Don’t Get Down About Down Payments—Part 2 of 2

Share This:

Episode Summary

Listen on iTunes
Listen on Spotify
Watch on YouTube

“How can I borrow my down payment?” I hear that question a lot, asked directly to me, sometimes a lot of times asked in groups and communities and sometimes it’s phrased a little bit differently. Like, boy, I was really planning to borrow funds for my down payment, but now my lender says I can’t. So I want to help you get to a point where you’re not feeling down about down payment. So we need to address this topic of the idea of borrowing for a down payment. So we’re going to talk about different models for how that works and the mentality around it. So let’s cue the theme song, we’re going to jump right into this.

Episode Transcript

Welcome to Racking Up Rentals, a show about how regular people, those of us without huge war chest of capital or insider connections, can build lasting wealth acquiring a portfolio of buy and hold real estate. But we don’t just go mainstream looking at what’s on the market and asking banks for loans, nor are we posting We Buy Houses signs are just looking for “motivated sellers” to make lowball offers to. You see, we are people-oriented deal makers, we sit down directly with sellers to work out win-win deals without agents or any other obstacles, and buy properties nobody else even knows are for sale. I’m Jeff from the Thoughtful Real Estate Entrepreneur. If you’re the kind of real estate investor who wants long term wealth, not get rich quick gimmicks or pictures of yourself holding fat checks on social media, this show is for you. Join me and quietly become the wealthiest person on your block. Now let’s go rack up a rental portfolio.

Hey, hey, hey, thank you for joining me for another episode of racking up rentals show notes for this episode can be found at thoughtfulre.com/e174. Please do us a big favor by hitting that subscribe or follow button in your podcast app. It really helps other fellow thoughtful real estate entrepreneurs who are looking for a show just like this one, to find that. Thank you so much; on with today’s episode.

In today’s episode, we’re tackling the second part out of two parts of a conversation about how to not get down about down payments, not let down payments get you feeling down. Where did this all kind of come from? Well, I have experienced a lot just through observation. That one of the things people feel really constricted by or concerned about a lot as they’re getting going or trying to grow in real estate. Entrepreneurship and investing is the idea of down payments and sort of this notion, this over simplified notion that says if it takes a big down payment that makes the deal bad. And I feel like that’s a very self defeating idea that could end up causing us to just walk right on by opportunities that could be really excellent.

Now, let me just be clear about something. I am not saying that. I hope you just have tons of cash and put it all into your deals and just leave it tied up there. That’s not at all what I’m saying. All else equal? Absolutely. I want you to use as little of your own cash, as you reasonably in realistically, can. I’m just simply saying that there are other ways to think and look about down payments and structure them and make a down payment but get some of it back immediately. That’s sort of what we talked about in the first of this two part series. So I don’t want you to think that a big down payment equals bad and I don’t want you to think that a big down payment equals it has to be all your money.

So let’s jump into this conversation about borrowing down payment. So as I mentioned in the intro, you know, the simple question people ask a lot is, can I borrow my down payment? Now, let me just give you this simple answer to the simple question, which is, yeah, absolutely you can. And to make a potentially annoyingly philosophical a side remark here, as I am want to do. Every down payment is borrowed, because even if you have the cash sitting in your account, you’re basically borrowing it from yourself in the sense that there is an opportunity cost to the cash you have in your account, you know, if you saved up $120,000, that you might call a reserve account, and you take 100,000 of that, to put towards the down payment of a new property, you have borrowed that money from yourself, you are going to expect as the lender to yourself to get paid back, not only the money you borrowed, but maybe a return on that money you borrowed because there is an opportunity cost to having put that money that $100,000 into your new acquisition, you could have done other things with it, in other words, so there was always a borrowing of a down payment, even if you’re borrowing it from yourself, but that is not really the main point of our episode today.

I want to talk with you about different models that you could think about employing for borrowing a down payment. Now, you may have found or you may have heard other people say My lender won’t let me borrow the down payment, right? So this is usually said by somebody who is probably newer into the game. And they are talking to a lender, a bank lender, usually, maybe a conventional bank lender, and they asked, Can my uncle loan me the money for my down payment? And the answer may be no in some of those cases. So they start to take that specific data point of that lender who said no in that situation, and they start to extrapolate that to mean, I can’t borrow my down payment or borrowing down payments isn’t a thing, in this case, or in any other, but that’s not definitely not true.

