How to Recognize and Avoid 8 Real Estate Financing Mistakes

Real estate investing may seem like it’s either easy or hard, and both may be correct. The secret oftentimes is dependent upon how the investor manages his or her Real Estate financing.  Nothing can be more discouraging than to structure a great real estate investment and then have everything come apart because of financial pressures that could have been avoided.

Possibly the problem occurs because of how the investor structured the purchase and financing, or maybe it’s because of outside personal financial pressures. Regardless of the cause, the problem is real and should be avoided.

Avoiding the financial problem in the first place is by far the best course of action, but unfortunately, that doesn’t always take place.  Recognizing the problem or mistake is only the diagnosis, but now you must take corrective action.  It’ going to be a process that can take both time and effort.  Once you recognize the mistakes, you can take action to avoid these problems altogether.

Mistake #1 – Not Obtaining Accurate and Complete Information on Past, Present and Future Expenses

You can’t expect to achieve success in real estate investing if you do not have accurate records of past expenses involving the property.  This includes all expenses related to the property itself including utilities, taxes, and especially repairs.  If the appliances pertaining to the property have been repaired in the past, you want to know when the repair occurred and what the actual expenses were.

It’s entirely possible that you will need to repair or replace the same items again.  You also want to know if there is any warranty on the work performed.  Failure to get this information forces you to become responsible for additional unexpected repairs.

One of the primary reasons for having a complete inspection report on the property prior to closing is so that you can understand and project upcoming expenses.  You must be prepared financially for repairs and maintenance to the property.  When you aren’t financially prepared for large upcoming expenses, you put yourself in jeopardy of losing the property.

If you are purchasing a rental property, you want to have a complete history of not only the revenue received but of all expenses associated with the property.  In essence, you are purchasing the new rental business.

Mistake #2 – Accepting Poor Owner Financing

Owner financing involves the seller financing the sale of the property to a buyer and can allow the buyer to achieve financing without normal banking approval.  With a traditional mortgage, you borrow money from a bank to pay for the property.

Then, you make payments back to the bank to pay off the loan. With owner financing, you make arrangements to pay the owner in installments, typically of principal and interest, until you’ve paid off the purchase price of the property.

Owner financing can be a valid and profitable way to purchase real estate, but you must ensure that you are not going to assume unwanted problems.  If at all possible, you should attempt to certify that the property is free and clear of Mortgages.

If this is not the case, you could be in jeopardy if the owner doesn’t make payments on the underlying mortgage.  You can solve this if you escrow a portion of your payment to go for payment to the underlying mortgage.

If the owner has legal or financial issues, the property is still in potential legal jeopardy and could be foreclosed on.  If the property is free and clear, you can get a title policy and have the owner actually take a first mortgage against the property and act just like a bank.  In this way, the property is transferred by title to you and is no longer in the name of the seller.

If you elect to pursue owner financing, make sure that you are protected in the case of the seller not paying any underlying mortgage.

Mistake #3 – Taking a Hard Money Loan with Unreasonable Terms

Hard money loans are loans made almost entirely based on the value of the property without regard to the creditworthiness of the borrower.  These loans are normally bridge or short-term loans and come with higher payments and interest rates than traditional loans.

The lenders are generally private individuals or entities and they are relying primarily on the value of the property if it were to be sold to pay the loan. These hard money loans have a lower loan to value ration than traditional loans and they generally have a loan period of one to three years.

Most of these loans are used when the property is going to be fixed up and resold.  Because the interest rate and payments are higher, along with a short-term payment period, you may be subject to an increased risk of foreclosure if your real estate business doesn’t go as planned.

If you elect to pursue a hard money loan, make sure that you are getting a loan with terms that are reasonable for your real estate business.  Don’t be caught unaware when the loan or payments come due and you don’t have means to make the payments.

Mistake #4 – Assuming Existing Loan with Underlying Problems

Not all real estate loans are the same, and when you assume a loan obtained by a previous borrower, in your case the seller, you will be subject to the terms of that loan.  Maybe the existing loan has restrictions or payments that don’t meet with your real estate business plan.

