Financing in Real Estate

Home Loan closing costs

Regardless of what you might believe when you see some late-night infomercial, there is no such thing as free real estate. Immovable property is an asset that must be paid for. As a real estate investor, putting together your deals using a number of different financing methods will be one of the most critical roles you’ll play. This article will show you the ins and outs of the options available for funding your investment in real estate.

Understanding Real Estate Financing

This article will address the many different forms of financing available for real estate.

This article is written to help you actually those real estate tactics to use.

Finally, the list below is by no means complete, but it provides an overview of some of the funding strategies used by real estate investors. This knowledge will allow you to incorporate an investment vehicle, policy, and method of financing to tackle an investment in real estate.

No Money Down?

Want to spend a lot of money in real estate?

The short answer will be no. The solution is more complicated. There are various approaches that investors use without getting a lot of cash to invest in real estate. Without using any capital, some deals can be made!

Below you can find some approaches for financing your real estate deals, but if you want more in-depth details, we invite you to pick up a copy of The Book on Investing in No (and Low) Money Down. Written by Brandon Turner, this book contains various tips, suggestions, and techniques for investing in real estate using capital from other people (OPM).

With that, here’s a list of available financing methods for your real estate deals:

  1. All Cash β€” A lot of investors chose to pay for an investment property in cash. We analyzed that 24 percent of U.S. investors use 100 percent of their own cash to fund their real estate investments. To be more precise, although investors use words such as “all cash,” no cash is actually exchanged. In most cases, the buyer gives the title company a check (usually approved funds, such as bank cashier’s cash), and the title company writes a check to the seller. Other times, the money is sent out from the bank via wire transfer. It is the simplest method of funding, because there are generally no risks, but all cash is not an choice for most investors (and possibly the overwhelming majority of new investors); Additionally, when leveraged, the return offered from a cash deal is not the same. Let’s take an example to discuss that further.

    Example in Real Life: John has to invest $100,000. He may opt to use that $100,000 to buy a house that will generate an income of $1,000 a monthβ€”$12,000 a year. This amounts to an investment return of 12 percent.

    Instead, John could use his $100,000 as a down payment of 20 percent on five identical houses, each priced at $100,000. With a $80,000 mortgage on each home, the cash flow will be about $300 a month, per home, which is equal to $1,500 a month β€” $18,000 a year. That is equal to an investment return of 18 percent, which is 50% more lucrative than only buying one home.
  2. Conventional Mortgage β€” As the example above indicates, financing your investment property will produce substantially better returns than paying in cash. Most investors prefer a cash down payment and traditional mortgage to fund their investments. Many traditional mortgages need at least 20 percent down but, depending on the lender, can reach as high as 30 percent for investment properties. Home buyers use traditional mortgages as the most common form of mortgage, which typically have the lowest interest rates.
  3. Portfolio Lenders β€” Conventional mortgage loans come from a variety of outlets, including banks, mortgage brokers, and credit unions. In most cases, these lending sources do not actually use their own capital to fund the loan but rather acquire or borrow funds from another party β€” or resell the loan to government-backed institutions, such as Fannie Mae and Freddie Mac, to replenish their own funds. Consequently, when it comes to funding a project, most lending institutions must adhere to a very stringent set of rules and guidelines. These stringent rules can make it difficult for many to obtain conventional financing, particularly for real estate investors and other self-employed borrowers.

    Some banks and credit unions, however, have the right to lend entirely from their own assets, thereby making them a lender with portfolios. Since they are lending their own money, they are able to provide more flexible terms for loans and qualification requirements. That means they can make loans available at whatever conditions they find appropriate. Often a portfolio lender may provide funds that are available with less stringent requirements than a traditional lender.

    Many banks and lending institutions don’t advertise portfolio lending, but by connections and networking with other investors you can find certain individuals. You can also just grab a phone book, call lending institutions and inquire if they are offering portfolio loans.
  4. FHA Loans β€” The Federal Housing Administration (FHA) is a government agency in the States that insures bank mortgages. When you have auto or health insurance, you can probably understand the concept: pooling money to distribute the risk to everyone. FHA loans are only intended for homeowners who are going to live on the property, and you can’t use an FHA-backed loan to buy a house as an investment. You may also take advantage of an exemption allowing an FHA-funded home to have up to four different units. In other words, if you intend to stay in one of the units, you might purchase an FHA loan duplex, triplex, or fourplex.

    An FHA loan’s advantage is the low down payment ratio, which is currently just 3.5 percent. This will help you get going quicker because you don’t have to save up 20 percent.

