the cash in reserve for emergencies and scheduled repairs is a better use. Using the cash to invest further is another. The lenders just do not see the logic in paying down the principal. Loan pay down is not considered the highest and best use for the rental income.

But how will the lender get paid? If you ask them they will say that either the borrower will refinance to extract equity at some point in the future or the loan will be paid off when the property is sold. Only in the case of falling values will the lender be concerned. As the lender expects a 15% deposit (down payment) they do not see much risk of the asset ending up being worth less than the outstanding balance of the loan.

Interest-only loans for real estate are a tool. Somewhat like a car lease. With a house you are more likely to see the asset’s value rise while it is almost a certainty that the car’s value will drop until all you have is rolling scrap. Leases make sense for many car buyers. Interest-only loans are fine for many investors. You just have to understand the math and the assumptions so you can plan for the future. The future might include falling property values in the short run so plan for alternative outcomes.

When the dot.com meltdown happened even good firms that were making money suffered. In the present sub-prime storm all ARMs, all interest-only loans and all other exotic loans are considered toxic. All sub-prime borrowers were somehow taken advantage of by the lenders. It could never be the borrower made a bad decision and now needs to deal with it. Interest-only is a tool. As a real estate investor it is your responsibility to use the right tool for the task. Do Your Own Research (DYOR).

What about the headlines and the other blogs who say…

The savvy real estate investor focuses on the details of the specific deal. They understand their game. They read the headlines to understand what the public is thinking. They know the headlines are largely crap when it comes to finding great deals. They want motivated sellers to present them with great deals. The headlines condition the sellers that the future is bleak. Sellers who only look at the headlines (the sky is falling, house prices are crashing, news at 11:00 PM) will not act rationally. When speaking to a motivated seller the savvy investor needs to know what is possible using the tools in their toolbox. To solve the seller’s problem while picking up the property at the same time. An interest-only loan is one such tool.

You make your profit when you buy. You collect your cash when you sell or refinance.

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4 Responses to “Interest-only loans & real estate investing”

  1. Beach_babe9711 Says:

    That makes since. In the city I’m in there are over 30 pre forecloses that have a notice of default. preforeclosers are higher than they have been before. some people who take out the exotic mortgages, ARMS, and interest only do that to just qualify, but then they are forced to refinance or they cant keep up with the payments. There are a lot of banks that now you don’t have to put any money down, and people are paying the lowest payments and it just adds to their loan because it’s a negative am. if your buying a home for your self i think you need to put money down, or make sure you can pay the payments, besides the interest only or introductory ARM. I think its better to get a 30 year or 40 years fixed rate. But if your investing, then sometimes not having money can be for the best. even if you have all the 20% to put down, you can use different loans as tools, so you can keep your money, and still finance the property, and use your money for repairs, and the monthly payments. If your investing and plan to have the property for a short term, then using interest only, or a fixed arm would be better. some loans offer a 5 year arm and a 7 year arm at the same rate, so to be safer, you’d want to go with the 7 years. so if your not investing, and you want to do interest only, or an arm, you need to make sure you can pay the payments after that time period. And making payments to both interest and principle would be better if it’s your primary home. But for investing, you should always look at the loan options, to use the different tools that can help with your investment. I always make sure my loan has no pre payment penalties, and no PMI, even if I borrow more than 80%. And you don’t have to pay your taxes in the monthly payments. If you have a savings account making 5%, then you can use that to pay the taxes the end of the year.

  2. Beach_babe9711 Says:

    another comment. one thing that makes me mad, is that most people do not have an education about properties or investing because they don’t teach you in high school. I’m young and some of my friends are in high school, and no one is teaching them about properties. when they leave high school and want to buy a house when theyr older guess what most of them are going to do? when they find their house they wan that’s for sale, the sign has the sellers agents number. so there going to call and guess what happens next? the seller agent says they can help them buy the property and show them the house, and they are nice and seem helpful. But the seller agent is looking for the best interest of the seller and not the buyer. so if the buyer tells the agent the most they are willing to pay, the seller agent will tell the seller. but the agent WILL NOT tell the buyer what the lowest price the seller will accept. BUT the agent made it look like it would be a good idea to also work for the buyer. “sure I can do your paperwork and show you the house and answer all your questions. every time I call an agent when they are selling a property the first question they always ask me is ” do you have an agent” if I say yes, guess what they say…….”well you can ask your agent to get the comps for you” and they are turned off. not saying they are bad, but some people wont know what the best thing to do when they are buying.

  3. Beach_babe9711 Says:

    some of my ways of making money. I was seeing if you would agree with it. just for tax liens, the only problem is they are only once or twice a year. so like what you were saying, ( one way to make money is to exit every 30 days, so it can be 12x a year like retail) but with tax liens you cant really do that. so what I was going to do is focus on the states I’m interested in. I like arizona 16%, flordia 18%, iowa 24%, and michigan, texas, and goergia because they have penalties as high as 50%. so I would put them in order. (for example) I would start with one state which would be on one month, then go to another state that does their tax liens on a different month, instead of waiting 1 year in the same state, then I could do 5 states in the same year. like I’m doing 5 months close together. also, if I have 50,000 to invest, instead of trying to buy 1 lien for that amount, it would be better to divide my money into different liens(but still purchasing the liens in the thousands) so if 1 lien gets redeemed real fast, I still have other liens to fall back on for the full year or more to get the entire interest or ROI. for example iowa is 24%, so that’s 2% each month adding up till its redeemed. if one lien is redeemed in the first 2 months, I still have more that may not get payed till the full redemption period of 21 months for iowa. and to limit risk, I would always make sure I look at the properties first, and that their worth a lot of money and are in good condition. then I know how much I’m willing to bid up if there is a lot of competition. my goal would be to stop at about 50% of the value of the property so I would always have that 50% equity to be safe. even in a down market, that equity would still keep it safe. and if the property has a mortgage on it, then that’s good, because the lenders will pay the taxes if they have to, to save their investment, so it will be payed. I plan on saving money for two years, but after my first year of money, I would invest in liens so I can make more money while I’m saving.

  4. Beach_babe9711 Says:

    addition- one thing i don’t like is that some people say liens are guarteed safe because its from the government. but thats not completly true. it doesnt mean your guarenteed to get payed. it means your first in line. I dont think liens are FDIC insured. another problem is if the owner declares bankruptcy, that could make it a little harder. but there is that 5% of the time they dont redeem it, then you get their property, and you also have the right to foreclose on the propertry. BUT the only thing im concerned about are the “businesses” that pool money together from 100’s of investors. that could make the bidding hard, and seem like everytime they would win. thasts the only part im looking into rightnow.

    You are correct when you say that tax lien certificates (TLC) are not government guaranteed. There is no guarantee other than a lien. The TLC might not be in first (there can be other TLCs in front). The property might not be worth the value of the TLC.

    DYOR – that is the key.

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