Real estate can be a great money-making machine that can help you build wealth. Most beginner real estate investors, however, are not able to fund a real estate deal with their own money. Very few people are lucky enough to have readily available cash to launch their real estate careers.
However, one big misconception about real estate investing is that you must have a lot of money to get started. The lack of enough money for a down payment continues to hold back many beginner investors in the current market. The secret that many people don’t understand is that there are several alternative real estate investment financing strategies that work for beginners.
As a beginner real estate investor, understanding how to get financing for a real estate investment is just as important as finding one. The way in which a specific real estate deal is funded can also greatly influence its outcome. In this article, I am going to go over some real estate investment financing options for beginners.
1. Conventional Mortgage
A conventional mortgage is the most common type of investment property loan. To get one, you need to provide a specific down payment and then the bank provides you with the rest of the money. Even though conventional mortgages typically have lower interest rates, they follow strict guidelines. You need to have a sufficient down payment, an adequate credit score, and a low debt-to-income ratio. These requirements can limit some investors.
Conventional mortgages are suitable for buy-and-hold investors who want to build a real estate portfolio of income properties. The mortgage repayments are usually done monthly, making them easier to budget for. However, these loans are not normally used for short-term financing.
2. Seller Financing
This form of real estate investment financing involves getting a loan from the property seller. If the property seller is willing to offer you a loan, this can be a good option for beginners. Seller financing (also known as owner financing) is easier to acquire and involves less paperwork than a conventional mortgage from a bank. Seller financing deals work in different ways. The seller can finance either the down payment for an investment property or the full purchase price. To be successful, ensure you and the seller agree on a fair interest rate for your loan. Also, ensure that you put all the terms of the loan in writing and sign it.
3. Real Estate Partnerships
Real estate partnerships are another great real estate investment financing option for beginners. You can identify someone with enough money for a down payment and partner with them. For instance, you can partner with a family member or a friend who wants to get involved in real estate investment but is not interested in the daily work of a rental property like tenant screening and rent collection. Your partner will take all the financial risk and you will put in all the groundwork of bringing in rental revenue. What one partner lacks, the other partner can make up for.
To succeed in a partnership, you both need to agree on how the proceeds will be split depending on your contributions. Also ensure you put all the terms you agree on in writing, including the roles and responsibilities of all parties.
4. Federal Housing Administration (FHA) Loan
If you are buying your first investment property, another sound real estate investment financing method you can use is getting a mortgage that is insured by the Federal Housing Administration. The FHA loan was founded to encourage homeownership. However, you can buy a multifamily property with a down payment of just 3.5%, pick one unit to live in and rent out the rest to qualify. This makes an FHA loan a very cost-effective real estate investment financing method, especially if it’s your first.
5. Hard Money Lenders
Traditional mortgages usually take around 60 days before closing. This is a long time if you are making a deal. Hard money lenders help to solve this problem. Hard money loans are short-term, high-rate investment property loans funded by private individuals or businesses. They are usually backed by the value of the property.
Although hard money loans have higher interest rates, they give you the flexibility to strike fast when you have a great deal in your hands. It may not be a sustainable long-term real estate investment financing option. However, it is a valuable resource when you need to close quickly. These loans are usually used as bridge loans to help you close a deal before you acquire traditional financing.
6. Private Money Lenders
Private money lenders are also a good real estate investment financing option for new investors. They are nonprofessional individuals who offer investment property loans at a specific interest rate and payback period. They are usually interested in investing in the property just as you are.
If you are well-connected, you can tap into the capital from your personal network. This may be a friend, family member, co-worker, etc. Private money loans need fewer qualifications than conventional loans and have a more flexible loan structure. These loans are commonly acquired by real estate investors who believe they can raise the value of an investment property over a short period of time through renovations.
7. Home Equity Loan
This is a real estate investment financing method where the lender uses your existing property or primary residence as security for the loan. It enables you to capitalize on your already existing equity. However, you risk facing foreclosures and losing your home if you are unable to keep up with monthly payments. Ensure you weigh the risk before going for this option. Home equity loans are offered by banks and other financial institutions.
The Bottom Line
A common obstacle among beginner real estate investors is getting capital. However, there are several alternative ways of financing a real estate investment even if you don’t have money. Even so, not all real estate investment financing options are the same. Each option has its own set of advantages and disadvantages. The real estate investment financing method you use will depend on the investment property as well as your unique financial situation. What works for someone else may not necessarily be the best for you. Do your research and pick a real estate investment financing option that best fits your investment strategy.
Keep reading Mashvisor’s real estate investment blog if you want to learn more about all the aspects of property investing.