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Building Financial Freedom Through Real Estate Investing

March 28, 2012
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Jeff Donnellan Re/Max

A book that I recently read had this quote and I was deeply impacted by the thought of having control over my time.

” What do you consider the signs of a successful life?  Many people think that accumulating wealth & belongings is the central sign of success: others are happy to have their health and retirement security.  You need to come up with your own definition,  but here is an idea about success that deserves consideration.  Success may be defined as achieving complete financial and personal freedom.  That allows you to do as you please while maintaining complete control over how you spend your time.”  – Michael Thomsett

Everyone has a dream about their future and how they would spend time if money was not a factor.  Your work doesn’t define who you are, but provides a means to an end.  A way to pay for living expenses, obligations and hopefully enough to save for investing or retirement.  Real estate investing can be a means to an end and a way to take control of your time while becoming financially free.  Rental properties have four advantages that no other investment can combine.

– Cash Flow

– Appreciation

– Leverage & Loan Amortization

– Tax advantages

A rental property can generate monthly income that can be used to pay bills or reinvest into the property to increase its value or overall ownership.  Most real estate appreciates over time.  A home purchased today for $250,000 that appreciates at 3% per year will be worth $336,000 in 10 years.  Residential home loans can leverage your down payment.  With a 20% down payment a buyer can borrow five times more than what they put in and over time the loan is amortized to pay down more principal.  This allows the owner to gain more equity each year of ownership.  The tax advantages of owning real estate can be significant.  The interest paid on the loan is a tax deduction as well as depreciated home value.  The IRS allows the value of a home to be depreciated down to zero over 27.5 years.  This creates a paper lose when the home is creating cash flow and appreciation every year.

Real estate should be viewed as a long-term non-liquid asset and its value compounds over time.  This period is usually 5-10 years and called seasoning.  If a property cash flows the owner can choose the correct time to sell for maximum profit in a good market,  instead of being forced to sell and lose value in a bad market.

Many people who I speak with are interested in real estate investing, but don’t know how to begin.  Saving enough cash for down payment can be difficult and usually doesn’t come quickly.  I tell them to think of the time used to save as a learning period as well.  Learn as much as possible about mortgages, properties available and plan the details of the purchase.  One way to begin investing immediately is to buy a 2-4 flat and live in one of the units.  By taking this approach you can get owner occupied financing ( lower rates, better loan terms & smaller down payment).

Another way to begin is called move up and rent out.  This is where the owner of an existing home rents out their current home and purchases a different home to live in.  Again the advantage of owner occupied financing comes in to play so cash flow is more likely.  The challenge in this scenario would be financing.  Today you would have to qualify for both loans or have more than 20% equity in your current home.  This is to prevent a “buy & dump” which is when some one purchases a new home and stops paying for the old one.

The next most common way to begin is buying real estate as pure investment.  Usually a larger down payment of 25% is needed, but the larger down payment will help the investment cash flow because less money is going toward paying a mortgage.  Real estate investors at this stage are looking at properties for ROI or return on investment, and not as a stepping stone.  Make sure your Realtor or real estate adviser can provide details on ROI for each property so you can make an informed decision.

Real estate investing is not for everyone.  There are some down sides like dealing with tenants needs, repairs, & possible vacancies.  Choosing the right team to help you is of the most importance.  A Realtor with investment experience can help in the selection of properties or help manage rentals.  A mortgage lender can suggest the best form of financing and qualify you for the appropriate purchase price.  An accountant can plan your taxes in order to take advantages of the most deductions and pay less in income tax each year.  Real estate attorneys act as an insurance policy & protecting your interests from losses.  Selecting the correct advisers will set you up for success.

http://www.webhomesearcher.com

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What’s the Difference Between Short Sales, Foreclosures and Traditional Real Estate

March 21, 2012
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By Jeff Donnellan Re/Max

Residential real estate has been turned upside-down in the last 4 years.  Purchasing a home was a fairly simple process.  A buyer could find a home they like, make an offer directly to the owner, negotiate price and terms, then close within thirty days.  Today real estate is a completely different world and the market is dominated by short sales and foreclosures ( up to 50% of all sales in some areas).  However,  there’s a lot of confusion concerning expectations and values between these types of sales.  The largest differences between the three types of sales are price, timing, terms, and condition.

