Ralph R. Roberts Real estate professional and coauthor of Foreclosure Investing For Dummies

Chip Cummings Real estate financing expert and author

• Evaluate potential lenders

• Maximize your cash flow

• Finance through private lenders

• Tap into government programs

Learn to:

Financing Real Estate

Investments

Making Everything Easier!™

Open the book and find:

• Real-world advice on financing without tying up all your capital

• How to get prequalified or preapproved for a loan

• Questions to ask your lender upfront

• Ways to avoid common beginner blunders

• How to protect your personal assets from investment risks

• Bargain-hunting hints for low-cost loans

• Strategies for surviving a credit crunch

• Ten pre-closing steps you must take

Ralph R. Roberts is an internationally acclaimed real estate agent, speaker, investor, and consultant. Chip Cummings is a real estate lending expert, a Certified Mortgage Consultant with more than 25 years of experience, and a seasoned real estate investor. Roberts and Cummings coauthored Mortgage Myths: 77 Secrets That Will Save You Thousands on Home Financing.

$21.99 US / $25.99 CN / £15.99 UK

ISBN 978-0-470-42233-5

Business/Real Estate

Go to dummies.com®

for more!

Want to be a smart, successful real estate investor? This no-nonsense guide contains everything you must know to make the right choices about financing your investments — from the various options available and the impact on cash flow to the tax implications and risk factors involved. You also get tried-and-true tips for surviving a down market and using current investments to finance future ones.

• A crash course in real estate financing — understand standard terms and concepts, learn the various sources of investment capital, and gather all essential facts and figures

• Weigh your options — decide which type of financing is best for your circumstances and incorporate it into your real estate investing plan

• Finance residential properties — evaluate residential loan programs, navigate the loan application and processing, and handle the closing

• Invest in commercial properties — know the different property types, choose the one that meets your investment goals, and discover unique sources for financing

• Tap into unconventional sources — discover the pros and cons of “hard money,” capitalize on seller financing, partner to share risk and equity, and invest on the cheap with no-money-down deals

Your practical guide to scoring cash to fuel your real estate investments Financing R

eal Estate Investments

Roberts Cummings

Spine: .576 in

02_422335-ftoc.qxp 3/11/09 11:50 AM Page viii

Financing Real EstateInvestments

FOR

DUMmIES‰

by Ralph R. Roberts and Chip Cummings with Joe Kraynak

01_422335-ffirs.qxp 3/11/09 11:49 AM Page i

Financing Real Estate Investments For Dummies®

Published byWiley Publishing, Inc.111 River St.Hoboken, NJ 07030-5774www.wiley.com

Copyright © 2009 by Wiley Publishing, Inc., Indianapolis, Indiana

Published by Wiley Publishing, Inc., Indianapolis, Indiana

Published simultaneously in Canada

No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form orby any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permit-ted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written per-mission of the Publisher, or authorization through payment of the appropriate per-copy fee to theCopyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600.Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley& Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online athttp://www.wiley.com/go/permissions.

Trademarks: Wiley, the Wiley Publishing logo, For Dummies, the Dummies Man logo, A Reference for theRest of Us!, The Dummies Way, Dummies Daily, The Fun and Easy Way, Dummies.com, Making EverythingEasier, and related trade dress are trademarks or registered trademarks of John Wiley & Sons, Inc. and/orits affiliates in the United States and other countries, and may not be used without written permission. Allother trademarks are the property of their respective owners. Wiley Publishing, Inc., is not associated withany product or vendor mentioned in this book.