    But not everything is so rosy. While the low down payment option is fantastic, an additional cost of an FHA loan, known as private mortgage insurance (PMI), is required. This form of insurance covers the investor and is needed when there is less than 20 percent down payment. PMI would marginally increase the monthly charge, thereby raising the cash flow.
  5. 203k Loans β€” A variation of the FHA loan, a 203k loan allows a borrower to purchase a house in need of some renovation work by building up the cost of renovations or upgrades to the property itself. Unlike a regular FHA loan, a small down payment also allows for a 203k loan. This form of loan also extends to duplexes, triplexes and fourplexes (as long as they are occupied by the owner), and comes with loan claims of less than 20 percent for PMI.

    Real Life Example: John has found a small duplex he wants to buy for $100,000. He has decided to live in one unit and rent out the other. The property would require around $12,000 for new painting and carpeting. John will add $12,000 to the loan rate, putting down 3.5 percent β€” a total of only $3,920. Now John is able to get the new paint and carpet (paid by the loan), move into his renovated house, rent out the other half, and start making cash flow and create wealth. John’s a happy camper.
  6. Owner Financing β€” Banks or other giant lending institutions are not the only entities financing your house. In certain situations, the property owner you want to buy will directly finance the purchase; in this case you will just make monthly payments to the seller instead of a bank. Usually, the only way a property owner does that for you is if they own the free and clear house, which means they have no current mortgage on the land.

    If the seller has another loan and then sells the home to you, the seller’s loan must be instantly reimbursed or the house risks foreclosure. That is because a legal provision is inserted into nearly any loan called the due on sale provision. That provision grants the previous lender the right to mark the note immediately due. If that balance is not payable, the lender shall have the right to foreclose the land. Some creditors chose to disregard this provision and instead buy under the other loan, risking foreclosure by the bank.

    If the conditions are correct, owner financing can be a great way to acquire real estate ownership without having to use a mortgage. Owner financing can also be a good method for future sales of your assets.
  7. Hard Money β€” Hard money is funding that is received from a private company or entity to invest in real estate. Although terms and styles sometimes change, hard money has several characteristics which define:

    – The principal source of the loan is the valuation of the property
    – Shorter term (due within 6–36 months)
    – Higher than average (8–15 percent) interest
    – Strong loan points (loan fees)
    – Most hard money lenders may not need a verification of their income
    – Lots of hard money lenders do not need credit references
    – Does not turn up on your credit report
    – Hard money can also fund a deal in just days
    – Hard money borrowers understand that real estate requires

    In some cases, hard money may be useful for short-term loans, but other borrowers who have used hard-money lenders have found themselves in tough circumstances when the short-term loan has run out. Making sure you have several escape plans in place before you take the loan, use hard money with caution.
    Check out the following tips for finding a hard money lender:

    – Ask a real estate agent
    – Ask a house flipper
    – Newspaper
    – Craigslist
    – Google
    – Mortgage broker
  8. Private Money β€” Private money in many ways is similar to hard money, but it’s generally distinguishable because of the lender-borrower relationship. Usually the lender isn’t going to be a qualified lender like a hard money lender with private funds. Instead, it will be a person looking to get higher cash returns. Sometimes, there is an existing partnership with a private money lender, and those borrowers are much less business-oriented than borrowers of hard money. In addition, private money typically has less payments and points, and the length of the contract can be more readily arranged to meet the parties’ best interests.

    Private lenders can lend you cash in return for a fixed interest rate to buy a home. Their investment would be backed by a promissory note or mortgage on the home, meaning they will foreclose and take the house (just as with a bank loan, hard money, or any other forms of loans) if you don’t pay. A private lender’s interest rate is generally set up front and the money is borrowed for a fixed period of time β€” anywhere from six months to 30 years.

    Usually, a private investor does not earn an equity share in cash flow or potential value outside of their agreed interest rate, but when it comes to private capital, there are no hard and fast laws. Private capital is usually funded by one investor. These loans are widely used when an investor thinks they can increase the property’s value in a limited period of time. They’ll take on the debt from the private money loan, refinance the property after adding value, and then pay the private lender back. Much as with hard currency, you can only use private money when you have well defined exit strategies.

    Developing reputation is a must if you are seeking to establish relationships with private capital. Whether it’s by writing about your real estate projects, sharing your real estate updates on Facebook, talking about real estate investing in casual conversation, or attending your local real estate investment club, you can make yourself visible.

    Ask yourself if your exposure is being maximised. Will you build ways to put your investment experience to the fore? You don’t need to be a braggart, so when someone asks next time what’s new in your life, share some information about your real estate efforts. You never know what can come to pass.
  9. Home Equity Loans and Credit Lines β€” A lot of buyers chose to use their main home equity to help fund the purchase of their investment properties. Banks and other lending institutions have several different items, such as a home equity installment loan (HEIL) or a home equity line of credit (HELOC) that lets you tap into the equity you already have.

    For example, an investor may decide to buy a property but instead of going through the usual hassle of trying to fund the investment property itself, they may take out a HELOC to pay for the property on their own house.

