Real Estate – By Tony Horner

Real-Estate-Basic

In America, all land is owned by someone. In many cases, the government owns the land. Sometimes it’s a national park or a military base, or it could be a public housing project. In other cases, a company might own the land, in the case of a factory or office building. But in most cases, it’s just everyday people that own land. The older houses. Or maybe a landlord owns a house and rented. Real estate is the word we use in the industry that means land someone owns, including any house or building which is on that land. My Autopilot Property Riches course focuses on residential real estate. Residential just means real estate that someone lives in. Someone owns some land with a house on it and they reside there. That’s residential real estate.

Now, most people that want to buy residential real estate are not investors. By that, I mean they are not trying to resell it for a profit or rent it out. They just want to live there. However, anything that you can buy, you can sell, and there is money to be made. Investors don’t want to buy houses to live in, they want to rent them and sell them and make money. You can make a great living doing that, and that is what I teach.

Many people think buying a house is really difficult. Actually, it just sounds more daunting than it actually is. If you think about it, you probably have a lot of experience buying things. In fact, you probably buy something every day. You buy shoes, you buy groceries, maybe you bought your car. You probably find good deals at the grocery store, and you probably haggle with the dealer a bit on that car. My point is, most likely you are a pretty good shopper. So, don’t get too intimidated about identifying and buying real estate deals. YOU CAN DO IT. Of course, I’m not saying buying real estate is the same as buying shoes. Real estate is the most expensive thing most people ever buy. Many times you’re talking about one or several hundred thousand dollars. And anytime you’re dealing with that much money, of course it is going to be more complicated than buying a pair of shoes, because there’s a lot of money at stake. Fortunately, people have been buying and selling real estate for decades, and over time, a pretty smooth and standard system has been developed for buying real estate in each state.

Ownership

Because real estate is worth so much, and because it can’t be moved or transported, there is a system for keeping track of who owns the property. There is a document called the Title (or sometimes called the Deed) that describes the property and who owns it. Every piece of real estate has a title. The government keeps copies of all the titles on file, so it’s very easy to keep track of who owns that property, even if you somehow lost the title document. It’s different in every state — it could be the city, county, township or courthouse, but often it is the County Clerk or County Recorder who keep these records. You can always get replacement copies from the government. It is also important to note that if you buy or sell a house, the change in ownership is not official until the government updates the information on the title. This is called Recording the Title.

Property Taxes

Why does the government keep track of all the titles? Well, one reason is that most states have a property tax. Some states don’t have property tax, but most do and the rates vary. A property tax means you have to pay a tax for owning property. This tax is usually collected every year. So if the property taxes are 1% and your house is worth $100,000, then you’ll pay property tax of $1000 each year. If you don’t pay your property tax, then the government can place a Tax Lien on your property, and eventually take possession of your house and sell it to collect the tax money you owe. Needless to say, property taxes are serious business.

Mortgages and Lenders

Because real estate costs so much, it is very rare that someone pays cash for a house. If people had to pay cash, very few could afford a house. Most people borrow the money to buy a house. This is the standard way of doing things. When you borrow money to buy a house, this loan is called a Mortgage. Whoever you borrow the money from, whether it is a bank, some other financial institution, or even a person, they are called the lender. You agree to pay back the lender over a period of time. The standard length of a mortgage is 30 years, but they can be 10, 15, even 40 years. So you just make monthly payments to the lender for that time period, and when you’re all paid off, you own the house Free and Clear.

Why would the lender loan you all of that money to buy a house? Well, the simple answer is that they can make a lot of money on that loan, because they charge you interest. Let’s say you get a loan for $100,000. This original loan amount is called the Principle. But then you have the interest. Here’s a simplified example. As we just learned, they are not going to loan you that money for free, they’re going to charge you interest. Let’s say they charge you 7% interest, and you have 10 years to pay it back. Now, 7% of $100,000 is $7000 per year times 10 years which is $70,000. So the total payments are $170,000. T here are 12 months in the year, so you make 120 payments of $1415 and then you own the house free and clear. Now in reality, the way you compute the interest payments is a bit more complicated, but we don’t need to get into the detailed calculations. But for example, on a 30 year loan it is not uncommon to have the total interest payment be as much the principle (original amount of the loan). So, you might borrow $100,000, but at the end of 30 years you’ve paid $200,000 in payments. My point is that the lender stands to make a nice profit from the interest, and that is why so many lenders are in the mortgage business.

