Before the housing crisis in 2008, there were a lot of people who thought it was perfectly all right to buy a house without any downpayment. In fact, people in the industry even encouraged them.
Although a sweeping statement about what led lenders to give homebuyers these very risky mortgage options cannot be made, one thing is certain: The lax underwriting processes, whether these were motivated by sheer greed or not, led a lot of homeowners to experience the trauma brought about by foreclosures.
Buying a house or any other piece of real estate for that matter without any money down is never a good idea. It goes against every grain of good financial sense, making it a very risky endeavor. The risk is even greater when it comes to buying a real property for investment purposes. There are a lot of reasons to support this so let’s tackle them one by one.
Buying a house or any other piece of real estate for that matter without any money down is never a good idea.
Increase in Financing Costs
One of the many draws that lure many people to accept the no-downpayment scheme of buying a piece of real estate is that it allows them to own their dream properties even if they haven’t really prepared for it. After all, they can afford the monthly mortgage anyway, so if there is such an offer to buy a property and start earning from the rent of the tenants right away without paying any significant amount up front then why not go ahead and grab it?
Unfortunately, this reasoning does not take into account one very important fact: When there is no downpayment given, the costs of financing also increase. This means that the interest and consequently, the monthly mortgage will go up. Maintenance expenses, taxes, insurance, utilities and other fees will also go up. Even if you bought a rental property which is already fully occupied and all the tenants there paid rent on time, you’d still be hard pressed to pay all the monthly expenses if you acquired the property without giving any downpayment for it.
The risk you take when you buy a piece of property without any downpayment is just too high. Consider this: The value of real estate moves in tandem with the rate of inflation in the long-term. However, in the short haul, the price movement of real estate can occur rather quickly. You won’t get affected if the value of real estate goes down in the short-term and you are the sole owner of the property. If you gave a 30 percent downpayment for the property, you’ll probably be a bit anxious if the decline in value prolongs but you’d still be able to manage the mortgage. However, the effect of a downward trend can be disastrous if you got the property without any downpayment. You could lose the property. Worse, if the value of the property has declined lower than the original loan amount, you will be responsible for paying the difference.
It Takes Longer to Make a Profit
When you buy real estate without downpayment, you better expect to hold on to it for a longer time period. If you have intentions to sell the property in three years, you can’t expect to get a lot of profit. Since the value of real estate moves together with the value of inflation which is pegged at 3 percent a year then in three years, your real estate will go up in value at 9 percent after 3 years. Now if you sell that property after 3 years, the closing costs is usually around 10 percent of the sale price. Thus, you’ll basically just get even on your investment. If you can wait for five years before you sell the property then you can expect to get modest returns on your investment.
Make no mistake about it, real estate can make for a very good investment. Owning a rental property can help diversify your portfolio and help provide a steady stream of income when you retire. However, what makes it a very risky investment is if you get it without any downpayment. Doing so would be courting disaster which could potentially make you lose the property in a down real estate market. To avoid that, here are some guidelines to keep in mind when buying real estate.
1. Save for the downpayment.
The need for a substantial downpayment for a piece of real estate cannot be underemphasized. If you really want to become a property mogul one day, you should start saving now so that when you find the perfect property to buy, you will already have the money.
2. Have a stable job to back you up.
To get approved for financing to buy the properties you want to buy, you need a stable and reliable job. Even if you believe that the rental property you buy will be enough to finance your needs, you still need to have a job so that the financing process can be completed without too much hassle. Perhaps you can quit your day job when your rental property has become so self-sustaining that it can comfortably provide for you many times over. However, this probably won’t happen in the near future yet and not with only a single property.
3. Make sure that you are well-acquainted with rental regulations.
There are a lot of rules associated with rental properties in most cities. Because rentals are considered businesses, they have to abide by various regulations enacted for the purpose. Neglecting these regulations could cause you to run in trouble with the law. You could be asked to pay fines or worse, go to jail for it. Knowing what the regulations are will also allow you to budget for the renovations that you will need to undertake.
4. Get financing ready.
Before you start scouting for properties, make sure that the financing is already in place. You want to make sure that you can readily make an offer for a property when you see it. If you don’t have financing already arranged, you could lose out on a good bargain because someone already has made an offer while you are still thinking if you can afford the mortgage.
5. Treat real estate investing as a long-term endeavor.
As mentioned above, real estate investments are not short-term investments. If you want something that will give you returns in less than five years, go for short-term bonds or put your money in certificates of deposits instead. With real estate, the returns are long in coming so if you are really serious about becoming a property mogul, treat every property you buy as something that you are going to keep for a long time.
6. Buy properties in working class neighborhoods.
Not all neighborhoods welcome rental properties. Very high class ones, in particular, won’t like it and may even have rules against it. On the other hand, neighborhoods where a lot of crimes are happening will rarely attract tenants. Thus, the best places for rental properties are those where modest, working class people live.
7. Purchase properties that don’t need a lot of renovations.
There are some homes that are sold quite cheaply. However, the reason why these are sold at a discount is that you’ll most likely need to spend a lot for the repair and upgrades, adding to the capital you need to acquire the property. As much as possible purchase properties where you don’t need to spend additional funds for repair. If you’re lucky, you might even be able to find a rental property which is already occupied by tenants. At the right price, this would be the ideal purchase.
8. Do due diligence before you jump into the water.
Before you buy your first rental property, take the time to really educate yourself about the real estate industry. Talk to people you know who are already in the business, read books about the topic, research online through reliable websites about the state of the real estate market and attend seminars devoted to the subject. When you know what to do, you are less likely to make the mistakes that neophyte real estate investors make that cost them huge amounts of money.
Rental properties can make for good investments—especially if you have chosen the right properties and know what you are doing. However, don’t be so eager to get into real estate investment that you snatch up an offer to buy a property even without any downpayment. That would be a bad move as the financing costs are going to increase.
The smartest way to go about investing in rental properties is for you to start saving on the downpayment early on. When you already have that amount, get the financing ready so that when you see a good bargain, you can readily make an offer. Finally, don’t forget that real estate investing is a long-term investment. You will only be able to recoup your investment if you think of your rental properties as something that you will manage for the rest of your life.