There are two fundamental ways to make money with houses. One way is to buy it to sell or to rent it. The other was is to lend money to those who want to buy it or rent it. We've just about beat owning houses to death in the past dozen posts, but haven't said much about lending money to those who want to buy houses.
When you lend money, it begins earning a return immediately. There are no delays for fixing, marketing, and selling. Nor are there any maintenance or zoning wild cards out there to delay and reduce your profit.
What are the downsides to being a lender rather than a wheeler dealer? First of all, when you lend someone money, you get back a promise to repay in the form of a Note or Contract. This is ordinarily secured by a recorded Deed of Trust or Mortgage. When you boil it all down to its basics, you are traiding property for a promise; and promises can be broken. Broken promises in the form of loan defaults and bankruptcies are what caused the current economic melt down, and it can happen to you too. It certainly has happened to me over the years.
The solution is not to start thinking like a banker and trying to adjust your interest rate to compensate for perceivable risk associated with the credit rating of the borrower and the value of the collateral. This is what all those bankers who are in trouble today did, and look at the result. I think there's a much better way to lend money:
Today, when I'm approached by someone who wants to borrow money, I totally disregard any request for money unless it is going to be used to buy deeply discounted houses or finished subdivision lots. I also refuse to lend any money to anybody who doesn't pay his bills on time. I don't rely upon FICO scores. I go directly to his banker, to the local credit union, and to other lenders reflected on his credit report. Even after all of that, I still go an extra step that is critical.
I don't lend money at all. If I think what he is buying is a really good deal, I create a Trust for which I am the sole Beneficiary, and have the Trustee buy it. Then I have the Trustsee give the would-be borrower an Option to buy it back from me at a price that increases every year on the anniversary of the date of purchase.
For example, I recently bought a half filled mobile home subdivision for about $5000 per finished space. That's about 10% of the price the finished spaces were being sold for in 2006. In return for his agreement to pay only nomial property taxes, I gave the person who wanted to borrow money from me a 3 year Option to purchase any or all of these lots for $6000 at any time during the first year of ownership. The next year, the Option price was $7200 per lot. And the final year, the prices was $8640 per lot. A careful observer would note that I am getting about 20% profit, or more, every year until the lots are paid off.
Next time, we'll see how this arrangement benefits the buyer as well as me.
