Using Personal Assets for Funding

The realities of tapping into life insurance, CDs, mortgages, IRAs and 401(k)s

By David Newton

Many budding entrepreneurs want to know about the realities of funding their business by tapping into nonsavings areas of their personal assets, such as life insurance policies, certificates of deposit, home mortgages, individual retirement accounts and pension plans. Be careful to recognize upfront that this type of funding strategy is definitely going to blur the lines between personal wealth and enterprise development. Ideally, it is best to keep clear distinctions intact for individual assets and the objectives for these funds, compared to capital raised for the business. However, when a funding strategy with these kinds of assets is executed within a comprehensive plan for both the business and the personal assets, it can provide much-needed cash for the venture without completely throwing personal common sense aside.

The first rule is to understand that if funds are diverted from these traditional products to a business, it should be viewed as either a temporary or intermediate-term remedy for funding. This kind of funding does not constitute a good long-term approach to venture capital. There must be a plan in place to return these funds to these other financial products, or to replace these products at a later date once the venture is producing solid revenue and positive cash flow. I cannot emphasize this enough. There are tremendous risks involved in funding a business. Bringing personal assets into the picture only adds to that risk exposure, because it can further complicate personal risks by reducing insurance or retirement benefits or jeopardizing the status of one's primary residence.

The place to begin is with some brief qualifications on these products. Today, most people buy term life insurance, and very few, if any, individuals purchase traditional whole life insurance. Term life insurance simply provides a cash payment to beneficiaries. Whole life insurance is more expensive and accumulates a "cash value" over the long term (like a traditional savings account). Whole life policies allow the owners to borrow cash value for personal use (i.e. funding a business), but the funds borrowed must be paid back. Whatever is not paid at time of death will reduce the death benefit by that amount. And interest must be paid (typically monthly or quarterly) on the outstanding principal balance until it is paid back. Interest rates tend to be relatively low, so that an entrepreneur could access the funds for one to three years and pay interest only on the outstanding loan, and then pay back the cash value in full once the company becomes profitable and regular compensation can be drawn. Term insurance has a much less expensive premium compared to whole life and accumulates no cash value over time, so there are no funds to borrow against such a policy.

This same general format holds true for pension plans as well. The fund value for a 401(k) or 403(b) retirement account can be typically borrowed for the short term to midterm without penalty, but must be paid back, and interest charges will be incurred during the loan period. The same holds true for IRAs. One major concern is that if funds are borrowed on insurance or retirement funds and the business goes bust, interest must still be paid on the outstanding loan balance. The death benefit will be reduced by that outstanding loan, and of course in the case of the pension funds or IRA, the retirement benefit will be reduced proportionate to the borrowed funds still not paid back.

A certificate of deposit is a midterm to longer-term savings vehicle, where the bank agrees to pay a stated contractual interest rate for a specified time period of the deposit. Banks offer higher rates when funds are kept on deposit for a longer period of time (and lower rates when the term is shorter). Pulling money out of a CD prior to its maturity generally incurs significant penalty fees. However, some institutions will allow a CD balance to serve as collateral on a short-term to midterm loan. If interest is paid regularly on the loan, funds remain in the CD accumulating interest. When the loan is paid back in full, there is no effect on the CD's balance or interest earned. But if the business had difficulties and the loan could not be paid back, the bank would liquidate all or a portion of the CD to cover the loan, and that would include penalty fees for early withdrawal.

When the entrepreneur's primary residence has accumulated sufficient equity (the difference between the home's market value and the outstanding balance on the first mortgage), it is possible to borrow some or all of this equity with either a home equity line of credit or a second mortgage. The lender will have a secondary lien on the residence and typically requires interest only paid each month or quarter. And in many cases, this interest is tax-deductible on the individual's personal tax form. The word of caution, again, is that if the business fails, the interest payments on the second or equity line are still due, and the equity in the house has been reduced by the amount of that loan outstanding.

If a venture idea needs some funding for the near term, borrowing against personal savings, retirement plans and a primary residence can be an easy way to access much-needed cash. When the business begins to generate positive cash flow, then is the time to begin paying back these outstanding principal balances. Remember, too, that it is important to have a legal written loan document between the company and the entrepreneur lending the funds. If the funds are invested into equity, then stock certificates should be issued, as these funds are not a loan. If the business needs money for a longer term, or if the risks are significant, it would probably still be prudent to obtain funding through banks and/or capital investors and leave the lines of distinction in place between personal assets and the company's funding needs.

