Making Money With Foreclosures and 2/1 buydown
Posted on February 19, 2008
Following is an article by Shane Backer who was a guest expert in our chat February 18, 2008.
©Shane Backer 2007
In the current turbulent mortgage industry, there are many opportunities –and one of them is buying foreclosures. Default Research is a great source for excellent leads – maybe you’ve already started to buy them, which is a very smart move. Every single month more foreclosures hit the market. The most ever will hit in the fourth quarter of 2008, because that’s when a huge number of adjustable rate mortgages will expire, leaving many people with payments they can’t make. To make this work to your advantage, you need good leads (you’re already in the right place for that), and you need to know what to do with them once you’ve acquired the properties. That’s what this article is all about.
Several important strategies are available for making money with foreclosures. Two of my favorites are Lease Option to Buy contracts and the 2/1 Buy Down mortgage. Both of these exit strategies are very good ones – my advice is to pick one, master it and make it your niche.
To begin, you’ll market your property in the local paper or on the internet as “Lease Option to Buy”, offering to rent it for two years, with an option to buy when the two years are up. The rent will total slightly more than the cost of the mortgage, taxes and insurance. You’ll also require a large down payment, typically enough to cover about six months of mortgage payments, in case your renter misses one. For example, say you get a foreclosure worth $250,000 for $150,000. You obtain a mortgage for $150,000. With an 8% Interest Only mortgage your monthly mortgage payment will be $1,000. Your yearly taxes are $3,500 and your homeowners insurance for the year is $900 (monthly cost $291 and $75 respectively). Your total monthly costs are $1,366. You rent the property for $1650 a month and get a $9,900 down payment at contract signing. This money is non-refundable to the renter but will come off the purchase price if the buyer exercises his option to buy.
This is just one example — you can play with the numbers until they make sense for your situation. In any case, if you rent the property immediately, rather than waiting to sell, you’d get a monthly cash flow of $284 and an upfront fee of $9,900. If the renter exercises the option to buy after two years, you’ll profit by the difference between your cost at foreclosure and the selling price (in this case, by $100,000). If the renter chooses not to buy, you keep the $9,900. By that time, the property will have likely increased in value and gained back a lot of its equity. The down market might even be over. At that point you could list the property at its current value or do another Lease to Own contract.
If you want to sell a foreclosure immediately, I recommend using a 2/1 Buy Down mortgage. Of course, you could sell the property on the open market to an end user who will be the new owner, which works well in a seller’s market (few houses available to buy). However, we’re in a down, or buyer’s market (a surplus of houses for sale). – wWhen you’re competing with many other sellers, it’s harder to sell your own.
There are many unique and creative strategies for making your property stand out. Remember, you already have some equity, because you bought at foreclosure, so you have some room to maneuver when it comes to the selling price. In fact, you could just dump the property by listing it on the open market at way a good amount under value; — somebody would jump at the chance to buy it, but that would eat away at your profits. There’s a better way — sell it for just-below market with a very unique mortgage program. The 2/1 Buy Down was created for a buyer’s market. Understanding the 2/1 Buy Down will give you tremendous advantages when it comes to marketing your property. This mortgage product gives the buyer lower interest rates in the first and second years of the mortgage. The first year carries a 2% interest rate reduction, and the second carries a 1% rate reduction, which gives the product its name.
What does this mean in real numbers? Let’s look at an example. With a purchase price of $300,000,300,000 and 10% down, the mortgage is $270,000. Say the buyer qualifies for a 5.9% interest rate on an Interest Only loan (the payment will cover only interest, no principal). The first year’s interest rate would be 3.9% and the second 4.9%. Years 3-30 would revert to 5.9%. So how much would the buyer actually save in the first 2 years of the mortgage? At 5.9 percent, the payment is $1327.50. The 2/1 Buy Down makes the first year payments $877.50, saving $450 a month or $5,400 in the first year. In the second year, the payments go up to $1102.50, saving $225 a month or $2,700 for the year. Total savings: $8,100.
You’re probably asking yourself, “Who pays for this buy down and where does the $8,100 come from?” From the equity in the house. As the seller, you forego this equity to create a benefit to the buyer. Why? Because advertising your house with a 2/1 Buy Down offers a huge incentive to the buyer, making it a more attractive buy than all the other houses on the block. Understand that as the seller, you set the asking price. Say you buy a foreclosure for $220,000. The correct market price is $300,000. You want to sell the house at market value, and there are six other houses selling for the same price in your area. But you’re offering a 2/1 Buy Down, and the other sellers aren’t. Plus, you’re going to advertise the house with a payment amount rather than a selling price.
To explain, traditionally a seller would advertise the house with ads saying “House for Sale $300,000″ … just like all the other sellers of $300,000 houses. But armed with the 2/1 Buy Down, you can advertise the payment, instead of the price. People identify with payments. They know what they can afford A lot of people believe the payments on a $300,000 house would be too high for them. Advertising the payment instead of the price will create a lot more calls and a lot more willing buyers. What’s more appealing – “House for Sale, $300,000″ or “Home for sale, $877 a month, 2and 2% first year interest rate reduction”? A lot of people can afford $877 a month. The end result: a happy buyer and a quick flip of the property for you, providing more cash to buy more foreclosures. A win-win.
Creative methods can help sell a house quickly and efficiently. You can even use these methods simultaneously. For example, buy a foreclosure with a 2/1 Buy Down yourself, then employ the Lease Option to Buy strategy. This will increase your cash flow for two years, when the renter will buy the property. If he chooses not to, you pocket the cash, then market the property to a new buyer with another 2/1 Buy Down.
Naturally, to make this system work, you’ll need a ready source of mortgage money, and a broker who thoroughly understands the strategies. As a Senior Loan Specialist, I am well-positioned to help you navigate the foreclosure market from the financial end. I welcome your questions and look forward to working with you.
Shane Backer
Branch Manager-Senior Loan Officer
Robbins & Lloyd Mortgage
347 Fifth Avenue Suite 1506
New York, NY 10016
Office: 212.213.5120 X3008
Fax: 212.202.4396
Email: ShaneB@robbinslloydny.com
Web:http://www.ezmortgagedirect.com
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