LIMIT OF LIABILITY/DISCLAIMER OF WARRANTY: THE PUBLISHER AND THE AUTHOR MAKE NO REP-RESENTATIONS OR WARRANTIES WITH RESPECT TO THE ACCURACY OR COMPLETENESS OF THECONTENTS OF THIS WORK AND SPECIFICALLY DISCLAIM ALL WARRANTIES, INCLUDING WITHOUTLIMITATION WARRANTIES OF FITNESS FOR A PARTICULAR PURPOSE. NO WARRANTY MAY BE CRE-ATED OR EXTENDED BY SALES OR PROMOTIONAL MATERIALS. THE ADVICE AND STRATEGIES CON-TAINED HEREIN MAY NOT BE SUITABLE FOR EVERY SITUATION. THIS WORK IS SOLD WITH THEUNDERSTANDING THAT THE PUBLISHER IS NOT ENGAGED IN RENDERING LEGAL, ACCOUNTING, OROTHER PROFESSIONAL SERVICES. IF PROFESSIONAL ASSISTANCE IS REQUIRED, THE SERVICES OF ACOMPETENT PROFESSIONAL PERSON SHOULD BE SOUGHT. NEITHER THE PUBLISHER NOR THEAUTHOR SHALL BE LIABLE FOR DAMAGES ARISING HEREFROM. THE FACT THAT AN ORGANIZATIONOR WEBSITE IS REFERRED TO IN THIS WORK AS A CITATION AND/OR A POTENTIAL SOURCE OF FUR-THER INFORMATION DOES NOT MEAN THAT THE AUTHOR OR THE PUBLISHER ENDORSES THEINFORMATION THE ORGANIZATION OR WEBSITE MAY PROVIDE OR RECOMMENDATIONS IT MAYMAKE. FURTHER, READERS SHOULD BE AWARE THAT INTERNET WEBSITES LISTED IN THIS WORKMAY HAVE CHANGED OR DISAPPEARED BETWEEN WHEN THIS WORK WAS WRITTEN AND WHEN ITIS READ.

For general information on our other products and services, please contact our Customer Care Departmentwithin the U.S. at 877-762-2974, outside the U.S. at 317-572-3993, or fax 317-572-4002.

For technical support, please visit www.wiley.com/techsupport.

Wiley also publishes its books in a variety of electronic formats. Some content that appears in print maynot be available in electronic books.

Library of Congress Control Number: 2009921030

ISBN: 978-0-470-42233-5

Manufactured in the United States of America

10 9 8 7 6 5 4 3 2 1

01_422335-ffirs.qxp 3/11/09 11:49 AM Page ii

About the AuthorsRalph R. Roberts, CRS, GRI, is a seasoned professional in all areasof real estate, including buying and selling homes, investing in realestate, and building and managing real estate agent teams. He hasbeen profiled by the Associated Press, CNN, and Time magazine,and has done hundreds of radio interviews. He has authored andcoauthored several successful titles, including Flipping Houses ForDummies, Foreclosure Investing For Dummies, Foreclosure Self-DefenseFor Dummies, Mortgage Myths: 77 Secrets That Will Save You Thousandson Home Financing, and Foreclosure Myths: 77 Secrets to SavingThousands on Distressed Properties! (John Wiley & Sons); ProtectYourself Against Real Estate and Mortgage Fraud: Preserving theAmerican Dream of Homeownership (Kaplan); and REAL WEALTH byInvesting in REAL ESTATE (Prentice Hall).

To find out more about Ralph Roberts and what he can offer youand your organization as a speaker and coach, visit AboutRalph.com.For details on how to protect yourself and your home from realestate and mortgage fraud, check out Ralph’s blog at FlippingFrenzy.com. And don’t miss the latest addition to Ralph’s family ofWeb sites and blogs, GetFlipping.com, where Ralph offers addi-tional information and tips on the art of flipping houses and invest-ing in foreclosures and pre-foreclosures. You can contact Ralph byemailing him at RalphRoberts@RalphRoberts.com or calling586-751-0000.

Chip Cummings, CMC, is a recognized expert in the areas of realestate lending and e-Marketing, and is a Certified MortgageConsultant with more than 25 years in the mortgage industry andmore than a billion dollars in sales volume.

Chip has written hundreds of articles and appeared numerous timeson radio, television, and in various magazines including Entrepreneur,Mortgage Originator, Real Estate Banker/Broker, and The MortgagePress. He is an experienced professional in all areas of real estatefinancing, including residential and commercial mortgages, govern-ment lending, regulatory and compliance issues. He is past presidentof the MMBA (Michigan Mortgage Brokers Association), and is alicensed mortgage broker and lender in Michigan.

