The difference between success and failure may be choosing the best funding for your real estate investment deals.
It takes a lot of capital to build up a portfolio of investment properties. To acquire and manage their investment properties, most investors rely on a mix of real estate financing options.
The wise use of leverage, or borrowed money, can deliver better returns than paying cash when investing in real estate. Here are 12 sources of real estate financing regularly used by investors (in no particular order).
A conventional mortgage is a common real estate financing option for investors buying and holding rental properties for monthly cash flow and long-term appreciation. You are taking out a loan to purchase a property, then making monthly payments until it is paid off. Your local bank or larger financial institution are good sources of competitively priced conventional financing.
The better your credit score and financial position, the better the rate to which you are going to qualify. Most borrowers hold the number of traditional loans to 10 for individual investors. You are going to want to look into a portfolio lender beyond that.
This is a loan insured by the Federal Housing Authority (FHA). This is meant to help consumers enter into homeownership for the first time by reducing the down payment required to purchase homes.
For real estate investors, FHA loans are a rarer option since the borrower will stay in the house. This is great for new investors who will “home hack” or purchase an investment property to live in with roommates whose rental payments cover most or all of the mortgage payment and ownership costs.
A 203 K loan is a type of FHA funding designed to enable a homeowner to buy a fixer-upper or a home in need of some job. By incorporating this into the loan the lender funds the purchase price and the cost of maintenance.
As with FHA loans, 203ks are only available for properties occupied by the owner.
Credit lines and home equity loans
If you have equity in your primary residence, banks and other lending institutions will allow you to borrow money against that equity using a home equity loan or credit line (HELOC) for home equity.
Usually, interest rates are one percentage point above the prime rate if you have good credit and you can normally borrow up to 90 per cent of your home’s value. Let’s say your home is worth $500,000, you’ve got a first mortgage with a $250,000 balance and you’d like to borrow against your equity to purchase an investment property. The lender would approve you for a line of credit of $200,000 ($500,000 x 90 per cent less the $250,000 you owe). I regularly use my HELOC to finance immovable properties. It facilitates the making of cash offers on investment properties and offers the most trouble-free access to ready cash.
Loans made with hard money
Hard money loans are private loans, or loans provided by private lenders, rather than financial institutions regulated by the Government.
Hard money loans are typically short term loans used to:
- Finance fix-and – flip deals in which the aim is to get your money back quickly and repay the loan or
- Bridge the difference between buying an investment property and long-term financing.
These loans have higher interest rates than other alternatives and the requirement is slightly less rigorous than institutional funding.
Automated IRA (SDIRA)
It is a special form of IRA account that lets the owner invest outside the usual stocks and bonds in a wide variety of investments. You can convert retirement-qualified assets into real estate, precious metals and other “alternative investments” by working through an account trustee or custodian.
By transferring my 401 K into an SDIRA I bought my first three investment properties. If you have a sizable IRA and you follow the rules, it is an excellent source of funding. You can also use borrowing to fund a property into a non-recourse loan under your SDIRA. This is a special type of loan that uses only the property as collateral, rather than your personal creditworthiness (which is necessary because of the distance from the funds in your SDIRA that you must keep).
Private borrowing money
Sometimes referred to as “mom and dad ‘s bank,” private money real estate financing often comes from family , friends, acquaintances, and high-net worth individuals seeking higher cash returns than traditional banking offers.
There are no hard and quick rules defining the terms of the loan. Private money lenders will expect an investment return commensurate with the perceived risk. If you think you can raise the value of a property and return the capital with interest within a short period of time, you might turn to private money.
Two are better than one, okay? If the cost of acquiring and rehabilitating an investment property goes beyond your scope, you may consider bringing in an equity partner to help fund the deal.
Although the relationship can be arranged in several different ways, it is common that a partner gets a percentage share of the return on investment from the project. Of course, working with a partner has benefits and drawbacks that you’ll want to weigh carefully before you jump in.
Loans to the Portfolio
Conventional loans have strict guidelines for underwriting, and qualifying as borrowers can be difficult for property investors and self-employed. Many credit unions and some banks are offering portfolio loans with more flexible terms and less stringent standards of qualification. That makes portfolio loans a particularly valuable way for investors to finance real estate.
The interest rate may be even more advantageous than having a bunch of one-owned loans. Not all banks offer these, however, and you will want to carefully compare terms and rates between several lenders in the portfolio.
Financing by seller / owner
If a seller directly owns a property they can finance it for you. Instead of a financial institution, you do pay them. If the seller has a mortgage on the house, the loan must be completely repaid before title can change hands unless there is a provision where you can assume their loan.
Every home is unique and therefore each owner financing agreement is unique. You arrange to pay the owner in installments, typically of interest and principal. The specific terms of the loan, such as the interest rate, credit length and down payment, are all negotiable with the seller.
Loan to life insurance
You can borrow against the value of the policy if you have a permanent or life-long policy — typically up to 90%. The policy is used by the insurance company as collateral for the loan. In my lifetime policy I borrowed against the cash to fund the rehabilitation of one of my buy-and – hold properties. I was pleasantly surprised by the advantages of financing this type of real estate:
- Receiving funds is simple and fast, as there is no underwriting process to apply for.
- The amount borrowed does not appear in your credit report anywhere so it has no effect on your debt-to – equity ratio.
- You don’t have to have paid daily. Interest accrues every month, but you don’t have to adhere to a repayment schedule.
- The interest rate is very competitive; a percentage point above the prime is normal.
Crowdfunding is a way to get small amounts of money from a large number of citizens. There are a number of crowdfunding platforms, including Roofstock, Patch of Land, Sharestates, Fund That Flip and LendingHome, that lend money to real estate investors.
These platforms lend money to investors of all sizes in residential and commercial real estate rehabilitation, though some may only offer real estate finance to experienced investors. Compare the various options to find out which one is best for you.
Think carefully about financing real estate
As a real estate investor, you are able to find money from many sources to support your projects. What’s best depends on property-specific variables, including the amount of money required, your investment strategy, your exit strategy, your creditworthiness and your experience.
While borrowed money lowers the personal cash needed, you still need some cash — and that is good. Buying a house with no money down led to the collapse of the housing bubble. Investors likewise need skin in the game. Becoming overleveraged means putting the loss of the asset, creditworthiness and reputation at risk.
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