A traditional real estate sale will usually reflect the top price of the market.  In most cases the owner has maintained the home and will quickly negotiate reasonable offers.  In addition they will be open to fixing problems that come up during an inspection.  This situation is ideal for a purchaser that wants to move quickly

Short sales are a type of distress sale where the owner can not keep up with mortgage payments or property maintenance.  This type of purchase can take between two & six months before receiving a counter offer from the seller’s mortgage company.  Most cases the  seller will likely not make repairs to defects in the home.  The typical discount when purchasing a short sale is 13%-30%.  If you have time to wait and don’t mind making a few repairs this can be a great option.

Foreclosures are usually the deepest discount, but there are many unknowns.  The home has been vacant for some time and an empty home in the winter has a high probability of frozen water pipes which then break.  Repairs can be extensive and a buyer will need cash or a rehab loan.  If the repairs needed are extreme, the home may not qualify for financing.  A very thorough home inspection is needed to determine what type of repairs are necessary and how they will cost.  Responses from the bank are usually quick and very from 24-72 hours.  Closings can also happen quickly and in 30 days or less.  This is definitely a “buyer beware situation.”  If not planned properly a foreclosure could turn into a money pit.

When purchasing a home you must consider which option best fits your situation.  Before falling in love with a home find out what type of sale it is and can it be financed.  Realistic expectations are critical.

Jeff Donnellan  Re/Max

http://www.webhomesearcher.com


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Pay off your Mortgage Quicker, Save Money & Build Long Term Wealth in Real Estate

March 12, 2012
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If I can could share just one real estate tip it would be to pay off your mortgage early. I will show you how by using biweekly payments.  It’s a simple and easy trick that your bank doesn’t want you know about and will save you tens of thousands of dollars.

I bought my first home during the peak of the real estate boom thinking I would own it for a few years and make a massive profit because prices were rising dramatically every year.  Was I ever wrong.  Within 2 years my property value took a downward spiral and to this day I owe way more than what it’s worth.  But this doesn’t bother me because I have a long-term plan where my home will make me money every month.  Let me show you how.

For those of you who have purchased a home, there was most likely a document you signed called the truth in lending disclosure.  It showed how if you made every payment on time for the next 30 years you would pay almost double what you bought it for.  That is how bankers calculate compound interest loans.  Let me show you a different set of rules that will literally save you tens of thousand of dollars.  It’s called biweekly payments, and will help you gain home equity at a rapid rate

Now the bank’s way of calculating interest is based upon paying the loan payment once a month using compound interest.  With a biweekly mortgage payment plan the loan payment is divided into half of the monthly amount paid every 2 weeks. You would make 26 half payments which equal 13 monthly payments.  The is the equivalent of making 13 mortgage payments in 1 year instead of 12 and takes a 30 year mortgage pays it off completely in 25 years.   Let me show you what this looks like in actual dollars.

As you can see the biweekly payment plan accelerates the principle pay off so the finishes 5 years early and saves $30,000 in interest payments.  The key principal is that you pay the same amount every month like a normal mortgage but it’s divide up into two equal payments.  Now who wouldn’t want to save that kind of money, gain rapid equity in their home and finish making payments 5 years sooner?

This abbreviated chart below shows principal remaining by year for a $250,000 mortgage at 4% interest.

