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Pros: Paying upfront significantly improves your opportunity to purchase real estate since it removes any financing question doubts in the seller’s mind. Paying cash enables you to acquire properties at significant discounts in exchange for the convenience cash offers. In addition, paying cash saves buyers a lot of money in interest expenses that come with private, hard-money or conventional loans.
Cons: This one is all about risk versus reward. Paying in cash is a safer, more conservative approach, but it caps your potential gains. Think about it this way: If you invest $250,000 in cash and then rent the property for $2,000 per month, youll see $24,000 in gross revenue per year, or a 9.6% gross return on investment. Alternatively, if you make a $50,000 down payment, then take out a 30-year mortgage at 5%, youll pay $977 per month in principal and interest. Rent that property for $2,000 and subtract the mortgage payments, and you have an annual gross revenue of $12,276 nearly 25% gross return on the initial $50,000 investment in just the first year. Although this explanation is oversimplified, it illustrates the leverage that your money can give if you choose other financing options.
Paying with cash certainly provides security and stability, but removing the risk dramatically reduces the potential reward.
Option 2: Finance your property with a private individual lender.
Option 3: Finance your property with hard-money loans.
Which option is right for me?
Tips To Get The Best Loan Possible
If you are a reasonably qualified borrower, you can typically find someone to loan you the money for your real estate investments. However, you dont want just any loan — you want the best investment property loan you could possibly get.
To do that, you need to be the most attractive applicant possible in the eyes of lenders. With that in mind, here are five suggestions to help you find the best loan for your next investment property.
Think About Investing In Rental Properties
Tiffany Alexy didnt intend to become a real estate investor when she bought her first rental property at age 21. Then a college senior in Raleigh, North Carolina, she planned to attend grad school locally and figured buying would be better than renting.
House hacking allows you to live in your investment property while renting out rooms or units.
I went on Craigslist and found a four-bedroom, four-bathroom condo that was set up student-housing style. I bought it, lived in one bedroom and rented out the other three, Alexy says.
The setup covered all of her expenses and brought in an extra $100 per month in cash far from chump change for a grad student, and enough that Alexy caught the real estate bug. Now age 27, she has five rentals and is a broker and owner of Alexy Realty Group in Raleigh.
Alexy entered the market using a strategy sometimes called house hacking, a term coined by BiggerPockets, an online resource for real estate investors. It essentially means youre occupying your investment property, either by renting out rooms, as Alexy did, or by renting out units in a multi-unit building. David Meyer, vice president of growth and marketing at the site, says house hacking lets investors buy a property with up to four units and still qualify for a residential loan.
If you manage it yourself, youll learn a lot about the industry, and if you buy future properties youll go into it with more experience, says Meyer.
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How To Keep Your Project Costs Low
No matter where your funding comes from, your profits will be higher if you can keep your costs lower. Although you need to build contingencies into your estimates, its better if you never dont have to tap into that buffer at any point.
Keeping your development costs low will result in a better profit for you and any potential equity investors in the project. Even if you dont reach your income goals, lowering the overall cost of a project will help you achieve your objectives.
Its also generally easier to secure funding for lower cost projects as a percentage of projected value upon completion, than for relatively higher cost projects. Banks will provide debt based on the lower of two numbers , one, a percentage of your total projected cost, and two, a percentage of total projected value upon completion.
“Unless you have a lot of experience with high-value real estate projects, youre not likely to get high leverage for your project, and neither would you want it.”
The repayment of debt is the single hardest financial challenge you have to face during a development project. Banks are highly regulated and consequently are generally an unforgiving lender should things go wrong.
They will take the property from you in a foreclosure action if you fail to pay them on time. Having a disciplined approach to development can help you to build successful projects.
What can you do to keep costs lower? Focus on a few things in particular.
Forming Partnerships To Invest In Real Estate With Little Money
Real estate partnerships are common for investing in real estate with little or no money. If you want to invest in a property, but the price tag is out of range, then an equity partnership may be what you need. An equity partner is an individual whom you bring into a transaction, to help finance a property. There are different ways that partnerships may be structured, and thus it is up to the buyer and the partner to agree on a more viable structure.
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Creative Financing Strategies For Real
There are quite a few ways to think outside of the box when it comes to funding your real-estate deals.