As an international speaker, he has addressed groups and organiza-tions of all types, and trains thousands of mortgage professionalsfrom around the country every year. Chip is a certified nationaltrainer for continuing education in more than 40 states, and hasserved as an expert witness in state and federal courts. He is alsothe author of ABC’s of FHA Lending and Stop Selling and StartListening! – Marketing Strategies That Create Top Producers(Northwind), Mortgage Myths: 77 Secrets That Will Save YouThousands on Home Financing, Foreclosure Myths: 77 Secrets toSaving Thousands on Distressed Properties! and Cashing In on Pre-foreclosures and Short Sales (John Wiley & Sons).

01_422335-ffirs.qxp 3/11/09 11:49 AM Page iii

Chip lives in Rockford, Michigan with his wife Lisa and three chil-dren, Katelyn, CJ, and Joe.

To learn more about Chip Cummings, his many successful productsor how he can help your organization as a speaker or business con-sultant, visit www.ChipCummings.com. To receive a complimen-tary subscription to his multimedia e-newsletter and online events,check out www.eCoachingClub.com. You can also reach Chip byemailing him at info@ChipCummings.com or by calling616-977-7900.

Joe Kraynak (joekraynak.com) is a freelance author who haswritten and coauthored numerous books on topics ranging fromslam poetry to computer basics. Joe teamed up with Dr. CandidaFink to write his first book in the For Dummies series, BipolarDisorder For Dummies, where he showcased his talent for translat-ing the complexities of a topic into plain-spoken practical advice.He then teamed up with Roberts to write the ultimate guide to flip-ping houses — Flipping Houses For Dummies and delivered encoreperformances in Foreclosure Investing For Dummies, AdvancedSelling For Dummies, and Foreclosure Self-Defense For Dummies. InFinancing Real Estate Investments For Dummies, Joe assists Chip andRalph in delivering the ultimate guide to scoring some cash to fuelyour investments in real estate.

01_422335-ffirs.qxp 3/11/09 11:49 AM Page iv

DedicationFrom Ralph: To real estate investors and professionals who arededicated to supporting and promoting the American dream ofhomeownership.

From Chip: To my assistant Debbie Forth who has managed to keepme organized for the last 14 years, and to my wife Lisa who puts upwith all the crazy hours and remains my #1 fan.

Authors’ AcknowledgmentsThanks to acquisitions editor Lindsay Lefevere, who chose us toauthor this book and guided us through the tough part of gettingstarted and to our agent, Neil Salkind of StudioB (www.StudioB.com),who ironed out all the preliminary details to make this book possible.Chad Sievers, our project editor, deserves a loud cheer for acting as avery patient collaborator and gifted editor — shuffling chapters backand forth, shepherding the text through production, making sure anytechnical issues were properly resolved, and serving as the unofficialquality control manager. Megan Knoll, our copy editor, earns an editorof the year award for ferreting out our typos, misspellings, grammaticalerrors, and other language faux pas-es, in addition to assisting Chad asreader advocate — asking the questions we should have asked our-selves. And, we tip our hats to the production crew for doing such anoutstanding job of transforming a loose collection of text and illustra-tions into such an attractive bound book.

We also wish to express our appreciation to the National Associationof Mortgage Brokers, National Association of Realtors®, the MortgageBankers Association of America, and the Michigan Mortgage BrokersAssociation for their support and assistance.

We owe special thanks to our technical editor, Patrick Lecomte, forflagging technical errors in the manuscript, helping guide its con-tent, and offering his own tips, tricks, and insights from the world ofreal estate financing.

01_422335-ffirs.qxp 3/11/09 11:49 AM Page v

Publisher’s AcknowledgmentsWe’re proud of this book; please send us your comments through our Dummies online regis-tration form located at http://dummies.custhelp.com. For other comments, please con-tact our Customer Care Department within the U.S. at 877-762-2974, outside the U.S. at317-572-3993, or fax 317-572-4002.

