Russ Whitney brags about and advocates what he calls overfinancing techniques in his various books. One of the two categories of this are property improvement loans. I understand from his promotional material, he and/or his instructors do the same at some of his seminars. Are these techniques legal?
Probably not.
I will address the issue from two perspectives:
I researched this by interviewing some of the top experts in the nation on improvement loans.
I also let Whitneys attorney read an advance copy to see if it had any errors or omissions.
There are two bedrock principles when you apply for a property improvement loan:
I think Whitney almost certainly did break the law, but I cannot say for sure without seeing the loan applications and interviewing the loan officers and such. Also, if your definition of breaking the law is being convicted, I am not aware of any prosecutions of Whitney for mortgage law violations.
That he has not been prosecuted with regard to his “overfinancing” techniques may just mean the prosecutors are too busy or are not aware of what he did. There is a lot more law breaking in the world than there are prosecutions.
Having noted that some of the pieces are missing, let me go ahead and analyze the pieces we do have.
Whitney is a big advocate of Department of Housing and Urban Development Title I improvement loans. He claims to have obtained them on a number of occasions.
The starting point for ascertaining whether someone broke the law is to ask, What, exactly, is the law? In the case of Title I improvement loans, it is 12 USC 1703. The original name of the law, as it was going through Congress, was the National Housing Act (1934). Title I, Section 2 of the National Housing Act as amended is another common citation for this law.
The basic idea of HUD lending is that the federal governmentthat is, the taxpayersinsure such loans in order to encourage private lenders to make them. If the borrower doesnt pay the loan as agreed, and the lender suffers a loss, they can file a claim with the federal government to get reimbursed for their loss just as you might file a claim with your car insurance company after an accident.
So although you get the loan from a local bank or savings and loan, the loan is a federal matter because of the insurance provided by the federal government. The fact that it is a federal matter means that the law enforcement authority who gets called when the law may have been violated is the FBI. If the FBI does, indeed, find evidence of a violation of the law, they refer the matter to the United States Attorneythat is, the U.S. Department of Justices local prosecutor. If they decide to indict you, the case will be tried in federal court.
In the citation of the law above, 12 USC 1703, USC stands for United States Code, which is the official name for federal law. As is often the case with federal laws, the Congress and President put a phrase in the law that tells the cabinet department in question to create regulations to enforce the law. In 12 USC 1703, it says,
(h) The Secretary is authorized and directed to make such rules and regulations as may be necessary to carry out the provisions of this subchapter.
The Secretary refers to the head of the Department of Housing and Urban Development.
To see whether Whitneys overfinancings break the law, we must look at those regulations. In the case of HUD Title I improvement loans, they are at 24 CFR Part 201. CFR stands for Code of Federal Regulations. The section that is most pertinent to Whitneys overfinancing is 24 CFR Part 201.20.
It says, in part, to get a HUD Title I improvement loan:
Less formal articles by HUD on the Internet (e.g., http://www.housingall.com/STEPUP/FinImprovements.htm) state in plainer English, that if the improvement in question is do-it-yourself, you can only borrow the materials cost. On the other hand, the regulations say,
If the borrower plans to use a dealer or contractor to carry out the improvement work, the lender shall obtain a copy of a proposal or contract that describes in detail the work to be performed and the estimated or actual cost. (§201.20(b)(1) [emphasis added]
Russ Whitneys approach appears to be as follows:
Is this legal? I think not. You are entitled to form a contracting companyalthough state law typically requires that you register it as a fictitious name, doing business as, or assumed name with the county clerk. Thats true unless the name of the company is your real namelike L. L. Bean or your real name and the nature of your businesslike Russ Whitney Contracting or my John T. Reed Publishing. The purpose of the registration is to tell the world the real people behind that particular company name. Of course, if your contracting company consists only of you or you and your wife, and you only work on your own properties, what do you need a company name for?
Whitney used the names R&I Enterprises and R&I Contracting Company according to his books (e.g., Building Wealth pp. 89, 123). Because those names do not contain the name Russ Whitney, they must be registered as assumed names. I checked the Schenectady County Clerks office. He did not register those names.
In addition to other penalties, if you do not register, you may not file a lawsuit with regard to anything you did under that name. For example, if R&I Contracting Company agreed to build a garage for someone and the customer did not pay when they were done, R&I could not sue for breach of contract because they failed to register their assumed name.
As far as I know, all states require building contractors to be licensed with the state. One guy told me that Texas may allow unlicensed contractors. As far as I know, Whitney never obtained a contractors license.
On page 68 of Building Wealth, Whitney says, anybody can act as his own contractor without a license as long as he owns the property. Im not sure its that simple. With rental property, there are safety considerations. Some contracting work can cause injury if done incompetently, like collapse of heavy or high structures or unsafe electrical work which can cause shock and/or fire hazard. Some plumbing mistakes can lead to disease or structure collapse.