David Newton is a professor of entrepreneurial finance and head of the entrepreneurship program, which he founded in 1990, at Westmont College in Santa Barbara, California. The author of four books on both entrepreneurship and finance investments, David was formerly a contributing editor on growth capital for Industry Week Growing Companies magazine and has contributed to such publications as Entrepreneur, Your Money, Success, Red Herring, Business Week, Inc. and Solutions. He's also consulted to nearly 100 emerging, fast-growth entrepreneurial ventures since 1984.



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The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.

Take a bite out of closing costs

Take a bite out of closing costs

Hold the fees please. How to save if you're buying a new home or just refinancing.
April 22, 2004: 4:30 PM EDT
By Sarah Max, CNN/Money senior writer



BEND, Ore. (CNN/Money) - With mortgage rates still as low as they are, financing a house is dirt cheap these days, right?

Not if you pay a fortune in closing costs.

As anyone who has shopped around for a mortgage knows, it's extremely difficult to compare one lender's offering to with that of another lender because the up-front fees vary so much and are not guaranteed. Lenders and their venders can, and sometimes do, add or inflate fees in the eleventh hour of a transaction.

The U.S. Department of Housing and Urban Development (HUD) has been working on regulations that promise to simplify the mortgage process and save consumers as much as $1,000 off a typical mortgage transaction. When such rules will be rolled out, if ever, is still anyone's guess.

With no regulation in sight, borrowers should consider these strategies for keeping their closing costs in check.

Get friendly with your current lender
If you're looking into refinancing, the first call you should make is to your existing lender, who already has critical information about you and your house on file, said Keith Gumbinger, vice president for HSH Associates.

Since you have an existing relationship, a "streamlined" process might be possible. That can save you a lot of extra paperwork and money on everything from application fees to appraisal fees.

Fee-ed Up?
Here are just some of the costs of closing on a mortgage.

Fee Average cost*
Application $272
Appraisal $310
Credit report $28
Document preparation $206
Processing $288
Recording $86
Underwriting $236


*Based on a $100,000 loan. Not every lender surveyed charges all of these fees.
Source: HSH Associates December 2003 survey of lenders

Although fees for title search and title insurance are not determined by the lender, you may also get a break there. If you recently refinanced or took out a loan, you can save as much as 50 percent on title insurance by asking for a reissue rate, which your lender can request on your behalf.

If you're a homeowner shopping for a new house, you should also try giving your existing lender first dibs on the new business. Assuming you've been a good client and your lender originates the kind of mortgage you're interested in, it's possible to get a better-than-market deal, according to Gumbinger.

Get nitpicky about fees...
There are more than a dozen kinds of fees that could show up on your final closing statement, including credit report fees, appraisal fees, document preparation fees, title fees, recording fees and underwriting fees.

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All told, fees on a $200,000 mortgage could add up to anywhere from $1,000 to $3,000 – that's not including any "discount" points you pay up front to get the best interest rate. (A "point" is a fee that equals 1 percent of the loan amount.)

Lenders are required to give you a good-faith estimate of your closing costs within three days after you apply for a loan. Some will give you such an estimate even before you apply if you ask for one. Even if it is no guarantee, this written estimate will give you an idea of what kind of fees you can expect to pay, as well as an opportunity to negotiate for a better deal.

"If you're a good credit borrower you can challenge fees if they seem excessive," said Gumbinger, noting that lenders don't control many fees that show up on your statement.

Keep in mind that the good faith estimate doesn't include such out-of-pocket costs as state mortgage taxes, homeowners insurance and property taxes, which you may be expected to pay at the time of closing. In fact, your total tab at closing could be several times more than originally estimated, said Gumbinger.

... but keep the big picture in view
Closing costs are certainly a consideration for both new loans and refinancing. But it's important to not lose sight of what should be your first priority – getting the lowest rate possible.

Indeed, the difference between paying, say, 6 percent and 5.5 percent on a new loan adds up to nearly $23,000 in total interest on a $200,000 30-year loan. If you have to pay a few hundred dollars in closing costs to get that rate, you can rest assured that it is a worthy investment.

It may even be worth it to pay a point or so up front in order to lock in the lowest rates. Let's say that you'll knock your rate down to 5 percent on that $200,000 loan by paying an extra point ($2,000) up front. Considering that you'll cut $62 off your monthly payment and about $22,000 from total interest by going from 6 percent to 5.5 percent, it makes sense as long as you plan to stay in the house long enough to recoup those up front costs.

In fact, if you're short on cash you might even consider rolling the closing costs into your loan, if that is an option. You'll want to consider how much more you'll pay each month as well as in interest over the life of a loan.

