Can You Really Acquire Real Estate with No Money Down?

The latenight television shows are heavy of nothing down stories. Are they true? And, if so, is it possible to buy real estate with no money down. Moreover, is it advisable to acquire real estate with no money down?

Everyone aspires to acquire real estate without any down payment (especially if you have no ready funds), since it is the ultimate form of leveraging. However, individuals should bear in mind that buying a property with no money down is nothing special. On the other hand, if you manage to acquire the property at a substantially belowmarket price and with no money down, you then have a very good deal. This is buying 100% loantopurchase, not 100% loantovalue.

The problem with buying a property at a belowmarket price is that its lenders tend to penalize you with their loan regulations. Fannie Mae conforming loan guidelines usually require that an investor put up 20% of his own cash as a down payment. The 20% rule applies even if the purchase price is half of the propertys actual appraised value. Thus, the loantovalue (LTV) rules are based on an appraised value or purchase price, whichever is less.

A common, but illegal, practice is for the buyer to put up the down paymen and for the seller to give it back to the buyer after closing under the table transactionst. An even dumber method is to overappraise a property, effectively financing a property for 100% of its actual value. People may get away with it all the time, but these practices are loan fraud, punishable by a nice vacation at Club Fed.

Side Note  Refinancing Your Equity

Many investors refinance every few years as property values increase, using the extra cash to buy more properties, as suggested in the bestselling book on real estate, Nothing Down. Although this mechanism enhances your leverage, it also enhances your risk factor. There is nothing bad about taking out cash in a refinance provided that the funds are utilized porperly. Spending the money as profit is not a smart use. If you end up with high LTV and/or negative cash flow on the property and housing prices fall, you are in for a world of financial hurt.

A RealWorld, CommonSense Nothing Down Deal

As can be gleaned, there are smart and notsosmart ways to buy nothing down. The following is an example based on a real deal I helped a student of mine put together:

Sandy is interested in purchasing a home to live in, but she does not have much cash in her pocket. She has just started her own business and cannot not qualify for a conventional or FHA lowdown payment loan. Sandy manages to find a seller with a good property, with very little equity if any, but a lowinterest rate loan. Sandy leases the property from the owner for three years for $1,200 per month, with an option to buy at $162,000. The current house worth is $179,000. The seller agrees to the discounted price because he saves a real estate commission and can wrap up the deal very quickly.

The agreement provides that the seller give Sandy a 25% ($300) credit towards the purchase price for each rent payment Sandy makes. Sandy also puts up $1,200 as a security deposit, which will be credited towards the purchase price when she exercises her option to purchase the property.
After 12 months, the property has appreciated in value to $189,000. Or, if the property values do not increase, Sandy has made improvements to the property that increased its value. In addition to that, Sandys equity has increased because of the $300/month rent credit. Thus, after 12 months, Sandys equity position is $31,800:

$162,000 original option price
less $ 3,600 rent credit
less $ 1,200 security deposit

$157,200 strike price
$189,000 market value
minus $157,200 strike price

Equals $31,800 equity
Sandy exercises her option to purchase the property at the strike price (original option price, less credits).

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The Lease/Option Refi
In funding a loan to buy the property, most lenders would consider this transaction a purchase, and lend base their LTV on the option strike price ($156,100), not the appraised value ($189,000). A small number of lenders will treat the transaction as a refinance, in which case the LTV is based on the appraised value. So, a 90% LTV refinance would allow a lender to give Sharon .9 x $189,000 = $170,100, which would cover the strike price ($157,200) and the loan costs (approx $4,000). In fact, Sandy would even have enough cash left over to buy new furniture. Or, Sandy could simply borrow less, having a lower monthly payment. Either way, this is a solid, nothing down deal.
Note that a lease/option refi is not an ordinary transaction, so be patient if you are looking for a lender that will fund in this manner; it will take a lots and lots of phone calls!

Written with the support of Los Angeles Mortgage, low cost auto insurance, and Tucson long realty