Whitney says on page 69 of Building Wealth that, As long as you are working exclusively on your own properties or properties you co-own in a partnership or joint venture, it isnt necessary to formalize your business by filing a company name or doing business as (DBA) with your local county courthouse. But thats kind of a silly statement isnt it? Its like saying that you dont need to register a car wash company name if you wash your own car on your driveway. True, but why would anyone need a company name to wash their own car or work on their own property. For whose consumption is the company name?
On page 151 of Building Wealth, Whitney admits the company name is for loan purposes. And what, pray tell, might that be? Could it mean anything other than deceiving lenders? I cannot think of another legitimate loan purpose reason to give a sole proprietorship that works only on your own properties a name other than your own name.
At Harvard Business School, they taught us that, when it comes to annual reports, The numbers giveth and the footnotes taketh away. When it comes to get-rich-quick books, the front of the book giveth and the later pages often taketh away. Whitney does acknowledge the regulation against borrowing the amount of contractors profit when you use do-it-yourself labor, but not until you get to page 125 of Building Wealth. Its an Oh, by the way like the Youmustbeeighteenyearsoldtoentervoidwhereprohibited you hear at the end of radio contest ads.
He does not say, but I will, that the same principle applies to all types of improvement loans. In other words, the reasons why HUD adopted that regulation apply to all improvement loans and non-Title I lenders should adopt the same rule for the same reason. Many have.
Whitney states, correctly, that general contractors include profit and overhead in their bids. Then he rationalizes that he is entitled to call himself a general contractor and include profit and overhead in work he does on his own properties. Tilt!
There are several things wrong with that.
What is the purpose of the proposal and contract form when you are doing the work yourself? Who is proposing what to whom? You are proposing to yourself. Thats dumb if its disclosed; a waste of time and money if its not. Almost certainly, the fact that you and the contracting company are one in the same is not disclosed. The purpose of the proposal is to make it look like an outside contractor is doing the proposing.
Same is true of the contract. Whatre you gonna do? Sign a contract with yourself? Proposal and contract forms are just that. They contain contract language to bind the contractor to do certain work and the property owner to pay for the work. Why would anyone need a contract to force themselves to do work on their own property or to pay themselves for having done it?
I can think of no other purpose of the company name and proposal and contract form than to mislead the lending institution into thinking the estimate is from an arms-length, unrelated, third party and that the third party will be doing the work.
In 1984, Whitney wrote a book called Offers & Contracts Basics Rehabs Realities Overcoming the Hurdles and Pitfalls of Real Estate Investing. It was published by real estate guru Mark Haroldsens National Institute of Financial Planning. It purports to contain actual documents from various deals Whitney did. Pages 13-15 are a stationery store Proposal and Contract.
At the top, it says Southwest Management and Development and lists an address in Cape Coral, FL.
A search of the Florida Secretary of States Web site finds no registration of the fictitious name Southwest Management and Development. The only fictitious name Whitney ever registered was, oddly, the first initials and last names of three persons, one of which was Whitney, one was a partner, and the third was another person. That fictitious name registration was filed 9/30/91 and expired 12/31/96.
Someone has stamped GENERAL CONTRACTOR on either side of the name and address. The address is 2520 S.E. 8th Place. I do not know what that address is or how Whitney was connected to it. The date on the proposal was 3/4/83. I would appreciate someone in the Cape Coral area telling me the nature of the structure at that address and also the nature of Whitneys connection to it.
The first line says proposal submitted to Whitney and his partner at 1630 Woodford Street in Fort Myers. The architect is listed as RW. To claim to be an architect, you must be licensed with the state. Generally, you also must have a college degree in order to claim to be an architect. After listing three pages of improvements to be done, the proposal says Southwest proposes to do this work for $17,775. There is a signature, which appears to be an illegible version of Whitneys signature. The Acceptance of Proposal is signed by Whitneys partner.
So we appear to have a proposal from Whitney, doing business as Southwest Management and Development, prepared by an architect with the initials RW and submitted to himself and his partner. Whitneys partner signed acceptance on behalf of himself and Whitney.
Page 16 of the book has a one-page Proposal and Contract from Southwest to Whitney and his partner for furniture for the same building. It is dated one day later for some reason, and generously offers to add dozens of furniture items for no additional charge. Not surprisingly, Whitney and his partner signed acceptance.
Page 24 of Offers & Contracts has a 5/11/83 purchase agreement that lists Whitney and his partner as having the address 2520 S. E. 8th Place, the same address as Southwest.
A Reg Z notice on page 26 shows Whitney and his partner living at 4944 Normandy Court, Cape Coral on 6/30/83. Page 28 lists a contract for sale of real estate in which the company name has now become Southwest, Management, Development, and Realty, Inc. Florida Secretary of State records indicate that corporation was filed 8/12/83 and involuntarily dissolved on 11/4/88.
