With over 7 million real estate investors in the United States, real estate investing is gaining popularity. There are more ways than ever to profit from real estate investment, thanks to innovative technology and investment opportunities that go beyond the traditional methods of buying and selling. Real estate investing can be an excellent way to protect yourself when the stock market is unstable. There are numerous advantages to owning an investment property, and it can be a lucrative source of income.
However, buying an investment property is not the same as buying a primary residence. If you’ve never purchased an investment property before, taking out a high-interest loan and borrowing money to spend on something that won’t be your home can be scary.
Despite the turbulence of the pandemic-affected economy, many people continue to find real estate to be a profitable investment. Last year, home prices increased significantly, owing to several demand-side factors. First, the new work-from-home economy has prompted many adults to leave high-cost areas. Furthermore, interest rates have remained at record lows for over a year, making it cheaper to borrow money and secure financing in real estate.
It’s essential to remember that securing financing for real estate investment properties can be more complex than for a primary residence. Because investment properties are not owner-occupied, lenders consider them to be riskier investments. As a result, lenders have stricter requirements for down payments and credit scores when considering borrowers seeking loans for investment properties because of the increased risk. In addition, lenders typically charge rates that are 0.5% to 0.75% higher on investment property loans than on owner-occupied property loans.
Other options are available for real estate investor financing if you don’t have enough credit or income to buy a property with cash or through traditional lending products. It’s best to know what these are to make the best decision for your needs.
Buying investment real estate can be a great strategy for building wealth over time. The key is finding financing to help you out. In this article, we’ll discuss the different types of loan products that are used to finance an investment property, as well as the benefits and drawbacks of each.
Conventional Bank Loans
Conventional bank loans are the most common way to get money for real estate investing. In this case, a financial institution lends money to the borrower based on the borrower’s credit history and ability to repay the loan in the future.
A down payment of 20% of the home’s purchase price is typical when using conventional financing. However, if you use conventional financing to purchase an investment property, lenders may require a larger down payment.
Your credit score and history impact your ability to get a mortgage and the interest rate the bank will charge. Lenders also scrutinize borrowers’ income and assets. Borrowers must also demonstrate that they can afford both their current mortgage payment and the new monthly loan payments.
Most lenders require borrowers to have at least six months of available assets, like cash or retirement fund dollars, set aside to cover both mortgage obligations to qualify for financing in real estate investment properties.
Conventional bank loans are best for borrowers who have good credit scores and cash on hand for a down payment.
Pros: While interest rates on investment property loans are higher than those on primary residence loans, the conventional bank loan option typically has a lower interest rate than a private lender. Furthermore, as previously stated, bank financing for real estate can maximize your potential profit based on the amount of cash available for a down payment.
Cons: There are several potential drawbacks. Banks can be slow and rigid when approving mortgage applications, which means you’re more likely to be turned down for a loan. Banks also have strict lending guidelines for real estate investor financing, putting additional strain on the borrower’s finances.
Private Money Loans
Private money loans are approved and funded by individual private lenders and are another alternative for real estate investor financing. Private individual lenders are individuals who operate outside of financial institutions. They generally make a profit by lending money to those who increase the value of their investment properties.
Private money loans are loans from one person to another. Family and friends are the main sources of private money loans. Real estate investment events can be a good place to network and seek out private money lenders if you don’t have any direct connections already established.
Real estate investors can attend these events, network with other investors, and learn how they get their funding resources. In addition, attending these events will give you the opportunity to meet experienced investors who may be willing to mentor you or even become your private lender.
Private money loans are best for borrowers who do not have access to equity to finance an investment opportunity.
Pros: Private lenders are less rigid than traditional institutions such as banks. They are willing to take on higher credit risk and make lending decisions based on more than just an algorithm. There is a human factor at work. This can be beneficial when it comes to real estate investor financing if you have a low credit score but a high-income potential from a rental property.
Cons: Interest rates will most likely be higher than at a bank. Furthermore, you may need to put in some effort upfront to cultivate a network of private lenders who will assist you with financing for real estate.
Accessing Home Equity
Borrowing against your home equity is another way to secure real estate investor financing. You have a few options and could use a home equity line of credit, home equity loan, or cash-out refinance. You may be able to borrow as much as 80% of the equity value of your home to purchase, rehab, and repair your investment property.
Home equity loans are best for borrowers who have enough equity in their homes to use as leverage for an investment property.
Pros: With a home equity line of credit, you can borrow against your equity the same way you would with a credit card, and the monthly payments are frequently interest-only. A cash-out refinance would have a fixed rate.
Cons: HELOC rates are typically variable, which means they can rise if the prime rate rises. A cash-out refinance may allow you to extend your current mortgage term. However, a longer loan term means you could be paying higher interest rates on your primary residence. You will have to compare this to what you expect to bring in from your investment property.
Hard Money Loans
A hard money loan is one of the most common methods of financing in real estate, specifically when it comes to a house flip. You’ve probably heard of this type of loan before, but what exactly is it? And how do you know if a hard money loan is appropriate for your house flip?
This short-term loan is best for flipping an investment property rather than buying and holding, renting it out, or developing on it. A hard money loan to finance a flip can be easier to qualify for when compared to a conventional loan.
Some borrowers use this strategy when dealing with private lenders. A hard loan is so named because it is based on a hard asset, in this case, the property. This is a bridge loan, a short-term loan that provides funds until you can sell the house or secure a more traditional funding source.
Hard money loans are best for borrowers who plan to sell their investment property rather than buy and hold, rent or develop it.
Pros: Hard money loans are a good option for real estate investor financing. They are ideal when you need to close on a property quickly. Loans can be approved in as little as seven days, and borrowers can get the money they need to buy and repair a house with little money down.
Cons: Hard money loan interest rates can be significantly higher than traditional mortgage interest rates. These loans necessitate that you know what you’re doing. If you cannot complete the repairs on time (usually within six to 18 months), you may be forced to pay higher rates or, worse, end up with nothing.
Any real estate investor will tell you that financing in real estate can be tricky to navigate, so you need to know the ins and outs of the available loans out there and what kind of financing best meets your needs.
The right real estate investor financing option will depend on your circumstances. Still, there are four types of loans that meet most investors’ needs:
- Conventional loan: The most common type of loan, it’s based on your credit score, debt-to-income ratio, and other factors. Conventional loans can be used to buy any type of property, as long as the purchase price meets certain minimum requirements.
- Private money loan: This is a loan from one person or business to another. Private money lenders usually charge more than conventional lenders because government regulations don’t bind them. They may also require higher down payments and additional fees.
- Accessing home equity: This type of financing is similar to taking out a second mortgage on your home, but you can use home equity as collateral for other purposes besides home improvement projects, such as paying off debt or consolidating credit card balances into one lower payment each month.
- Hard money loan: A hard money loan is a short-term loan with a high-interest rate (typically in the double digits). Hard money lenders typically provide funding for projects with fast turnaround times, such as flipping houses or buying land to build on later. Because these loans are so risky for the lender, they often have strict underwriting guidelines and a quick repayment schedule.
Leveraging financing in real estate is an intelligent way to stay competitive. But it’s essential to know everything you’re getting into before committing to a particular investment property or strategy.
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