If you’re an aspiring real estate investor thinking of buying an investment property, the first thing that would be of concern to you is financing. Fear not, financing an investment property is actually not as hard as one might think. Sure, beginner property investors might not have enough money to buy a rental property all cash, but there are many other financing methods to consider.
In this article, we break down 5 of the most common ways to finance buying an investment property. After reading this, you’ll understand the pros and cons of each financing method, what is required form you as a real estate investor to obtain them, and their outcomes. This will help you determine which option is the best for you depending on your financial situation and real estate investing goals. So, without further ado, let’s dive right in!
Buying an Investment Property with a Mortgage
Following this method, property investors go to a bank or a mortgage broker and apply for a loan. To obtain a mortgage loan, a real estate investor would typically have to put down 20% of the investment property’s purchase price (down payment). So, if you’re buying an investment property that is worth $200,000, for example, you’d have to put down $40,000 in cash as a down payment. The bank or mortgage broker will then cover the other 160,000, and you, as a real estate investor, will have to make monthly payments to pay down your mortgage.
This is the most common option to finance buying an investment property. However, if this is the financing method you’re opting for, you should make the purchase sooner than later this year as mortgage rates are expected to rise.
Click here to read why now is the best time for property investors to buy investment properties in the US housing market!
Moreover, beginner property investors have to keep their credit score in mind before applying for a mortgage loan. Most banks require a credit score of at least 620 in order for a real estate investor to qualify for a mortgage loan for buying an investment property.
Buying an Investment Property with Private Money
Private money lenders are basically people that you, as a real estate investor, know and want to finance buying an investment property but not deal with property ownership. They could be a family member, a friend, or even a co-worker. This is another common financing method because it comes with fewer conditions and formalities between private money lenders and property investors. Interest rates are often lower, the length of the loan is fixable, and both are negotiable thanks to the relationship between the parties.
Nonetheless, there are some challenges that may arise when you finance buying an investment property in this way. First of all, it’s not always easy to find a relative or a friend who will have enough money and is willing to lend beginner property investors. In addition, there is a risk of losing your relationship if an argument or misunderstanding occurred. Therefore, the best thing to do is to create a contract so that both the private money lender and the property investor remain calm and make things clear from the start.
In addition, it wouldn’t hurt to provide some kind of guarantees and sign a repayment agreement. When buying an investment property with this method of financing, it’s important to stay professional as a real estate investor.
Buying an Investment Property with Hard Money
Hard money lenders are also people who lend money to you for the purpose of buying an investment property without being involved in the managing part. However, what makes them different from private money lenders is that those are professional companies rather than people you personally know.
The best thing about buying an investment property with hard money lenders is the fast money. Once a real estate investor gets the approval, it’s only a matter of days to acquire the money. However, this financing method comes with a never-ending list of formalities, documentation, and guarantees.
In addition, property investors must keep in mind that hard money are short-term loans. Unlike mortgage loan which could last from 15-30 years, hard money loans last only up to 3 years! Not to mention the higher interest rates. Therefore, hard money is best for financing the purchase of a fix-and-flip as these investment properties are quickly sold for a profit after buying and repairing them. On the other hand, it wouldn’t make financial sense to buy a single-family home with hard money loans simply because it’s impossible for property investors to pay off the loan in only 3 years.
So, before you finance buying an investment property with hard money loan, keep in mind the type of property you’re investing in. Furthermore, this financing method is typically recommended for experienced property investors, while beginner property investors will find private money a better option.
Buying an Investment Property through Partnerships
One of the great ways to finance buying an investment property is through a real estate partnership. So, what are the advantages of this financing method? Well, there are a couple of things beginner property investors should know.
First of all, you will be able to afford larger real estate investments. For example, assume you have $10,000 saved to start real estate investing. This amount might be enough for a down payment of a small rental property. However, if another real estate investor is willing to put an additional $10,000, you will be able to afford to buy a rental property that is much bigger.
In addition, real estate investing with a partner is more secure for you as risks will be split between the two parties if something goes wrong with the rental property. Moreover, buying an investment property with more experienced property investors allows beginner real estate investors to gain the necessary knowledge, skills, and even network to make a successful investment. Your partner will act as your mentor from which you’ll learn all the different aspects of real estate investing.
However, if you’re going with a financing method, there are a number of things you need to make sure of, or otherwise the partnership will turn into a nightmare. These include:
- You and your partner are on the same page when it comes to your investment goals
- Make it clear who is bringing what into the partnership
- Agree on profit-sharing
- Communicate regularly
- Sign a contract
- Be fair and honest
Buying an Investment Property through Seller Financing
Seller financing is when the seller of a rental property agrees to provide financing for you as the buyer in order to close the real estate transaction. Basically, this financing method for buying an investment property is like taking a loan from the seller. This is a great option for a real estate investor with not enough capital to qualify for a mortgage loan or who can’t find hard and private money lenders or a partner.
However, the seller isn’t going to simply hand over the cash to the rental property buyer. Instead, the seller extends a kind of credit, and as real estate investor, the buyer makes monthly payments. It’s quite similar to how a mortgage loan works, but you make monthly payments directly to the seller to pay off the purchase.
Another thing beginner property investors should keep in mind before buying an investment property through seller financing is that sellers might set a higher interest rate compared with a mortgage loan. Moreover, this is also a short-term financing method – typically, monthly payments have to be paid over 5 years.
Now that you know the different ways to finance buying an investment property, it’s time to decide which one works best for you. What works for one real estate investor might not work for another. Thus, remember to evaluate your financial abilities, conduct a financial analysis, and understand the requirements of each method to ensure you’re making the right decision.
Once you’re set on a financing method, the next step is to start your search for a rental property to invest in, and we’re here to help!
To learn about how our platform makes searching for and buying an investment property easier, click here!