With the current economic climate, we are likely to soon see a prolonged period of “subject to” (Sub2) opportunities and owner-financed wraps. Not familiar with these concepts? Take my classes on these... they are vital concepts for making money!
So how do you know when a Sub2 deal is a “good deal”? There are really only two key concepts to look at. First is one you are already pretty familiar with: equity. If the amount of equity alone makes the deal a good one, then it’s a good deal. Remember, “Sub2” is merely a financing mechanism.
But what if there is not enough equity to make the deal a good one by itself? While many pass on these deals, they may be missing opportunity found in the other key factor: Age of Loan. To understand how that works, let’s do some math.
Math! I know, not the most fun topic, but, it’s hard to make money in real estate without it! But hopefully I can break it down into some easy concepts that will allow you to recognize a good deal!
Let’s take your standard 30 year mortgage. Depending on the interest rate (5.304% is roughly the dividing line), the total interest paid on that loan (if paid in equal installments for 360 months) will be the same as the loan amount. In other words, if you get a 30 year loan at 5.304%, for $300,000.00, the real cost of the property is $600,000.00!
Of that interest, roughly 50% of that $300,000.00 is paid in the first 10 years of the loan. That is because amortization piles up the interest to the front-end of the loan! I call that “front-loaded interest” and its a key component if you got a good deal or a bad deal!
So if I find a property that I can purchase Sub2 and it doesn’t have much equity, but it has some age to the loan, it can still be a very good deal especially if I intend to wrap it.
Take the example above. If there was NO equity in the property, but the note was ten years old, and I sold it with a new loan of $300,000… I would pay the remaining $150,000.00 in interest, but GAIN $300,000.00 in interest (or more with a higher interest rate on the sale!). That means I could still profit $150,000.00 on a property with little or no equity!
Of course, I always suggest purchasing with at least some equity (what if you had to sell it tomorrow or you sold on a wrap and got paid off in 3 months?). However, hopefully you can see why the age of the note is just as important as the equity!