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The Power of "Non-Lien-Able Debt" to a Real Estate Investor
Isn’t it great that there are so many ways to finance real estate investment projects these days? This is important because sellers want to get paid to sell their houses… Right? Just because there seems to be an endless supply of funding sources doesn’t mean that these funds are easy to come by… or if you can get them… they’re easy to afford. In many cases, the borrower is obliged to “jump through hoops” to obtain the necessary funds. Credit approval, appraisals, LTV/ARV… and even then they usually don’t get it. All they need is “skin in the game”.
Good debt vs. bad debt
Most real estate investors are familiar with the phrase “Good Debt vs. Bad Debt.” The problem is that most don’t fully understand the difference. My daughter knew the difference when she was 8 years old. I remember when we went to lunch and he went from asking me for pros and cons to doing story problems. So, in the interest of “educating him early,” I presented him with a story of problems related to business. He would accidentally learn everything from costs to profits…including the differences good and bad debt. His understanding was so thorough that he could recite the definition and, more importantly, explain it when asked.
Unfortunately, we are not taught anything like this in school today. We are taught how to be spenders/savers instead of how to be investors/entrepreneurs. In other words, we are never taught how “money works”, but we are certainly taught how to “work for money”. Knowing the difference between good and bad debt isn’t brain surgery, but the negative consequences of not knowing can be huge. The difference is very simple. Bad debt costs you money, good debt makes you money. Yes, it’s just that simple.
What banks know that we don’t
Banks are well aware of the difference. Just look at the difference between what they “pay” you (and I use the word “pay” very loosely) for your deposits and what they “pay” when they “sell” you credit. Understand that banks’ business is to sell credit. They also know and understand the saying “Own nothing, but control everything”. They live by it. The fun part is that by using unsecured debt, a real estate investor can do the same. They can almost become your own bank.
Bad debt costs you money because it results in you getting less than you started with. Good debt will make you money because you end up with more than you started with. In business, you compare profits and costs. In our personal lives, we compare income to “income substitutes”… sometimes called credit cards.
Obvious examples of good debt are things like SF rentals, multi-family rentals, commercial real estate, and other significant cash flows. Examples of allowable debt would be the previously mentioned credit cards, boats, RVs, etc… The equity in our own home is not an investment. It doesn’t make us money, building it does. Now if it is used in the form of a loan, it becomes a debt… what type of debt depends on what it is used for. Note that I’m not saying we should all refinance our homes, take out the equity and invest. If you choose to do that, you do not have my blessing. You are putting your home at risk. Not smart. Mainly because there are many other safer ways to get money to invest.
The power of connection… Dubbing on steroids
Banks understand all this. They leverage your assets/deposits into credit/debt. This is their credit and debt to you. They own nothing and can actually use credit, actually selling you “virtual money” for many times the “face value” of your deposited property. That topic is for another time. For the purposes of this discussion, understand that the bank takes advantage of the ability to duplicate. In fact, they take advantage of what Albert Einstein called “the greatest invention of the 20th century”… compound interest. He went even further and claimed that those who understand it (the banks) live off those who don’t (the rest of us).
Want a very powerful example? Start a Penn… just 1 cent. Then double it over the next 30 days. So day 1 would be 2 cents, day 3 would be 4 cents, day 4 would be 8 cents and so on. Do it on paper. It will have a much bigger impact on you. What is the answer? Try it. You are surprised. What you are looking at is an example fusion at its best.
So how do we do the same as real estate investors? Can we do the same? The answer to the second question is resounding yes! You guessed it, the answer to the first question is using unsecured debt.
The Power of Lien Free Debt… Compounding on Steroids
How do you ask? Simple. First, keep in mind that the typical type of financing used in investment properties is mortgage debt. Property… there is some type of lien on the property being purchased. If we use unsecured debt, there is no lien on the real estate. In fact, there is no real estate connection at all. This is critical. That’s what makes it work. That’s what makes us your bank. How?
What’s the first thing that happens at closing, after the mountain of paperwork is signed? The answer is that the seller’s original lender is paid off. In other words, lien has been paid. The seller doesn’t even see the money. Wouldn’t you at least want to touch it when you sell it… even for a minute? How to do more? How about if you could recycle this over and over again? Yes you can. This answer was for all those who read this and say “know you can’t”. Here’s why… and how.
Let’s look at typical real estate financing. First, the loan is acquired and we buy and renovate the property. We flip the house and at the sale we do two things: 1) we pay back the original financing (lien); 2) we make a profit (hopefully). Now we need to get new funding and deal with the “app triples” again to move forward. You know, a new application, evaluation and approval. Everything is expensive, time consuming and without guarantees.
If it was unsecured debt, we wouldn’t need to pay back the borrowed money…at least not right away. It also means that instead of walking away with only our profits to use, we walk away total revenue from sales. Sell the house for $75,000 with a $50,000 mortgage and we walk away with just $25,000… profit. Sell that same house with unsecured debt and we walk away with the full $75,000…minus closing costs. Which would you rather do?
Turning “Bad Debt” into “Good Debt”
OK, before I go any further, I need to respond to all the readers who say “I still have to pay off the debt”. In fact, I have monthly payments coming up that are usually very large due to the nature of most NLD terms. So what do I do, do I fund a cash reserve as part of the NLD. The cash reserve is your silent partner whose only role is to make monthly payments until you can develop your system to be independent and self-sustaining. Combine the profits from the first couple of flips and buy/rake another “Flip House” so that you can use those funds again and again because the second house would have no debt… you bought it for all the money you bought. The idea is to NEVER use this principle for anything other than the cost of the next Flip House. You are now working with two “flip houses” after the second flip
Flip the two houses, combine the two profits and buy/rake the third Flip House. Again, you use the costs of all 3 houses to buy/renovate the next 3 Flip Houses. You now have three rows of Flip Houses. No matter how many times you try spend principle… they keep giving it back to you. This is where the real fun begins.
By the time you’ve developed your system, your cash reserve will dwindle to nothing. So, time to pay back, don’t you think, and buy yourself more time. Remember that the payments you make from the cash reserve are actually paying off the debt… or it won’t work, so keep that in mind when calculating how much money to put into the reserve. Now for the real fun.
As I said, the cash reserve is “no more”, so return it…with one of the three flip house profits. What do you do with the other two profits? Buy/renovate “Hold house” for cash flow…with all cash. Then keep flipping the 3 flip houses over and over using the “profit only” to buy more cash flow with all the cash and pay back every now and then until the debt is paid off… and you’re completely debt free.
Lind’s story… Einstein was a pretty smart guy
Question 1: How many times did we pay for these funds?
Answer: One time… we just didn’t pay it back all at once like we would have if it was a lien debt.
Question #2: How many houses can we use these funds for (remember we only pay for them once)?
Answer: I don’t know. I will let you know when I stop recycling them.
We just became our own bank. We now leverage our money for ourselves at no extra cost. Each time we reuse these funds at no additional cost, we reduce the cost of debt per house. This means that we just made the initial cost of this type of financing unimportant.
Einstein was right. Connecting is a beautiful thing. Combined with unsecured debt, this can be a “gold mine” for real estate investors.
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