As a novice investor, it’s just as important to understand how to fund a deal as to find one. A lack of financing for real estate tends to impede the majority of potential buyers in today’s industry, simply because they are not aware of the numerous financing avenues. Whether or not you have access to working capital, there are still ways to capitalize.
Real estate investment is never a bad idea. It provides a slew of financial and personal benefits to potential buyers, such as improved cash flow, house appreciation and tax benefits. In fact, investment in immovable property remains one of the most common vehicles in financial wealth growth. According to the IRS, in the last 50 years, about 71 percent of Americans who reported more than a million dollars on their income tax returns were in real estate. Ironically, first-time developers face the task of learning how to get funding for real estate investment before they can start generating wealth. Read on to learn about some of the most common forms of real estate financing options, as well as popular real estate investment loans out there.
What Is Real Estate Financing?
Real estate financing is a term widely used to describe the process used by an investor to raise funds for an imminent transaction. As its name suggests, to buy and renovate a property, this strategy must help investors obtain capital from an outside source. However, not unlike conventional financing, real estate financing comes complete with terms and underwriting, the least of which must be thoroughly understood before a contract is entered into.
How to Receive Real Estate Financing
One of the main myths about real estate investment is that you need to get started with a lot of money, which is simply not true. However, the secret that many professionals do not understand is the fact that a multitude of different financing options for real estate are available to fund every investment. Since the method by which a particular deal is funded can have a significant impact on its outcome, it is imperative to understand the financing aspect.
There are a few different ways to go about funding real estate investments as an investor. Each one will have their own set of pros and cons and the approach to financing will rely on the property and the situation. It’s crucial for novice investors to note that not all financing options for real estate investments are created equal. What works for someone else may not actually work for you, but the trick is to consider which financing choice for real estate would compliment your business strategy. New investors are sure to know how easy investment can be by taking the time to study the numerous real estate financing options out there. Extending one’s real estate investment finance options toolkit is simply a matter of understanding what approaches exist and how to exploit them properly. Bear in mind that at some stage in their career, all investors have faced the funding hurdle; when in doubt, there is nothing wrong with tapping into your network of investors and asking for advice.
Real Estate Financing Options
Investors with a lined-up deal have already achieved one of the most critical home-flipping moves. Finding a viable offer is just one piece of the puzzle though. When you find a good property to invest in, you then need to be able to fund the deal that is inevitable.
Financing a real estate deal appears to send new buyers into a fit of fear, or is even enough to cause them to give up their dreams and go back to their nine-to-five job. However, if an investor agrees to perform due diligence, it is unreasonable to fear a shortage of funds.
There’s no limit when it comes to ways to finance a deal if you have a good one on the table. A great example would be to leverage a self-directed IRA which would take some careful planning in advance; however, it goes to show that there are many options available for funding investment in real estate. For investors wondering how to fund an investment property, I’ll explain a few of your financing choices for real estate:
- Cash Financing: Perfect for investors who have access to large amounts of money, either directly or via their network, and who want to purchase assets in a free and simple way.
- Hard Money Lenders: Open to borrowers whose credit or financial background is less than ideal and who need a short-term loan.
- Private Money Lenders: Well-connected investors will often tap personal connections into capital, borrow money at a defined interest rate and payback period.
- Self-directed IRA Accounts: Individuals who have chosen to build savings through a self-directed IRA can choose to use their account as a means of accessing money.
- Seller Financing: Often buyers and sellers will reach a mutually beneficial deal, allowing investors and sellers to avoid having to go through a private lender in full.
As an investor, cash is an ultra-important tool to get what you want. Cash funding, along with having more deals accepted, helps investors to save on interest, boost their cash flow and gain instant equity in their investment. It also has the opportunity to save on purchasing sum for investors.
According to RealtyTrac, all-cash homebuyers for single-family homes and condos paid 23 percent less per square foot on average in the first quarter of 2016 than all homebuyers nationwide.
Moreover, it is important to note that there will be periods when paying cash for a property makes sense, and other occasions when consideration should be given to other financing options. However, should you still suggest using it in the best possible situations, if you have your own money.
