4 Most Popular Types Of Real Estate Financing
Everything in real estate starts with obtaining financing. This is the case whether you are a first time homebuyer or a seasoned investor. How the property is financed often dictates how the rest of the transaction will go. Purchases backed by hard or private money can be closed in as little as ten days with little to no issues. Lender financed purchases can be as long as 45 days with multiple hoops to jump through. Each option has a specific set of strengths and weaknesses based on your short and long term goals and your credit profile. However you plan on financing your purchase it needs to be firmly in place prior to looking at any properties. Here are the four most popular type of real estate investing financing.
- Hard Money Loans. A hard money loan is any loan obtained by an individual or group of individuals for the purposes of purchasing real estate. The number of hard money lenders has grown exponentially over the past decade. What was once a niche group used primarily for foreclosure prevention is now a formidable financing option in almost every market. Hard money lenders are similar yet completely opposite to that of traditional lenders. On one hand they still follow a set of guidelines and criteria like any big bank. On the flipside they base their decisions more on the property than the individual borrower. The ideal hard money candidate is any borrower who is either credit challenged or has trouble documenting their income. A hard money lender will ignore income issues as long as the deal makes sense. The property must have significant appreciation potential and the borrower must have some type of collateral. Using hard money allows the borrower to close quickly and usually close many more deals over the course of the year. The downside is the increased fees and well above average interest rates. A hard money loan is best used for rehabs and flips where the intention is to be in and out as quickly as possible.
- Private Money Loans. A private money lender is typically one individual lending from their savings or self-directed IRA account. They have probably thought about investing in real estate from some time but did not know exactly where to begin. A private money lender can be any friend, family member or co-worker who has access to capital. They are similar to a hard money lender in that they provide you with the funds and usually step out of the way. They do not want to know about credit guidelines and focus almost solely on their rate of return. They want to know that their yield will be higher on the real estate deal than what they will receive from the yield their money is current in. They are also worried about potential risk and the worst case scenario. A hard money lender knows and understands everything that can go wrong. A private money lender is not as versed in real estate and needs to be walked through the process step by step. As long as you hash out all of the details before any money is exchanged a private money lender can be your best option.
- Conventional Loan. In the past if you wanted to purchase an investment property your only option was a traditional lender. Much has changed with the mortgage market over the past decade. Long gone are the limited documentation and down payment programs. If you want a loan through a conventional lender you need at least 20% down payment, strong credit scores and low debt to income. Every step of the process is scrutinized and the underwriting guidelines are much stricter. On the flip side interest rates have hovered near all-time lows for the better part of the last few years. If buy and hold rental properties are your focus a conventional loan is your best option. Low rates and strong down payment will help you generate increased cash flow and build equity. There are plenty of hurdles to jump through but conventional loans can be the perfect fit for the right situation.
- FHA Loan. A great option for a first time investor is the FHA purchase option. An FHA (federal housing administration) loan is one that is back by the government with increased mortgage guidelines. To qualify for an FHA loan a borrower needs to make under a certain income amount for the zip code the property is located in. Not only does FHA offer reduced interest rates but there are differences in guidelines. An FHA borrower can purchase a one or two family property with just 3.5% down payment. This creates a great opportunity for a first time investor looking to minimize their monthly payment. With a two family purchase they can live in one unit while renting the other. They can reap all of the tax benefits associated with rental property ownership as well as greatly reducing their monthly mortgage payment. An FHA loan only applies to owner occupied properties so this can only be used one time. Many investors have gone this route to gauge if they are comfortable with being a landlord and to make their first purchase work for them.
As an investor you need as many different financing options as possible. These are just four of the most popular options. Find the option that works for you based on the specific deal you are looking at.