Another reason lenders like to offer mortgages is that it is a pretty safe loan for them to make. They always structure the mortgage such that if you start missing your payments, they have the right to take ownership of the house. This is called collateral or security; it is a guarantee to the lender that the loan will be repaid, one way or another. They loan you the money and take the real estate as collateral, which is called a Lien. And real estate is great collateral, because the property isn’t going anywhere, and you can’t steal it. If you make all your mortgage payments on time, no problem. But if you don’t stick to the terms of the loan, and you start getting behind on payments, the lender can take ownership of the house, kick you out, and sell it to someone else. That way they get their money back, and their investment is safe. This process is a legal process and it is called a Foreclosure. So, if you stop paying back your mortgage, the lender can foreclose on you and take back the house. When the lender forecloses and takes ownership of the property, the property is often called an REO property. This stands for Real Estate Owned by the lender. Therefore, as you can see, a mortgage is a pretty safe bet for the lender.

Appraisal

Now because the real estate is collateral for the mortgage, the lender is always concerned about what the house is really worth. In other words, what can they sell it for. They want to make sure that if they have to foreclose, they will get their money back. They don’t want to lend you $100,000 to buy a house, and then find out a year later that you overpaid and it’s really worth only $50,000. So before a lender will give you a mortgage loan, they will use a third-party called a real estate Appraiser. An Appraiser is an expert that does a lot of research and inspects the property and gives his expert opinion on what the house is worth, and what it could sell for. S/He prepares a document called an Appraisal for the lender.

Down Payment

The lender is obviously trying to be as safe as possible with their money. And you can’t blame them, since it’s a lot of money and they are not in the business of losing money. But many times they go a step further and make their loan even safer by requiring you to make a Down Payment on the house. In other words, they won’t lend you the full value of the house. They want to have a bit of cushion in there, in case housing prices go down. What a house will sell for today might not be what it will sell for a few months or a year down the road. The price could go up or it could go down. What if they loan you $100,000 to buy a house, and a year later, you stop making payments and they foreclose on the property? What if the housing market is down? Or maybe you let the house get really run down. For whatever reason, now they can only sell your house for $90,000. In this case, they wouldn’t get all their money back. So the price of the house is a risk for them.

Real-estate

Homeowners Insurance

Another way lenders like to protect their money is by requiring the borrower to take out a Homeowners Insurance policy on the house they are buying. Homeowners insurance policies are offered by most insurance companies. Basically, you pay a yearly insurance premium, a payment to the insurance company. In exchange, if your house burns down any time during the year, they will pay for a new house to be built. Now there are all kinds of homeowners insurance options, and they come with different deductibles and cover different kinds of catastrophes. You might have to get a separate policy for earthquakes or floods. But the basic point is that the lender wants to protect their collateral. If the house burns down, they can’t sell the property for nearly as much as they could if it had a house on it. Let’s say you borrow $80,000 and make a down payment of $20,000 on a house, for a total purchase price of $100,000. The very next month it burns to the ground. You move to an apartment, but now you can’t afford your mortgage payments and your rent, so the lender is forced to foreclose on the property. But without a house they can only sell it for $20,000, and they just lost $80,000 in the deal. Now if you had homeowners insurance, the policy would pay to build a new house, and it might even pay for your rent for a year or so, depending on the policy. In any case, it’s just another way for the lender to protect their loan money.

Lenders have been making home loans for many years, and it should not be surprising that in this day and age, they’ve thought of just about everything possible to protect their loan and make sure it gets paid back one way or another. So here’s another one: it’s called an Impound. An impound is where the lender doesn’t rely on you to pay your homeowners insurance premium or your property tax. They figure if you get hit with a $3000 property tax bill or a $600 insurance premium, you might not be able to afford that big lump sum payment. And they don’t want the property to become uninsured, and they don’t want the government to foreclose on the property because you didn’t pay your taxes. So with an impound, they break up your tax bill and your insurance premium into monthly payments, and they add that into your monthly mortgage payment. So in the example above, they would collect $50 for property tax and $50 for insurance each month, in addition to your mortgage payment. Then they would set that money aside in a special account called an impound account. Now a year later, when your property tax bill arrives and your insurance premium comes due, they would pay those out of the impound account. They just collect that money in monthly installments and set it aside. That way they make sure the bills get paid.