Hard Money Lenders
Hard-money lenders, funded by private companies and individuals, offer high-rate, short-term loans for real estate investors. This funding alternative, which does not meet creditworthiness banking requirements, is usually used by rehabilitators seeking to renovate a house.
In general, hard money financing is calculated by the valuation of the investment property itself, with borrowers measuring the “After Repair Value” (ARV) to determine the size of the credit. Hard money borrowers may usually not finance a whole amount, but finance a portion of the purchase price or the after-repair value that ranges from 50 to 70 percent.
In addition to the interest on the loan, hard money lenders often charge fees aside. Such charges are typically delineated in points (three to five), which reflect additional percentage charges depending on the volume of the loan. In general, borrowers of hard money demand even higher interest rates – at times double the amount of a conventional mortgage, plus fees. All hard money borrowers will eventually have specific criteria and real estate investors need to be fully aware of what they are getting into.
Private Money Lenders
Private money lenders are essential to any new investor’s growth. They have the means and the ability to invest money in your company and they are just as interested in partnering with you as you are with them.
In general, private money lenders can provide cash for investors to buy real estate assets in return for a fixed rate of interest. Generally, these conditions should be set up front and with a defined payback period – anywhere from six months to a year. These loans are most popular when borrowers, usually through renovations, assume they can increase the value of a specific property within a short period of time. It’s also important to understand that private money should only be used, like hard money, when you have a clearly defined exit strategy.
Self-Directed IRA Accounts
A self-directed IRA (Individual Retirement Account) is, simply put, a savings account which allows for compounded, tax-free growth. Self-directed IRAs are distinct from other forms of retirement plans, such as a 401K, because the investor can manage a broad variety of investment options, like real estate.
Owners of self-directed IRA accounts enjoy the unique benefit of being able to purchase, rehabilitate and sell assets while also able to postpone taxes. It is important to remember however that owners under the age of 60 are usually subject to a penalty for early withdrawal of funds.
There are several cases where both a buyer and a seller are willing to enter into a mutually beneficial seller financing contract. In seller financing, the property’s buyer may make payments directly to the property’s seller, rather than passing through a bank. It can help a motivated seller sell the property quicker, and the lender can avoid jumping over conventional barriers in mortgage lending, such as financial and credit score minima.
The purchaser and seller will often enjoy a quicker settlement phase together, as well as escape certain costs and fees associated with the closing process. The owner still has the option of selling the promissory note if they don’t want to handle their own owner financing any longer.
Best Loans For Real Estate Investing
Loans provided by government, conventional lenders, as well as methods of leveraging personal equity should also be taken into consideration when analyzing the broad umbrella of different real estate financing options. Read on to find out some of the most common lending solutions that investors use creatively, including real estate investment loans on bad credit loans:
- 203K Loan: A special form of loan provided by the Federal Housing Administration, enables the purchase of older or distressed assets in need of rehabilitation.
- Home Equity Loan: Homeowners who have built up equity in their properties will take out a loan in the form of a credit line, allowing them the ability to increase their investments using their equity as collateral.
- FHA Loan: Customers with less than ideal credit, or those who do not have access to capital to meet a substantial down payment, may gain ownership of the home by taking out a Federal Housing Administration-backed mortgage.
- Traditional Mortgage Loan: Bank-financed conventional home loans remain one of the most common methods of funding real estate deals.
- Conforming Loan: As its name implies, a conforming loan is a mortgage equal to or less than the amount fixed by the FHFA’s compliance-loan limit. Perhaps even more importantly, Freddie Mac and Fannie Mae comply with conforming loans.
- Portfolio Loan: Portfolio loans are serviced by the initial borrowers who received the funds first. However, rather than selling the loan to the secondary market, the servicer may retain the loan within their own portfolio.
- VA Loan: A VA loan is a mortgage backed by the US Department of Veterans Affairs.
203K loans are a special form of loan guaranteed by the Federal Housing Administration and are specifically intended for those looking to rehabilitate old or distressed assets. The loan includes the purchase price for the house, plus the projected maintenance costs. Because of the low down payment rate of 3.5 percent, 203K rehabilitation loans are appealing to some and allow the financing of cosmetic or major repairs as necessary. The borrower will also provide 6 months of mortgage payments in the loan.