If you roll $2,000 in finance costs into a loan with a 5.5 percent rate, for example, you'll pay an extra $11 a month and about $2,000 extra in total interest. In this case you're still better off than if you had not refinanced at all.

Avoid these rookie renovation mistakes

Avoid these rookie renovation mistakes

You'll save money and grief -- and improve the odds that your project will turn out as planned.
August 15, 2005: 4:09 PM EDT
By Jeanne Sahadi, MONEY Magazine

NEW YORK (MONEY Magazine) - You've just parted with serious cash to buy your first home. Now you need to part with more so the place no longer screams bad taste, broken pipes and bathrooms circa 1970.

Or maybe, with real estate prices through the roof, you can't afford to trade up from the starter home you bought two children ago. So you've decided to upgrade instead.

Whatever your reasons for renovating, take heed: Rookies often "don't understand how much it will cost, how long it will take or how proactive they should be," says Sal Alfano, editor of Remodeling magazine. Here are the pitfalls to avoid.

Mistake no. 1: Underestimating the cost
No matter how carefully you budget, count on spending at least 10 to 20 percent more than your initial estimate. That's because expenses invariably pop up that you couldn't anticipate beforehand.

Once workers knock down walls or rip up flooring, for instance, they may find mold, rotting pipes or other structural problems that need repair.

When Marc Siegel, a corporate underwriter in New York City, wanted to put a new floor on top of an existing tiled one, he was told by his contractor once work began that the tiles were too loose and the old floor would have to be ripped out. Extra cost: $3,000. Siegel agreed -- but only after negotiating the price down to $1,500.

To help minimize unexpected outlays, research the materials and brands you'd like to use before commissioning work, so you don't have to rely solely on contractor estimates. That $2,000 high-end fridge you choose after your kitchen remodeling begins may cost twice as much as the standard appliance he assumed you'd buy.

Mistake no. 2: Pinching pennies
Sure, you want to save a few bucks where you can. But sometimes it doesn't pay to scrimp, says Danny Lipford, host of the syndicated TV show "Today's Home."

With contractors, go with someone who's highly recommended and experienced in your type of renovation, not the cheapest guy. Favor quality products for anything installed in your walls; the cost to replace, say, a faulty shower valve is high since it involves breaking the wall and calling in a plumber.

Nor should you stint on items you'll use every day. Buy what you love. Otherwise, you'll kick yourself every time you turn on a faucet or open a cabinet.

Mistake no. 3: Failing to anticipate chaos
The stress of a renovation builds as the dust mounts, workers traipse through your home and everything takes too long.

"Remodelers count on at least one [client] explosion per job," says Alfano.

To minimize surprises, ask potential contractors lots of questions about the process, like "What's your time frame?" and "What time do you start and finish work?" Be clear too about your preferences, such as how often you'd like updates and how much the contractor can spend without consulting you.

Then tame your inner Felix Ungar. Good contractors will clean your place every day. But remember, "broom clean" doesn't mean "mop clean," Alfano says. Some dirt and debris are inevitable.

Mistake no. 4: Overestimating the payback
Not all renovations are equal equity builders. Typically, you'll recoup the most on bathroom and kitchen jobs. But the exact payback depends as much on where you live as on the project itself. Talk to local real estate pros for the lowdown on what you can expect in your area.

What you can't measure in dollars and cents, of course, is the pleasure you'll derive from the improvements to your home. In the end, since you are the one who will be living there for a while, that's the payback that matters most.

A tool kit for new landlords

A tool kit for new landlords

Many professions have their own special tools. Here's some for the well-equipped landlord.
November 2, 2005: 2:50 PM EST
By Les Christie, CNN/Money staff writer

NEW YORK (CNN/Money) - "You know you're a landlord," says Matt Martinez, a real estate investor from Boston, "when you get a new drain snake for your birthday."

Landlords face daunting problems, from tenants behaving badly to leaky pipes and clogged drains (that's where the snake comes in) to unexpected vacancies.

It takes more than plumbing tools to run a home-rental business. With all the complicated paperwork and governmental filings landlords are responsible for, they need a lot of do-it-yourself help to keep everything organized.

This subject is of more interest to more Americans every day. Some 15 million now own rental properties in the United States, according software maker Intuit, which makes property management software. About nine million of these investors are small property holders, owners of 10 units or less.

Some are accidental landlords -- they've inherited or otherwise taken possession of a property and decided to keep it and rent it out.

Many of these, and other new landlords as well, are less than fully prepared to run their business.

For them, there are a few items essential for making running their small business empire run smooth. Call it a tool kit for small landlords.

