Over time you’ll find it much more profitable to stop applying for conventional institutional loans. You’ll go a lot farther, faster if you try to borrow from private investors who understand your problems rather than from banks and mortgage companies. This might require a shift in your thinking. Who owns the money that you’ve been borrowing? In the vast majority of cases, it won’t be the institution that lends it to you. Instead capital is owned by investors who buy bonds, open accounts in banks, stock brokerages, thrift institutions, credit unions, etc.
By locating a few of these people and offering them a better deal than that offered by institutions into which they’ve been depositing funds, you will have access to financing that is far superior to those nosy and gossipy institutional credit sources which you have been accustomed to using.
Why is private financing more valuable to you than institutional? There are myriad reasons which relate to availability of money at times when institutions won’t lend it for investment. Remember, the institutional lenders are in a regulated industry. Their decisions are pretty much limited because they are using someone else’s money, not their own. They can only lend on certain kinds of property within fairly limited geographic areas. They are relatively inflexible when it comes to repayment terms, the security they will accept, and the speed with which they can react to a special situation.
In contrast, the private lender is not regulated (when lending to non-owner occupants). Because he is lending his own money, he can withdraw it from the very bank who might turn down your request. He is probably not going to charge loan closing costs or points. He can make a decision to grant the loan in just a few moments, and also make the loan based more upon your demonstrated character than on the precise appraised value of collateral you might offer.
Your private sources will be available year after year and won’t be prone to “transfer” like bank officers. In many instances you’ll be able to secure better terms, and establish long term credit relationships that won’t appear in your credit file. If you get into a tight spot, in circumstances in which bankers would foreclose, private lenders tend to work with you, or to transfer debt into equity in the property. Your private lender won’t have weekend and holiday closings, and he’s “open” at night. Don’t overlook him. Certainly it’s much more difficult to round up credit from private investors than from institutional sources, particularly when it comes to big dollars; but it is also certainly worth all the trouble. Why?
Few private lenders are plugged into a computer system that would share your financial information with the world. Thus, there is a lot less chance that you’ll fall victim to someone on the prowl for assets to grab through a law suit or levy. And virtually no chance that an error concerning your credit performance will be entered into some computer system.
PRIVATE LINES OF CREDIT
One can’t overstate the importance of having a financial line of defense against unexpected cash flow drains. Having outstanding private and institutional credit references can stand the investor in good stead during periods of economic recession — not only the institutional line advanced by commercial banks and credit unions but also private lines of credit advanced by private lenders and money market investors.
Before you get all befuddled trying to discover just where these private lines of credit can be found, pause a moment and think a little about how banks and savings institutions really work. In so many words, don’t they actually operate on private lines of credit themselves? Oh sure, they have large commercial accounts holding millions of dollars, but much of it is on relatively short term deposit.
The real back bone of institutional lenders consists of thousands of small savers who deposit their savings regularly. When these depositors desert a savings institution as a group, which is what happened in 1974/75 and in 1980/82, and which will probably happen again any time that the economy slumps again. They call the sudden withdrawal of deposits in large quantities “disinter mediation of funds“. That’s a long word that means depositors are taking their money out of institutional savings accounts.
This hurts the lenders much more than one might expect. Bankers use a system of leveraged reserves which calls for only a mere fraction of their loans to be covered by reserve deposits. Leverage hurts the banker when his revenues are reduced just as it hurts you, the SFH investor when your rents don’t come in.
Any withdrawal of funds leaves the banks in the position of potentially having to call in short term and demand notes held by their customers. This in turn creates a lack of confidence in the minds of borrowers as to the conditions under which they can expect future support from their bank.
When might a private investor choose to withdraw savings from his bank? When a greater yield might be available with the same amount of safety, or when the inflation rate is so high that low average institutional interest yields are insufficient to offset loss of purchasing power.
Thus, if you can establish a solid reputation for prompt payment of bills and for fiscal responsibility, you might entice private investors to extend to you limited short term lines of credit. Of course you would have to offer higher than average secure yields. You might find ways to collateralize these loans by pledging your rents but there are advantages.
Private lenders can be reached on the weekends and holidays when banks are closed. Private loans usually require far less paper work and expense. And lenders will be loyal when times are hard, or more understanding when it is necessary to renegotiate a loan.
Failing in attracting private lines of credit, the single family house investor should try to induce his commercial banker to extend a limited line of credit. We’d suggest that you try to get a line that would pay at least two months of your mortgage payments if the need were to arise. Why?
Suppose something happened to cut off your rental income such as temporary, area-wide, high unemployment rates. Or loss of income could stem from something as simple as street repairs which blocked access to your property, water line breakage, etc. Should this happen, you’ll need to provide for your monthly payments until the situation can be remedied by selling the property or restoring rents.
You can see that it’s crucial that you be able to anticipate these events as much as possible by being aware of the plans of the state road department, building department, public utilities commission,-expansion or contraction of major employers, etc. Normally the papers are quite reliable about informing owners of impending programs, but it is up to the investor to have a contingency plan. The line of credit serves just this purpose.
WHEELING AND DEALING WITHOUT CASH
In the final analysis, investment boils down to sacrificing income and assets today in order to enjoy them at a point in the future. The less cash and credit you use to get higher yields the less sacrifice and risk; and the less time until you can start enjoying your profits. Several factors influence investment and net return. These are:
Taxes, Inflation, Interest, Leverage, and Amortization. To the extent you can use these factors to your own advantage, the higher your yield will be. Almost all real estate investors and speculators use Debt Leverage to acquire and control assets, but this is risky and expensive. Let’s review:
1. Credit is usually obtained from institutional lenders at market interest rates and terms.
2. Borrowers have to guarantee payments personally, thereby placing all their assets at risk for each additional loan they sign on personally.
3. When net market prices after costs of sale and taxes are rising at a rate in excess of the rate of interest, the use of leverage is warranted, but …
4. Appreciating property values don’t offset negative cash flow unless the property is sold, or re-leveraged.
5. Selling property to replace cash flow robs the seller of all future appreciation in a rising market.
6. Borrowing at higher and higher interest rates to increase cash reserves with which to repay debt on negative cash flow property merely transfers equity to the lender.
7. Risk for the debt-leveraged owner is increased by external factors such as the EPA (Lead Paint, Asbestos, Formaldehyde, Radon), Social legislation (Rent Controls), Down-Zoning and restricted use policies.
8. Control of a property through the use of leases + Options without ownership removes most of the risk associated with real estate investing and speculation.
9. Leases and Options enable those without much money to leverage future profits without the need to qualify for, or to guarantee, acquisition loans, or repayment of them.
Learn more with Jack Miller’s Money Matters Recorded Seminar which Includes video, audio and workbook from 3-Day event
