Detroit Area Real Estate - Canton | Plymouth | Northville | Livonia - Community News » buying homes for investment

Good Debt Vs. Bad Debt

alsted — Wed, 26 Mar 2008 17:27:15 +0000

Trading Bad Debt for Good Debt could help you build wealth

The current weak housing market in Canton, Plymouth, and surrounding communities in the Detroit, Michigan suburbs has created financial woes for home owners. At the same time it has created fantastic investment opportunities for renters or those who wish to buy a second home for investment purposes.

Investing your money these days may be something you feel apprehensive about given the current news on the economy. I can tell you from experience however, that now is a great time to increase your debt for the right reasons…increasing your wealth.

When it comes to debt, most consumers fall into either of two camps – those who fear debt and those who embrace it. Let’s call the first group the debt-o-phobes. To these folks, debt is to be avoided at all costs. They don’t carry a credit card and refuse to buy anything, except a home perhaps, on credit. We’ll call the other group debt-thusiasts. As long as they can have whatever they want right now and can afford the monthly payments, they don’t care how much debt they are in or interest they will pay.

Neither extreme is healthy. The debt-thusiasts are constantly paying too much for goods and services, because in addition to the purchase price, they are usually paying a hefty amount in finance charges. They never get ahead and have little chance of building wealth.

The debt-o-phobes, on the other hand, can save a considerable amount of money in interest, but they have less money available to fund revenue-generating investments. Because they refuse to take on debt, the only money they have to invest is the money they have squirreled away.

Financially healthy, wealthy, and wise individuals are not opposed to taking on debt, but they are very proactive in limiting bad debt and maximizing the power of good debt.

Bad Debt

What exactly is bad debt? Bad debt is money you owe on something that 1) does not increase your earning potential and 2) depreciates – decreases in value over time. Generally speaking, if you go on a spending spree with your credit card, you are taking on bad debt.

Some experts would claim that a loan taken out to purchase a new car is bad debt, because as soon as you drive the car off the lot it depreciates. While that may be true, financing the purchase of a nice car could increase your earnings potential, allowing you to drive to a workplace that offers a higher salary. A nice car could also improve the earnings potential of someone in sales who must drive clients around.

Good Debt

Good debt is money you owe on something that either 1) increases your earnings potential sufficiently to pay back the debt, and then some, or 2) enables you to invest in an appreciable asset – an asset whose value increases over time sufficiently to cover the debt.

Experts generally agree that a mortgage loan used to purchase a home represents good debt, because while you are paying the interest on the mortgage, your home is appreciating in excess of the percentage interest you pay. In addition, your home mortgage is tax-deductible, assuming you can and do itemize your deductions.

Most people also consider education loans to be a form of good debt, because an education generally improves your earnings potential – although that may depend on what you study in school and how much debt you graduate with.

Exchanging Bad Debt for Better Debt

Although you may not be able to trade bad debt for good debt, you may be able to decrease your amount of bad debt. If you have a large amount of credit card debt, for example, and some equity in your home, you may benefit by refinancing your mortgage loan to pay off your credit card debt. (Equity is the amount of money locked up in your home – if you sold your home today and paid off the mortgage, the amount of money you would have left represents the equity.)

Refinancing your home mortgage to pay off your credit card debt could benefit you in two ways:

• Decrease the amount of interest you’re paying. A mortgage loan usually carries a significantly lower interest rate than the rate charged on credit card debt.

• Makes the interest you are paying tax-deductible. Home mortgage interest is tax-deductible. The interest you pay on your credit card balance is not.

Caution: Consult with a trusted and qualified accountant or loan specialist before refinancing your home to pay down your credit card debt. Refinancing too often can cost you a considerable amount of money in loan origination fees and other expenses related to taking out the loan.

Caution: Refinancing to pay off credit card debt converts the unsecured credit card debt into secured debt. The debt is now secured by your home, which allows the lender to foreclose if you are unable to make payments. Credit card companies cannot seize your home if you fail to make payments. In addition, if you file for bankruptcy, secured debts have priority over unsecured debts, so if you think you might have to file for bankruptcy later, converting unsecured debt into secured debt may not be a good idea.