    To get a house equity loan or credit line, you must have equity in your home first. Usually banks can only lend up to a certain amount of the overall value of your house. This percentage varies among lenders but it’s not unusual to find a lending institution that will pay up to 90 percent of your home’s value.

    Real World Example: John’s present home is worth $100,000. John visits his local bank and discovers they’ll clear up to 90 percent of the home’s debt. Hence John will borrow on the house a total of $90,000. If he already owes $50,000 on a first mortgage, $40,000 will be put on the home equity line or loan to ensure that the cumulative loans will not reach 90%.

    The use of home equity loans and credit lines has several benefits over conventional loans, including:
    1. The debt is focused on the value of your primary residence β€” not the newly purchased house. This means that usually the bank which provides the loan does not even look at the new property. They generally don’t care about what your goal is with the money, just about your ability to pay it back. The new property can be in poor shape as well, and the bank probably won’t care.
    2. If you have a loan or line for home equity, then the money is yours to do with what you want. It’s not dependent on the new property β€” so when making deals on new properties you can give cash, and as a result you will have a better chance of someone accepting your deals.
    3. Home equity lines and loans can have certain tax advantages, such as the right to exclude interest charged on the loan. For more detail, see a professional CPA or Solicitor.
    4. Since your primary residence secures the loan, the interest rate on a home equity loan or line is usually very small as opposed to hard money or private property.

      Real World Example: Sarah, an investor, decides to purchase a $100,000 investment house, but she doesn’t have enough spare capital to make a down payment. However, she does have a lot of equity available in her own primary residence (she owes $50,000 but the house is worth $100,000). Sarah opens a $20,000 home equity loan on her house to cover the down payment, and then gets a traditional mortgage from a bank for the remaining $80,000 owed to the investment property.

      Lines and home equity loans come with fixed and flexible interest rates. While deciding which home equity product you want to use to advance your investment career, consider your ambitions, timetables and financials.
  10. Partnerships β€” In Chapter 4, we focused briefly on the use of partners, but what we didn’t discuss was their willingness to help you fund a contract. An equity partner may be a great addition to your team if you want to invest in a property but the price range is beyond your control. An equity partner is someone you are bringing into a deal to help fund the land.

    Partnerships can be arranged in several different ways, from using cash from a partner to finance the entire house, to using a partner to fund the down payment easily. There are no set rules for equity investments, so each scenario and transaction needs its own study of how the agreement will be put together, who will make the decisions, and how profits will eventually be divided.

    The equity partner may have an active or passive role in relation to the operating agreement signed by both parties. The equity partner’s ownership stake can allow the partner to participate actively in almost all aspects of property ownership. In addition, as a partner, they usually earn a return on their investment that includes cash flow, appreciation, depreciation, and eventual income when the property is sold, in accordance with their ownership percentage.

    Unlike a private investor, the equity partner does not get an negotiated interest rate on the loan. Instead, they only receive a percentage of what is produced by the property. When it makes a lot of money, then their return will be higher, but if the investment loses money, they will need to contribute financially to keep the property afloat.

    Equity partners take a higher risk than a private investor might, but in return, if the investment is successful, they have the ability to make substantially more. Like private lending, investment by the equity party is not protected by a mortgage or promissory note. Instead it is protected by an interpartners operating agreement.
  11. Commercial Loans β€” While most of the above options focus on residential loans, the commercial lending universe can also be a viable choice for your investment. In fact, if you’re looking to buy a property other than a residential one- to four-unit home, a commercial loan is probably just what you’ll need.

    Commercial loans usually have marginally higher interest rates and costs, shorter terms and different levels of qualification. Within the world of residential loans, the borrower’s income is valued above all else; however, commercial loans put even more pressure on the property. The reasoning behind that is simple: if you own a $10 million apartment building and things go wrong, if you make $20,000 or $200,000 in personal income a year, you won’t be able to make your mortgage pay. The commercial lender can also look at your profits, credit, and other personal metrics, but that is just to get a wide view of your financial capabilities. What counts most in the vast majority of cases is the amount of revenue produced by a property.

    In addition, commercial lenders may also extend a credit line of business to fund flips or other investments. Some investors get a broad credit line, which helps them to access cash for house flipping and other real estate projects.
  12. Equity Indexed Universal Life Insurance (EIULS), Life Insurance, Roth IRAs, and Other Sources β€” A multitude of other investment and savings products for real estate investment are available. Here we do not discuss them in depth, so be sure to talk to a professional financial advisor about ways you can use these items in your investment career.

Step Ahead

One of the most important qualities to cultivate as an investor is to search for new ways to keep going forward with your investments. Since each deal is special, you will most likely find that you are using a lot of different financing approaches in your career. And it is immensely helpful to consider all the various choices available.

Another useful and equally important role that you as investor can play is the role of a marketing professional. Marketing is not only essential for the purchasing of properties but also for the selling and rent.

Understanding Real Estate Financing