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I don't have any background of loans and finance since I am an Engineer, but I have been planning to own a property lately. What I understood from my research is that there are two options to get a new property, if you don't have enough money in your account to actually buy it from the developer/owner. First is getting a loan from the bank by pledging any of my other existing property on the line as a collateral, and then making monthly payments to the bank (including the interest). Second option is to go for mortgage, where the bank will actually buy the property from the developer/owner and then sell it to you (ofcourse at a higher price). Here, I would own the new property under the clause that if I don't submit the due payments on time, then bank has the right to confiscate the property. However, for the latter case, I don't need any collateral at all and can still own a new property by just paying monthly installments.

But if this is possible, then why don't we see everyone doing it? I mean just go for mortgage, rent out the property and do the monthly payments to the bank, and you might still find yourself saving some money at the end of the month. As soon as get done with the complete payments to the bank, I can have a property written to my name where I haven't actually paid a single penny to own it.

But ofcourse, I don't think it would be that easy. So can anyone make comparison between the pros and cons of both, collateral and mortgage?

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  • "But if this is possible, then why don't we see everyone doing it?" By "doing it", do you mean using the new property as collateral instead of using a different property as collateral, or do you mean managing a mortgaged rental property instead of not managing a rental?
    – glibdud
    Nov 28 '21 at 18:35
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    I've never heard of your second option where the bank buys the property.
    – JohnFx
    Nov 28 '21 at 21:02
  • @JohnFx, I am from a Muslim majority country and it happens in some banks in my country where the bank actually buys the property and sells it to you at a higher price than what it had bought, in order to eliminate the concept of interest (which is not allowed in Islam). So you can just pay them monthly, until all the installments are settled out. Nov 28 '21 at 21:18
  • If "everyone" was doing this, then either (a) they pay as much renting a place to live as they do from renting out their own place, so there's no net income from the latter (plus taxes and costs make it a net loss); or (b) "everyone" rents somewhere cheaper for themselves, which would require an infinite number of progressively cheaper houses - it's an unworkable pyramid scheme. (This is also ignoring all the more relevant real-world issues around access to mortgages.) Nov 30 '21 at 11:20
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What stops people from doing this? At least one of:

  • the person doesn't have the 10% (or better 25%) downpayment - banks don't lend 100% of the price, and of course there are costs associated with buying a house too (cleaning, painting, fixing problems you find after closing etc.)
  • the person doesn't have the income to qualify for the mortgage. Sure, you intend to rent it, but banks don't lend money on intent.
  • the person doesn't know how to find renters, screen renters so they end up only with good ones, pester renters who are late with rent, fix damage some renters cause (or just wear and tear) quickly between renters, and so on.
  • the person knows how to do all that, but doesn't want to do that work for that money in return.
  • the person is worried about the months with no rent (for whatever reason) and how they might end up having to cover the mortgage from their other income at times.
  • the person is concerned they might overpay for the property or buy in the "wrong" area and not see an overall growth in the value of the property by the time they want to sell it.

I know people who've bought second places, rented them out, covered the mortgage and then some, not minded the work (one for example rented to his sister at slightly less than she would have paid on the open market and both were happy with that deal; another was a handy guy who liked to fix things married to a handy lady who liked to re-upholster furniture and run garage sales), and ended up selling the property for a profit. They're happy. Doesn't mean you would be if you did the same, and most certainly doesn't mean everyone should do it.

You're taking a financial risk (the mortgage is still due if you have no tenant, your tenant isn't paying, or you have to spend a lot on a new roof or whatever), you're tying up your capital and your borrowing power, meaning some other opportunities may arise that you won't be able to take, and you're taking on time-bound work that can be both physically and emotionally difficult. None of that is something everyone should do.

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    1. "Banks don't lend money on intent" -- but they do (it's called a business plan) -- this falsely implies that expected rent isn't considered at all. Typically, "borrowers can count 75% of their potential monthly rental income" when qualifying for an investment property mortgage. 2. How about adding to the bulleted list: The rent (especially after subtracting property management expenses) simply may not cover the mortgage payment.
    – nanoman
    Nov 28 '21 at 21:06
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    if op writes a business plan (and considers all these things) the bank may consider that. The bank is not going to use "I am sure i can get x a month for it" and approve based on that. Nov 28 '21 at 21:11
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First, your understanding of mortgages is wrong. Banks don’t buy properties and sell them on to their mortgage customers, they lend the customers the money and the customers buy the properties.

Second, you don’t know that the rent you can charge will cover the mortgage and maintenance costs for the next thirty years. And nor does the bank. So a bank won’t lend you 100% of the money to buy a property you intended to rent out — you’ll need to put down a substantial deposit to reduce the risk to the bank. And you may still end up making a loss.

Third, of course, letting a property is work. You need to handle maintenance and repairs, find new tenants from time to time, and so on. You may already have a job and not want another one.

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  • So if the bank is literally providing me with the money in both cases i.e. collateral and mortgage, then why do we even have these two different options? The former requires a property to be plegded but the latter doesn't. From a client's point of view, mortgage ofcourse overshadows the collateral option, but definitely there might be catch. What is this catch? Nov 28 '21 at 19:29
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    @RameezUlHaq No, in both cases a property is pledged. If you put up a property you already own as collateral, and fail to make the payments, the bank will take that property. That's what collateral means. Why might someone do that? Maybe the bank doesn't agree that the new property is worth the amount being loaned, but thinks your existing property is. Same with taking out a mortgage on the new property: you fail to pay the loan, the bank takes the property. That's why the bank will be very concerned that the property be worth the loan amount. Nov 28 '21 at 20:31
  • @CharlesE.Grant, but for the collateral, I need to have an existing property but for the mortgage, I don't. I just put the newly bought one on the stake and pledge it out. Still, mortgage appears to be easier to go with since I don't need to already own a property. That is why I was saying there might be a catch with mortgage which is not always visible at first. Nov 28 '21 at 21:21
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    @RameezUlHaq 'but for the mortgage, I don't. I just put the newly bought one on the stake and pledge it out.' Right, but as Kate explains, the bank is not going to pay the full cost of the new property. You are going to have to put down somewhere between 3% and 15% of the purchase price as a down payment from your own funds. If you default on the loan, you almost certainly won't get any of that back. That's that general scheme in the US at least, I have no knowledge of how it works under any system of Islamic law. Nov 29 '21 at 1:10
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    @Rameez Ul Haq: At least in the US residential market, it's very rare (AFAIK, anyway) to put up one property as collateral for another. You would instead take out a separate mortgage on the first property (or do a cash-out refinance if you already have a mortgage), then use the cash as a downpayment on the second property. This way the mortgage lender can foreclose on the properties individually, if you fail to make payments.
    – jamesqf
    Nov 29 '21 at 17:38

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