Take for example a loan with a balloon payment due in a short period of time.  An unexpected balloon payment could destroy your real estate investment.  If you were not projecting the large balloon payment, it could literally put your real estate investment into foreclosure.

Many real estate investors enter into adjustable rate mortgages that have increased interest rates.  As the interest rate goes up, your profits are going to go down.  Don’t be caught unaware of the potential increase in payment, nor on the potential for a requirement that the loan is paid off entirely in a short period of time.  This could occur in a matter of a few short years or even months.

Mistake #5 – Ignoring Potential Legal Problems

As a real estate investor, you should be cognizant of all potential legal problems involved with your real estate endeavor.  This includes not only your personal actions but the actions of other people who may be involved with your property.  Take for example an owner who is being sued personally from past tenants or even individuals who worked on the property.  If the previous owner had work done on the property and did not pay the person doing the work, there is a potential for a special kind of lien to be levied against the property.

These liens are called mechanic liens and are best described as a security interest in the title property for the benefit of those who have supplied labor or materials that improve the property.

Your seller may be facing legal problems of a personal nature, and if the seller is unsuccessful in such circumstances, the property could be subject to potential liens.  Make sure that you acquire the property in such a way that you get a title policy on the property that ensures that all seller legal issues are resolved.

There are also potential legal problems between yourself as a landlord and the tenants in any rental property.  It is highly recommended that you secure an umbrella insurance policy to protect yourself against such occurrences.

Mistake #6 – Not Vetting Existing Tenants

A major financial mistake that plagues real estate investors who acquire rental properties is having non-paying tenants.  There is no guaranteed that you can always secure great tenants, but you can do several things to improve your tenant payments.  When you purchase a property, ask for all rental records for each tenant.  If you have one or more existing tenants who have shown that they don’t always pay their rent on time, you need to make sure you correct this situation.

Perhaps you can get them to agree to use an auto payment program in return for not raising the rent.  Whatever incentive you come up with, you need to do all in your power to increase your success in collecting rent.

SEE ARTICLE: (Link to article written by Gary Cochran “Follow a 7 Step No-Fail Checklist When Purchasing Your 1st Rental Property”)

When you become a landlord, you are automatically assuming the role of rent collector.  It is critical that you establish strict payment policies with both old and new tenants.  If you have already identified a potential problem through existing financial records, try to replace bad tenants with good new ones.  If it’s not possible to do this, it might be best for you to pass on this specific rental property.

Mistake #7 – Purchasing Property with Excessive Leverage

When you purchase property with borrowed money, you are using leverage to potentially increase your return on the real estate purchase.  If you purchase a property with a one hundred percent (100%) leverage, you are borrowing the full purchase price of the property.  When you have excessively high leverage in real estate, you put yourself at risk of potentially losing the property through foreclosure if things don’t work out exactly as planned.  If you are in such a situation and expenses become larger and rents don’t come in as planned, you could be in danger of not having enough money to meet mortgage payments.

Most traditional lenders have found that if the borrower has at least a 20% down payment, they are in a much better position to have the borrower make payments.  It has been proven that excess leverage in real estate leads to much greater risk.

Mistake #8 – Excessive Personal Debt

Most financial mistakes can be overcome if the borrower or real estate entrepreneur has sufficient capital to meet future expenses.  If you are a new, or even experienced, real estate investor and you have a very high debt load, you are already in a position of risk.  The higher your personal debt, the higher your risk.  When you have excessive debt, you automatically are in the position of having to pay out more and more of your income.

In many cases you may feel it necessary to draw too much on the income coming from your real estate investments.  This puts those investments at risk.  It is recommended that you reduce your personal debt as much as possible when entering into real estate.

Financial mistakes in real estate investing are far too common.  Sadly, most of these problems can be avoided if we take the time and make the effort to follow proven solutions.

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