As a beginner investor, understanding how to finance a deal is just as important as finding it. A lack of real estate financing continues to hinder the majority of new investors in today’s market simply because they are not aware of the different financing avenues. Whether you have access to working capital or not, there are always ways to acquire capital.
Investing in real estate is never a bad idea. It offers potential investors a slew of financial and personal benefits such as increased cash flow, home appreciation and tax benefits. In fact, real estate investment continues to be one of the most popular vehicles in producing financing wealth. According to the IRS, approximately 71 percent of Americans that declared more than a million dollars on their income tax returns in the last 50 years were in real estate. Ironically, beginner investors face the challenge of learning how to obtain real estate investment financing before they can start creating wealth. Read on to learn about some of the most common types of real estate financing options out there, as well as prominent loans for real estate investing.
Don’t Fear Real Estate Investment Financing
One of the biggest misconceptions of real estate investing is that you need to have lot of money to get started, which simply isn’t true. The secret that many professionals don’t understand however, is the fact that there are a multitude of different real estate financing options available to fund every investment. Because the method in which a specific deal is funded can greatly impact its outcome, understanding the financing aspect is imperative.
As an investor, there are a few different ways to go about financing real estate investments. Each one will have its own set of pros and cons, and your financing approach will depend on the property and the situation. For beginner investors, it’s important to remember that not all financing options are created equal. What works for someone else may not necessarily work for you, but the trick is understanding which real estate financing option will compliment your business strategy. By taking the time to research the various real estate financing options out there, new investors are sure to realize how accessible investing can be. Broadening one’s toolkit of financing options is simply a matter of being knowledgeable about what strategies exist, as well as proper ways to leverage them. Keep in mind that all investors have faced the financing hurdle at some point in their career; when in doubt, there is nothing wrong with tapping into your investor network and ask for advice.
Real Estate Financing Options
- Cash Financing: Great for investors who have access to a significant amount of capital, either personally or through their network, and wish to purchase properties free and clear.
- Hard Money Lenders: Accessible to investors who have less-than-perfect credit or financial history, and are in need of a short-term loan.
- Private Money Lenders: Investors who are well-connected can often tap into capital from personal connections, borrowing money at a specified interest rate and payback period.
- Self Directed IRA Accounts: Individuals who have elected to create savings through a self-directed IRA may make the decision to tap into their account as a way to access capital.
- Seller Financing: Buyers and sellers can sometimes strike up a mutually beneficial agreement, allowing the investor and seller to avoid having to go through a private lender altogether.
The good news is, if you have a potential deal on the table, it means the hard part is over. The next stage is acquiring it.
Financing a real estate deal tends to send new investors into a fit of anxiety or is even enough to compel them to pack up their dreams and retreat back to their nine to five job. However, if an investor commits to doing his or her due diligence, the fear of a lack of funds is irrational.
If you have a great deal on the table, there is no limit when it comes to ways to fund it. A great example would be leveraging a self directed IRA, which would require some careful consideration beforehand; however, it goes to show that there are available options. For investors wondering how to finance an investment property, i’ll explain some of your real estate financing options.
As an investor, cash is a monumental tool to getting what you want. Along with getting more offers accepted, cash financing enables investors to save on interest, increase their cash flow, and receive instant equity in their investment. It also has the ability to save investors on the purchase amount.
In the first quarter of 2016, all-cash homebuyers for single-family homes and condos paid, on average, 23 percent less per square foot than all homebuyers nationwide, according to RealtyTrac.
In addition, it’s important to remember there will be times when paying cash for a property makes sense and other times when other financing options should be considered. If you have your own capital, however, you should always consider using it in the best possible scenarios.
Hard Money Lenders
Funded by private businesses and individuals, hard money lenders provide short-term, high-rate loans for real estate investors. This financing option, which doesn’t conform to bank standards of creditworthiness, is typically used by rehabbers looking to renovate a property.
Hard money financing is generally determined by the value of the investment property itself, with lenders analyzing the “After Repair Value” (ARV) to determine the size of the loan. Hard money lenders generally won’t fund an entire deal, but rather fund a percentage of the purchase price or the after repair value, which will range from 50 to 70 percent.
Furthermore, hard money lenders also charge fees apart from the interest on the loan. These fees are generally delineated in points (three to five), which represent additional percentage fees based on the loan amount. In general, hard money lenders charge much higher interest rates – sometimes double the amount of a traditional mortgage, plus fees. In the end, all hard money lenders will have different requirements and real estate investors need to be fully aware of what they’re getting themselves into.
Private Money Lenders
Private money lenders are integral to the growth of every new investor. They have the means and intent to invest capital into your business, and they are just as interested in working with you, as you are with them.
Generally speaking, private money lenders will provide investors with cash to purchase real estate properties in exchange for a specific interest rate. These terms will generally be established up front and with a specified payback period – anywhere from six months to a year. These loans are most common when investors believe they can raise the value of a particular property over a short period of time, typically through renovations. It’s also important to understand that, like hard money, private money should only be used when you have a clearly defined exit strategy.