I would say if a lender tells you to your face or via email over the phone, you can’t borrow your down payment, I would say either one of two things is true. And maybe both of those things is true. You need to be talking to different types of lenders, because you are clearly talking to somebody with a lot of very strict rules and parameters, which you know, banks and federally insured mortgage lenders are in that category of having strict rules that they have to follow. But if you were just talking to, you know, Joe and Susie, who are your neighbor who might have some money to invest in the form of making a loan, then that question, can I borrow my down payment is not one that they’re going to have a operations manual that clearly says no, you can’t do that.

So anyway, the first point is, if you hear the words, no, you can’t borrow your down payment from a lender question if maybe you need to be talking to different types of lenders and expanding your tools in your toolbox of ways to borrow money. But the second thing, and this is kind of what we’re going to talk about and focus more on today is you also need to learn to be a little bit more creative about potentially how you do it. How do you go about borrowing it? Where is the source of the money? How do you borrow it? In what form is it borrowed?

So I want to talk with you now about four different models for borrowing a down payment from the obvious to a little bit of the less obvious. And also, let me please note, I’m not saying there’s only four models, but I want to give you four, to kind of get your mind working, we’ll start with the first model, which is obvious perhaps, and easily understood. And this is where you are directly borrowing money through an unsecured loan, and you’re taking the unsecured loan proceeds directly into the down payment for your acquisition, right.

So there are two types of loans, there are unsecured loans, and there are secured loans. unsecured loans are like, for instance, a line of credit or a credit card, or when you just ask your parents to borrow 20 grand and say, hey, I’ll pay you back next month. That is an unsecured loan, right? You make a promise, and you guarantee it, maybe you even sign a promissory note, but there’s no collateral. And that is the distinction between unsecured and secured loans are that the secured loans have some type of collateral and you’re pledging something that says, hey, I promised to pay this money back at this time and in this manner with this return or with this interest rate. And I’m pledging this property or this item, as a part of my promise to that. So you could have this if I don’t live up to my promise.

So the first and obvious model is you directly borrowing money in an unsecured manner to put into down payment funds. So this could, these funds could come from a person, they could come from a credit card. For instance, there’s a program called a funding grow that I have worked with successfully that applies for you for business credit cards and get your business credit, and then helps you see how you can extract the credit card proceeds as cash that you could use in the case of a down payment. If you want to learn more about that you could go to credit.thoughtfulre.com. and you can hear about my experience with that. But you could ask a friend, you could ask a family member, you could ask a neighbor, somebody like that to just loan you money that you could put into a down payment.

So again, if you are planning to do that, and you were working with a conventional bank lender, and they know that that’s where your money is coming from. They might not be okay with that. But perhaps you need to be talking to different types of lenders. Now, you could also in this model, you could borrow that money from that source that person or that credit card, perhaps stick it in your bank account and let it quote season meaning if it shows up in your balances for three consecutive months, well then perhaps a conventional lender would count that money because it’s been in your bank account for the whole period of three months or whatever that they might be looking at your past bank statements. But that is an obvious way. So we won’t belabor that because I think you probably understand that you could just ask for money, or ask somebody for money that you could use as a down payment. And making sure that the primary lender on the property is okay with that, if they’re even paying attention to that. But let’s move on to stuff that’s a little bit more interesting, a little bit more entrepreneurial.

Here’s the second model, you could get a second loan on the property that you are buying, in addition to the primary loan for the property that you are buying, so let’s say that you are buying a house for $300,000, maybe you’re going to get a seller financing loan, but just for a small portion of that, let’s say the seller is going to be involved in $50,000 of the financing of this $300,000 purchase. And now you have a primary lender who would loan let’s say, $230,000, against this property. So now you have two loans that together are worth $280,000. And you’re now effectively coming out of pocket for only $20,000. So you have a primary loan from a new lender for $230,000. And what would otherwise be a $70,000. down payment is now made into just a $20,000 down payment, because your seller is doing what is kind of commonly referred to as a seller carry back now, is the seller in first position on this loan, or in this property, or are they in second position? Well, the truth is, it could be either way, in all likelihood with these numbers, the larger loan, the lender, especially if it’s any kind of a lending institution is going to be in first position and your seller is going to be in second position. But it is possible that those things could be reversed. And that to close on the property. As long as all lending parties are okay with it, you could actually have two loans right out of the gate to close this property, the second loan being the one that’s offsetting a great deal of what otherwise would be your down payment.

