Financing can be a real challenge for just about anyone in real estate, but it can be a particularly big hurdle for those just starting out. That being said, there can be some advantages for newbies over more seasoned investors. This is because banks love W2 income. If you have a decent-paying job, it can be an enormous boon for getting a loan approved on an investment property. After you “go full-time” into real estate investing, you will need to show that the income you receive from your investments is sufficient to meet a bank’s debt service requirements.
But for those starting out, here are some of the things you should focus on to begin with.
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4 Items to Focus on Before Applying for Financing
1. Clean up your credit.
If you have any stains on your credit, you’ll want to start there by getting those cleaned up. Run a credit report on yourself and see if there’s anything that shows up that shouldn’t. If there’s something on your credit that shouldn’t be there, you can challenge this and hopefully get it removed. You can also talk to a credit counselor or a mortgage broker to come with a strategy to improve your credit score.
But the big keys (other than not having any late pays or charge-offs) is to reduce the amount of revolving credit you have. If you have credit card balances, I would make sure to pay those off first and foremost. Even the best real estate investments will rarely return more than the abhorrent interest rates you’ll pay on credit cards. Other types of loans, such as student loans, have very low interest rates and are probably not worth paying off. I can’t tell you what you should and shouldn’t pay off in each case, so you should look at all the debts you have and discuss it with a professional to come up with a plan.
2. Build up your savings.
Despite what some gurus may have told you, real estate investment almost always requires some money. Even Brandon Turner’s great book on the subject is titled The Book On Investing in Real Estate with No (and Low) Money Down. While there are strategies that can get you into a good deal without any of your own money (subject to, seller financing, wholesaling, BRRRR, etc.), having no money of your own leaves you with no margin for error if say the rehab costs more than expected.
Furthermore, you will usually only find the best deals with some sort of marketing campaign, which will require some money to launch. So while you can buy properties for little or no money down, it’s very, very difficult to actually be an investor without any savings. So focus energy on saving more than you spend each month. After all, the most important skill to master in order to become successful is the ability to defer gratification.
3. Study your craft.
Banks are composed of individuals. And a large and underrated part of getting a loan is convincing those individuals on a subjective level that you are worth lending to. The lender you make your loan request to will be your advocate (or not) when your loan request goes to committee. If you impress him or her with your knowledge of real estate, professionalism, and strategy, you are much more likely to get that person on your side. And if that person is on your side, they’re much more likely to convince the committee. Banking is a people business, after all.
You should also focus some time on making sure your accounting is in order, especially if you have a few properties under the belt. A confused mind says no, so it’s important that your accounting is clear, accurate, and understandable. I’ve lost track of the number of ma and pa property owners I’ve come across with terrible accounting that makes it all but impossible to see how well their properties have actually performed.
4. Make sure your loan proposals are impressive.
This is a large subject, which you can read more about here, but make sure that when you do seek financing, that you include everything the lender needs and more. Make sure it is thorough, accurate, and laid out professionally. You want to impress lenders with your loan requests, not simply check off all the boxes they require.
Now that you’ve got your foundation down, you can start looking at methods of financing.
5 Types of Real Estate Financing to Consider
1. FHA Financing
One of the best ways to start is to buy a property with an FHA loan. You will need two years of employment history and you can only use these loans on your primary residence. But the great part is that you can buy any property up to a fourplex. So why not live in one unit and rent out the other three? These loans come with great rates and they will lend up to 96.5% of the property’s value. And for properties that need some work, you can take advantage of the 203K program they offer as well.
Related: What Newbies Should Know About Financing Investment Properties (Versus Homes)
2. Traditional Banks
For the most part, the banks that will be willing to lend to you on small investment properties are local community banks. You may have some luck with the larger, national variety, but they tend to shy away from these types of loans. For tips on finding such banks, you can see my article on the subject here.
If you own your own home and have some equity, it may make sense to take out a Home Equity Line of Credit (HELOC) on the property in order to fund your investments. This is especially true if the property you want to buy needs some work or you plan on flipping it. Using a HELOC prevents you with getting hit with a bunch of loan fees up front. And then, once you flip or refinance that investment property, you can pay down the HELOC and then use it again on your next property.
4. Seller Financing, Subject To, and Lease Options
If you’re negotiating with a motivated seller, creative financing is definitely an option you should consider. Again, I will note that it’s very difficult to do even these types of deals if you don’t have any money of your own. For example, you might be able to buy a property with seller financing for 100% of the purchase price, but what if it needs some repairs? Generally, these should be seen as “low money down” not “no money down” deals unless you plan on wholesaling.
Each subject would take and article of its own, but if you want to learn more about them, check out the following articles:
5. Partnerships and Private Lending
Private lending is our favorite method to finance properties when we purchase them. But we only use this as the first step in the BRRRR strategy and refinance out of these private loans with a traditional bank when the property has been rehabbed and rented. Generally speaking, private loans will not be something you want to stay on your property for long because they are too expensive. Hard money loans will virtually always be too expensive. But even private loans (from individuals with money that you meet and convince to lend to you) will still generally be 8% or higher. That being said, if you are able to find a private lender who will lend to you for less than that, you could conceivably use that as a source of long term financing. Just be warned that private lenders will eventually want their money back, so you should have a plan in place for when that happens.
Related: 4 Outside-the-Box Ideas for Financing Real Estate Investments
Another option is to use a partner. This could be your strategy in general, where you bring the time and effort and your partner provides the money for the down payment. The partner can also help you by providing strong credit and income that will make a bank feel more comfortable lending. This doesn’t mean a bank will lend to you if you your credit is in the mid 300’s even if you have a financially strong partner, but it certainly will help if on your own, you are on the edge.
Regardless of the route you choose, the first things to do are to get your financial house in order and learn as much about real estate as you can. At that point, there are plenty of options for financing. You just have to keep your eyes open and pound the pavement a little.
What’s your favorite form of financing?
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