- Those with unimpeded access to investment property loans will have a significant advantage over those that struggle to find financing each and every deal.
- Real estate investment loans can vary significantly, so make absolutely certain that you acquire the right type of loan for your next deal.
- The terms of each investment property loan should play a significant role in how you move forward with a respective deal.
All the market knowledge and property listings in the world won’t do you much good if you don’t have access to investment property loans. 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.
What Is An Investment Property Loan?
Investment property loans are, as you may have already guessed, loans used to acquire and work on an investment properties. That’s an important distinction to make, as investment property loans are typically relegated to those intent on investing. Investment property loans are, therefore, not to be confused with traditional loans. While it is entirely possible to use traditional loans to finance a rental property, I would usually advise against it. For starters, traditional loans (those acquired through traditional banking institutions) take far too long to receive and coincide with a lot more “hoops” to jump through. Despite coming with lower interest rates, traditional loans simply take too long to serve as a viable option for real estate investors, and their durations are upwards of 30 years.
Investment property loans, on the other hand, boast one benefit traditional loans can’t even come close to: speed of implementation. Investment property loans, like hard or private money loans, can sometimes take as little as a few days to receive. Since the time it takes to acquire them is much more in line with the typical investor’s time line, investment property loans are much more practical. And even though they come with higher interest rates, I can assure you the speed in which you get them is well worth it.
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Best Ways To Finance Rental Properties
Conventional mortgages, unlike most investment property loans, 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 if you want to avoid paying private mortgage insurance.
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
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.
Hard money loans serve as one of the best sources of funding for today’s investors for one simple reason: speed. Hard money loans can often be had in a moment’s notice if you have lined up the right partner. That said, it’s the speed in which you may receive the funding that will give you an advantage over the competition. When others are waiting for bank approval, you can proceed to make an offer
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).
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).
Investment Property Loan Rates
As I have already discussed, there are several types of investment property loans for investors to choose from. That said, there are two real estate investment loans that investors covet the most: hard money loans and private money loans.
Hard money lenders will usually ask for about 11 to 15 percent and about five points (additional upfront percentage fees based on the loan amount). It is worth noting, however, that there are no universal hard money lender guidelines; each will come complete with a different set of criteria. Private money lenders, on the other hand, will ask for slightly less, as they are usually someone within your own network. It’s not uncommon for private money lenders to charge interest rates upwards of 12 percent, but without the points hard money lenders ask for.
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 investment property loans, 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.