Page 40 of Offers & Contracts says Southwest is A division of R & D Companies of Florida. No such fictitious name is found in the Florida Secretary of State records.
As 24 CFR §201.20(b)(1) says, Title I loan proceeds may be used only for the purposes disclosed in the loan application. Since Whitney presumably is not disclosing to the lender that there is a profit-and-overhead amount in each line item of his estimate, he may not use the loan proceeds for those purposes. The same would generally be true of any non-Title-I improvement loan as well on the grounds of contract law and prohibitions against lying to a lender or concealing material facts.
Whitney says the general contractors markup, can be anywhere from 25% to 400%, and more. (Building Wealth p. 69). In one deal he brags about, he told the lender that work which actually cost $3,000 was going to cost $17,000 (Building Wealth p. 70) Thats a 567% markup.
You can take courses in estimating at many community colleges. It is a rather complex skill and art. There are a number of companies that continuously analyze construction costs. They sell their results in the form of books, CDs, and on-line services. Heres what three construction costs books that I have say about contractor profit and overhead.
Book
|
Profit and overhead (varies according to size of job and nature of work)
|
Saylor Residential Construction Costs | 6.5% to 25% of total |
Means Repair and Remodeling Cost Data | 5% to 40% of total |
National Construction Estimator | 20% of total |
You can find the current editions of these or other similar books in your local book store or library.
One of the things that real estate gurus I do not recommend all seem to do is make real estate investing sound far more profitable than it really is. Thats how you sell real estate investment seminars. Whitneys 400% to 567% markups are prime examples of that.
The Title I law and regulation I quoted above are not the only ones pertinent to misleading a lender with regard to what work is being done, who is going to do it, and what its actual cost is. There are other more general federal laws that prohibit misleading someone in a federally related matter either by false statements or by concealing material facts. Here are the ones most often used against perpetrators of mortgage fraud.
18 USC 1014 prohibits making false statements to a federally-related lender. If the loan involves HUD, like a Title I home improvement loan, 18 USC 1012 applies. Banks are generally federal lenders because of federal deposit insurance or federal charters as well as because of federal loan insurance programs like HUDs Title I.
18 USC 1010 prohibits the following in HUD lending:
The use of proposal and contract forms with the names of companies that appear to be unrelated to the borrower may constitute counterfeiting under this law. Marking up cost estimates may constitute overvaluing security or asset value.
31 USC 3802 prohibits false claims and statements.
Concealment of a material fact from the bank is prohibited by 18 USC 1001. That law is also often cited in the sentence just above where you sign a mortgage application. The application my wife and I signed in 10/02 to refinance our home cited this statute.
Some of the forms Whitney Information Network, Inc. has filed with the Securities and Exchange contain the phrase, ATTENTIONINTENTIONAL MISTATEMENTS OR OMMISSIONS OF FACT CONSTITUTE FEDERAL CRIMINAL VIOLATIONS (SEE 18 U.S.C. 1001)
On page 75 of Overcoming the Hurdles and Pitfalls of Investing in Real Estate, Whitney says, regarding a deal where he is putting a third mortgage on the property right after the bank second, youll note on the Projected Rent Role [sic] statement there is no mention of a third mortgage. Is that dishonest? No!
Yes, it is. It is concealing a material fact in a federal matter. It is a felony punishable by a fine and/or five years in prison or both.
Whitney goes on, It is not the banks business if we have a third mortgage.
Who is Russ Whitney to make this determination? The money that is being loaned belongs to the banks depositors and shareholders. Ultimately, the taxpayers money is at risk. If you cannot tell the truth, the whole truth, and nothing but the truth to the lender, then you are behaving unethically and probably illegally.
Whitey continues, As long as their money is protected in the second mortgage position the banks loan is safe.
The fact is a third mortgage makes the loan far more risky. The main cause of foreclosure is lack of borrower equity. A third mortgage reduces or eliminates borrower equity. That, in turn, reduces the borrowers incentive to keep the payments current in the case of difficulty with this property or another or financial difficulty in any other aspect of the borrowers life. Whitney would not know that because he was never a lender and apparently never studied sound lending practices.
Whitney: I just want you to understand that business is business.
What does that mean? Nothing. The fact is page 75 of Overcoming is Russ Whitneys tortured attempt to rationalize mortgage fraud. I left out more of the same on that page.
Mortgage applications generally ask for the whole story of the transaction. You are required to sign the loan application saying that you have told them the whole story. They often ask if there is any secondary financing or loans junior to the loan they are making. If you sign it and do not tell them the whole story, you have committed fraud as well as violating the federal law against concealing material facts. The fact that the real estate industry has a name for this tacticsneaky second or sneaky third in this caseindicates it is well known to be improper behavior.
