The Ultimate Beginner’s Guide to Real Estate Financing
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You’ve found the perfect house. It meets all your criteria, in a terrific location, and makes your heart skip a beat just thinking of it. So you whip out your checkbook and write the check for the full purchase price, remembering of course to record the purchase in your check register.
Of course not.
Financing real estate is not usually as simple as that. Finding the funds to buy a piece of real estate is not as simple as buying milk, an ATV, or even a new car. Whether the property is for your own future home, a flip, or a long term investment, this article is going to explore ten different ways to finance real estate.
Ten Ways to Finance Your Real Estate Investments
1.) All Cash
Yes, it is possible to pay all cash for an investment property. In fact, according to the recent joint study by BiggerPockets and Memphis Invest, 24% of US investors use all cash to finance their deals. However, even when investors use terms like “All Cash,” the reality is that no “cash” is actually traded. In most cases, the buyer brings a check (usually certified funds such as a bank cashier’s check) to the title company and the title company will write a check to the seller. This is the easiest form of financing, but for the majority of investors (and probably VAST majority of new investors) all cash is not a viable option.
2.) Conventional Mortgage
Most investors (51% to be exact) choose to finance their investments with a down payment of up to 50% of the purchase price. Most traditional conventional mortgages require a minimum of 20% down, but may extend to 25-30% for investment properties. Conventional mortgages are the most common type of mortgage used by home buyers.
3.) FHA Loans
The Federal Housing Administration (FHA) is a United States government program that insures mortgages for banks. In other words, they are like health insurance but rather than pooling money to spread the risk for sick people, they pool their money to spread the risk of bad mortgages to the banks. FHA loans are designed for homeowners who plan to live in the property â but an investor can take advantage of the rule that allows the home to have up to four units. A homebuyer could effectively purchase a small multifamily with a low (currently 3.5%) down payment. On the down side, with small down payments the FHA does require an additional payment (known as PMI) and with small down payments your loan (and therefore your payment) can be rather high.
4.) 203K Loans
While really a sub-set of the FHA loan, the 203K loan is a product that allows an individual to buy a home that needs some work done and be able to finance those repairs or improvements into the loan itself (but still allow for the low down payment options allowed by the FHA.) I have been involved with several 203K loans, and while they are wonderful products in spirit, the paperwork and potential for problems can be huge, causing delayed closings. My best friend used a 203K loan to buy and renovate his home and the time it took from his initial offer to closing took over six months. While he doesn't regret using it â it was definitely a struggle.
5.) HomePath Mortgages
Another government backed loan, the HomePath Mortgage is a product offered by the government-owned morgage giant Fannie Mae. The program allows for smaller down payments, no mortgage insurance, and several other benefits. Additionally, the HomePath program is open for investors as well and even includes the ability to finance repairs into the purchase. The catch, however, is that these loans are only available on Bank Repos owned by Fannie Mae.
6.) Hard Money
“Hard money” is money that is obtained from private individuals or businesses for the purpose of real estate investments. While terms and styles change often, Hard Money has several defining characteristics :
- Based primarily on the value of the property
- Short Term (6 – 36 months)
- High Interest (8-15%)
- High loan "points" (cost to get the loan)
- Often do not require income verification
- Often do not require credit references
- Quick ability to fund
- O.K. with property in poor condition
Hard money can be highly beneficial for extremely short term loans, but many investors who have used hard money lenders have been placed in disastrous situations when the short term loan ran out. Use with caution.
7.) Private Money
Similar to “Hard Money,” private money is usually distinguishable because of the relationship between the lender and the borrower, as the lender is not a “professional” but rather an individual looking to achieve high returns on their investment. Often times there is a closer relationship ahead of time and is often much less “business” oriented than hard money. Private money usually has fewer fees and points and term length can be negotiated more easily to serve the best interest of both parties.
8.) Home Equity Loans and Lines of Credit –
Many investors choose to use the equity in their own primary residence to finance the purchase of their investment properties. Banks and other lending institutions have many different products to allow individuals to do this type of transaction. For example, my in-laws recently purchased a duplex but rather than going through the hassle of trying to finance the investment property they simply took out a mortgage on their own home to pay for the property.
9.) Partnerships –
Most of the lending options above can be done alone but also with a partner (except possibly the government-backed loans.) Partnerships can be structured numerous different ways, from using a partner’s cash to finance the entire property to using a partner to simply fund the down payment. There are no “rules” when it comes to partnerships but each scenario requires it’s own examination of how the deal will be structured, who makes the decisions, and how profits will be split.
10.) Commercial Loans –
While most of the above options focus primarily on the residential side of loans, the world of commercial lending is often a viable option as well. Generally speaking, commercial loans are used when a property has more than five units, but exceptions can be made. Commercial loans typically have higher interest rates, higher fees, and shorter terms. Additionally, commercial lenders can often extend a “business line of credit” to finance flips or other investments.
What do you think? Which have you used? What financing tools have I forgotten? What kind of questions do you have? Please leave me a comment below and let’s talk about it!