Some of the people who helped bring this book to market include the following:

Acquisitions, Editorial, and Media Development

Project Editor: Chad R. Sievers

Acquisitions Editor: Lindsay Lefevere

Copy Editor: Megan Knoll

Assistant Editor: Erin Calligan Mooney

Editorial Program Coordinator: Joe Niesen

Technical Editor: Patrick Lecomte, MA, MBA

Editorial Manager: Michelle Hacker

Editorial Assistant: Jennette ElNaggar

Cover Photos: © Comstock Images

Cartoons: Rich Tennant(www.the5thwave.com)

Composition Services

Project Coordinator: Patrick Redmond

Layout and Graphics: Melanee Habig,Melissa K. Jester, Christine Williams

Proofreader: ConText Editorial Services, Inc.

Indexer: Potomac Indexing, LLC

Publishing and Editorial for Consumer Dummies

Diane Graves Steele, Vice President and Publisher, Consumer Dummies

Kristin Ferguson-Wagstaffe, Product Development Director, Consumer Dummies

Ensley Eikenburg, Associate Publisher, Travel

Kelly Regan, Editorial Director, Travel

Publishing for Technology Dummies

Andy Cummings, Vice President and Publisher, Dummies Technology/General User

Composition Services

Gerry Fahey, Vice President of Production Services

Debbie Stailey, Director of Composition Services

01_422335-ffirs.qxp 3/11/09 11:49 AM Page vi

Contents at a GlanceIntroduction.......................................................1

Part I: Gearing Up for Financing Your Real Estate Investments..............................7

Chapter 1: Taking a Crash Course in Real Estate Investment Financing ..............................................................9

Chapter 2: Shielding Your Personal Assets from Investment Risks ...25Chapter 3: Gathering Essential Documents, Facts, and Figures.........43Chapter 4: Scoping Out Prospective Lenders.......................................61

Part II: Financing the Purchaseof Residential Properties..................................77

Chapter 5: Finding the Residential Loan Program That’s Right for You ...........................................................................79

Chapter 6: Bargain Hunting for Low-Cost Loans ..................................93Chapter 7: Navigating the Loan Application and Processing ...........105

Part III: Financing the Purchase of Commercial Properties ................................127

Chapter 8: Picking the Right Commercial Property Type for You....129Chapter 9: Exploring Sources of Financing

for Commercial Properties .............................................................149Chapter 10: Securing a Loan to Finance

Your Commercial Venture ...............................................................163

Part IV: Sampling More Creative Financing Strategies ......................................173

Chapter 11: Financing in a Pinch with Hard Money and Other Tough Options ...............................................................175

Chapter 12: Capitalizing on Seller Financing ......................................193Chapter 13: Partnering to Share the Risk and the Equity .................207Chapter 14: Profiting from No-Money-Down

and Other Creative Deals ................................................................219

Part V: The Part of Tens..................................231Chapter 15: Ten Ways to Avoid Common Beginner Blunders...........233Chapter 16: Ten Steps to Take before Closing ....................................239Chapter 17: Ten Tips for Surviving a Credit Crunch..........................245

Glossary ........................................................251

Index.............................................................261

02_422335-ftoc.qxp 3/11/09 11:50 AM Page vii

02_422335-ftoc.qxp 3/11/09 11:50 AM Page viii

Table of ContentsIntroduction .......................................................1

About This Book .........................................................................1Conventions Used in This Book ................................................2What You’re Not to Read............................................................3Foolish Assumptions ..................................................................3How This Book Is Organized......................................................3

Part I: Gearing Up for Financing Your Real Estate Investments......................................4

Part II: Financing the Purchase of Residential Properties .............................................4

Part III: Financing the Purchase of Commercial Properties............................................4

Part IV: Sampling More Creative Financing Strategies .....................................................4

Part V: The Part of Tens...................................................5Icons Used in This Book.............................................................5Where to Go From Here..............................................................5

Part I: Gearing Up for Financing Your Real Estate Investments...............................7

Chapter 1: Taking a Crash Course in Real Estate Investment Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Pumping Up Your Purchasing Power with Borrowed Money ...10Minimizing your potential by owning

property free and clear ..............................................10Maximizing your potential with

other people’s money.................................................10Paying cash with borrowed money..............................11

