- The Washington Times - Thursday, October 27, 2005

Q:I am under contract to purchase two investor town homes. The

contracts were made preconstruction, almost two years ago, for $400,000 each. The properties are now worth at least $500,000 each, and I’m scheduled to go to settlement in about a month.

When I made loan application, the loan officer told me that I can’t qualify for the loans because I can only put 10 percent down and my salary is $80,000. The only thing he came up with was a 12 percent, no-payment note with six points and a six-month balloon.

Now I’m afraid I’m going to lose these houses and the $200,000 equity. I was hoping to hold the properties and rent them out for a year to avoid the big tax hit. The houses should rent for about $2,500 a month.

Any advice?

A: At first glance, I can conclude that you have put yourself in a highly speculative position. A 10 percent down payment on a $400,000 purchase price equates to a loan of $360,000. Two units make $720,000 in mortgage debt. On an $80,000 salary? It’s pretty clear you are in over your head.

Let’s run some general numbers and see where we are. Assuming you could qualify and receive the best rates available for 90 percent investor financing, you might find a rate at about 7 percent with no points. Principal and interest payments would be $2,395 per month.

Let’s estimate taxes at $275. Hazard insurance might be $75. Private Mortgage Insurance (PMI) at a minimum might be $150. PMI might be eliminated with a “piggy-back” 80-10-10 loan, but that’s a detail we needn’t worry about yet.

Add all this up and you have a total monthly obligation of $2,895. Multiply by two and you have a total monthly obligation of $5,790.

For someone who makes $80,000 per year, or $6,667 per month, you can’t qualify for conventional financing.

Even if you could secure good financing, how quickly can you get these units rented for $2,500 each? Even if you could rent them quickly, you would still have a rent shortfall of nearly $400 per unit.

Can you afford an additional $800 per month for the next year to cover the shortfall? Shouldn’t these numbers have been crunched two years ago?

From my experience, you will have a hard time finding good financing given your salary, the amount of money you want to borrow, and your relatively low down payment.

Your loan officer might be right. “Hard money,” as it is called, might be your only alternative.

The frenetic pace of the Washington area real estate market is finally showing signs of slowing down.

While I’m certainly not in the business of speculating where the market is headed, I can easily recommend that you abandon the notion of holding these units for rent. What if the rental market softens and the units sit vacant for a few months?

If the town homes are, indeed, worth $100,000 more than your contract price and could be quickly sold, it may make sense to take the hard money and flip them.

Here are some quick numbers: 12 percent on $360,000 equals $43,200 per year, or $3,600 per month. If it takes you two months to sell the properties, your accrued interest would total $7,200. Six points on $360,000 equals $21,600. Other costs associated with the purchase and subsequent sale might be an additional $6,000.

Let’s also assume that you pay a 6 percent sales commission when you sell. $500,000 X 6 percent = $30,000.

Total costs, therefore, might be $64,800.

Gross proceeds from each sale would be $500,000. Subtract the principal loan balance of $360,000 and the total transaction costs of $64,800 and you would net $75,200. Your down payment was $40,000 so your taxable profit would be $35,200 for each unit.

Besides taking the safe route and walking away from the deal, such a scenario is the only thing that I can come up with.

My advice would be to fine-tune your knowledge of the marketability of these units.

The real estate market can turn on a dime. Your overall financial picture does not suggest that you hold these properties. If you can get out with a profit, do so.

Henry Savage is president PMC Mortgage Corp. in Alexandria. Contact him by e-mail (henrysavage@pmcmortgage.com).

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