Investing in real estate is among the most popular ways of generating income. However, financing real estate investments continue to be a major challenge for many new investors. Just like any other investment, it is important that you understand the different financing tools available to finance your real estate project. Many people fear venturing into real estate for various reasons. Some people shy away from real estate properties due to the popular belief that it is for the rich. This is not always true because there are many financing options available that you can make use of to close many real estate deals.
What Is Real Estate Financing
Real estate financing refers to the different tools an investor can use to fund a real estate project. This financing options enable a real estate investor to acquire a new real estate property or renovate an old one. Various real estate financing options come with different terms and conditions which should be understood well before deciding which one suits you best.
Types of Real Estate Financing Options
1. All Cash Financing
Paying in cash is a very popular option when financing a real estate investment. It is important to note that cash financing does not mean paying in cash. The term is usually used to denote the availability of the cash needed to meet the entire cost of the property. For example, checks are classified as cash financing.
- Cash financing has various advantages which include:
- It saves you from paying high interest which comes with loans
- Most cash offers are easily accepted
- One can immediately receive equity on the investment
Although many new investors cannot afford cash financing, it is the most convenient and simplest means of financing real estate investments. This option is less complicated and saves you a lot of time.
In situations where a real estate investment is beyond your financial ability, an equity partner may be a great option. An equity partner helps finance the investment in different ways. The partner’s money may be used to fund the entire project or only pay for the down payment. Unlike other lenders, an equity partner does not demand interest on their money. However, depending on how much the investment makes, they receive a certain percentage of what is generated by the property.
Depending on the signed agreement by both parties, an equity partner may play an active role or a passive role in the management of the property.
3. Hard Money
Hard money lenders provide loans for the purpose of financing real estate investments for a short period. Unlike other loan providers, hard money lenders provide loans with a higher interest rate for a short time based on the property’s value. Hard money loans should be used with caution when financing real estate investments due to their high interest rates. It is therefore important to have a clear exit strategy before considering hard money loans.
Hard money lenders can be found by consulting real estate agents, searching on the internet or in the newspaper.
4. Private Money Lenders
Private money is similar to hard money in many aspects but is usually differentiated by the relationship between the borrower and the lender. Unlike a hard money lender, a private money lender is not an experienced lender. A private money lender only aims to generate interest from their cash. These loans are common to investors who believe they can raise the cash within a short period of time; usually 6-12 months. Just like hard money loans, private money loans should be used with caution when financing real estate. Additionally, you should only consider private money lenders when you have a clear exit plan.
5. Owner Financing
Other than banks, the seller of a property can help finance your investment. In owner financing, the buyer makes monthly payments to the seller rather than going through traditional mortgages or through the bank. One advantage of using this financing option is the seller is able to sell the property quickly. Furthermore, both parties save on the high fees incurred during the closing process.
Most Popular Loans for Financing Real Estate Investment
When evaluating different financing options for real estate investments, one should put into consideration the various types of loans available. Some of the best loans available for real estate investments include:
1. Conventional Mortgage
Traditional mortgage loans are one of the most popular tools of financing real estate investment. Typically, conventional mortgage loans require a down payment of at least 20% of the value of the property. A conventional mortgage is the most popular mortgage because of its low interest rates.
2. 203K Loan
This is a special type of loan designed for the purpose of financing real estate investments. A 203K loan is used to purchase and renovate old or damaged properties. These loans are attractive to many people because of their low down payment requirement (3.5%), and because they include both the purchase cost together with the renovation cost. It is important to note that 203k loans are only available for owner occupants only. This means they are not available for commercial properties.
3. Federal Housing Administration (FHA) Loans
These loans are available to people who cannot own homes due to their poor credit score, or those who cannot save and raise a higher down payment. These loans also have low interest rates and a low down payment (as low as 3.5%). Just like 203k loans, FHA loans are only available for owner-occupied properties. They also do not allow the purchase of more than one unit property.
4. Portfolio Loans
Some banks and other lending institutions lend funds from their own sources which qualifies them as a portfolio lender. Since it is their money, they are able to offer flexible qualifying terms to their borrowers.
5. VA Loans
VA is a mortgage loan that is guaranteed by the U.S. Department of Veterans Affairs (VA) to U.S Veterans, their spouses and service members. VA usually guarantees a maximum of 25% of the loan property.
6. Home Equity Loan
This loan is available to homeowners who have built equity on their property and are therefore able to take a loan that can finance their real estate investment against that equity. Borrowers can enjoy flexible terms and can restructure their repayment at their convenience. In addition, the flexibility of these loans enables real estate investors to expand portfolios on their own terms.
There are many strategies you can use as a first timer to finance your real estate investment. Deciding how you will fund your real estate property is as important as finding the property. Therefore, as a real estate investor, it is your role to come up with creative ways to fund your new projects. Different real estate investments may require different funding, and you should, therefore, evaluate the available options to decide on which best suits your investment.