Brushing Up on Basic Real Estate Financing Lingo ..............12Identifying types of lenders...........................................12Grasping different loan types........................................13Brushing up on important legal lingo ..........................14Pointing out mortgage concepts ..................................16Examining equity ............................................................16Looking at loan-to-value (LTV)......................................17

Distinguishing Investment and Home Financing...................17Paying a premium for riskier investment loans..........17Using quick cash to snag bargain prices .....................18Accounting for taxes on your capital gains

(or losses)....................................................................18Protecting your personal assets...................................19

02_422335-ftoc.qxp 3/11/09 11:50 AM Page ix

Exploring Common Sources of Investment Capital ..............19Tapping your own cash reserves..................................20Borrowing from commercial lenders ...........................21Obtaining a hard money loan........................................22Financing your purchase through the seller ...............22Taking on a partner ........................................................22

Prepping to Meet with a Lender..............................................23Gathering paperwork and other info ...........................23Crafting a business plan.................................................24

Chapter 2: Shielding Your Personal Assets from Investment Risks . . . . . . . . . . . . . . . . . . . 25

Understanding Why You Need to Protect Your Personal Assets ..............................................26

Limiting Your Personal Liability by Forming an LLC............26Understanding the pros and cons ................................27Setting up an LLC............................................................28Taking and securing title to real estate........................28Eyeing Sub-S corporations and partnerships .............29

Transferring Personal Assets via Trusts................................30Weighing the pros and cons of owning property

in another’s name .......................................................31Gaining asset and tax protection

with an irrevocable trust ...........................................32Considering real estate investment trusts (REITs) ....33

Staying Away from Promissory Notes with Recourse Clauses .........................................................33

Opting for a nonrecourse loan......................................34Negotiating the recourse clause ...................................34Avoiding cross-collateralization ...................................35

Steering Clear of Real Estate and Mortgage Fraud ...............36Telling the truth on your application...........................37Dodging predatory lenders ...........................................38Saying “no” to inflated appraisals ................................39Turning your back on cash-back-at-closing

schemes .......................................................................40Avoiding illegal flipping..................................................40Defending yourself against chunking schemes...........41Refusing a builder bailout..............................................41Acting with integrity: The golden rule .........................42

Chapter 3: Gathering Essential Documents, Facts, and Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Examining Your Credit Reports...............................................43Obtaining free copies of your reports..........................44Checking your credit score ...........................................45Inspecting your report for problems ...........................46

Financing Real Estate Investments For Dummies x

02_422335-ftoc.qxp 3/11/09 11:50 AM Page x

Repairing your credit and boosting your score..........47Avoiding mistakes that can sabotage

your loan approval...................................................................48Chasing Down Vital Paperwork...............................................49

Delving into your personal financial information.......49Accounting for business income ..................................53Documenting the property you plan to purchase......54

Show Me the Money: Identifying Sources of Ready Cash ....59Sources of cash for down payments,

closing costs, and prepaid items ..............................59Rainy day funds: Cash reserves....................................60

Getting Prequalified or Preapproved......................................60

Chapter 4: Scoping Out Prospective Lenders . . . . . . . . 61Borrowing Directly from Banks...............................................61

Weighing the pros and cons ..........................................62Conventional loans.........................................................64Subprime (nonconforming) loans ................................65

Dealing with a Middleman (or Woman): Mortgage Brokers ...66Weighing the pros and cons ..........................................67Shaking the branches for a broker ...............................68Checking a broker’s credentials....................................68

Taking the Hard-Money Route through Private Lenders .....70Borrowing from Uncle Sam: Government Loan Programs ......72Financing through the Seller ...................................................73

Lease options ..................................................................73Land contracts ................................................................74

Teaming Up with a Cash-Heavy Partner.................................74Opting for a limited partnership...................................75Going the corporation route .........................................76

Part II: Financing the Purchase of Residential Properties ...................................77

Chapter 5: Finding the Residential Loan Program That’s Right for You . . . . . . . . . . . . . . . . . . . . 79