Whitney knows what would happen if he told the whole truth. Continuing on page 75, he says, If I approached the banker and told him I bought the Spanish mansion for $90,000 with no money down and I need to borrow $15,000 to boot, what do you think my chances would be for a loan? Exactly, zero. This is a chess game. A battle of brains and wits.
So theres the proof of intent. Whitney knows if he tells the whole truth, he wont get the loan. So he tells less than the whole truthmaybe lies depending on the wording of the loan application and/or discussions with the lender. The chess game comment is more rationalization. In games like chess, you sometimes feint and bluff. But borrowing thousands of dollars from a federal lender is not a game of any sort. It is a transaction where the stakeholders on one sidethe banks owners and depositors and the U.S. taxpayersentrust the person on the other sideRuss Whitneywith a substantial amount of their money.
Applying for a loan is not a battle of brains and wits. Defrauding lenders is a battle of brains and wits.
Page 87 of Overcoming :
I anticipated that the banker might come right out and ask if I put $60,000 down on the property. [It was a nothing-down deal.] I dont want to lie to him, so how do I answer? one lender did ask. I, of course, had the answer. I told him we did some trading on some things which resulted in the equity reduction on this property.
Once again, Whitney is well aware of what he is doing. He feels the need to add,
What about morality and ethics in this case? Well, I told him the truth. We did do some trading. The seller traded us the property for no money down and we both traded agreements on not recording the third mortgage immediately.
Judges call this sophistryfallacious reasoning; reasoning sound in appearance only. The bottom line is the lender would not have made the loan if they knew the whole truth so Whitney concealed the whole truth. His statement that he traded things is simply false, his strained explanation notwithstanding. Making an argument like this at your trial would likely get you chewed out by the judge in addition to your losing the case.
We did what has to be done to expedite it and make them feel good about lending the money.
In other words, we defrauded the lender. Expedite is a wholly inappropriate euphemism. It means to speed up. In this case, as he admitted earlier, he would have been stopped cold had he told the whole truth, not just slowed down.
On page 37 of Overcoming the Hazards and Pitfalls of Financing, Locating, and Analyzing of Real Estate, he says,
I have had people ask me if that is ethical or not. I dont know.
He doesnt know?! Isnt that kind of important? Dont you make sure something is ethical before you do it? Actually, I have read a bunch of Whitneys books and listened to a bunch of his tapes and I found no indication anywhere that he is concerned about ethics.
The next sentence on page 37 of that book is,
I have been doing it for seven years and have not yet lost any sleep over it.
First, well have to take Whitneys word for that. Second, the ability of a person who misled a bank to sleep afterward carries no weight in court. His student asked him a very good, legitimate question and Whitney responded, in part, with an irrelevant comment. If Whitney did, indeed, sleep well after misleading lenders, it may merely mean he lacked the sort of conscience that prompted his student to ask the question.
Continuing that paragraph,
I think one could certainly substantiate that even though he owns the house, he is his own contractor and does invariably deserve to make a profit for his time and effort; it is quite ethical.
I disagree. If the loan in question is Title I, the regulation specifically prohibits borrowing more than materials cost. Even in non-Title I improvement loans, I suspect that the lender would not make the loan if they knew the borrower was making a profit on it. If you make full disclosure and the lender still approves the loan, more power to you. But all this nonsense about contractor names, proposal and contract forms, and marking up estimates 25% to 567% would almost certainly guarantee rejection if known by the lender.
The word deserve is a dangerous one to use in this context. It rationalizes improper behavior. No one ever deserves to make a profit. If you work hard and smart and you are lucky, you make a profit. But the word profit implies that you are an independent businessperson. Entrepreneurs have an opportunity to make a profit, but they never deserve it.
Finally, there is no profit here. This is a loan. If you are to profit on the improvement, it will happen when you sell the property. Whitneys habit of encouraging readers to view excess loans as profits is extremely ill-advised. The correct phrase in the real estate industry for this is mortgaging out or a cash-out mortgage. Mortgaging out or cashing out is a very difficult trick if you make full disclosure to the lender. If you pull it off ethically, you might get a compliment from a fellow knowledgeable investor, but no one will call it a profit.
One of Whitneys students told him he could not get a regular home improvement loan because he already had two mortgages. Whitney insisted he could and went to his hotel room to make the calls and prove it. He said of the student, He was right. Whitney was only able to find a couple of non-Title I lenders, each of whom insisted on second mortgages.
Whitney says, I then told the banker that I already had two mortgages on my home and my roof was leaking. The lender agreed to an unsecured $7,500 property improvement loan to replace the roof.
You have to admire Whitneys persistence. Theres just one problem. The my roof is leaking statement was a lie. Had Whitney actually obtained the loan on this basisor had his studentit would be fraud.
