Expert: Russel Ray - 1/9/2008

Question
I have a question.  I have decided to buy forclosure houses and fix them up and then flip them for a profit.  I am familiar with interest only loans, and would like to have one of these mortgages because i would only be in the house for about a year.  I know with these loans you do not build equity because you only pay interest not any of the principle.  So my question to you is, if i were to buy a $30,000 dollar house on the forclosure list and it was really worth $40,000 would i "so-called" start off with $10,000 in equity.  I just need to know how this works so i know if an interest only mortgage would be good for this or if i should go with some other type of mortgage to build equity.

Thank you for your time
Kory McLaughlin


Answer
Hey, Kory.

Sorry about the delay in answering this. Although I remember answering this shortly after you sent it, somehow it didn't get set. My apologies.

You've got the basics down as far as equity goes. That's why people can make so much more money in real estate. There's no place else where you can make such a great return on your investment. Here's how it works using your example:

If you get an interest only loan that costs you $500 a month and you keep the house for one year (more on that later), then your investment is $6,000. If you do nothing except keep the house vacant for a year and then sell it for its true $40,000, you've made $4,000 on your $6,000 investment, or a return of 67%! Where else can you get a 67% return on your investment in a mere year?

Now let's say that it would sell for $50,000 if you invested $4,000 in landscaping, paint, and kitchen and bathroom remodeling. Your holding costs for the year are now $10,000 but you make $20,000 when you sell ($50,000 minus $30,000), so you've netted $10,000 on your $10,000 investment, or a return of 100% in just one year! Can you tell I'm excited?

Do that concurrently for, say 12 houses, and you've just made $120,000. Now you see why real estate people are so rich. And the cool thing is that you can do it all with other people's money.

So if your goal is to flip a property (meaning buying, renovating, and selling all within a six-month period), then an interest-only loan is what you want. If you're going to keep it for more than six months, get an standard loan that builds equity. If you're keeping it for a year, which is not what flippers do, then you might consider keeping it for even longer and turn it into rental income property for you.

Your goal as a flipper should be to get in and out as quickly as possible because that lowers your holding costs (i.e., your mortgage payments, as well as utility and insurance payments).

My question would be, Where can you buy a house for $30,000? LOL Here in San Diego, that gets you a new car but that's about it.

Feel free to let me know how you do or if you have any other questions. We can even take our communications to private emails if you'd like.

Russel