This program is intended to help homeowners make mortgage payments during their recovery process when they can not stay in the house. However, borrowers should be mindful of any possible downsides to that particular loan. Next, 203K lenders are expected to employ a licensed contractor and consultant on building, meaning DIY projects are not allowed. Furthermore, fix-and-flip investment properties are not eligible. Through purchasing a property of 1 to 4 units, you will be able to employ an owner-occupied strategy.
Home Equity Loan
If an borrower has built up equity in the form of their personal property, then they can take out a loan against that equity. A home equity loan, more commonly referred to as a Home Equity Line of Credit (HELOC), allows homeowners to use their home equity as collateral for a loan. Popular uses for a house equity loan include home renovations, college, or debt settlement.
A major benefit of a home equity loan is the low rates usually based on the prime rate, at present low. Additionally, lenders enjoy the freedom to use the loan as they wish, and control their own repayment structure. This versatility provides homeowners with an opportunity to grow their investments on their own terms.
The FHA loan is one of many Federal government home loan options. The Federal Housing Administration (FHA) has developed the program to support borrowers with less-than-perfect credit scores expand access to homeownership, as well as those who do not have the financial resources to save up for a substantial down payment. When a new homebuyer shops for mortgage lending options, they should look for lenders that sell FHA-backed mortgage lending items. These loans offer a requirement for down payment of as low as 3.5 percent, while also having a low interest rate.
It should be noted, however, that a mandatory private mortgage insurance premium would result from putting down less than 20 percent on a home loan. Furthermore, the FHA loan only covers owner-occupied homes, but covers for the purchase of a more than one unit house. The current loan cap for a single-unit property ranges from $294,515 to $679,650 according to The Lenders Network, depending on whether the market is a low-cost or high-cost location.
Traditional Mortgage Loan
One of the most common methods of financing real estate is through traditional lenders, which includes both conventional and FHA lending. Most creditors seek conventional funding strategies for borrowers in today’s market because interest rates are at record lows.
Traditional lenders however follow strict guidelines with several demands that do not require other funding options. The obstacles for traditional loans, such as conventional mortgage loans, include an acceptable down payment (anywhere from 15 to 25 percent), an acceptable credit score (at least 680) and income documentation. Additionally, for at least 60 days, the money used must be what is called “sourced and seasoned,” and can not be a donation. This could restrict many investors in many cases.
As their name indicates, they conform to rules laid down by Fannie Mae and Freddie Mac. However, the “conforming” part of these loans more explicitly applies to the amount loaned out. Conforming loans must be less than the Federal Housing Finance Agency’s loan-conforming cap. The 2019 loan match limit is set at $484,350, or $31,250 more than the previous year’s matching-loan limit. However, it is worth noting that the loan-conforming cap is not common in all markets. The cap is higher in higher-priced places such as New York, or San Diego.
Excluding the size of the loan itself, the conforming loans often have the following characteristics:
- Loan-To-Value Ratio
- Debt-To-Income Ratio
- Credit Score & History
- Documentation requirements
The loan originator funds portfolio loans, but instead of being sold to a secondary market – like most conventional lenders prefer to do – the lender may hold the loan for their own portfolio. As a result, borrowers will not have to develop a partnership with another lender and will be able to retain the bond with their current lender instead. To put it another way, keeping an open communication channel would be much simpler.
The aim of VA loans is to support US veterans, Service Members and their spouses. VA loans are issued by eligible lenders, and are backed by the United States Department of Veterans Affairs. In fact, the VA can grant up to 25 percent of a home loan sum up to $113,275, restricting the overall loan amount to $453,100. Meanwhile, according to VAloans.com, the fair value of the property or the purchase price, whichever is less, plus the financing fee, may be borrowed.
To beginner investors, using lender financing is a great choice but it is important to be careful and prepared. Make sure that you understand the procedure and what it takes to get accepted.
When it comes down to it, real estate is a luxury to pay for. As an investor, it is up to you to decide which financing for the real estate would work best for what contract. Ultimately, recognizing the value of financing immovable property, and the various forms of financing used by real estate investors, will help begin. Now that you’ve got some of the most common funding methods, there’s no need to hesitate to take on your next project.