When you borrow money to buy a home, you’ll see many numbers thrown around. Most buyers focus on the purchase price of the home. It’s an indicator of whether or not you can afford the price. But since you probably won’t pay cash only, you must consider the loan amount.
The loan amount is the money you borrow to buy the home. It usually differs from the purchase price since most lenders don’t always provide 100 percent financing. Considering the loan-to-value ratio is important too. This value compares the purchase price and the loan amount and is a number lenders talk about often.
Understanding these numbers helps you make solid real estate investment decisions. While focusing on the purchase price makes sense, it’s the loan amount that plays the most important role in your decision, here’s why.
What’s The Purchase Price?
The purchase price is the amount you agree to pay the seller. It’s the amount on your sales contract or the amount your real estate agent worked so hard to get the seller to agree to.
For example, a home is listed for $175,000, but your real estate agent gets them down to $150,000. Your purchase price is $150,000. That’s what you agree to pay. Now, you probably don’t have $150,000 lying around, so you need financing, which is where the loan amount matters.
The Loan Amount Isn’t The Purchase Price
The loan amount differs from the purchase price because most lenders won’t give you 100 percent of the sales price. We’ll use our $150,000 sales price example from above. Traditional lenders or banks will typically give you 80 percent of that amount, so $120,000 if you live in the home as your primary residence. Primary residence properties have a lower risk of default because you live there, but you must come up with the remaining $30,000.
Lenders require your own investment to reduce the risk of default. They call it having ‘skin in the game’. Traditional loans require a 20 percent investment. Lenders feel if you have 20 percent of your own money invested, you’ll be more likely to pay your bills on time and not default on the loan, risking your property.
Traditional lenders require even higher down payments for investment properties, including fix and flip properties. Many require as much as 30 to 40 percent down and many traditional lenders don’t lend for fix and flips, but rather to primary homeowners or landlords.
A hard money lender, on the other hand, offers down payment options as low as 15 percent on investment properties including fix and flip properties. Hard money lenders focus on the after-repaired value and the collateral for the loan. They know if you default, they’ll take possession of the home. As long as the home is worth as much as the purchase price (or more) and the planned repairs will increase the value, you have a good chance of securing financing.
Understanding The Loan-To-Value Ratio
As an investor, you should know your loan-to-value ratio. This compares your loan amount to the home’s value. If you’re fixing and flipping, you’ll have two LTVs – the original (as-is) value and the after-repaired value.
Your after-repairs value is your ‘money.’ If you fix the home up enough, your LTV should decrease, which equals more profits. For example, if you invest 20 percent in the home, and then repair it, the value should increase. Your LTV should decrease from 80 percent to say 60 or 70 percent, depending on the changes made. An LTV decrease from 80 to 60 percent means a 20 percent increase in profits – not a bad investment, right?
Obviously, that’s a fictional scenario as each value and LTV depends on the market and the changes you make to the home.
Find a lender that provides the financing you need at affordable terms. Real estate investing provides ample opportunity for great profits when you find the right home and the loan with the right terms. Determine how much money you can invest in a property and find a lender that can accommodate your needs.
High LTVs don’t mean crazy high-interest rates or difficult terms. Find a lender that specializes in real estate investments, helping investors like you make the most of the fix and flip or buy and hold market. There are many opportunities out there – and with the right knowledge in hand, you will be ready to pursue them.