Getting organized
Since many real estate investors spend a lot of time in the field, either on site at their properties or looking at new buildings to buy, a laptop is one of the most useful of these tools. Making instant entries – the cost of a repair, a rent paid – as they occur can help landlords keep more accurate records.

Loaded into that laptop should be a robust software program. Many small landlords try to track their records by creating their own paperwork with worksheets, ledgers, and hand-written notes.

These "systems" are usually hard to keep up to date, error-prone, and often difficult to decipher – even for their author. It's better to get some information technology to help.

Martinez says first time owners can start out with a simple Excel spreadsheet, if they only have one or two tenants. Any more than that and it pays to invest in a more sophisticated package.

Jeff Zimmerman, product manager of Intuit, says property owners face three problems: keeping tax records, knowing whether properties are profitable, and keeping track of payments, leases, and expenses. Property management software helps landlords do all three.

Quicken's Rental Property Manager tracks expenses, organizes taxes, and performs housekeeping duties such as flagging problem tenants and keeping track of expiring leases.

At tax time it can automatically export that information to a Schedule E tax form that landlords must fill out, making the process of filing, normally a hellish one for even small operations, a little more agreeable.

The Quicken software can be used by landlords owning as many as 100 separate units. Other property management software, such as IDEAS Property Clerk or RentRight's Property Management Software, comes in several different flavors and price points, based mainly on the number of units under management.

Packages cost as little as about $99 for one designed to manage 10 units or less. The price of software for more robust operations can run into the thousands.

Other hardware
There are three other essential pieces of hardware for an active small landlord. Martinez always carries a digital camera on his prospecting forays for new properties. He'll snap several pictures of any potential buys to help document all the building's virtues and shortcomings.

Martinez also likes to carry a Blackberry-type device that enables him to e-mail and text message, send digital photos, access the Web, and organize his calendar.

Meanwhile, back at the office, he has a combination scanner, FAX, and copier. He can receive, send, and save all his bills, leases, contracts, bids, and other necessary paperwork.

Strength in numbers
Finally, although it doesn't qualify as either hardware or software, a support group is a great tool for many landlords new and old. Small landlords associations exist all over the country and can provide all sorts of useful information and resources for a fledgling property investor.

Martinez believes in these organizations so much that he started his own in Boston, the Landlord and Investor Group. His members talk over problems, trade information about properties, and offer advice to each other. They recommend contractors and share where the best buys are in building materials. More experienced members often act as mentors to newbies.

All that can make the difference between success and failure. Being a small landlord can be an extraordinarily complicated operation. Having the right tools can make a difficult job much more manageable.

Good news for landlords

Good news for landlords

After two years of falling rent and rising vacancies, the rental market may finally be on the mend.
September 15, 2004: 1:42 PM EDT
By Sarah Max, CNN/Money senior market



BEND Ore. (CNN/Money) – Landlords haven't had it easy over the past few years. A weak economy and an attractive housing market sent vacancy rates up and rental prices down.

In 2003 rental prices declined nationwide, according to M/PF Research and Torto Wheaton Research. Prices fell 6 percent in the San Francisco Bay Area and more than 5 percent in Denver. The national vacancy rate, meanwhile, reached 10.4 percent during the first quarter of 2004, its highest level since the Census Bureau began tracking it in 1960.

Now, however, landlords may be getting some relief.

"Rental markets have appeared to turn the corner after more than two years of declines," said Gleb Nechayev, an economist with Torto Wheaton Research. Nationally, rents are up 0.5 percent so far this year. In hard-hit rental markets, such as San Francisco, rents are still declining, though at a slower rate.

"Growth is negligent, but positive nonetheless," said Nechayev, adding that the slow recovery in the rental market reflects slow improvements to the economy overall. At the same time, interest rates have remained low, meaning that buying is still more attractive than renting in many markets.

After a recent survey of builders and property owners, the National Association of Home Builders (NAHB) concluded that demand for apartments is stronger than it was the same time last year. To track supply and demand, the NAHB rates responses on a scale of 1 to 100 with 50 representing a neutral response. Based on that index, demand for the average rental property was 50.6, a 7-point increase from a year ago.

Oversupply is still an issue in some markets, however. The NAHB's index tracking the number of apartments jumped more than 10 points between the second quarters of 2003 and 2004 to 64.
At the same time low interest rates prompted renters to become homeowners, real estate investors flooded the market with new rental properties. Although housing has cooled in some places (See "Leaving Las Vegas") rental prices won't improve significantly until supply levels off.

"As interest rates slowly rise, both the for-sale and rental multifamily sectors will approach new points of stability," says NAHB chief economist David Seiders in a release.

