The most common question every first time real estate investor has is about where to acquire financing to purchase their first deal. Few come into this business with the financial resources to pay cash, and obtaining financing can be daunting and keeps many people from even getting into the game.
There are several options, and they all have their pros and cons. The important thing is to be aware of what is available and make the best choice that will help you best achieve your goals. We have put together this guide to help you choose the best financing for you.
Conventional Bank Mortgages
If you own the house that you live in, you are probably familiar with this type of loan. A conventional mortgage uses the home as collateral, and if you are going to live there, many programs are available to allow you to get approved for the loan and move into your new home with very little, or sometimes even no money down.
Getting an investment property with this type of loan is similar, but you will have to put at least 20% down and sometimes even more. The bank will look at your credit history, debt to income ratio and appraise the house just as they would with a mortgage on a home you are going to move into.
For those with a good income and low consumer debt, this can be a great option, as the interest rate will be quite low compared to many other options. Unfortunately, you will not be able to use your projected rental income in the underwriting process, so those without a fairly large regular income may have to seek other options.
One work around the income problem is sometimes those who are unable to get underwritten for an investment property are able to get successfully underwritten for a duplex or other multifamily unit, and are able to live in one unit and rent out the rest. Many people have used this strategy to get into the investing game and then were able to grow their portfolio from there.
Conventional bank mortgages are often great all around options for those with a good income and good credit, and those without the extra income can often find success by starting out with a duplex.
Hard Money Loans
Hard money lenders are businesses that will give you a short term loan for a property and are often used for quick flips. The advantage of a hard money lender is that they will not check your credit or care about your income. They are only concerned with how profitable your deal is and the likelihood that you will be able to pay back the loan.
If you can show them that you are buying the property for a good price, and the After Repair Value (ARV) will raise the value of the property by more than the cost of the repairs, you will likely get approved.
The disadvantage of hard money loans is that the interest rate can be quite high, especially if you are just starting out in the business. As an inexperienced investor, you are seen as a higher risk. But once you get a few deals under your belt and establish a relationship with the lender, you will be able to get much better rates.
The terms of a hard money loan are quite short, usually less than a year. Hard money loans are good for flips, but can also be appropriate when buying a property in poor condition. If a home has major repair issues, many banks will be hesitant to write a mortgage on that property.
You have to remember banks are not in the real estate business, foreclosing on a property for them is still a huge expense they try to avoid, that is why houses needing repairs are often avoided. Many investors are able to pick up properties well under their market value using hard money, and then refinance with a traditional lender after the repairs are completed and the house has a clean inspection report.
Private Money
Private money loans are when one individual lends money to another to fund the real estate deal. Some people are able to get a loan from friends or family, but of course this option is not available to all. One other common way to find private money lenders is through networking with local real estate investing clubs. If you find a good deal but are unable to fund it, you may have luck at one of these events.
The terms of private money loans can vary greatly depending on many factors. Typically, the loan is secured with a contract that lays out the terms of the deal and allows the lender to foreclose on the property if the loan is not paid back according to the terms.
Business Loan
This one is another underutilized and often unknown way you can finance a rental property. Many banks will allow you to fund the rental property with a business loan using the house as collateral. This is not the same as a conventional loan as they do not fall under the Fannie Mae and Freddie Mac guidelines.
These will require a 20% down payment but the advantage is you can use the rental income in the underwriting process. As long as you have good credit and the projected rental income is greater than the loan payment, insurance and property taxes, you can get easily approved.
Not every bank will do this, especially the bigger national banks. If you go into a branch of a bank such as Chase or Bank of America, they would never consider it. But many small community banks will gladly write these types of loans, especially if the property is in that community.
Deciding which loan is best for you
Often deciding what is best for you depends on what you can qualify for. A conventional mortgage or business loan may be difficult to qualify for if you do not have the 20% down payment and good credit. Hard money is available to everyone but the high interest rates will eat into your profits, but is often a superb way for anyone to break into the business. Private money is also potentially available to all but may take some leg work to get set up. Whatever you decide, just keep in mind that your first deal will never be perfect and the key to success is to keep improving on each and every deal.