So let me give you an example where the seller might be in first position. So let’s say now you’re buying the same $300,000 house, but the seller is willing to be involved in $200,000 of the financing. So you look at this and you say all right, well, that sounds like $100,000 down payment to me, which I’m not really excited about. But instead of writing $100,000, check, as a as a down payment, you’re really just saying, okay, $100,000 has to come from somewhere else. Maybe some of that somewhere else is out of my pocket or my checking account, but not all of it. So you could go out, and let’s say you sought an $80,000 loan from an outside party, maybe a regular person, and you could secure their $80,000 loan in second position at the time of acquisition, again, thereby making your real down payment only $20,000. So, model number two, is a model in which you actually have two loans secured by the same property, the property that you are buying, in order to buy it and if there had only been one loan, you’d be looking at what would feel like a big down payment.

But now with a second loan, that’s offsetting a lot of that down payment, you are effectively borrowing your down payment by putting a second loan in second position on that acquisition. Let’s take a look at a third model says I am going to get two different loans so that I can buy my new property. But the second loan, the one that’s going to offset my down payment is going to be secured by something else I already own. So here is a really simple, relatable, obvious example that many people have thought about and many people have done in fact, I would say this is exactly how I bought my first investment property would be if you were to borrow additionally, against your primary residence, maybe let’s say in the form of a home equity line of credit or home equity loan, you borrow against your home equity loan, your home equity in your primary residence, and then you use those proceeds to buy your new investment property.

Now, you could do this in advance which is what I did when I bought my first invest property, I got the home equity loan, I took the money out, I plop the money into my checking account, I let it sit there. So that it looked to a new primary lender, like it had been there forever. And then I use those proceeds to make the down payment on my new acquisition. But here is a less obvious way to do it. You are in contract now to buy your investment property. And you need, let’s just go back to our example, it’s a $300,000 property, the seller is going to be involved in 200,000 of that 300,000, our purchase price, so you feel like you need $100,000. But you don’t either have that much money in cash, or you don’t want to use that much money in cash. But you do have another property, maybe it’s your primary residence that you already own. So now you go to at after you are in contract on the new property, you go to a private lender, and you say, I would like to offer you an opportunity to make a loan at this interest rate for this period of time, it would be secured in second position on this other property I already own. And you know that when they make that loan for you, those loan proceeds are going to be used for your down payment on the new acquisition. But that lender may or may not know at all about your new acquisition, because it doesn’t matter to them. They’re simply making a loan to you that they’re happy with terms and rates and all that that they’re happy with, secured by a piece of real estate that you already own. It doesn’t matter to them what you’re doing with those funds, you could be just putting in your checking account, you could be renovating your current home, you could be using it for something completely different.

So now you have two loans on two different properties. One is going to be the property you’re buying. And then one is on a property you already own. So what are we doing in model number three, here, we’re just simply harnessing and tapping the equity we already have in other properties we already own in order to come up with the down payment for our new acquisition. So that’s a third model for how you can effectively borrow a down payment.

Now, let me give you a fourth model that is, in some ways, kind of a hybrid of model two and model three that I just shared with you. So we’ll go back to our example, you’re buying a house for $300,000, your deal shows that you’re going to go out and get a new outside loan to fund your purchase. So you go out to the world of lenders, and you talk to a bank, and the bank says sure, we’ll loan you $200,000 against this $300,000 property. So again, you’re sitting there going, geez, looks like I’m gonna have to write $100,000 Check. And you might be thinking, I don’t like that. Or you might be thinking, I can’t do that, that’s too much. But you start to talk to the seller, and the seller is willing to get involved with a small amount of the overall purchase price. So the seller says, we’ll be involved with $60,000, we will, quote carry back $60,000 of this purchase price, right? So you used to need 100,000. Seller just said I’ll take 60,000 in the form of a promissory note. So now you need How much 40,000. So let’s say you decide, okay, I’m cool with $40,000 I can make that work. I’m okay with it philosophically, I can I can make it work practically. But then you talk to the lender and you say, hey, lender good news of this $100,000 I’m gonna put down the seller is going to take backup promissory note for 60 of it, and the lender says to you, yeah, I don’t think so we’re okay with that. But it can’t be secured by this property that you’re buying. And you think to yourself, oh, shoot, this is a problem. But then you realize you own other properties. And those other properties have equity and cashflow. And you look at one of your other properties. And you say hey, this other property I already own.

Again, maybe it’s your primary residence, maybe it’s an existing rental you already have has more than $40,000 of equity and as cashflow that could that could pay for a note and you so you go back to your seller. And you say okay, so seller for your $60,000 promissory note that you’re going to carry back. I’m going to give you a different piece of collateral other than the one I’m buying from you right now because the lender won’t let you be in second position on this property as we close but good news. I have another property over here and we can put you in second position there.

