Financing a real estate transaction on an all-cash basis is unrealistic for most people, and even most of those who can afford it opt for the added benefits of using leverage. Thankfully, there are dozens of options when it comes to financing your real estate investment property.
Here are some strategies you can use as an investor to finance your deals:
A conventional mortgage is the most common option for investment property financing. The process for getting a mortgage loan varies, but many lenders require investors to put down a percentage of the property’s purchase price as a down payment.
Your credit score and debt-to-income ratio will be determining factors in whether or not you will be approved for a mortgage loan. Your mortgage lender wants to see a history of on-time payments, a low debt-to-income ratio, stable income, and proof of your ability to pay back the loan.
Hard Money Loans
Hard money loans are issued from professional private lenders and are used for short-term, high-rate lending such as house flipping or real estate development. Lenders don’t look at the borrower’s creditworthiness. Hard money lenders care more about the potential value of the property after development.
Two big drawbacks to hard money lending are the cost and repayment period. Interest rates are higher for hard money loans due to the level of risk taken by the lender and the repayment period is much shorter. However, hard money loans offer convenience to real estate investors. Funding is quick, there’s more flexibility for negotiation with private lenders, and the property itself serves as collateral for the loan.
Private Money Loans
Private money loans, although similar to hard money, are offered by lenders not in the business of lending. Usually, there is an established relationship between the lender (either an organization or an individual) and the borrower with more room for personalization and negotiation. The lender finances the purchase with an interest rate and specified payback period and must comply with state and federal usury laws. Private lenders will look at the investor’s credit, pricing strategy, and exit strategy before offering a loan.
Peer-to-peer (P2P) lending allows investors to borrow from another investor or group of investors. There are P2P online platforms that connect lenders with borrowers. Each platform sets its own rates and terms, but most offer a range of interest rates depending on the borrower’s creditworthiness.
A non-recourse loan is a consumer or commercial debt secured by the collateral with no personal liability. The lender is entitled to repayment from the profits of what the loan is funding. Borrowers often need good credit to qualify, and there are higher fees and interest rates due to the higher potential risk. In most cases, borrowers begin repaying immediately in an installment plan.
Consider a home equity line of credit by tapping into the equity on your primary residence to purchase a property or fund improvements. Finding a HELOC lender for an investment property can be difficult due to the increased risk of default. Requirements are more strict for a HELOC, and lenders may require a credit score of 720 or higher, a maximum 80% loan-to-value ratio, long-term tenant occupancy, and a considerable amount of liquid cash reserves.
The financing method you choose depends upon the property, how much leverage you want to use, your creditworthiness, and your plan with the property. Make sure you compare different loans and look at the terms, fees, and interest rates and use the help of a trusted advisor to guide you through the process.
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