Escrow

If you’ve ever seen one of those movies where there is a hostage and someone is trying to pay the ransom with a briefcase full of money, you’ll appreciate this concept. Because neither side trusts the other, and so much is at stake, you always end up with a situation where one side is saying, give me the money first and then I’ll hand over the hostage and the other is saying, no way, give us a hostage first and then we’ll give you the money. Well, in real estate there are no lives at stake, but there is a similar situation. But say you want to buy my house for $100,000. You come give me the money, but what if I take it but never go down to the courthouse and change the title to the house to your name. Now I have your money and legally I still own the house. On the other hand, what if you give me a check, and I title the house over to you, but then the check bounces a few days later and I just gave you my house for nothing. So both sides have a lot to lose, and there is a lot of uncertainty if they are dealing directly with each other. Now, add in the mortgage and things get even more complicated, because the buyer doesn’t even have the money yet, but he needs to make sure the seller doesn’t sell the house to someone else while he’s trying to get a mortgage. The way this transaction is solved in the real estate business is through a process called Escrow. That means that instead of dealing directly with each other, the buyer and seller use a neutral third party to complete the purchase. The buyer and seller get together and agree to the escrow instructions. On a very basic level, the buyer puts the money into an escrow account. The seller gives his house to the escrow account. Yes, the company has instructions that on the most basic level say, once you’ve collected the purchase price from the seller, then you “Close Escrow “ and the escrow company gives the money to the seller, and gets a new title recorded with the county. Then the escrow might have additional instructions as well, and they will not complete the transaction until all terms have been met. Now the escrow process also has a time limit, say 30 or 60 days. If all the terms haven’t been met by either side, but say the buyer never comes up with the money, then the deal “Falls Out Of Escrow”. That just means the escrow company gives everything back and both sides are back to square one.

Closing Costs

Real estate transactions are different in every state. The basic principles are the same, but each state does it a little differently, and has slightly different traditions and laws. So the first thing you need to do is to become familiar with how real estate purchases take place in your state. In some states, an attorney is involved in a transaction. In other states, it’s an escrow company or title company, but no attorney is required. In any case, the process of transferring ownership of real estate will likely involve several different costs, and whether the buyer or seller pays for them is negotiable, and who usually pays for what varies by state, sometimes even within states. Closing costs can range anywhere from a few hundred dollars to 1 to 2% of the purchase price.

Equity

Because so few people buy houses for cash, and most people borrow money to buy houses, the concept of equity is very important in the real estate business. Equity simply means the amount of money the house is worth, minus the amount of money you owe on the mortgage. Another way to think of equity is how much of the home’s value you own, as opposed to how much the lender owns. Or you could think of it as how much cash you’d end up with in your pocket if you sold the house, after paying off any loans. The best way to illustrate this concept is through some examples.

Let’s say you buy a house for $100,000 and get a loan for $100,000. You decide to sell the house a year later, and it appraises for $105,000. Also, you’ve paid down the loan such that you now owe $98,000. So your equity in the property as $7000, the difference between what you can sell it for and how much you owe. Or let’s say it’s the same house but 25 years later. The house is now worth $200,000 and you only owe $9000. Your equity is now $191,000. So that’s your equity in the house. How much it’s worth minus how much you owe.

Appreciation

Now there are two ways equity grows. The first is by paying off your mortgage and the more payments you send, the less you owe. As you pay down the loan, that money becomes your equity in the property. The second way you grow equity is by Appreciation. Appreciation means that the house will sell for more than you paid for it. Over time, the price of housing has gone up. Historically, residential real estate is a good investment. That’s not to say that prices don’t go up and down in the short term. In the late 1980s, prices went way up. Then, in the early 1990s, they came down. Then in the late 1990s and early 2000 they went up again, and recently they went down again. It also depends on the neighborhood. Sometimes the prices of individual neighborhoods don’t follow national trends, and the prices go up or down for other reasons. Of course, if you focus on buying houses for motivated sellers, and follow my methods, then you won’t be too worried about the overall housing trends. If you’re buying a house for 10%, 20%, or 30% less than what it’s worth, then it’s instant appreciation, and that’s instant equity.

