Everyone has heard stories or read about someone who bought a property without paying a single dime as a down payment. But how on earth does this work?
“Down payment” by definition means specifically money that is used to “pay down” the total purchase price. This does not include money that is necessary for closing costs, points, interest, and other items such as appraisals or insurance, though in some cases those expenses may also be financed in the loan or paid by the seller.
There are several “classic” methods commonly used to purchase real estate with no money down. There are an infinite variety of circumstances that could lead to an opportunity to structure a purchase agreement that would allow you to purchase a property without needing a down payment. But for the sake of reality, I will focus on those that are most commonly seen.
1. Seller second – The buyer obtains a new first mortgage for most but not all of the total purchase price. The seller finances the rest by taking back a second mortgage for an amount equal to the down payment needed. For example:
Purchase price: $100,000
Buyers loan: $90,000 (90% LTV) (new first mortgage)
Sellers finances $10,000 (in the form of a new second mortgage)
The buyer has borrowed 100% of the purchase price. Thus, you have100% financing, and no down payment was paid by the buyer.
This is not a difficult strategy to employ if the seller has enough equity, is willing to hold a second, and the first mortgage lender approves.
One thing that is not mentioned in most articles about this strategy is the requirement for lender approval. The lender who is making the first mortgage loan will probably need to approve of the second mortgage as part of qualifying for the first mortgage.
Loan guidelines may also restrict second mortgages. Check with potential lenders before you sign a contract with a seller, and make sure you can use a second mortgage to fund your down payment. Every transaction is different, and lenders vary in their underwriting requirements. If you are buying for investment, you’ll want a lender who is specializes in investment property loans.
When it comes to finding a seller who will help you create a no money down deal, consider buying from an investor or any seller who is willing to be flexible. Some sellers are willing to do creative financing simply because they understand that it helps them sell houses. Some are motivated by other circumstances such as a need to move quickly for a new job. It never hurts to make an offer that includes a seller second. You never know until you ask.
2. Get with the Program – Another common way to obtain a no down payment loan is to utilize one of the many “low” or “no down payment” programs that exist. Most of these loans are intended for owner occupants, and since the housing market crash, they are usually found in specific programs such as VA loans for veterans, and USDA loans for rural property. In most cases, the property must meet certain requirements to qualify for the loan program.
There are loans out there that are designed for a variety of property types. Some for properties in rural areas, some for properties found in certain parts of the city, or in an “enterprise zone”. Talk to a lender first, and find out what kind of special “no down payment” programs may be available for the property you have in mind.
3. Hard Cash – More common among professional investors is buying wholesale properties, using hard money to purchase and rehab. When the rehab is done, you get a new mortgage that pays off the hard money loan. Since this is a refinance, you may take cash out of the property. You may have to bring some money to closing on the hard money loan, but you get it all back when you refinance, so you end up with no money out of pocket. This becomes not only a “no down payment” deal, but also a “cash back at closing” deal.
It works like this:
- Purchase price $100,000
- Repairs $15,000
- Hard money loan $115,000
- Purchase and repair, then get new loan to pay off hard money.
- New loan is based on 90% of After Repair Value. (ARV)
For our example, the ARV is $150,000
- 90% of $150,000 is $135,000.
- New loan for $135,000. Subtract hard money loan pay off of $115,000 leaves $20,000.
- You keep the extra $20,000 in cash, tax free since it is a loan, rent your house out and let the tenant pay the loan back.
- Your gross profit is $20,000 cash and $15,000 equity. Total gross profit $35,000.
Not too bad for a couple months work.
If you do 3 houses per year, and you only net $25,000 total, after paying all expenses on each of the 3 houses, you are still netting $75,000 cash and equity in about 6 to 8 months. Plus, if you are renting these properties, you are also creating additional streams of income through monthly cash flow as well as accumulating equity in each property.
This is a solid strategy to achieve a retirement nest egg and ongoing income for life in less than 10 years. If you look around at the real estate investors who are wealthy, the vast majority own rental property, be it residential or commercial.
They understand the concept of buying at a discount, then holding their properties for years. They get to the point where their holdings are worth double or triple the price paid. This is free money that you can earn simply by buying and holding long term.
There are investors in every major city that specialize in selling fixer upper properties that fit with strategy number 3 in this article. In this era of high foreclosure rates, there are more discounted properties available today than there have been in years. ***
Donna Robinson is a staff writer for Realty Biz News and a 16 year veteran of the real estate industry. Her experience spans all phases of residential real estate. She is an active real estate investor who also provides coaching and consulting services to other investors. To discover how you may benefit from her expertise, contact her at firstname.lastname@example.org and request a free PDF copy of her latest book on residential real estate.