Entrepreneur
One of the biggest issues real-estate investors have is how to fund their real-estate investments. The two most common ways for an investor to purchase their first investment property is with an all-cash transaction or with a traditional bank loan. These are both acceptable ways to finance a purchase, but theyre not always the best options. Instead, using alternative solutions for securing capital can be an excellent way to quickly scale your business and expand your investment portfolio.
Utilizing creative financing options in your business will provide you with the ability to secure deals that you otherwise may miss out on.
Get Your Income And Employment Documentation In Order
There are asset-based lenders who dont care about your personal income or employment history when you apply for an investment property loan, and to be clear, they can be great options. However, conventional lenders generally offer better terms than asset-based lenders, and they will certainly consider your income and employment situation when making loan decisions.
If youre applying for a conventional loan, you generally cant have a debt-to-income ratio of more than 45%, including the expected payment on your new investment property loan. You can include three-fourths of the propertys expected rental income for qualification purposes, but youll still need to be able to document your other sources of income.
So, before you begin shopping for a loan, its a good idea to gather all of your income documentation. This includes your last couple of tax returns, W-2s and/or 1099s, and a few recent pay stubs wont hurt. Its also worth having a contact number for someone who can verify how long youve been at your job.
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Approach A Private Lender
Otherwise known as angel investors these are private individuals who are willing to support your property investment. Of course, you dont just want to ask any random person to do this, it helps if there is a degree of trust. Either way, the private investor will need assurances that you are a worthy investment and that their reward will be worthy of the risk.
Ways To Come Up With A Down Payment For An Investment Property
Not scared away yet? Good, because despite the high cash requirements for buying investment properties, you have plenty of options to come up with the cash for a down payment on a rental property. You may even be able to buy your next rental property with no money down!
Before we dive in, its worth pausing to note that the best source of funds for a down payment was, is, and always will be cash from your savings. When you borrow a down payment from someone else, you leave yourself vulnerable to overleverage, to slimmer cash flow margins and returns, and to possible rate hikes or called loans.
This is why were so big on boosting your savings rate and cutting your spending, and even going so far as living on half your income. The more of your own savings and cash you can invest with, the better position youre in to earn high returns from your rental properties.
All right, Im finished proselytizing, lets dive into some alternative ideas for coming up the down payment for an investment property!
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Pros And Cons Of Owner Financing
Based on the terms of owner financing, you can see that they offer benefits to both the seller and buyer of the investment property. However, just like everything in real estate investing, there are some downsides of this investment property financing method.
Advantages for Buyers
- Besides being able to start real estate investing when youâve been denied a traditional mortgage loan, owner financing has easier qualifications
- Down payment, interest rate, and terms are all negotiable
- A lot of what property investors pay for closing costs is simply services that banks provide for traditional mortgages. So, when you go for owner financing instead, you end up with lower closing costs
- Closing on the investment property is quicker, meaning you can start making money in real estate investing much faster
Disadvantages for Buyers
- Property investors may not find sellers willing to carry financing investment properties
- The flexibility of owner financing comes with higher interest rates and shorter repayment periods
- Difficulty if there are underlying mortgages
Advantages for Sellers
- Donât get all cash up front
- Might face some problems collecting payments
- The investment property can end up in foreclosure
- Sellers have to administer the loan
- The Dodd-Frank Act of 2010 placed limits on owner carried mortgages
What Clients Are Saying
“Hi Ingrid, coming from a situation with a previous mortgage broker that never met us face-to-face, and told us we’d need a 50% down payment , you exceeded our expectations with the mortgage you got for us! I also found you to be very down to earth and easy to talk to. Nothing I can think of to improve on… Thanks again, and we’ll be in touch when we’re ready for the next place!”
Emily and Peter, 2016
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Federal Housing Authority Loans
FHA loans are government-sponsored loans that incentivize people to purchase a home by offering a borrowing option in which the buyer needs to put down only 3.5%. The FHA doesnt loan the money it guarantees the loan for the lender. Since the FHA takes on some of the financial risk by insuring the payment of the loan if the borrower defaults, its easier for borrowers to qualify for an FHA loan than a conventional loan, and the lender is able to offer a competitive interest rate.
Real Estate Project Finance Vs Corporate Finance
When a corporationCorporationA corporation is a legal entity created by individuals, stockholders, or shareholders, with the purpose of operating for profit. Corporations are allowed to enter takes on a new investment, it can use cash flows from other operating activities to fund the new project. It can also use its general creditworthiness to borrow money and fund the project. The corporation might also issue equity with an indefinite time horizon. In real estate project finance, equity used to fund the project is usually repaid at the end of a specific time horizon.
