Purchase Amount vs Loan Amount
Buying a home involves borrowing money and dealing with many numbers. Homebuyers tend to focus on the home's purchase price. This is a good indication of your ability to afford the price. You should consider the loan amount since you may not be able to pay cash only.
A loan is the amount of money borrowed to purchase a home. Because most lenders don't always offer 100% financing, it usually differs from the purchase price. Therefore, it is also essential to consider the loan-to-value ratio. The value combines the purchase price with the loan amount and is commonly referred to by lenders.
Making solid real estate investment decisions requires an understanding of these numbers. Of course, you should focus on the purchase price, but the loan amount plays the most crucial role in your decision. Here's why.
What's The Purchase Price?
You agree to pay the seller a certain amount, which is the purchase price. Your sales contract stipulates the price or the amount your realtor negotiated with the seller so hard for.
For instance, an agent gets the home's listing price down to $250, 000 despite the sale being listed for $275,000. The purchase price is $250,000. If you buy the house, you will pay that price. You are unlikely to have $250,000 lying around, so we need to talk about loan amounts.
The Loan Amount Isn't The Purchase Price
Because most lenders will not lend you the entire purchase price, the loan amount will differ from the purchase price. As an example, we will use the $250,000 sales price. If you live in the home full-time, you could get 80 percent of that amount, or $200,000. Since you live there, primary residences have a lower default risk, but you need to supply the remaining $50,000.
Lenders require you to put up your own money to reduce default risk. This is known as putting "skin in the game.". For example, a traditional loan requires 20 percent of the money. Lenders feel that 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.
For investment properties and fix and flip properties, traditional lenders require even higher down payments. Many traditional lenders do not lend for fix-and-flip but rather to homeowners or landlords working on their own properties.
On the other hand, a hard money lender offers down payments for investment properties as small as 15 percent, including fix-and-flips. The hard money lender is focused on the value of the property after it has been repaired and the collateral. They know that they will take over the house if you default on the loan. Therefore, you are more likely to get financing if the property has a value equal to (or greater than) the purchase price, plus the proposed repairs will raise its value.
Understanding The Loan-To-Value Ratio
Investors need to know how much loan to value they have. In other words, you compare the loan amount with the home value. You will have two LTVs when you fix and flip a property - the original (as-is) value and the after-repair value.
After repairs, the home is worth more, so if you fix it up enough, your LTV will decrease, resulting in more profits. The home's value should increase if you invest 20 percent in the house and repair it. As a result of your changes, your LTV should drop from 80 percent to 60 or 70 percent. A 20 percent increase in profits is a good return if your LTV drops 80 to 60 percent.
Of course, this is a fictional scenario, as the value and LTV of each home differ based on the market and renovations made to them.
The lender should be able to offer the financing you need on terms you can afford. Finding the right home and obtaining the right loan can lead to significant profits in real estate investing. Find a lender that will accommodate your needs based on how much money you can invest in a property.
LTVs do not always mean high-interest rates or complicated terms. Instead, invest in the fix-and-flip or buy-and-hold market by finding a lender specializing in real estate investments. With the proper knowledge, you will be able to grasp many of the available opportunities.