Year #

Standard Mortgage

Biweekly Mortgage

1

$245,597

$244,342

5

$226,118

$219,315

10

$196,959

$181,869

15

$161,357

$136,171

20

$117,885

$80,401

25

$64,808

$12,058

26

$52,860

$0

27

$40,426

$0

28

$27,485

$0

30

$0

$0

 

 

 

 

 

 

Notice how after year 25 the balance is completely paid.  In this example it would save $29,000 in interest over the life of the loan.

Standard monthly payment of $1,193 & total interest paid $179,673.  Biweekly mortgage payments of $596 & total interest paid $150,450.  The biweekly option creates equity faster by paying the principle quicker.

One detail I do want to explain.  Not all mortgages have a biweekly option and some charge a service fee.  When inquiring make sure you choose the loan accelerating option.  If your mortgage doesn’t have a biweekly loan accelerator option you can do this on your own by taking the principal payments you make each month and divide by 12.  Add this amount to your mortgage payments every month as additional principal.Notice how after year 25 the balance is completely paid.  In this example it would save $30,000 in interest over the life of the loan.

Now most people would say, “I don’t plan on owning the same home for 30 years.”  In many cases this is extremely legitimate.  Jobs change, families grow or shrink,  all kinds of life changes happen, causing Americans move every 5-10 years.  But let me show you something first and I’ll use the same data from the figures above.  The same home that was mortgaged for $250,000 had a 5% down payment and a purchase of $262,500.  If that home appreciated at a modest 1% (Illinois average over last 30 years was 4.8%) 5 years later it would be worth $275,890, after 10 years $289,963, and after 30 years $353,810.  If we use an appreciation of 4% that same home would be worth $851,391 in 30 years.  Now that’s absolutely amazing.

If you’re satisfied with this one tip then there’s no need to read further.  But if you want to know how to build wealth in real estate with no gimmicks, risky schemes, or speculation, just honest hard work and smart decisions, then please read on.

An overwhelming number of Americans are not super rich and made of money, but over time through working a steady job are able to save a little bit of each paycheck.  Let me give you an example of how you can leverage your personal savings account,  buy another home and “move up.”

When the average American moves in that fifth year, what if they were to rent out their existing home and purchase another?  The passive income opportunities could be absolutely astounding in the years to come.  I’m going to stick with the figures from above and estimate that same home would rent for about $2000 per month.  The table below will explain cash flow per year.

Principal & Interest

$1,193

Taxes

$479

Insurance

$50

Monthly Rent

$2,000

Monthly profit

$278

Yearly Profit

$3,336

Rate of Return on Down Payment

25%

This table does not take into account lawn care, snow removal, or maintenance fees since these items vary drastically.

Rate of Return:

Yearly Profit divided by initial investment

3336/ 13,125 = 25%

Let’s convert this to investment terms and return on investment (ROI).  Let’s remember the initial 5% down payment or $13,125.  Divide yearly earnings of $3,336 by $13,125 and your rate of return is 25% per year with your initial investment being paid off in just 4 years.  That is outstanding considering only the riskiest stocks pay 15%-18%.  Taking this scenario to it’s logical conclusion has the tenants paying off the entire mortgage, after which point $1193 a month is all profit in today’s dollars.  This does not account for inflation, rental price increases and tax increases since we have no idea what that would be so far into the future.

So there you are earning $14,000 a year, the home is paid off, and appreciated up to over $850,000.  How does that sound?  What if you were to do this more than once and purchase one home every 5 years as either a “move up” or investment property.  Given the same scenario from above, by purchasing 6 homes whose value’s are $262,000, the total appreciated value when owning each for 30 years is $5.1 million (4% appreciation), and the potential rental income in today’s dollars would be $90,000 per year, earned just by collecting rental checks.

This is why I’m a strong advocate for long-term, buy and hold real estate.  No matter what kind of market you buy into, rental income can pay your monthly bills and over time the asset or home is paid off, allowing you to pick the perfect time to sell when the market is up.

