An almost invisible profit is generated anytime that capital owned by others can be used at low cost. The most obvious example of this would be where I borrowed your vacation home, then rented it out to others. Taking this a step further out of public glare, I might rent it from you at below-market rents, then rent it at market. Or, I might buy an Option, then re-sell the Option at a profit. Or, I could do both of the above. In any event, I'd be using your capital rather than mine. Let's extend this concept a little:
I could buy an Option from you simply by setting up a series of payments under a 'Contract for Option'. For instance, if you wanted $10,000 for a 3 year Option to buy your house for $100,000, subject to the remaining balance on a, now, $50,000 loan. I might agree to pay $100 a week for 100 weeks, after which I'd have 1 more year in which to exercise my Option. That would give me control over all the appreciation from my first payment. If the house were to appreciate at 3% per year, or .25% per month, each month, my $100 would be earning $250 in equity. 250% per week is considered to be a pretty fair return, but I can do better.
Suppose my Option gave me 90 days to raise the money and close the sale following my exercising it? That would add another 1% to my appreciation, or $1000. Taking no prisoners, I might structure the Option so that I paid you the firm figure of $40,000 plus my $10,000 in payments, taking over payments on the then current loan balance. This way, I'd also pick up all the loan amortization that you would have paid for in the interim. This might add another $1000 or so. I'm still using more of your money, and now, credit, than mine.
Suppose my Option had called for a credit against the purchase price of 25% of any lease payments I made to you. On a Lease/Option arrangement, at $1000 per month, I'd be getting a $250 credit against the price each month, or $3000 per year. If I were able to sub-let the house at a loss for $900 per month, the $100 in negative cash flow would be earning another 250% per month. If I were in the 28% tax bracket, I'd be able to deduct about $250 per year too because of my rental activity losses even though my equity in the Option would be exploding.
The principle continues to apply if I were to get you to carry back the financing of your equity with a zero-interest loan once the Option were exercised. Why might you do this? Because, you might have moved into another house, or into another city; or because you had realized a large profit in the house on the sale price. Or you might really need the $100 per month for 100 months, and wouldn't want to upset the deal.
Or, you could be in danger of losing the house altogether. In distress situations, merely getting another person to make up back payments and to keep future payments paid on a current basis is a valuable benefit. Suppose you were going to lose your house because a job change had taken you out of the area. In the event that I couldn't convince you to provide zero interest financing, I'd surely try to arrange for accruing simple interest at a competitive rate. Let's say this might be 6%, look at the benefits to me:
If I paid 6% simple on your loan for 5 years, I'd pay you $200 per month with the balance of $40,000 due in full in 5 years. I'd try to sell the property prior to the fateful day, and enjoy what might turn out to be about $200 per month cash flow in the interim. That would amount to $12,000.
In the above situation, I might even let you convince me to accelerate my Option so as to take over your loan payment on the $50,000 earlier. In return, I'd ask for a single payment on the balance remaining on your $50,000 equity; all due in cash in 5 years. This would give me a zero interest rate, deferred payments, cash flow from the rents, and even higher profits. Understanding the value of all of the above variables, and using them, is how fortunes are made.
Suppose you buy someone's high equity house and negotiate single payment, zero interest financing. In effect, you're getting the use of the seller's equity at no cost, and with no payments until the loan term expires. The higher the equity, the more money you'll be borrowing at the lower interest cost; thus the lower your average cost of borrowing when you average in any existing loan rates.
You can always set your sights lower and make payments to fully amortize the loan, or pay something less than market interest rates. The closer you move to conventional financing arrangements, the less profit spread there will be for you.
The next thing you could try to do would be to use something other than the house that you're buying as collateral for your loan. When you can buy using corporate shares as explained earlier, or another property, you free up more equity in the house you're buying.
You'll be able to sell the newly purchased house, or borrow against it, for cash to lend to others at high rates. All this can be pretty confusing unless you keep your eye on three things:
1. You can't make money borrowing at market rates and lending at market rates. You must create the potential for a spread between these two.
2. You have to be able to find a source of reliable consumers with good personal credit to whom you can re-lend the money you've borrowed. They must be willing and able to pay high interest rates for the use of your money, and to secure their promissory notes. The security for the notes must be something that you would be willing to buy with cash for the amount of cash that you're lending them.
3. People who are motivated by the need to sell property are the best sources of single-payment, zero interest rate loans. And people who need shelter are the best customers to whom a house bought this way can be sold at a profit.