The fraudulent nature of what Whitney advocates, and claims to have done, is starkly evident on pages 125 and 126 of Overcoming the Hazards and Pitfalls of Financing, Locating, and Analyzing of Real Estate. Here is what he says, along with my comments in [red brackets],
I must share some other realities with you There are many instances where you must be a little deceptive with your banker. [Being deceptive is illegal. It is fraud. There is no distinction in the law between being a little deceptive and being a lot deceptive. Furthermore, I see no basis for Whitneys use of the word little. Exaggerating improvement costs by more than double, using loan proceeds you said were going into the property improvements for down payments on other properties, etc. are fundamental and major misrepresentations.]
If, on the home improvement loan, you indicate that you are going to do the contracting yourself and take some of the money as profit, your chances of approval will diminish. I generally portray that I will not only use all of the loan money to get the work done, but that I will probably kick in a thousand or two of my own money. [This is a barefaced lie. You can go to jail for this.]
When the government prosecutes this sort of stuff, they also often invoke the mail fraud statute 18 USC 1341. Mail fraud is a misnomer. You do not have to mail a fraudulent document to be guilty of mail fraud. You cannot avoid mail fraud by using Federal Express or hand carrying everything. All you need to do is commit fraud, and anyone in the deal send or receive anything by mail as part of the transaction. Wire fraud is similar (18 USC 1343). The feds also often invoke the money laundering statute (18 USC 1956) in mortgage fraud cases.
If you commit mail fraud or wire fraud more than once in a ten-year period, you can be charged criminally or civilly under the federal racketeering statutes: 18 USC 1961-4. A bank could actually sue Whitney civilly under 18 USC 1964 if he did two deals that involved mail fraud in a ten-year period. Furthermore, if they win, they get triple damages.
Another statute the government frequently invokes with regard to mortgage fraud is 18 USC 371 or conspiracy. This would be a hazard to both Whitney and the previous owner/second mortgage lender. The essential elements of federal conspiracy are two or more people not only conspiring to defraud someone connected to the federal government, but actually doing some act to bring the conspiracy to fruition.
The HUD Inspector General publishes an annual report. In part, it details prosecutions of the above crimes. You can read it on the Internet. Here are some examples from the 2002 report.
An LA federal grand jury indicted Louis Reyes on one count of conspiracy, two counts of wire fraud, and one count of money laundering. Among other things, Reyes falsely stated that Title I loan proceeds would be used to improve the properties in question.
In a Texas investigation code named Operation Straw House, the feds obtained numerous convictions. In that case, proceeds of Title I loans were used to pay bills of the borrowers unrelated to the improvement of the properties in question, as well as cash being pocketed by the borrowers instead of spending the money on improvements.
The 1/6/03 Sports Illustrated Catching up with column featured Chuck Foreman who had been on the cover of the magazine on 10/18/76. Foreman played seven years for the Minnesota Vikings and went to three Super Bowls. He had three straight 1,000-yard rushing seasons as a running back and was All-Pro five times. But he also did this:
In February 2000 he was charged in connection with a 1995 scheme to defraud mortgage companies and later admitted he had used falsified documents to obtain two loans totaling $157,800. Foreman, who assisted prosecutors in their investigation of similar real estate cases, pleaded guilty to one count of mail fraud in March 2000 and was sentenced to three years probation in February 2001.
Whitney frequently makes statements that indicate that he did not put all of the improvement loan money into improving the property in question. The whole contractors-profit-and-overhead concept constitutes at least some of the loan proceeds going somewhere other than into improvement of the property. That, in turn, means that the lender was misled, which sounds likes fraud.
In fact, down payment money for rental property purchases is akin to venture capital, one of the riskiest types of financing. Congress passed the National Housing Act in the depths of the Depression to help small property owners and to create jobs, not provide venture capital to greedy convicted felons. Institutional lenders like banks and savings and loans are generally not allowed to make any venture capital type investments.
Here are some of Whitneys comments indicating that his improvement loan proceeds did not go into improvements.