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Plan For Multiple Locations
Loans may take some time to be processed, which could result in the property you wanted being sold to another buyer. Because of this, its wise to come up with a few options for where you are going to source your debt. In order to get a loan, youll need to show that you have a plan in place that will likely result in a good return on investment .
Plan for working with multiple lenders, not just your preferred lender, just you in case you have to come up with a backup plan should things take longer than you expect.
Three Final Tips To Make Financing Your Investment Property As Easy As Possible
I’ll leave you with three suggestions to make sure the investment property financing process goes as easily as possible:
First, don’t just check major lenders. You might be surprised at how willing some smaller local banks and credit unions are to finance investment properties. These institutions also have an excellent knowledge of their local markets. Don’t overlook them.
Second, get your documentation in order before you start applying. Besides a signed purchase agreement, gather your recent tax returns, W-2s, contact information for your employer, and other documents. When you apply for a mortgage, you’ll need a lot of paperwork before your loan can be processed. The less time you take to get everything in your lender’s hands, the better.
Finally, be responsive throughout the process, especially if you have a tight closing time frame. If your lender has a question for you , it’s important to respond as quickly as possible. Expect curveballs and deal with them quickly.
Investment property financing is a complex topic, and it’s important to know the practical options and best practices for navigating the process. There’s no one-size-fits-all way to finance investment properties, so weigh the pros and cons of each financing method to find the best fit for you.
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What Is Real Estate Investing And Why Is It Important
Real estate investment means buying property to earn income. That income can be passive or active .
Real estate can and should play a significant part in your investment strategy. Historically, itâs one of the most reliable investments you can make and is an excellent way to diversify your portfolio.
You can invest in real estate directly by using leverage to purchase a home or rental property or indirectly by buying shares of a real estate investment trust or online real estate crowdfunding platform.
In addition to giving you ownership of a tangible asset , real estate can effectively hedge against inflation and other market sectors. Overall, investing in real estate is one of the best ways to generate cash flow, build wealth, and increase your net worth.
Other Ways You Could Finance An Investment Property
If you’ve exhausted those options, there are some other ways you could get financing for an investment property:
- Home equity loan or line of credit: Borrowing against the equity in your home could be a smart way to fund an investment property. These loans can generally be obtained with relatively low interest rates and reasonable fees. Plus this effectively make you a cash buyer, which can make your offers more attractive to sellers.
- 401k loan: Many 401k and similar retirement plans let participants borrow up to $50,000 from their funds. While retirement funds should be used for retirement, there’s a solid value case to be made for investment properties. After all, you’ll generally pay prime plus one on a 401k loan, and the interest is being paid to you, not a bank.
- Owner financing: Getting a seller to finance a property themselves isn’t unheard of, but it isn’t common, either. Owner financing is often suggested as one of the “creative” ways to buy an investment property with little or no money down. If someone offers owner financing or you want to ask, great. But I’d advise against planning on using this method.
- Crowdfunding: The real estate crowdfunding industry is evolving rapidly. Although there aren’t a ton of choices when it comes to single residential rental properties, several new options will likely come to market soon. Groundfloor is a good existing option if you’re interested in pursuing this route.
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Dip Into Your Home Equity
Home equity refers to the portion of your home that you already own, or in other words, the portion of capital in your home loan that you have already paid off. Market forces can also affect home equity by raising the value of your home.
You can leverage your home equity for a loan, which you can then use to fund a second home loan for your investment property, or at least the deposit for that property. Over time, if all goes according to plan, the rental income on your investment property will enable you to pay off the loan. Bear in mind that there are tax implications as an investor if you choose this option, so best consult with your tax expert first.
Special Us Govt Schemes Like Usda Loans
With an end goal to fill underpopulated zones of the U.S., the U.S. Department of Agriculture’s Rural Development office gives mortgages with down payments as low as 0%. These loans are offered only in towns with populations of 10,000 or less. All things considered, 10,000 is very sizable for most towns, so 97% of the U.S. is secured.
USDA loans are zero-down-payment mortgages for rural and suburban homebuyers. These loans go to those who qualify as having a low or moderate-income. Theyre mainly for borrowers who aren’t wealthy and cant get a traditional mortgage. To check whether your area qualifies for this loan, you can visit USDA.gov and read their terms and conditions.
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