Real estate loans come in many different shapes and sizes, and with varying degrees of terms and compliance — and this only homebuyers looking for a primary residence.
As real estate investors, especially when starting out, it can be challenging to know which particular form of financing makes for the best investment property loans — and whether as an investor you can meet the (at-times) stringent investment property loan requirements.
Here’s a quick guide to some of the more common types of real estate loans and advice on how to pick one that’s right for your next deal.
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Which Real Estate Loans Work Best For Investors?
1. Conventional Mortgage Loans
While most of us have used conventional mortgage loans to purchase a home at one time or another, the main problem with these loans for real estate investors is that the amount you can borrow is tied to the appraised value of the property being purchased.
This means real estate investors seeking to buy a low-value (at time of purchase) property in need of renovations will find it difficult to get financing they need get the property up to a suitable condition for selling. Though some investors do “go conventional” with the purchase of investment properties, this is not an ideal source of financing for an investment property.
2. Lines of Credit (HELOCs and Home Equity Loans)
A home equity loan, or home equity line of credit, allows real estate investors to use existing property they own to get quick access to funding in the hopes of purchasing an investment property. A line of credit loan is usually approved quickly, once equity and credit are established, making this a convenient option for investors.
Don’t worry if your credit history is a little on the shaky side. One of the key advantages with this type of loan is that one’s credit history and score has little bearing on whether a loan is accessible (the home equity is the collateral).
One of the major drawbacks of this financing option lies in the fact that once one’s line of credit has been used up, there’s little or no money to be had. Additionally, every now and then, an investor can encounter an untrustworthy lender — home equity loans can be taken out from any lender, not just the holder of your primary mortgage — who pulls the line of credit when it is needed most.
A common investing strategy is to use the home equity loan as the source of the down payment for a property, and either find additional financing elsewhere or unload the property before more cash reserves are needed.
3. Portfolio Lenders
Think of portfolio lenders as an extension of a more traditional lending institution, such as a bank or credit union, but one in which loans are secured by the bank’s own capital, not a federal organization such as Freddie Mac. This means the loan terms and rates are much more flexible for portfolio lender loans than other types of loans.
As a result, portfolio mortgaged loans can be a great source of financing for real estate investors who want to work with a mortgage lender that understands their needs. This option is also useful for those who may not be eligible for traditional mortgage options.
Although portfolio lending is a safer, more flexible option for borrowers, it is not without its drawbacks. As is the case with many other loan options, good credit is necessary to secure a portfolio mortgage loan. Additionally, although borrowers can use stocks as collateral to secure this loan option, this can also result in an extended period before securing the loan, due to market volatility.
4. Private Money Lenders
Private money lenders are private investors, not affiliated with a lending institution, who offer borrowers money in exchange for a solid return on their investment. The advantages of private money loans are numerous: much quicker approvals than traditional loans, rates and terms can be negotiated, credit is not usually a factor.
The most important factor in finding private money is the ability to build relationships. And while this can be an advantage, for some this is probably the biggest drawback to raising private money. You must be able to cultivate relationships and convince people your business vision is worth investing in.
Many first-time investors, looking for investment property loans through a private lender, reach out to friends, family and colleagues to serve as private investors. These types of private money lenders may be less dissuaded by a lack of experience, and more convinced by the commitment and dedication a residential redeveloper brings to the table.
5. Hard Money Lenders
Don’t let the name fool you. Getting financing from a hard money lender isn’t necessarily difficult or painful; it simply means hard money lenders have firmer financing terms than a private investor.
Whereas traditional lending institutions have lending criteria, even with portfolio lenders, and private investors have varying lending criteria, a hard money lender strikes a balance between the two. Hard money lenders are more flexible than a bank but more rigid than a private investor, as they are usually connected to a financial institution.
This means enjoying advantages such as a quicker loan approval (much quicker than a bank) and more flexible borrowing standards in regards to credit. But this also means stricter loan terms, especially with rates and length, and the simple fact that it’s all about the “numbers.” If the numbers make sense for a hard money lender, they’ll usually do the deal. (No amount of “pitching” can wallpaper over the numbers.)
Still, despite some of the drawbacks — high-interest rate being one — this loan method is exceedingly flexible and can be a great option for investors looking to move on a property quickly.
6. Roth IRA Financing
Though many people view a Roth IRA as a glorified savings account, real estate as a long-term investment (especially with the acquisition of rental properties) fits well with the nature of a Roth IRA.
By having real estate as a part of one’s Roth IRA, investors can not only increase their income through rent they collect, but the Roth IRA can fund the purchase of a home — bringing the investor a ton of extra tax advantages. However, the money must be in the account beforehand.
One drawback of having real estate in a Roth IRA account is that the investor must pay attention to all details, as there are big tax implications, if not done correctly. Investors must have a custodian oversee their self-directed Roth IRA; therefore it’s important to find a custodian who offers the service of handling real estate purchases to their customers.
Also, to avoid disqualification, people who use an IRA as a real estate investment funding option must ensure all proceeds from the property (including rent and money from a sale if sold) go to and remain in the account. A great loan option, nonetheless, but one that needs to be researched and vetted thoroughly.
Keeping Your Options Open
When you’re scouting for investment property loans it can be far too easy to lock into just one source of financing, and be discouraged when that one avenue of funding doesn’t pan out. But by being flexible, and keeping all options on the table, you’ll find those elusive real estate loans you’ve dreamed much closer to reality.
Commercial Vs. Residential Real Estate Loans
There are a few key differences between commercial and residential real estate loans. Most notably, commercial loans will be larger and have shorter loan terms when compared to residential real estate — though the amortization period may be longer than the loan itself.
Commercial loans are typically granted to businesses, rather than individuals. As an investor, this would mean starting an LLC, S Corp, or other official designation before seeking financing. There are several reasons for this, including the layer of legal protections available.
Residential real estate loans typically go to individual borrowers when they are ready to purchase a house. Many residential loans are financed through traditional banks for 30-year loan terms. Residential loans also often have lower interest rates.
Many new investors get caught up on the idea of real estate financing, but it should never stop you from jumping into the industry. As the above list goes to show, there are numerous financing options available — and many investors use more than one. Remember there are pros and cons to all real estate loans and it’s important to weigh them each and every time. Research will be your best friend as you start this new journey.
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