Source
|
Whitney comment
|
p.5 Overcoming the Hurdles and Pitfalls of Investing in Real Estate | We applied for the [Title I] loan and received the $15,000. the work only cost $5,000. We compensated ourselves $5,000 a piece for two week of labor. |
p.6 Overcoming | I applied again to the trust company for another FHA Home Improvement Loan for $12,000. I needed some more investment capital. I used about $4,000 for improvements and kept $8,000 for some investments. |
p.37 Overcoming | My cash was very low I had literally no income at all. I didnt feel really pressured yet, though. I knew I could go out and find some properties, then arrange a Home Improvement Loan and start rolling again. |
p. 70 Overcoming | we could put a home improvement loan on them and pocket some tax free money |
p.74 Overcoming | plus a $15,000 home improvement loan (of which only $7,500 would go to renovation) |
p.87 Overcoming | borrow $15,000. I will probably get the job done for $6,500 to $7,500 and pocket the rest. You keep the difference as a consulting fee, or whatever you want to call it. Just make sure you get paid |
p.111 Overcoming | A list of 9 Techniques for starting capital includes Home Improvement Loans as number 2. |
p.20 Overcoming the Hazards and Pitfalls of Financing, Locating, and Analyzing of Real Estate | We have a house for no money down, which is overfinanced for $10,000, of which we get to keep $4,000 (because the rehab only cost $6,000 ) |
p.20 Overcoming Financing, Locating, and Analyzing of Real Estate | I applied for a home improvement loan of $9,000 and only used $3,000 to complete the work and put $6,000 in my bank account |
p.20 Overcoming Financing, Locating, and Analyzing of Real Estate | I went and bought my own contract and proposal forms and wrote my own estimates for the cosmetic [improvement]s. I jacked the estimates up to cover the entire $30,400. Consequently, whatever is left after I sub the work out at a cheaper cost, I get to keep. In this instance, that figure was a handsome $9,000. |
p.85 Overcoming Financing, Locating, and Analyzing of Real Estate | Home Improvement LoanHere lies a source of seed capital that generated over $60,000 for me in my first year of rear estate investing at age 21. I have used the FHA Title I loan several times. |
p.86 Overcoming Financing, Locating, and Analyzing of Real Estate | The Title I is an excellent source of seed capital and continuing capital. |
p.122 Overcoming Financing, Locating, and Analyzing of Real Estate | look for some FHA Title I or regular home improvement monies to generate yourself continuing seed capital. |
p. 69 Building Wealth | Heres how you would do it and pocket some of the easiest money youll ever make. (This example is drawn from my personal experience with numerous home improvement loans.) |
p. 70 Building Wealth | I have marked up $3,000 worth of work to a retail price of $17,000 on a consistent basis and never had a lender question the figures. That means Im able to pay myself as much as $14,000 to get the work done on my own property. Remember, when you form your own contracting company, youre taking the markup yourself instead of giving it to someone else. |
p. 71 Building Wealth | Depending on how much of the work you do yourself, the actual costs of the improvements could be as low as $3,000 to $7,000, which leaves you with as much as $7,000 in cash as your general contractor profit. |
p.72 Building Wealth | I made $117,000 in spendable cash in my first year of real estate investment by acting as my own general contractor and securing home-improvement loans on my properties. |
p.122 Building Wealth | The secret cash machine of the 90s subhead for two-page discussion of home-improvement loans |
p.122 Building Wealth | Home improvement loans are basically designed to finance home improvements, but for the creative thinker they can be consistent and profitable sources for sizeable lump sums of cash. |
p.123 Building Wealth | You can take out a home-improvement loan on the house you live in, improve your property, and still be able to generate capital for another project. |
p.123 Building Wealth | home-improvement loans have provided me with millions of dollars in working capital over the years. [Reed note: Millions? At $10,000 a pop, that would take at least $2,000,000 ÷ $10,000 = 200 improvement loans.] |
p.123 Building Wealth | two ways to generate quick cash with a home-improvement loan act as your own contractor and take the contractors profit from the improvements |
p.127 Building Wealth | Used correctly, a rehab/construction loan can finance your down payment and all of your rehabilitation costs, and put some tax-free working capital in your pocket for your next investment. |
pp.19-20 Building Wealth Keys to Real Estate Financing Locating & Analyzing | Says he got a $33,000 loan to pay for costs related to moving a house, used $16,200 for that purpose, $4,000 for a down payment, and pocketed $12,800 Net Profit to Me |
p. 23 Building Wealth Keys to Real Estate Financing Locating & Analyzing | $9,000 home improvement loan, $3,000 to complete the work, $6,000 in my bank account |
Remember, when you apply for a property-improvement loan, you tell the lender that you will put 100% of the improvement-loan proceeds into the improvements you described in your loan application. If you do otherwiselike use the money for profit and overhead, working capital, or seed capital you have almost certainly broken a number of laws.
As I have mentioned, the actual loan application you fill out invariably contains pointed questions. Answering them inaccurately violates multiple laws.
If your files contain any improvement loan applicationsTitle I or otherwise, I would appreciate it if you would send copies of them to me so I can get the exact questions asked during the period when Whitney was seeking these loans. I already have one source: one of Whitneys own books. His Real Estate Forms Book contains some samples.
FNMA residential mortgage loan application Form 1003 (Revised 8/78) I/We fully understand that it is a federal crime punishable by fine or imprisonment, or both, to knowingly make any false statements concerning any of the above facts as applicable under the provisions of Title 18, United States Code, Section 1014.