Investing with Other People’s Money

One of the secrets to maximizing the return on your investments is to use borrowed money (other people’s money) to finance your investments. For example, say you have $100,000 to invest in real estate, knowing that you can buy and fix up a home for $100,000 and then turn around and sell it for $120,000. If you could pull it off, you would earn a 20% profit, which isn’t bad.

But what if you took that $100,000 purchased and fixed up five properties? For each property, you would use $20,000 of your own money as a down payment and $80,000 of borrowed money – other people’s money. Now, you buy, fix, and sell five homes, earning $20,000 per home for a total of $100,000 in profits – a 100% profit!

That’s what you call leverage, and you gain leverage by using other people’s money.

When you are ready to begin building your own wealth in real estate, talk to your loan officer or mortgage broker about leveraging the power of other people’s money. He or she will know exactly what you’re talking about.

Ralph R. Roberts, GRI, CRS is an experienced real estate agent and investor and author of Mortgage Myths: 77 Secrets That Will Save You Thousands on Home Financing (John Wiley & Sons).

Flip This House… But Isn’t Flipping Illegal?

alsted — Sat, 01 Mar 2008 15:44:56 +0000

Reduced house prices in Canton, Plymouth, Northville, Novi most other Detroit, Michigan suburbs are presenting unusual opportunities for purchasing and flipping houses for profit.

During the housing boom, flipping houses was almost a national pastime. Shows like Flip This House, Flipping Out, and Flip That House attracted huge viewing audiences, and nearly every book in Amazon’s real estate top sellers category had the word “flipping” in its title.

If you mention house flipping to a real estate or law enforcement professional, however, they are more likely to think that you are talking about committing a crime. To them, the word “flip” is a nasty four-letter word. HUD (the U.S. Department of Housing and Urban Development) declared it so when it released its FR (Final Rule)-4615 Prohibition of Property Flipping.

So, is flipping good or bad? Legal or illegal?

Well, that depends which form of flipping you’re talking about. The illegal variety consists of selling a home multiple times over a relatively short period in order to artificially inflate the home’s value and cash out the inflated equity.

To begin, a con artist will purchase a home (typically a dilapidated property that costs very little). He or she will then obtain an inflated appraisal for the property – by finding an appraiser willing to go along with the scam, stealing an appraiser’s identity to forge a fake appraisal, or using a phony appraisal document. The con artist can then apply for a loan for the inflated amount. (Or, the con artist will apply for the loan and then, with the help of a cooperative loan officer, obtain the inflated appraisal to present to the lender.)

In either case, the con artist usually takes out the loan in the name of a straw buyer (someone who owns the home in name only) or by using a fake or stolen identity. Eventually, the house flipper either sells the home to somebody who is unaware of its true value or abandons the home.

That’s illegal flipping in a nutshell.

Legal flipping consists of buying a home for less than its true market value (usually at least 20 percent less), fixing it up, and then selling it at or near its true market value. This fix-and-flip approach is the type of flipping they do on TV shows like Flip This House and Flip That House. It is a shrewd and honorable way to earn a buck in real estate. As a consumer, knowing the difference between the two types of flipping is important.

Know the illegal form of flipping so you don’t break the law or get stuck with an overpriced piece of real estate that’s being used in a flipping scheme. Know the legal form of flipping, so you can fix and flip your way to wealth in real estate.

Author, Ralph R. Roberts, GRI, CRS is an experienced real estate investor and consultant and the author of Flipping Houses For Dummies (John Wiley & Sons).

Looking for a good house flip candidate can be tricky. Typically investors look for foreclosed or distressed houses. This can be dangerous however since such purchases are cash and full of "buyer beware" danger signs. Foreclosures for instance usually come with hidden title defects that the buyer is saddled with.

To avoid getting into something that turns into a nightmare make sure you hire a good Realtor that is expert in investment strategies. It is always helpful to find a professional who has several properties of his or her own and is personally involved with the house flipping process.

You also want someone who will be a good negotiator. Experience makes the difference when they go to bat for you. This trait in a Realtor can make the difference between making a profit or ending up losing your shirt.

Don’t forget the other side of the equation…selling the house you just fixed up. Marketing is the key. Selling your newly renovated investment can take a long time unless the Realtor you choose has an aggressive marketing plan. Capturing Internet buyers is what’s most important. Before you hire a Realtor ask them to show you specifically how he/she captures buyers and how many they are currently working with. In this market the Realtor who controls the buyers controls the market.