Part of the Real Estate Analysis is the analysis of financing and therefore the concepts of mortgage. Mortgage is defined as a transfer of an interest in a property to a lender as a security for a debt. This means that mortgage itself is not a debt, but it is lender's security for a debt. If the borrower satisfies the conditions of the mortgage, the interest in land is transferred back.
There are many types of mortgages and there are also some important consequences of using mortgage in RE investments. These are discussed below.
Types of mortgages
The two most commonly used types of mortgages are fixed rate mortgage (FRM) and adjustable rate mortgage (ARM). While with fixed rate mortgage, the investor can count on the same interest rate through the whole period of the loan, the interest rate of the adjustable rate mortgage is going to change / adjust in time.
In the Real Estate Investment Software, we will be working mainly with the fixed rate mortgage. It's also recommended for investors to use this type of mortgage. Even though the interest rate is usually higher than with ARM, it is important to have the security that interest rates will not skyrocket and ruin the entire investment. This development of interest rates is impossible to estimate in the long term. Hopefully people realize this better now, after the major problems with mortgage defaults and foreclosures in the whole US.
Consequences of mortgage on RE investment
Using mortgage is always highly recommended to RE investors. The main reasons are leverage and tax purposes. Utilizing more debt decreases required equity needed for the investment and it increases the tax shelter. Both of these consequences are well contributing to the net present value of the investment. In other words, to increase NPV and Return on Investment, it is, in most of the cases, better to borrow as much as possible. On the other hand with higher loan-to-value ratio, the interest rate increases as well.
The only time when it is not recommended to use a financing for a RE investment is, when the interest rate on the mortgage is higher than what will be the overall internal rate of return (return on investment) of the investment. In that case we would be paying the bank more money on the interest than we can make with this borrowed money. That is another reason, why it is very important to do Real Estate analysis before acquiring a new property.
John K. is a successful Real Estate investor and expert in the Real Estate Analysis. He has earned a Master Degree in the economical major - focusing his final project on Real Estate Investment Software. He is using the analysis in the real world on researching potential new investments and on tracking the ones he already owns.
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