Understanding Why Finding the RightResidential Loan Is Key ........................................................79

Choosing a Loan Type to Maximize Your Cash Flow............80The power of OPM (other people’s money)................81Interest-only mortgages.................................................82Grabbing a hold of ARMs...............................................83Hybrids.............................................................................85Hard-money loans: Private investors...........................85

Taking Advantage of Government-Secured Loans ................86Tapping the FHA for a loan............................................86Viewing Veterans Affairs (VA) loans .............................89

Table of Contents xi

02_422335-ftoc.qxp 3/11/09 11:50 AM Page xi

Financing Real Estate Investments For Dummies xii

Considering REO loans ..................................................89Tapping into state and local grants and loans............90Digging up USDA Rural Development loans ................92

Avoiding the Prepayment Penalty Trap .................................92

Chapter 6: Bargain Hunting for Low-Cost Loans. . . . . . 93Understanding How This Interest Thing Works....................93

Keeping simple with simple interest ............................94Grasping the concept of amortization .........................94Telling the difference between the

interest rate and APR ................................................96Exploring how adjustable rate mortgages work.........97Paying interest upfront with points .............................98

Considering the Mortgage Term .............................................99Accounting for Closing Costs ................................................100

Getting socked with origination fees .........................100Forking over other fees................................................100Examining the Good Faith Estimate ...........................102

Calculating a Loan’s Total Cost .............................................103

Chapter 7: Navigating the Loan Application and Processing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

Completing Your Loan Application.......................................105Walking through the parts of the loan application...106Reviewing the lender’s disclosures ............................108Supplying the requested documentation ..................111Signing a release of information .................................112

Following the Loan Processing Trail ....................................112Getting up to speed on the underwriting process ...113Obtaining an appraisal or AVM ...................................113Having the property inspected ...................................114Obtaining a survey .......................................................119

Navigating the Closing............................................................120Keeping your attorney in the loop .............................120Dealing with the preliminaries....................................120Signing the documents.................................................122Knowing your right of rescission . . . or lack thereof ...122Dealing with surprises .................................................123

Financing Other Types of Residential Properties ...............124Digging up money for vacation properties................124Financing investment properties................................125Purchasing vacant land................................................126

02_422335-ftoc.qxp 3/11/09 11:50 AM Page xii

Table of Contents xiii

Part III: Financing the Purchase of Commercial Properties.................................127

Chapter 8: Picking the Right Commercial Property Type for You. . . . . . . . . . . . . . . . . . . . . . . . . . 129

Estimating the Income Potential of a Commercial Property ..................................................130

Calculating effective gross income (EGI)...................130Calculating Net Operating Income (NOI)...................131Estimating the property’s true value .........................132Projecting future profits with a pro forma ................133

Dwelling On the Thought of Multifamily Homes.................134Two- to four-family homes...........................................135Garden apartments.......................................................136Large multifamily properties.......................................136Crunching the numbers ...............................................138

Buying and Renting Out Office Space: The A-to-D Grading Scale ...................................................139

Investing in Retail Real Estate ...............................................140Collecting your cut of gross sales...............................141Comparing strip malls and convenience stores .......142

Running Your Own Hotel or Motel........................................142Distinguishing between flagged

and unflagged properties.........................................143Encountering income challenges................................144

Checking Out Industrial or Warehouse Properties.............145Calculating income and costs .....................................145Considering storage facilities......................................146

Exploring Mixed-Use Properties ...........................................146Sampling Some Special Use Properties................................146

Restaurants and bars ...................................................147Gas stations ...................................................................148Adult foster care ...........................................................148

Chapter 9: Exploring Sources of Financing for Commercial Properties . . . . . . . . . . . . . . . . . . . . . 149

Sizing Up Various Commercial Loan Programs...................150Exploring the middle market (local

and national banks)..................................................150Hitting up the private sector:

Hard-money lenders .................................................151Financing Main Street property

with Wall Street money ............................................152

02_422335-ftoc.qxp 3/11/09 11:50 AM Page xiii