The four main benefits of real estate are:

1. Cash flow

2. Appreciation

3. Loan amortization

4. Tax shelter.

I have explained the first three and here is how real estate functions as a tax shelter.  The IRS has a mortgage interest deduction.  In the same example from above with the $250,000 mortgage the tax deduction would be about $9800 per year at the beginning of the loan and slowly decreasing until it is paid off.  The second benefit comes in to play with rental properties and it’s called depreciation.  The basic principle is the IRS degrades a property’s value down to zero over 27.5 which is considered it’s useful life.  In this same example it would average $9000 per year in further tax deductions.  This combines for a total tax shelter of $18,800.  Combining both tax deductions may even drop you into lower taxable rate from paying 25% in taxes to 15%.  On this topic I would definitely contact your accountant to see how it would affect your personal finances.

Yearly Loan Interest Paid

$9,800

Mortgage Interest Deduction

$9,800

Depreciation Deduction

$9,000

Total

$18,800

Rental income

$3,336

Additional Tax Shelter of other Income

-$15,464

$15,464 is a paper loss only and may shelter part of your full time income.  Speak to an accountant about your specific tax return.

I hope you have enjoyed this and helps give direction to your financial future.  Please contact me with feedback and questions.For these reasons real estate out performs all other asset classes year after year, decade after decade.  It builds long-term wealth, generates monthly income, long-term appreciation, has tax benefits, you can personally manage it, can be financed, your money can be leveraged and most importantly everyone needs a place to live.

Jeff Donnellan

Re/Max

jeffdonnellan@gmail.com

www.webhomesearcher.com

773-828-8151


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Building a New Home

March 7, 2012
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Jeff Donnellan Re/Max

Building an new home is an exciting process and some times necessary when the real estate market is short on supply of what you need or want.  When people have specific needs or looking for that forever home it’s important to get what you want, otherwise you just end up moving again.

The home builder market has shrunk considerably since 2007, with many being stuck with a large inventory and eventually declaring bankruptcy.  In many ways this was a good thing since it cleared out many of the people that had no idea what they were doing as well as the disreputable business men.  What remains is the best of the best and home builders with a well run business.  Most home builders do not build spec homes any more or if they do, the selection is very limited.  Because of this they some times charge a premium which is a little bit over market.

The benefits of a building a new home are that you get to make all the selections, such as location, lot, features and amenities with no trade offs or remodeling.  The benefits of projected long term ownership and energy efficiency can be well worth paying a bit over market because moving costs are extremely expensive when you consider closing cost, hiring a Realtor and paying commissions.

Once you find the right home builder and location it’s important to negotiate the final price of the home with the lot and all upgrades.  Find out what is standard and what is an upgrade.  Ask about the materials used and how they effect over all usage, durability and energy efficiency.  Make sure the home builder provides a warranty and is reliable about fixing any issues that go wrong in the 1st months of ownership.  Also ask for at least 3 referrals.

The largest challenge is planning a strategic move.  Financing plays key role and may take some creative financing to make it work since many home buyers also have a home to sell.  Here are some options that can set you up for success if you currently own a home and want to build a new one.

1.  You many need to qualify for loans, your current and the new one in order to start construction.  The construction period is usually 4-6 months.  This would give 3-5 months to market your home and find a buyer.  This may be challenge depending your current real estate market.

2.  Qualify for both loans and rent out your existing home just before construction is complete.  This may be a great option if you can afford the new down payment and use rents to pay your existing mortgage.

3.  Find alternative financing or a portfolio loan.  The rates may be a bit higher but they do not have to meet conforming mortgage standards and could be a bit more flexible.  Many of these mortgage lenders will set up a refinance with in 1 year once the mortgage has  seasoned and you build property management history.  At that point you can qualify for a conforming loan with lower rates.

4.  Option 4 is to sell your home and find temporary living while the new home is being built.  This could be a short term rental of 6 months.  The key to this option this option would be to select all the details of your new home and once you get a purchase contract for your existing home, get the construction process started immediately.

