Many people think of buying an investment property because of the great financial return that investment properties can provide. However, to buy an investment property, real estate investors must put down a large amount of money. Typically, you need to put 20% cash down on your investment property, but not many real estate investors have this amount of down payment that most banks require. In this blog, we’re showing you where to find the money for financing and buying an investment property.
Buying an Investment Property Through a Conventional Mortgage
This is the most popular method for finding money to finance investment properties. A conventional mortgage is a loan that private entities like banks, credit unions, private lenders, or savings institutions offer. This financing method is available to everyone, but requirements vary from lender to lender.
A conventional mortgage requires up to 20% for a down payment. Because of that, real estate investors are less likely to default and tend to have a more secure financial standing. However, the large down payment also results in lower monthly payments. In addition, investors are often responsible for mortgage insurance, origination, and appraisal fees.
Buying an Investment Property Using Hard Money
Using hard money can be a good way for buying an investment property. Hard money lenders are typically private investors or small companies that are willing to lend money (for a short term) when a bank or traditional lender will not.
Using hard money is beneficial for a number of reasons. First, you are not going to have to go through the credit approval process; hard money lenders don’t pay as much attention to credit as traditional lenders do. Instead, they pay more attention to the value of the real estate deal that you are getting into. Also, you can obtain hard money loans quicklier than traditional loans. Potentially, you will be able to get your money in a few days instead of multiple weeks.
When you get a hard money loan, you’ll notice that the structure of the loan is different from traditional lending. Generally, a hard money loan has a higher interest rate. This can be risky because you have to pay off the loan all in one payment at the end, but you face the risk that your investment property might not generate a profit. Thus, using hard money for buying an investment property saves you a lot of cash in the short term, but it is more expensive in the end.
Buying an Investment Property Using Private Money
Another way to get hold of money to buy a real estate property with is to use private money. Private money doesn’t come from a professional lender, but from an individual looking to achieve higher return on his/her cash – it could be a private investor, a friend, or a family member.
This private investor acts like a bank and lends money to real estate investors who are buying – or flipping – a investment property at a certain interest rate. This rate is established upfront and can vary from very expensive to very cheap, and the money is lent for a specific period of time depending on the relationship between the investors, the investment itself, and the terms of the loan.
One advantage when using private money for buying an investment property is that it’s possible for real estate investors to have more room for negotiation on the terms of the loan. However, the private lender is secured by a promissory note or mortgage on the rental property. This means that if you don’t pay, he/she can foreclose and take the house.
Buying an Investment Property Through Home Equity Loans and Line of Credit
If you have equity in your home, a line of credit is a great way to get extra cash to invest in a real estate investment property.
Usually, with lines of credit, banks like to see the balance move up and down. So, if you plan on buying an investment property and keeping it as a rental, use the line of credit to buy and rehab and then refinance the property with a more permanent loan. Using home equity loans and lines of credit has multiple benefits including:
1. This loan is based on the value of your primary residence (not the investment property you plan on buying). This means that banks won’t even look at the new property; they are only concerned with your ability to pay the money back. As such, the new investment property might be in a poor condition, and the bank won’t likely care.
2. Because the loan is secured by your primary residence, the interest rate on these lines is generally very low compared to hard money or private money, and the payments are very low as they are interest-only payments.
3. These loans can have certain tax benefits allowed by the IRS, such as the ability to deduct the interest paid on that loan – you need to see a qualified CPA for more information on this.
Buying an Investment Property Using Seller Financing
Seller financing is when instead of the buyer getting a loan from a bank, the seller of the real estate property is actually willing to provide the financing for the investment, and the buyer sends monthly payments directly to the owner rather than a bank.
The Benefits of Using Seller Financing
1. Ease of Financing: As mentioned earlier, when you use seller financing for buying an investment property, you avoid the need to use a bank.
2. Possible No or Low Down Payments: Because you are dealing directly with the homeowner, you get what you negotiate with the seller instead of having to deal with rigid rules when it comes to the down payment.
3. Option for Creativity in Structuring the Deal: Interest rate, term, payment amount, payment dates, and everything else is completely negotiable, which can turn a mediocre deal into a great deal.
4. Purchase “Un-Financeable” Properties: Sometimes, you might want to invest in a property whose condition may be too poor to use traditional financing. In this case, using seller financing gives the buyer a chance to own the investment property, fix it up, and possibly refinance into a more traditional later on, which is a huge cash flow benefit.
5. Does Not Show On Your Credit Report: This makes it easier for the buyer to obtain other loans and mortgages in the future.
Risks and Drawbacks of Using Seller Financing
1. The Due on Sale Clause: This means that if you have a mortgage on a property and you sell it using seller financing, then the bank has the right to demand that the loan is paid back – in full – right now or foreclose on you. Therefore, you should only use seller financing when the home is owned free-and-clear.
2. Higher Interest Rates: Although seller financing allows for incredible creativity, generally speaking, you will pay a higher than the normal rate with seller financing. In today’s lending environment, it’s difficult to get a seller to accept interest as low as 4%, for example.
3. Fewer Potential Properties: Seller financing can be a great win-win for both parties; however, the vast majority of homeowners are either unable or unwilling to provide seller financing. Therefore, when looking to work with seller financing for buying an investment property, the pool of potential deals is significantly smaller.
Buying an Investment Property Through Real Estate Partnership
If you are looking to invest in a real estate income property, but the price range is outside of your budget, consider adding an equity partner to your team. Real estate partnership can be a win for both parties and is very beneficial to new real estate investors.
There is no specific way to structure the real estate partnership; you can use the partner’s cash for financing the entire investment property or use a partner to only fund the down payment; real estate partners may actively participate in nearly all aspects of property ownership or may play a passive role. There are no set rules, but each deal requires its own analysis of who makes the decisions, how profits will be split at the end, etc.
Also, real estate partners do not receive an agreed upon interest rate on their money, but instead, they receive only a percentage of what the income property generates – that includes cash flow, appreciation, depreciation, and eventual profit when the income property is sold.
Real estate investment properties can be expensive, and as a real estate investor, you need to be able to know where to find the money and the most suitable way to keep your investment property moving forward.
Understanding these different options will help you throughout your real estate investing career. But whatever way you choose for buying an investment property, research the financing method well in order to make sure that it is legal in your state, that your lender approves it, and that you are not stretching your finances too thin. Visit Mashvisor for more information on real estate investing and financing tips.