Avoid Real Estate Investment Scams
It seems so very simple. You pay a couple hundred dollars and get the “secret” to making millions practically overnight in real estate. It all sounds so tempting. You walk in with nothing, sign some papers and walk out with cash and the keys to a house. And, you can do it over and over until you make a million! Yes, you can make a million in real estate. And some people have started with nothing and built an empire. But, it’s not easy and certainly not a sure thing. But, here’s a secret no one has to pay for. It’s called leverage.
Borrowing money to invest isn’t new. People who buy stocks on margin or play the commodities markets do it every day. It is interesting to note that there are limits as to how much they can borrow. The regulators know that if you borrow too much it’s dangerous. Given the right set of circumstances you can borrow money to buy an asset, have that asset appreciate and sell it for a profit.
Here’s how it’s done. Suppose you buy a home for $100,000 and pay cash. Three years pass and the house is now worth $150,000. You sell it and make $50,000 on your original $100,000 investment. That’s a 50% return in just three years.
What happens if you had taken out a mortgage? Suppose that you put $10,000 down. Again, three years later you sell it for a $50,000 profit. But this time that’s a 500% return on your original $10,000 investment. The reason is that you were making money on borrowed money. That’s called leverage.
Could you go in with 0% down and make that profit without putting any of your money up? Yes, if you could find someone willing to lend you 100% of the purchase and the house appreciated 50% over three years you could indeed make $50,000 without putting up your own money. So, why not jump right in?
The first problem is higher payments because you are financing more than the value of the house. You will probably also pay a higher interest rate because you didn’t have a down payment. That means less money for food, health, auto and other routine expenses. The second problem is you are locked into the home. Unless you’re willing to write a check at closing, you won’t be able to sell until the house is worth more than the loan.
Finally, can you use this strategy to buy more properties? Typically you want income property to pay for itself and leave some extra income for you. Using this method the higher mortgage payments will make it hard to build equity or have a positive cash flow. You can also expect some repairs, late rental payments and the occasional vacancy. Unless you have cash to ride out these storms, any problem could make you late with your mortgage payment. And that’s when things start to unravel.
The bottom line is to watch your bottom line. Be cautious and always question “overnight millionaire” programs.
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