Good luck with your new home.

www.webhomesearcher.com


Real Estate Short Sale Deadline Nears

March 4, 2012
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Jeff Donnellan  Re/Max

Click here for Short Sale HELP

The Mortgage Debt Forgiveness Act is set to expire at the end 2012.  This act provides tax exemptions to home owners who have a deficiency judgement as the result of a foreclosed or short sale their home.  A deficiency judgment is an unsecured money judgment against a borrower whose mortgage foreclosure sale did not produce sufficient funds to pay the underlying promissory note, or loan, in full.  The IRS considers this taxable income.  For example is a mortgage balance is 100k and and after the home is sold through short sale or foreclosure the total amount recovered after expenses is 50k.  The IRS would consider the 50k of debt cancellation as taxable income.  The Mortgage Debt Forgiveness Act is an exemption for home owners to not be taxed on forgiven debt, but this is the last year to claim it.

A major benefit of a short sale over a foreclosure is the ability to negotiate the deficiency judgement away.  When using an experienced short sale Realtor & attorney they will most likely be able have the bank release the mortgage deficiency and have it reported to your credit scores as “paid in full” or “settled.”  This has a dramatic difference simply because a foreclosure will not be on the record, which will damage credit for 7-10 years.  In effect it’s like a fresh start with the slate wiped clean, giving home owners a chance to start over and one day purchase again.

Is Cancellation of Debt income always taxable?
Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:

  • Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.
  • Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
  • Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.
  • Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.
  • Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.

More information is available on the IRS website http://www.irs.gov/individuals/article/0,,id=179414,00.html


Steps to Purchasing a Chicago Home

March 2, 2012
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Jeff Donnellan

www.webhomesearcher.com

So you’ve found that perfect home after searching for a week, a month, or a year.  So what’s next?   Most likely you’ve already done your pre-approval and financially qualified the home to make sure it’s in your budget.  The next steps will show in detail of how to make that perfect home yours.

1.  Ask for the Home owner’s disclosures such as “lead paint”, “Radon”, and the Seller’s disclosure that lists about 20 items that are critical to a well-functioning home.  If you are buying a foreclosure the seller will not provide disclosures.  So a home inspection is crucial.

2.  Next a CMA or Comparative Market Analysis prepared by gathering at least 3 sold homes with in close proximity and similar features will help determine value and offer price.  If a home is asking 200k and the comparable sales are 195k, the home is well priced.

3.  Making the offer:  These are the 5 negotiable parts of the contract.

  • Price
  • Earnest Money ( good faith deposit kept in escrow until closing when it is returned)
  • Closing Date
  • Personal property ( appliances, fixtures, furniture)
  • Financing (FHA, VA, Conventional, Cash)

4.  After the contract is negotiated it’s time to get busy.  A home inspection should be scheduled in the 1st 5 days after acceptance.  The inspection will help determine if there are any defective parts of the home and issues that need to be repaired.

5.  An attorney should be contact as well to review the contract and get in writing  home inspection issues that the seller agreed to fix or give as cash credits. (with in 10 business days  after contract acceptance)

6.  Contact your mortgage lender and let them know you have an accepted contract.  They will take a mortgage application and start your loan processing.  They will ask for additional documentation such as bank statements, pay stubs, w 2’s and tax returns.

7.  Many of the next steps take place behind the scenes.  The underwriting your loan will begin to make sure all documentation is place and the appraisal will be order to verify the property’s value meets the loan amount.

8.  A mortgage commitment will be issued stating that funds are approved and awaiting the closing.

9.  You will want to do a final walk through of the home usually the day before or morning of closing to make sure no damage was done to the home when the seller moved out and that all agreed upon items have been left in place.

10.  And finally the Closing.  Your mortgage funds will be wired to the title company where the closing is taking place and loan documents will be signed.  Items needed:  A cashier check for down payment, & closing costs made out to the title company and Identification like drivers license or passport.

Congratulations!!! You’re now the proud owner of  a home.