One of the most challenging steps that new investors in the real estate business have to overcome is finding financing for their business. Real estate has excellent potential and having a good understanding of how financing in this industry works can mean the difference between losing money and gaining a profit. Here are 11 financing options to make investing in real estate a possibility:
Traditional loans are loans that are sourced from established lenders such as banks. This is the most common and probably most familiar form of conventional financing. Traditional loans are generally readily available for qualified borrowers and considered reliable sources of financing for real estate. However, these types of loans take a while to complete and there is a risk that the borrower could lose the property to a buyer who pays cash.
Private lenders can be anyone – family members, friends, business acquaintances and the like – who are keen on investing in real estate, and have the funds necessary to finance the business. A key advantage to these fund sources is that they allow the potential investor to pay for a property with cash. It is also likely that their interest rates are lower than those offered by commercial sources. They would also probably agree to be paid back at the closing of the sale of the property.
A drawback with seeking financing from private lenders is that new investors may not have the track record and proven reliability when it comes to their success in investing. Hence, private lenders may be hesitant to participate.
Angel investors are wealthy individuals who offer capital for new businesses. What they ask for in return is ownership equity or convertible debt. Angel investors are risk-takers and are quite willing to invest in unproven ventures as long as these show good potential. However, financing from angel investors do not come as loans. These inventors become part owners of the business and will continue to share the profit from it as long as the business exists.
Venture capitalists offer financing to start-up businesses, particularly the ones that show the highest potential for becoming profitable. On the one hand, venture capitalists can offer large amounts of cash to new investors. In fact, they could offer more financial support than other traditional loan sources. On the other hand, venture capitalists tend to have very stringent requirements when selecting their investments. They are quite challenging to convince and often earn through profit sharing.
Small Business Administration Loans
The government is a key player in helping the nation’s small businesses find traction and grow. It is a good source of financing for real estate, with the number of lending options it offers. Real estate investors, for example, can consider 7(a) loans for basic loans or CDC 504 loans for fixed-rate and long-term financing. The disadvantage with small business loans is that the process is lengthy and quite tedious.
Microloans offer small sums of money for new businesses to use as capital. A microloan can go as high as $50,000 depending on the qualifications and conditions set. However, most borrowers are likely to receive an average amount of only about $13,000. Microloans are easy to apply for compared to traditional loans and these are quite accessible for investors who have no credit. However, the small amount of capital granted from these types of loans are often insufficient to help the investor move forward or expand. In most cases, investors have to find additional funding. Some micro lenders also charge high interest rates.
Real estate investors can do a number of things with commercial loans. They could, for example, use the existing equity of their business, or purchase, expand, remodel or refinance the business property to fund a number of business requirements. Commercial loans have the lowest interest rates, providing investors with more cash to use for their business. Payment plans can also be extended, thus minimizing the risk that an investor will default on a loan. However, to qualify for a commercial loan, the borrower must have an excellent credit history to prove his/her capability to pay back the loan.
Home equity line of credit or HELOC is a type of loan wherein the lender offers the maximum loan amount within an agreed-upon term. It does require a collateral, usually in the form of the borrower’s home equity. This is a revolving type of credit that provides more flexibility on the part of the borrower in terms of making payments.
If the borrower is unable to pay the principal on a given month due to some financial difficulties, for example, he/she may pay only the interest charges – at least, for as long as the problem lasts. But this generosity does not last long. If the borrower cannot pay off the debt, the lender could put pressure on the investor to sell the property that has been leveraged.
Hard Money Lenders
Hard money lenders are companies or private investors that provide short-term, asset-based loans secured by real property – in this case the value at quick sale of the borrower’s property. This is one of the quickest and easiest loans to apply for and borrowers can even complete the process in just 24 hours. The downside is that there are upfront fees and the interest rates are typically higher compared to the average fees and rates offered by banks.
Real Estate Crowdfunding
Real estate crowdfunding uses a pool of funds from different people for financing one or several deals. The terms of this type of financing tend to be flexible and it is increasingly becoming popular. The problem is that as more financers enter the agreement, the issue of equal compensation becomes more of a challenge.
A money partner is an individual or group of individuals who agree to share financing with the investor, along with other business responsibilities. The advantage of acquiring financing from a money partner is that expenses and business risks are shared. New business owners can also take advantage of their money partner’s additional contacts and complementary skills. However, money partners in general partnership organizations are both individually and jointly liable when it comes to business responsibilities. To minimize the risks, it is a good idea to document every agreement carefully and to work only with a partner who is reliable and can be trusted.