Real Estate Agents

Real estate agents are simply professionals that buy and sell real estate. They are licensed in each state, which is a process that generally requires taking a test or series of tests. Real estate agents are often called Realtors® because they belong to the national association. Most real estate agents have access to a database of all properties for sale, which is called the Multiple Listing Service or MLS. When they are selling a house, they often call it a Listing. Real estate agents can represent the buyer, seller, or both. They each get a commission that is paid by the seller. Traditionally, they split 6%, and get 3% each, even though this is not always the case. Of course, you don’t need to go through a real estate agent to buy and sell property, but many people do use them, unless they don’t have the money to pay the commission.

More about Mortgages

To get a mortgage, you need to go through a lengthy application process. This will include evaluating your credit rating. Usually lenders look at your FICO Score – ; the higher the number, the better your credit rating. They will also look at employment history, banking accounts, and a lot of other things. The whole process to get approved for a mortgage might take 30 days. Mortgages can have a fixed rate (for example 7%) for the entire loan, or an adjustable rate (also called an ARM), which means the rate changes with a market -some years it might be high and in some years it might be low. One of the first steps with a fixed rate mortgage is to “Lock In” an interest rate. This will be the interest rate at which they loan you the money. Also, you’ll have the option of paying “Points”. A point is a prepaid lump sum of interest payments that you make in exchange for a lower interest rate. And then, after all the documentation has been completed, the loan will “Fund”. This means the lender actually sends the funds to buy the house by writing a check or wiring the money. Although some mortgage loans have a Prepayment Penalty, most allow you to pay them off in full at any time without additional fees. So you could take out a 30 year loan, make payments for a year, and then pay the whole thing off, in which case you wouldn’t have to make 29 years of interest payments!

You can also have multiple mortgages on one property. They are referred to as the First Mortgage, the Second Mortgage, and so on. The order is just determined by the date. So if you bought a house for $100,000 but five years later it appreciated to $130,000, you could go to a bank and cash out some of your equity with a second mortgage for $20,000 or so. Any tax liens are always paid off first, even before the first mortgage. You can also take out the new mortgage loan to pay off and replace an existing one. This is called Refinancing. There are also many government-sponsored programs to help certain people buy houses. These types of mortgage programs include FHA (Federal Housing Administration), VA (Veterans Administration) and many more, even on the state level.

Income Taxes

First, I want to be very clear that these real estate courses are not intended to provide any tax advice. If you purchase an investment property and need advice on specific tax issues, you should consult a tax professional. In fact, I highly recommend it — you don’t have time to become an expert in real estate taxes, and a professional can make sure you are taking advantage of all the tax benefits you are entitled to. That said, it is important that you understand some very basic principles of how state rules affects income taxes, because that’s one of the benefits of owning and investing in real estate.

  • Mortgage Interest: For the most part, the Federal Government allows you to deduct mortgage interest on loans you take out for property you live in. This generous tax benefit is one reason people don’t mind borrowing money to purchase a house. But there are also a number of other tax benefits for real estate investments. For income property, mortgage interest can be deducted against the income the property produces, just like maintenance costs, property taxes and other expenses.
  • Capital Gains: In most cases, if you buy a house and sell it for profit less than a year later, the Federal Government taxes your profit at your normal tax rate. Say you are in a 28% tax bracket, and you buy a house for $100,000 and sell it three months later for $120,000. That $20,000 profit would be taxed at your normal 28% rate, just as if it were normal income. But if you wait more than a year to sell it, it gets taxed at a special rate called a Capital Gains Rate, which is generally lower than your income tax rate.
  • Depreciation: If you own an investment property, you get another tax break called Depreciation. You can generally depreciate a portion of the home value every year, and depreciation can have tax consequences if you later sell a property you have depreciated. Consult a tax professional for the details of this tax benefit and how it applies to your specific situation.
  • Maintenance: If you spend money to repair your property, or improve your property, or have other expenses related to maintaining the property so you could rent it out, these kinds of expenses generally go towards reducing your tax burden.

Summary

At this point, even if you have never dealt with real estate before, you should have a pretty good idea of the process and some of the jargon. You will now be able to understand my strategies, how they work, and why they work. But I’d like to point out again, real estate transactions are handled a little differently in every state. Each state has its own rules and regulations, and laws and procedures. Real estate is a business conducted locally. So you will need to investigate your area and get familiar with the process before making your first deal. I suggest you visit the library, or join a local real estate investment club, or just spend some time surfing the Internet. The information is readily available and it doesn’t take very long to understand exactly how real estate transactions are processed in your state.

Download Tony’s Best Selling Book “The Winning Way
That He Co-Authored With Brian Tracy.