Isn’t it great that today there are so many ways to obtain financing for real estate investment projects? That’s important since sellers want to get paid for their houses when they sell them … right? Now just because there are what appears to be an infinite number of funding sources, it doesn’t mean those funds are easy to get … or when you can get them … they are easy to pay for. The borrower must, in many cases, “jump through hoops” to end up with the funds he needs. Credit approval, Appraisals, LTV / ARV … and even then, they usually don’t get it. All they need is “skin in the game”.
Good debt vs. Bad debt
Most real estate investors are familiar with the term “good debt vs. bad debt.” The problem is that most do not fully understand the difference. My daughter knew the difference when she was 8 years old. I remember when we went to lunch and she went from asking me to do “pros and cons” to doing story problems. So, in the interest of “training her early in life,” I told her about business-related problems. She would accidentally learn about everything from expenses to profits … including the differences between good and bad debts. His understanding was so complete that he was able to recite the definition and, more importantly, explain it when prompted.
Unfortunately, we are not taught any of this at school today. We are taught how to spend / save rather than how to be investors / entrepreneurs. In other words, we are never taught how “money works”, but we are certainly taught how to “work for money.” Knowing the difference between good and bad debt is not brain surgery, but the negative effects of ignorance can be enormous. The difference is very simple. Bad debt costs you money, good debt makes you money. Yes, it is that simple.
What banks know that we don’t
Banks are well aware of the difference. Just look at the difference between what you are “paid” (and I use the word “pay” very freely) for your deposits and what you are “charged” when you “sell” your credit. Understand that the business of banks is to sell credit. They also know and understand the saying: “Own nothing, but control everything.” They live for it. What’s fun is that with the use of non-taxable debt, the real estate investor can do the same. They can almost become their own bank.
Bad debts cost you money as the net result is that you end up with less than you originally had. Good debt makes you money as the net result is that you end up with more than you started with. In business, you are comparing profits and expenses. In our personal lives, we are comparing income to, well, “income substitutes” … sometimes referred to as credit cards.
Obvious examples of Good Debt would be things like SF rentals, multi-family rentals, commercial properties, and other appreciable cash flow assets. Examples of bad debt would be credit cards, boats, RVs, etc. mentioned above. The equity in our own home is not an investment. It doesn’t give us money, it costs us money to build it. Now, if we take advantage of it in the form of a loan, it becomes debt … what kind of debt depends on what it is used for. Note that I am not saying that we should all go out and refinance our homes, withdraw equity, and invest. If you decide to do that, you don’t have my blessing. You are putting your home at risk. Not intelligent. Especially since there are many other, safer ways to obtain funds to invest.
The power of multiplication … duplication of steroids
Banks understand all this. They take advantage of their assets / deposits in credit / debt. That is, their credit and debt to you. They do not own anything and, in fact, they can take advantage of the credit, in fact, sell you “virtual money” many times the “face value” of your asset deposited with them. That topic is for another time. For this discussion, understand that the bank is harnessing the power of duplication. In reality, they are taking advantage of what Albert Einstein called the “greatest invention of the 20th century” … compound interest. He went even further by stating that those who understood it (the banks) live off those who didn’t (the rest of us).
Do you want a very powerful example? Start with a penny… just 1 cent. Then for the next 30 days, duplicate it. So day 1 would be 2 cents, day 3 would be 4 cents, day 4 would be 8 cents, and so on. Get it on paper. It will have a much bigger impact on you. Which is the answer? Try it. You will be amazed. What you will see is an example of composite at its finest.
So how do we, as real estate investors, do the same? Can we do the same? The answer to the second question is overwhelming. Yes! The answer to the first question is, you guessed it, with the use of non-lien debt.
The Power of Non-lien Debt … Getting Worse on Steroids
How do you ask? Simple. First, remember that the typical financing used in real estate investments is lien debt. There is a link of some kind on the asset … the property that we are buying. When we use non-lien debt, there is no lien on the property. In fact, there is no link to the property. This is essential. This is what makes this work. This is what makes us our own bank. How?
What’s the first thing that happens when closing, after the mountain of paperwork is signed? The answer is that the seller’s original lender is paid. In other words, the Link it’s paid. The seller doesn’t even see the money. Wouldn’t you like to at least touch it when you sell … even for a minute? How about we do more? How about power re-use And again? If you can. That answer was for all those who read this and say “you know you can’t.” Here’s why … and how.
Let’s take a look at financing a typical property. First, a loan is acquired and we buy and rehabilitate the property. We turn the house around and, by selling it, we do two things: 1) We return the original financing (link); 2) We make a profit (hopefully). Now, to move forward, we need to get new funding and get back to “app triplets.” You know, new application, appraisal and approval. All expensive, slow and without guarantees.
Now, if this were a non-liable form of debt, we wouldn’t have to pay back the money we borrow … at least not right away. This also means that instead of just leaving with only our earnings to use, we walk away with all proceeds from the sale. We sell a home for $ 75,000 with a taxable debt of $ 50,000 and walk away with only $ 25,000 … the profit. Sell that same house with a non-lien debt, and we walk away with the full $ 75,000 … minus closing costs. What would you rather do?
Convert “bad debt” to “good debt”
Okay, before I continue, I need to respond to all the readers who say “I still have to pay the debt.” In fact, I have monthly payments that are generally very high due to the nature of the terms in most NLDs. So what I do is finance a cash reserve as part of the NLD. Tea cash reserve is your silent partner whose sole role is to make the monthly payments until you can develop your system to become self-sufficient and self-sufficient. Combine the earnings from the first couple of pitches and buy / rehab a second “Flip House”, which will also reuse those funds over and over again as there would be no debt on that second house … you bought yes for all the cash . The idea is NEVER to use the principle for anything other than the cost of the next Flip House. You are working with two “swing houses” now after that second change
Flip these two houses over, combine the two earnings, and buy / rehab a third swing home. Again, you will reuse the costs of the three houses to buy / rehab the next 3 Flip Houses online. You now have three lines of Flip Houses. No matter how many times you treat spend the principle … they keep giving it back. Now, this is where the real fun begins.
While you’ve been developing your system, your cash reserve is shrinking to zero. So, it’s about time you paid it back, don’t you think?, And “buy” longer. Keep in mind that these payments you are making out of the cash reserve are actually paying off the debt … or it’s not working, so when figuring out how much to put in the cash reserve, keep that in mind. Now for the real fun.
Like I said, the cash reserve “no more”, so return it … with one of the profits from one of the three swing houses. What do you do with the other two winnings? Buy / Rehab a “Waiting House” for Cash Flow … with all cash. Then just keep flipping the three Flip Houses over and over again, using “just earnings” to buy more “cash flow” houses, with all the cash, and occasionally repaying the cash reserve until the debt is paid. .. and you are completely debt free.
The story of the tape … Einstein was a pretty smart guy
Question # 1: How many times do we pay for these funds?
Answer: Ounce… we just didn’t pay it all back at once, as we would have done if it were a lien-susceptible debt.
Question # 2: How many houses can we use these funds for (remember, we’ll only pay for them once)?
Answer: I don’t know. I’ll let you know when I stop reusing them.
We simply become our own bank. We are now leveraging our own money for ourselves, at no additional cost. Every time we reuse these funds, at no additional cost, we lower the cost of home debt. This means that we have also just made the initial cost of this type of financing insignificant.
Einstein was right. Compounding is a beautiful thing. When combined with non-lien debt, it can be a “gold mine” for real estate investors.