All the market knowledge and property listings in the world won’t do you much good if you don’t have access to capital for your deals. However, learning the ins and outs of finding real estate investment loans, and honing in on which particular path to explore to find those coveted real estate loans, is one of the most important tasks a new investor faces.
Even for those with a financial background, it can be challenging to comprehend all the moving financial parts that go into real estate financing (and that’s before we broach the subject of the exciting, if sometimes complex, subject of real estate crowdfunding).
Understanding the principles of capital is no quick feat. That said, here’s a guide to three common ways of finding real estate investment loans and securing your next project.
3 Methods For Finding Real Estate Investment Loans
1. Conventional Mortgages
Conventional mortgages, for those not familiar, are loans not offered by the government (e.g. the Federal Housing Administrations, the U.S. Department of Veteran affairs, or the USDA Rural Housing Service). These loans, instead, come from private financial institutions (e.g. banks, credit unions), the Federal Government National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac).
Despite their predominant use as a tool for homebuyers to buy a primary residence, conventional mortgages can be used by real estate investors looking for a loan with generous terms.
Though you’re likely to get much less-stringent terms than you would with a loan from a hard money lender, conventional mortgages do require a 20 percent down payment of the property’s purchase price, though this can go up to as high as 30 percent.
To be approved, the lender would look at the following:
- Personal credit score and credit history (to determine your interest rate)
- Income and assets
- The ability to pay for any existing mortgage on top of your investment property’s mortgage
- Most lenders would also prefer that you can cover at least six months worth of mortgage
You are not eligible for a conventional mortgage if you can say “yes” to any of the following:
- Declared bankruptcy or had a foreclosure in the past seven years
- Have a debt-to-income ratio over 43 percent
- Have a credit score below 650
2. Hard Money Lenders
Hard money loans are short-term loans typically used by residential developers whose aim is to renovate/develop a property, quickly, and sell it.
The term “hard money lending” is actually a misnomer; it doesn’t refer to how difficult it is to apply for; it refers to firmer financing terms when compared to other types of lending.
As opposed to bank loans, hard money lenders do not look at the credit score of a borrower (which can be a good thing if your credit is a little on the shaky side).
Instead, hard money lenders look at the value of the property — specifically the after repair value (ARV) — to decide whether they will grant the loan.
If you want to go the hard money lending route, consider these facts:
Pros of Hard Money Lending:
- Secure loans faster: Banks can take months to grant you your loan, due to strict regulations. Hard money lenders, on the other hand, don’t take nearly as long to give you a decision. This is especially important for developments on tight deadlines.
- Flexibility in collaterals: Your property is usually the collateral for loans. However, hard money lenders can also accept personal assets, like your residential property or your retirement account.
- Flexible terms: One of the best things about dealing with private lenders is you can negotiate loan terms. There are two key areas to negotiate: repayment terms and fees.
Cons of Hard Money Lending:
- Shorter repayment time: Hard money borrowing is for those who immediately need money to develop a property and put it in the marketplace, fast. As such, these types of loans have shorter repayment times when compared to conventional financing. Make sure you clearly understand the repayment terms before accepting hard money.
- Cost: The catch with the convenience of hard money lending is that it comes with higher rates (can be up to 10 percentage points higher than conventional lending) and higher fees (e.g. origination and loan-servicing fees, closing costs).
3. Private Money Lenders
The term private money lenders is sometimes used interchangeably with hard money lenders. (Both are forms of financing outside the more traditional realm of a financial institution.)
The key difference is that private lenders are not “professional lenders.” They are not affiliated with any lending company. Private lenders are usually people, within your network, who have extra money and want a good ROI on their money.
Common sources of private money would include:
- Parents, cousins, neighbors, or co-workers
- Associates of your primary circle for friends and family
- Accredited investors, people you met via networking or through advertising (remember you need to first establish credibility before asking for more money)
There is less formality involved with this type of lending. As such, this is a method that best fits new investors and seasoned investors who have been turned down by banks. Credit is not usually the biggest factor; rather your commitment to starting good business (and your ability to present yourself in the most professional way possible).
Process Of Elimination
Though we’ve covered many different types of real estate investment loans, some of which may not be a good fit for you as a real estate investor, understanding which path you won’t go down can often be as liberating, as knowing which path you will go down.
By taking a strategic approach to your financing, and narrowing down your options for raising capital, you’ll be that much closer to mastering the art of taking immediate, massive action on a real estate deal, when a good one presents itself.