Are you prepared to take the next step in investing?
Hi everyone, welcome to another wise money tools video. Glad you could join me today, as a follow up on our real estate videos, let’s talk about when is it a good time to use your cash value inside your banking system for real estate. Now as a general rule of thumb, anytime you get a safe return, that’s 2 to 4% more than the policy will deliver that might be worth doing. Now, let me say from the outset, I don’t want to give you any buying or investment advice here, just examples, every market and every scenario and cases different. These are simply general rules to consider when looking at real estate.
Now there is one principle of investing that you have to keep in the back of your mind, as we talked through these ideas. And this is it, your money is just as important, if not more so then the bank’s money. Now what I mean by that is you’d never even think of walking into a bank and getting a 0% loan. Right. There in the business of lending and making money. When you get a loan, you fully expect to pay back the principal and the interest on that loan. Now you’ve got to have that same expectation when it comes to your money to. In other words, the bank thinks their money’s worth X percent.
When they loan it to you, you need to know your money is worth at least that much, if not more. And here’s why I point that out. Oftentimes, when investors buy real estate, they put in their own money, we call it the skin in the game or the down payment, the bank may loan you 80%, but they want you to have 20% of your own money in the deal as well. This skin, as we like to call it is often overlooked by investors. In other words, when they calculate the rate of return or the cap rate on the property, they don’t typically include their skin needing a rate of return, they kind of rip themselves off so to speak.
Let me give you an example. Suppose you were going to buy a piece of property for $100,000. And it was going to produce $10,000 a year in income. This would be a 10 cap or a 10% rate of return, you put in 100K, you get 10,000 back each year, that’s a 10% return. Now, here’s a quick quiz for you. What is the payback time? How many years would it take for you to get your hundred thousand dollars back? 10 years, right. So the payback time is 10 years, this is a good number to know as you analyze real estate. Okay, so now let’s suppose the bank’s going to give you a 100% loan.
And to make this easy, let’s presume you get a 10 year loan and the payments are $10,000 per year. Pretty easy, right? The payments from the income cover the payments, you owe the bank. So here’s where people tend to rip themselves off or investors rip themselves off. Suppose you put 20% down or $20,000 and the bank loans you 80% or $80,000, your payment to the bank is now $8,000 a year, the income from the property is still 10,000. Well, many investors take that extra 2000 and presume its profit and even might start spending it. They never consider the $20,000 for the down payment, as needing a rate of return as well. It’s like it’s a sunk cost.
In this case, if I put $20,000 from my banking system into the property, I would want to treat myself at least as fairly as I did the bank. Remember the rule, your money is just as important if not more so than the bank’s money. So I would require $2,000 payment each year for my down payment. That is the 20% of the income. Because again, I put 20% of the cost of the property into the deal. This way, I’m treating my money at least as well as the banks. This, again is overlooked mistake for many investors. As I consider the purchase and cash flow on a rental, I want to make sure that the rent covers not only the mortgage to the bank. But my mortgage for the skin or the down payment in the deal as well.
If the rents don’t cover both the bank’s money and my money, well, it may not be a worthwhile investment. I may be kidding myself, it may not fit my model. And that’s when it’s time to move on. I want to pay back my cash value loan, because it’s the capital I’m gonna need for future investments. It’s not a sunk cost, it’s an investment. And I didn’t need a return on every penny, just like the bank does. Now if there’s one thing I can’t over stress, and that is this, the numbers have to work for both me and the bank. Now if I’m going to use my banking system for the skin or even for the entire purchase price. I want to make sure I’m getting at least 2 to 4% above my cost of money as a return. If my borrowing rate is 5%, then I’d likely charge myself 7 to 8%.
And make sure that the cash flows with the rental income are there. Otherwise, I’m gonna be ripping myself off. As you know, you get a dividend paid on your cash value even when you have a loan outstanding. Suppose the dividend is 6 and a quarter inside my policy, and I take a 5% loan, I still have somewhat of a positive growth. Now if your CPA allows for it, which most do, you can also write off the cost of money as a business expense. In this case, you’d write off the 5% cost of money, which may bring your real cost down to 3% or less, depending on your tax bracket.
So all in all, if you can net out 3 to 4% return above the cost of money plus your dividend, you’ll do just fine. Now in these examples, we’ve been very conservative. Hopefully, when you take advantage of an opportunity, you’re doing it at a time when assets are on sale, and you get a double digit return safely and predictably. Now one final thought. Right now there’s an opportunity in real estate lending, you can do short term loans, long term loans, and anywhere in between the advantages, they can be pretty safe and predictable. As long as your loan to value isn’t above the market price.
As an example, we have a building company where we build residential homes. We’ve oftentimes taken on an investor who loans this money and we pay between 8 and 9% for short term loans that are less than a year. We’ll take an investor money by the lot, then we’ll use bank financing for the vertical costs, our loan to value is usually less than 70%. What that means is we’ve got about a 30% or more equity. So that the entire loan balance to the bank, and the investor is still well within the loan to value ratio. So in a pinch or a significant market shift, we can lower the cost of the home by 30%. And everyone still gets their money out, lending can be a pretty safe way to go. And you should be able to get that 2 to 4% above the cost of borrowing from your policy.
If you have money sitting in a savings or a money market at the bank. You’re already lending, you may not know where it’s going exactly, but the bank is lending your money out making 68% while they pay you a half percent. Pretty good deal for the banks, right? Not so good for you might be a good idea to try to cut out the banks and get some of that income yourself. As always, let me give you a little word of caution. You want to understand the investment of course, feel comfortable. If it’s a home or a building, that this property has a good chance of selling and that the borrower is credit worthy.
If those things are in order, it might be worth looking into. Again, this is not a recommendation or advice. And using your costs. cash value, of course has a cost. So make sure it’s an economic advantage to you. If this is a good situation for you, it can be a good use of capital. All right, well, I hope this was good info for you kind of a follow up for real estate. As you can imagine, there are thousand ways to invest and build your wealth. We’ve just touched on a few.
I want you to make sure you stay tuned. Subscribe, don’t miss a video. And as always, if you have any questions, shoot them to questions at wise money tools.com. I’ll answer them just as quick as I can. And if you feel like you want to have a strategy session, talk a little bit about some of these concepts. Feel free to click on the link and set up a time that works for you. Until next week. Have a great week. Take care.