Self Directed IRA Accounts
A self directed IRA (Individual Retirement Account) is, at its most basic level, a savings account that allows for compounded, tax-free growth, over time. Self-directed IRAs are unique from other types of savings accounts, such as a 401K, as the owner can control a wide array of investment options, including real estate.
Owners of self-directed IRA account enjoy a unique benefit of being able to purchase, rehab and sell properties while still being able to defer taxes. However, it is important to note that owners under the age of 60 are typically subject to a penalty for withdrawing funds early.
There are some scenarios when both an investor and a seller can strike up a mutually-beneficial seller financing deal. In seller financing, the buyer of the property will make payments directly to the seller of the property, rather than going through a bank. This can help a motivated seller sell the property more quickly, and the investor can avoid having to jump over traditional mortgage lending hurdles, such as financial and credit score minimums.
Together, the buyer and seller can often enjoy a faster transaction process, as well as avoid many costs and fees associated with the closing process. Furthermore, the owner has the option to sell the promissory note if they no longer want to manage their own owner financing.
Best Loans For Real Estate Investing
- 203K Loan: A special type of loan backed by the Federal Housing Administration, 203K loans support the purchase of older or damaged properties in need of rehabilitation.
- Home Equity Loan: Homeowners who have built up equity in their property are able to take out a loan in the form of a line of credit, allowing them the flexibility to expand their portfolios by using their equity as collateral.
- FHA Loan: Consumers with less-than-perfect credit, or those who do not have access to capital to satisfy a large down payment can achieve home ownership by taking out a mortgage backed by the Federal Housing Administration.
- Traditional Mortgage Loan: Conventional home loans financed by banks still remain one of the most popular methods of financing real estate deals.
When examining the large umbrella of different real estate financing options, one should also take into consideration loans that are offered by the government, traditional lenders, as well as methods of leveraging personal equity. Read on to find out some of the most popular loan options that are used creatively by investors, including real estate investment loans on bad credit:
203K loans are a special type of loan backed by the Federal Housing Administration, and is designed specifically for those who plan to rehabilitate older or damaged properties. The loan includes the price of the purchase of the property, plus the estimated costs to make renovations. 203K rehab loans are attractive to some because of the low down payment requirement of 3.5 percent, and allows the funding of cosmetic or major repairs as needed. In addition, the borrower can include 6 months’ worth of mortgage payments in the loan.
This policy is designed to help homeowners make mortgage payments during the time that they cannot live in the property during its rehabilitation phase. Investors should be aware, however, of some potential downsides to this particular loan. First, 203K borrowers are required to hire a licensed contractor and construction consultant, meaning that DIY projects are not allowed. In addition, fix and flip investment properties are not eligible. Those would be able to take an owner-occupied approach, by purchasing a property with 1 to 4 units.
Home Equity Loan
When an investor has built up equity in the form of their personal residence, then they have the opportunity to take out a loan against that equity. A home equity loan, more formally known as a Home Equity Line of Credit (HELOC), allows homeowners to leverage their home equity as collateral in order to take out a loan. Common uses for a home equity loan include home repairs, education, or the resolving of debt.
A major benefit of a home equity loan is the low rates that are typically based on the prime rate, currently at a low. In addition, borrowers enjoy the flexibility to use the loan how they would like, as well as manage their own repayment structure. This flexibility creates an avenue for homeowners to expand their portfolios on their own terms.
The FHA loan is one of several home loan options offered by the federal government. The Federal Housing Administration (FHA) established the loan to help broaden access to homeownership for consumers with less-than-perfect credit profiles, as well as those who do not have the financial means to save up for a large down payment. When a new homebuyer shops for mortgage loan options, they can search for lenders that offer mortgage loan products that are backed by the FHA. These loans offer a down payment requirement of as low as 3.5 percent, while still allowing for a low interest rate.
It should be noted, however, that putting down less than 20 percent on a home loan will result in a required private mortgage insurance payment. In addition, the FHA loan only allows owner-occupied properties, but does allow for the purchase of a property with more than one unit. According to The Lenders Network, the current loan limit for a single-unit property ranges between $294,515 to $679,650, depending on whether the market is a low-cost or high-cost area.
Traditional Mortgage Loan
One of the more popular financing methods in real estate is through traditional lenders, which includes conventional and FHA loans. Many investors are pursuing traditional lender financing options in today’s market because interest rates are at historic lows.
However, traditional lenders follow strict guidelines with many demands that other financing options don’t require. The hurdles with traditional loans, such as a conventional mortgage loan, include a sufficient down payment (anywhere from 15 to 25 percent), an adequate credit score (a minimum of 680) and documentation of income. In addition, the money used must be what is called “sourced and seasoned” for at least 60 days and cannot be a gift. In many cases, this could limit many investors.
Using lender financing is a great option for beginner investors, but it’s important to be patient and prepared. Make sure you understand the process and what is required to get approved.
Read more: How to fund your first real estate deal