- The Washington Times - Wednesday, May 3, 2006

I have received several e-mails lately with tales of woe. Seems that would-be investors bought pre-construction dwellings a few months ago in hopes of grabbing a quick buck by flipping the house when they went to settlement.

In the heated market last year, many a novice investor made a lot of money this way. Few, however, heeded the warning given at that time that a turn toward a buyer’s market could cause them much pain and financial suffering. Now they’re paying for it.

Today’s market is less-fevered, but still healthy in some areas. Many would-be investors are now homeowners without two things: Cash to go to settlement or a renter to make their monthly payment for them.

They gambled that they would never have to go to settlement, with dreams of walking away with a lot of cash in return for simply being in line with deposit money a few months before.

So, when people ask me about a good place to invest, I do not point to the markets that have been moving upward for long periods of time and where they cannot cover their monthly payment with fair-market rent.

If you want to build cash flow, seeking more money coming in each month than is going out, then look for the long-haul principle of buy and wait.

Investors look for two ways to grow wealth: Asset growth and cash flow. In good times, you get both in the same property. Sometimes, though, you have to settle for one or the other.

Eventually, a market will appreciate so much that the going rents won’t pay the monthly payment for the come-lately investor. The investment creates a cash shortage each month. This isn’t necessarily bad. For instance, if your rent is $1,000 per month, but the mortgage is $1,200, the $200 monthly shortfall might be affordable and provide a good return on the investment in the long haul if the asset is growing at a healthy rate.

If the property is appreciating at 10 percent and its value surpasses the $2,400 per year in payments you have to make beyond the rental income through the year, the asset growth builds your wealth. The renter makes the majority of the investment per month for you.

If you’re looking to invest in short-term real estate — a fixer-upper to flip — then mortgage programs designed for a low monthly payment might be the tool to use. These would be various adjustable rate mortgages, Cost of Funds Index (COFI) or Option ARMS, and interest-only mortgages.

Some of these programs enable the investor/buyer to qualify for more property, control cash flow and wait for property values to rise before selling or exchanging for a larger, more profitable investment.

For instance, the 2/1 buy-down is making its way back into the marketplace. This is a mortgage that begins its interest rate 2 points lower than the fixed rate, then moves up another percentage point the next year and then finally to a fixed-rate on the third to 30th years.

This type of loan was what I used on my very first mortgage. I was so excited to get a starting rate of 10 percent. By the time it increased to the 12 percent mark, fixed-rate mortgages were headed downward and I refinanced to 7.5 percent, a rate that I found even more exciting at the time.

Another popular loan with investors is the Option ARM. Mortgage-X.com defines an Option ARM as a loan program with an adjustable rate mortgage “with added flexibility of making one of several possible payments on your mortgage every month, in order to better manage your monthly cash flow.”

This type loan provides very low monthly payments — lower than those mortgages with fixed-rate mortgages.

The primary concern for any ARM, especially the Option ARM, is the changing payment year by year. With an Option ARM, you could find that while you’re experiencing the false security of having positive cash flow each month, your mortgage is increasing because you pay the lowest allowed payment, which doesn’t even pay enough interest to keep up with the mortgage. You would be in a negative amortization situation, owing more than you originally borrowed.

Before trying these mortgages, get advice — plenty of advice — from a qualified, experienced mortgage professional who can explain all the benefits and liabilities of these programs.

M. Anthony Carr has covered real estate since 1989. He is the author of “Real Estate Investing Made Simple.” Post questions or comments at his Web log (https://commonsenserealestate.blogspot.com).

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