Department of Housing and Urban Development Federal Housing Administration Credit Application for Property Improvement Loan Form Approved OMB No. 63R-0037 (Revised 3/76) PROCEEDS OF THIS LOAN WILL BE USED TO IMPROVE THE DESCRIBED PROPERTY AS FOLLOWS: and WARNINGAny person who knowingly makes a false statement or a misrepresentation in this application or causes such a false statement or misrepresentation to be made shall be subject to a fine of not more than $5,000 or by imprisonment for not more than 2 years, or both, under provisions of the United States Criminal Code. And for persons who sold the improvements to the property owner, I/We certify that the above statements are true, accurate, and complete to the best of my/our knowledge and belief. and I/We certify that 1. I (we) am (are) the person(s) who sold the job. 2. The contract contains the whole agreement with the borrower. 3. The borrower has not been given or promised a cash payment or rebate nor has it been represented to the borrower that he will receive a cash bonus or commission on future sales as an inducement for the consummation of this transaction, that the improvements have not been misrepresented, no promises impossible of attainment, no encouragement of trial purchase, no promise that the improvement will be used as a model for advertising or other demonstration purposes, and no offer of debt consolidation.
On page 8 of Overcoming , Whitney says The bank was treating me more coldly, too. He surmises this was because of his youth and aggressiveness. It could also be that the bankers suspected that Whitney was not giving them accurate estimates of improvement costs and was not putting all of the loan proceeds into improvements..
Lenders like young, aggressive businesspersonswho are honest and competent. Like professional baseball teams, they try to identify such businesspeople as early as possible so they can build relationships with them. If they dont, they fear they will lose them to the competition.
As I said, estimating is a complex art and science. Even if you make a good faith effort to be accurate, you will inevitably make mistakeseither over or under. As long as you make a sincere, good faith effort to get it right, no one is going to prosecute you for being a little off.
The problem with Whitney, is that he obviously did not make a sincere, good faith effort to give the lenders accurate estimates of the improvements costs. On the contrary, he deliberately, grossly overstated the costs of the improvements in order to use improvement loans for other purposes like down payments on other properties. In at least one casealuminum siding on 3160 Guilderland in Rotteram, NYhis statements make it appear that he did not do the promised improvements at all. That is immoral, unethical, and illegal and you could go to jail for doing it.
On page 5 of Overcoming and elsewhere, Whitney says he sold a property and had the buyer assume his Title I mortgage. I am not sure that is allowed. I would have to see whether the mortgage contained a due-on-sale clause.
Whitney says this or similar words over and over. He is right to admonish readers to make sure they can make the payments on a property improvement loan. But his statements or implications that this is easy or normal are bull.
As even investors with very little experience know, it is extremely difficult to buy rental property that has positive cash flow. In almost all normal deals, the cap rate (net operating income divided by purchase pricenet operating income is all income minus all expenses other than the mortgage) is lower than the weighted annual constant (loan-to-value ratio of all mortgages on the property multiplied by the weighted average annual constant of the mortgagesannual constant is the total payments for the year divided by the loan balance). When the cap rate is lower than the weighted annual constant, you have negative cash flow. Trust me, properties with normal, 75%- or 80%-of-value mortgages that have positive cash flow are extremely rare.
Mind you thats with 30-year first mortgages. Improvement loans generally have higher interest rates and much shorter terms. That means they have much higher payments as a percentage of the amount borrowed, which is another way of saying they have higher annual constants.
Heres an example. Here is what the annual payments and annual constant would be on a self-amortizing (no balloon payment), $10,000, 10% home improvement loan for various terms.
Term |
Annual payments
|
Annual constant
|
30 years
|
$1,044.38
|
10.448%
|
15 years
|
$1,278.87
|
12.79%
|
10 years
|
$1,572.70
|
15.73%
|
7 years
|
$1,975.68
|
19.76%
|
As you can see, it is almost twice as hard to have positive cash flow with a 7-year improvement loan as a 30-year mortgage. Yet there are virtually no 30-year improvement loans, and Whitney blithely tells you to make sure that your net operating income covers the payments and repeatedly says you should be able to do this. When elephants fly!
You will find that unless you make a bargain purchase at a substantial discount below market valuelike 25% or moreyour rental property will have negative cash flow with just an 80% of value first mortgage. To buy for nothing down as Whitney advocates, and then borrow a property improvement loan to boot, will drive your negative cash flow through the roof! See my article on positive cash flow. To learn how to buy properties for at least 20% below market value, see my two-volume book on the subject.
In other words, Whitneys improvement loan techniques are not only arguably unethical and illegal, they are also impractical in the sense that you cannot afford to make the payments on all that debt from your rents unless you made an extraordinary bargain purchase.
Whitney often claims to have purchased property at great bargains because the seller were motivated. All sellers are motivated. Indeed, the various reasons Whitney cites for the seller selling in the various deals he brags about sound quite normal to me. They are not distress situations.
