From time to time, a real estate investment guru will talk about using credit cards to either fully fund a real estate purchase or as a down payment.
Does that make sense?
The short answer is – it depends. Let’s take a look at a few factors that can make credit cards as a funding source good or bad.
Before deciding if a credit card is a good source for a deal, you need to understand the deal and how the credit card will be used. Let’s examine at a few scenarios.
Scenario 1: You purchase a rehab project and get financing for the project that cover the purchase cost, all the closing costs and the rehab costs. The rehab costs are held in escrow and paid out upon the completion of specific rehab milestones.
In this scenario, if your cash on hand is low, doing the rehab prior to getting the payment from escrow may be a challenge. But if you have available credit on your credit card, you can work with the contractors to buy all the materials on your credit card and if necessary, even get a cash advance from your credit card to pay the contractors.
If you need the credit card to just make purchases of goods and are either doing the labor yourself or have enough cash on hand to pay the contractors as the work is completed, you have a potential good use for a credit card. If your credit card has no balance, chances are you can make the materials purchase for the specific phase of rehab and get reimbursed from escrow for the completion of that phase before the payment is due on the credit card. In essence, you used the credit card for a short term interest free loan. This is a good use of the credit card.
If you need to use the credit card to pay the contractor, there are often two options. And understanding the ramifications of each option will let you control your costs.
The first option is to use a purchase check. Quite often, you can use a purchase check the same as if you buy something at a store with your credit card. In other words, there is no fee to use it and no interest accrues if it is paid off in the next billing cycle. But you need to read the purchase check offer carefully as some credit card offers will treat a purchase check as a cash advance.
The second option is a cash advance. This can be expensive. You will usually immediately get hit with a 2-3% surcharge for taking out cash. And interest, usually at a very high rate, will start accumulating immediately. By the time you pay off a cash advance, even if it is the next billing cycle, you can run up a 5% or more interest charge for that money. And that can get quite expensive if you need to do it multiple times during the project.
Scenario 2: Use your credit card to finance the purchase. If you have enough credit on your credit cards, you can actually use them to finance either the down payment or full purchase price of a less expensive property or a low cost rehab. In our are, low cost rehabs can often be acquired for less than $30,000 and with an additional $20,000 of work, will be back to the neighborhood norm of 65-70K.
Many people who do these deals will go to a hard money lender and pay 3 to 6 points up front plus 15-20% interest. If they are escrowing your rehab, they will charge you inspection fees to release the funds. And if your project takes longer than expected, they may hit you up for another 3 to 6 points to extend the loan. It sounds terribly expensive. And it is. But if it makes the deal work and you make a healthy profit, it is worth the cost.
But suppose you had that same scenario with some credit cards with decent rates. You could use a purchase check or two to buy the property and be paying 7-12% holding costs with no up points to worry about. You could purchase all the supplies for the rehab as you need them. You could make some cash advances from the cards to pay the contractors if you didn’t have the cash on hand. You will not get any additional fees or points appraised if the project runs too long. On an average lower end rehab, using your credit cards responsibly could put thousands of extra dollars into your pocket.
Things to realize when using credit cards:
- Your credit score will greatly affect the amount of credit you can have and the interest rates.
- Your credit score will greatly impact the types of offers you get on purchase checks. Someone with a good credit score may get offers of 0% interest for 12 months on purchase checks used for any purpose – even cash. Others may get a 0% interest offer for 6 months with a 3% fee (up to a maximum of $75) for each check used. Others may get an offer of 7.99% fixed rate for the life of the balance. It all depends on your credit score and the bank.
- When using a credit card, it is best to use one with no balance. And pay it off when the deal is concluded. And never use the credit card in the interim. Many times when you take advantage of a special offer and use the credit card later, you will find that later use charged at the regular interest rate on the card. And that balance will not get paid down until you fully pay down the promotional balance. Again, know and fully understand all the terms of the credit card before using it.
The bottom line. Read your credit card offers carefully and fully understand the terms before using them as a real estate financing source. And if everything looks good – the deal on the property and the credit card terms – use the credit cards without fear. And pay them off as soon as possible.
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