Nechayev, meanwhile, is forecasting a slow recovery during the remainder of 2004 and a full recovery in the rental market during the second half of next year.

"Essentially the recovery is on track," he said. "It's just a matter of slow and steady improvements."

Fewer new buyers can afford a home

Fewer new buyers can afford a home

Housing affordability for first -time buyers dives as rates rise.
November 8, 2005: 8:34 AM EST
By Les Christie, CNN/Money staff writer

NEW YORK (CNN/Money) - Although earnings have risen about 2.6 percent, housing is even less affordable for first-time buyers than it was a year ago, according to the latest findings from the National Association of Realtors.

The NAR found that the average price nationally for a starter home rose to $183,500 in the third quarter, up $23,500 in the past year.

With a 10 percent down payment and a mortgage rate of 5.83 percent (the average in the quarter), the monthly cost to finance the purchase of the average starter home would be $999 a month.

A new homebuyer would need income of $47,952 to qualify for such a mortgage, but the median income of first-time buyers was just $32,781 nationwide last quarter, yielding an affordability index value of 68.4 -- down from 74.8 a year ago and 80.9 for all of 2003.

According to other surveys, home affordability has fallen even more drastically in some of the hottest U.S. markets. According to the California Association of Realtors, the situation is particularly dismal in that state.

The CAR report, which covered all houses, not just starter homes, revealed that a homebuyer in the state would need annual income of $133,800 -- factoring in a 20 percent down payment and interest rate of 5.87 percent -- to afford a median home ($568,890 through August 31). Only about 14 percent of Californians had that much income.

Interest rises hurt affordability
Since the NAR data was compiled, mortgage interest rates have jumped considerably and have made already expensive housing even less affordable for working Americans.

At the beginning of July, a 30-year fixed-rate mortgage carried a rate of about 5.53 percent. The national average is now 6.3 percent, according to Freddie Mac. That has added nearly $100 a month to interest payments on a $200,000 mortgage.

That extra $100 means borrowers can not afford to pay as much for a house; they might have to settle for one costing about $15,000 less or find some other way to make up the shortfall.

Bob Moulton, founder of Americana Mortgage Group, said the higher rates have already had a significant impact on his business. "Monday morning is usually my busiest time," he said. "I've had only a half dozen applications today."

For homeowners with existing adjustable-rate mortgages, the rise in interest rates comes as especially bad news. When the rates to these loans adjust higher, monthly bills can leap. Homeowners with interest-only ARMs may see an especially large increase.

Moulton says that for some ARMs that have recently come up for adjustment, the adjusted rates were actually higher than the rates for 30-year fixed-rate mortgages.

These trends point to a softening housing market, especially in the especially overheated markets. It also could spell trouble for the overall economy since cash from refinancing has helped fuel consumer spending, which has, in turn, helped prop up the economy.

College towns are more affordable than the average city. For more, click here.

A house in Killeen Texas costs one/fourteenth what it would in La Jolla California. For a look at the least and most expensive U.S. markets, click here.

Can you afford to pay $1 million for a home. Here are some that are on the market.

Good house, cheap house

Good house, cheap house

Adventures in creating extraordinary homes at everyday prices.
October 13, 2005: 1:39 PM EDT
By Kira Obolensky, for MONEY Magazine

NEW YORK (MONEY Magazine) - Great American homes, built or made over at prices you won't believe!

There is good cheap and there is bad cheap. You know bad cheap when you encounter it. Good cheap can be more elusive, although its best qualities surely include simplicity (a 20-cent Bic pen, for instance), practicality (a $27 set of stackable Tupperware bowls) and style (the $21,500 Mini Cooper convertible).

So too with homes, as you'll see from these construction and renovation projects profiled in the following gallery. Good cheap work requires durable yet inexpensive building materials -- those highlighted in this story include steel, concrete, glass, metal and plywood -- often borrowed from industrial or commercial contexts.

But the most essential material is resourcefulness. The owners here made magic happen, delivering flair and personality as well as durability, because they could successfully re-imagine what they initially thought they needed in a home.

For some, that meant forgoing square footage; for others, it meant rethinking their definitions of quality. Must it always be granite counters, hardwood trims and gold-plated faucets?

No way, says professional appraiser John Bredemeyer of the Appraisal Institute. "Quality is not in itself one style or another."

Bottom line: Simple, practical and stylish design can offer more value than high-end finishes -- words to live by when you're planning your next big renovation or doodling your latest dream house.

________________________

Kira Obolensky is the author of "Good House, Cheap House: Adventures in Creating an Extraordinary Home at an Everyday Price" (Taunton Press), available at bookstores in mid-October.