In the real world, the only way you get a bargain from a motivated seller is if he or she must sell in an enormous hurrylike they have to close in a couple of daysand you move with enormous speed to tie the deal up before the other buyers arrive. The situations Whitney depicts come nowhere near that. We have all read about sellers receiving multiple offers on properties. That happens when the asking price is only a couple of percent below market value. Imagine the crowd you attract when you put a property on the market for 20% below market value.
If you read various property improvement loan Web sites, you will find that shoddy construction work is a big concern. Thats why some lenders only work through contractors they know well.
How does what Whitney did and what he recommends come out in that regard? I think if you look up shoddy construction in the dictionary, Russ Whitneys picture will be next to the definition. Listen to what he says about getting work done on his properties and yours.
Source
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Whitney comment
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p.9 Overcoming the Hurdles and Pitfalls of Financing, Locating, and Analyzing of Real Estate | go to a discount carpet outlet and check the remnant carpets. You can get big enough remnants to cover any normal size living room or bedroom. [Reed comment: This means every room has different color wall-to-wall carpet.] |
p.9 Overcoming the Hurdles and Pitfalls of Financing, Locating, and Analyzing of Real Estate | In middle and lower income units, I saved money by not using padding and installing the carpet myself. |
p.9 Overcoming the Hurdles and Pitfalls of Financing, Locating, and Analyzing of Real Estate | if you make a wrong cut the first time or make a mistake, you will still get the same amount of rent Im sure the tenant will not come look at the unit and say, hey buddy, theres a mistake there in the carpet. I want the apartment for twenty-five dollars less per month. I have made many mistakes on all different types of things from panelling to painting |
p. 25 Overcoming Financing, Locating, and Analyzing | Buy used mattresses for your rooming houses |
p.64 Building Wealth | plenty of people around who are looking for part-time work students other people who will do painting and other fix-up work on weekends at very affordable rates. |
p.64 Building Wealth | You dont have to pay a painting contractor $20 or $30or more an hour when you can get a teenager to do the same work for $8 an hour. |
p.71 Building Wealth | Either install them yourself or hire a handyman to do the job; theres no reason to use a licensed electrician. |
p.71 Building Wealth | Purchase carpet and use your handyman for this job, too. |
p.67 Building Wealth | Become a Highly Paid Contractor Without a License or Ever Hammering a NailEven if You Dont Know Anything About Construction subhead |
p.7 Overcoming the Hurdles and Pitfalls | It was too expensive to put aluminum siding on the whole building, so I had the front done to dress it up. We painted the other three sides to match. |
p. 14 Overcoming and County clerks office | Had fire in 812 Grant Avenue. I really didnt want to go through the hassle of fixing the property, so I gave it to [my handyman] [Reed comment: Even though the fire burned the interior of the apartments pretty bad, according to Whitney (p.14 Overcoming ), the deed to the handyman was almost two years after the fire and indicated that the property taxes were in arrears and that Whitney had been cited for housing code violations in the property.] |
Improvement lenders are concerned about shoddy construction because they want the property value to be enhanced by the improvements in order to provide increased security for the mortgage if the loan is secured. Also, borrowers who are unhappy with improvements sometimes irrationally decide they do not need to make the payments on the loan because the work was shoddy. Since the lender did not do the work, they are understandably not happy about being blamed for it or for not getting their loan money back with interest. Lenders want to avoid shoddy improvement construction because they know an ounce of prevention is worth a pound of cure.
I believe its safe to say that the descriptions above of the way Whitney improves his properties would not be well received by Whitneys lenders.
A reader tells me he attended Whitneys Millionaire University and that at that session, Russ told the students to pay themselves a paycheck ot of their business account weekly then put the money back in the account. This was to genrate cancelled checks to prove income to qualify for loans. The student says he got into an argument with Whitneys staff members about the ethics of this.
Good for him. Sounds not only unethical, but also illegal to me. If it is not an attempt to mislead, what is the point of doing it?
Should you follow the Whitney approach to improvement loans.?
No way!
You could go to jail! You could also lose your good reputation. Loan officers are not as dumb as Whitney implies. Nowadays, lenders are also smarter about ferreting out this sort of fraudsometimes requiring inspections of completed work, receipts, and so forth. There is also the issue of making the payments if you do manage to defraud some lender into lending you more than the cost of your improvements.
It is outrageously irresponsible for Whitney to brag about and advocate his overfinance improvement-loan techniques without warning you of all the stuff I have told you about in this article. He is charging admission to send you into a minefield that he misrepresents as a picnic ground. I am warning you that it is a minefield and giving you a map of where the mines are. No charge.
Property-improvement loans make sense in many situationsfor improving properties only. For them to make sense, you must make a higher return on the improvement than the interest rate, furthermore, you must be sure you can make the payments on these high-annual-constant loans.
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