We are all aware that there is good debt and bad debt! It’s a matter of properly investing the borrowed amount to generate substantial returns. Accordingly, real estate investors with portfolios of all shapes and sizes are using debt to buy real estate. But, is it really the best way? Are all real estate investors using debt to buy real estate the right way?
One cannot simply mention using debt to invest without brushing up on the concept of leverage.
What is leverage in real estate investing?
According to Investopedia.com, Leverage is using various financial instruments and resources to increase your real estate net worth and ultimately increasing one’s return on investment. Keep in mind that leverage is not only exclusive to real estate investing. Many investment fields such as the stock market and money exchange rely heavily on making use of this mysterious concept!
Looking for more insights on leverage? Read this blog post: Real Estate Investments and Leverage- All You Need to Know.
What are the real estate financial instruments that allow using debt to buy real estate?
We’re quite familiar with the concept of mortgaging investment properties and the variables that go along with the deal. But there are more to mortgages than beginner real estate investors think. Here are some essential types of mortgages that all real estate investors must know before using debt to buy real estate:
Interest-only mortgage
An interest-only mortgage is one that comes with a big balloon payment when it matures! That’s the main reason that this type of mortgage is not common among homebuyers and real estate investors. While it may seem like a good idea to be using debt to buy real estate with this type of mortgage, think about how you’re going to come up with that big balloon payment at the end!
Adjustable-rate mortgage
Things are a bit more complex for the real estate investor with the adjustable-rate mortgage. The lender will loan you the amount and mortgage the property at an adjustable interest rate. This can be quite scary if you followed the federal funds rate during the market crash in 2008. To clarify, the adjustable-rate mortgage gives you a flexible interest rate and this typically starts with low-interest rates, in the beginning, but ends up costing you more along the way!
Fixed-rate mortgage
We’ve arrived at our favorite pick of a mortgaging option! When using debt to buy real estate, real estate investors want to know what’s going in and out of their pockets during their investment property’s financing life. The fixed-rate mortgage offers just that! What makes this unique and high in demand is the fixed-rate part of the deal. You know how much interest you’re paying throughout the life of the loan. No variables can affect the interest rate on this mortgage!
If you’re buying a rental property, check out this blog to learn about your rental property mortgage options: Learn the Ins and Outs About Rental Property Mortgage Options.
What are the benefits of using debt to buy real estate?
Increases return on investment for the real estate investor
Using debt to buy real estate works its magic with real estate investors trying to make a diversified real estate investment portfolio. If you have $100,000, you can invest it in different properties, making that leverage work for you! So, instead of buying one investment property with that amount, you can borrow the rest and have multiple real estate investments on your hands!
Allows you to make better investments that you can’t do with your own cash
Using leverage allows you to make bigger and more ambitious real estate investments. If you have $100,000 in cash and you wish to invest, you can use this money to buy a $500,000 investment property to get a higher return on investment in money that you’ve borrowed at a pre-determined rate. Of course, such decisions are not made that simple; a real estate investor must go through a proper investment property analysis to ensure the quality of such investments!
Gives you tax benefits!
We are all aware that there are tax benefits to real estate investing. But did you know that there are tax benefits to using debt to buy real estate?
Real estate investors and property owners don’t pay taxes on interest payments. This is an essential tax break to motivate real estate investors to get going!
Wondering about other tax benefits of real estate investing? Read this blog post: The Tax Benefits of Real Estate Investments.
What can go wrong when using debt to buy real estate?
We’ve all seen and heard real estate investors talking about buying investment properties with no money. While it can work for you after careful consideration, you must know how to make it work by conducting a through real estate investment analysis.
Now, let’s dive deeper into the things that can go wrong when using debt to buy real estate.
When using debt to buy real estate, it can enhance your real estate investment portfolio as well as bring it down! That is if you haven’t studied the real estate market or investment you’re going for. Let’s say you’re investing in a single-family rental property that’s valued at $100,000 and you’ve put a down payment of 20%. That leaves your equity in the real estate property at $20,000. Factoring in real estate appreciation and other real estate market factors, you might get a 5% increase in the property’s value on an annual basis which leaves you with a property worth $105,000. In this ideal scenario, you haven’t experienced the down part of using leverage to buy real estate. On the other hand, what happens when the market declines at a 5% rate? The property which was worth $100,000 is now worth $95,000!
This scenario can be adapted to fit multi-family investment properties, commercial real estate, and many other types. Of course, the 5% decline rate may not seem like a disaster for a $100,000 real estate property, but for a $500,000 real estate property, it marks $25,000 of loss! A very bad situation for the real estate investor.
A simple trick to using debt to buy real estate properties the right way
When buying an investment property, real estate investors must know all the factors that combine to form the magic of return on investment. Those factors are the cap rate, cash on cash return, and occupancy rates. As previously mentioned, real estate investors have the ability to conduct a real estate investment analysis to ensure the profitability of their investment. So, make sure to take the time and perform an analysis before committing to any real estate property.
What are you waiting for? Start looking for and analyzing the best investment properties in your city and neighborhood of choice by clicking here!
Final thoughts
Using debt to buy real estate is really an art form; real estate investors must understand the basics but have the free will to implement it in any way they see fit for their investments! So, if you’re a beginner real estate investor, make sure to brush up on your financing options to find the financing method that will bring you a sustainable return on investment. Try using an Airbnb calculator to see how much you can earn from your rental property. In any case, using leverage is not a bad thing, you just have to know where to put your money to get the most out of it!
If you have any more insights, please share them with us in the comments section!