So now you’ve got your good collateral, you’re getting paid a monthly payment and A primary lender is okay with this overall arrangement, this can be a really, really good model for really limiting your overall cash out of pocket. Because one of the main concerns of a primary lender often is they want to make sure their buyer has quote, skin in the game, right? You’ve probably heard that literally or, or thought about it figuratively, the lender wants to make sure you have skin in the game. Well, sometimes the lender can feel like you pledging the equity you have in other properties as collateral, they can interpret that as skin in the game. So that can be a really good tool for you as well.

So, to quickly recap, we have four models. And again, there could be lots more this is not supposed to be an exhaustive list. But it is supposed to be a list of things that show you there’s a lot of different ways to structure deals. And that’s really what we’re talking about. Here’s deal structuring. So model number one is you borrow money on an unsecured basis and put it directly into the down payment for your new acquisition model. Number two, is you get two loans secured by the property you’re buying. One of them is the primary financing you were going to get anyway. And the second one is a second loan that you use to offset the cash you need out of pocket. The third model is where you go and you borrow against something you already own. And you take those proceeds and put it towards your new acquisition and the lender who loans you money bought secured against the equity in your existing property may or may not have any idea what you’re doing or buying with a new property. And they don’t care because their loan is not based on your new acquisition or loan is simply based on the credentials and qualities of your existing ownership in a certain property. And the fourth model is one that blends models two and three, where you negotiate a seller carry back with the seller you’re buying from even if it’s just a small partial amount of money, but you secure that seller carry back with a different property, not the one you are buying from them.

So here’s the key idea that I hope you will walk away with as this episode wraps up: you can borrow money in one of two ways it can be unsecured, meaning you just say I promise to pay you back. And maybe you sign your name somewhere that says that. Or it can be secured, in which case you sign something that says I promise to pay you back and you pledge some collateral, we’re going to focus here on the second one, primarily the secured loans. Here is the point that I really want to spell out clearly for you: secured loan means that you have collateral to offer. If you already own a piece of property that has some equity and some cash flow, you have collateral that you could offer to a lender, if you could find a lender who likes your type of collateral, they can loan you money secured by that kind of collateral.

But here’s what a lot of us don’t really remember, in our new acquisition, we are creating new collateral, especially if we’re buying a property we’re going to add value to so the example we’ve been using all along here is you’re going to buy a property for $300,000. Well, what if this is a value add property? What if you know you’re gonna immediately go in, you’re going to put $30,000 of renovations into this $300,000 property, and it’s going to increase the value to $400,000. Because you have a vision for this property. Oh, my goodness, now you have actually just created a whole lot of collateral, because you have built equity immediately, you miss property through your renovations. And so in many ways, I hope that you will think of yourself as being in the business of establishing and growing your collateral. Because once you do that, you will always have more ways that you can borrow if you want to against the collateral that you have, which is always growing because you’re always making improvements. So the question I hope you will be pondering is, what collateral do I already have? Or what collateral will I be creating through this acquisition that I could borrow against to get this deal done?

That is it for today’s episode. And that is it for this little miniature two part series about not getting down about down payments; down payments are a very real part of our business, obviously. And we do absolutely want to find ways to limit the cash of our own that we take out of pocket to put into our deals, but it’s really an oversimplification and a disservice we’re doing to ourselves if we look at a deal and in 30 seconds, say Oh, that’s too big of a down payment, I don’t do a 35% down payments or I don’t do six figure down payments, we need to we deserve. We owe it to ourselves to pause and step back and say, regardless of how big the down payment is in absolute dollars or percentages, how might I make that down payment without it necessarily resulting in that amount of cash out of pocket, and that shift in mentality will really do us a favor and enable a lot more growth in our portfolios.

That’s it for today’s episode of racking up rentals. So again, show notes can be found at thoughtfulre.com/e174. Please do us a big favor by hitting that subscribe or follow button in your podcast app and rating and reviewing the show. That’s maybe the most helpful thing you could do if you want it to be helpful. I see each one and it really sends a message back to those platforms that you’re paying attention and you like what you’re hearing.

Did you know that we have a Facebook group for us thoughtful real estate entrepreneurs? It’s true. It’s called Rental Portfolio Wealth Builders. We’d love to have you join us over there. You could just go to group.thoughtfulre.com and the magic of the internet will take you right there. I will see you in the next episode. Thanks for being here with me again today. Until then, this is Jeff from the Thoughtful Real Estate Entrepreneur signing off.

Thanks for listening to Racking Up Rentals where we build long term wealth by being win-win dealmakers. Remember: solve the person to unlock the deal and solve the financing to unlock the profits.

Leave a Reply

Your email address will not be published. Required fields are marked *