For someone trying to start a career in real estate, or even just trying to buy their first home, the concept of real estate financing can seem daunting. Fear not though, there are many options for would-be investors of all sorts to join the market no matter what their intentions or available capital. What separates the successful from the unsuccessful in real estate investing is knowledge of the financing options on hand and choosing the one that’s right for your specific situation.
Here are the five most common options for real estate financing and some of the pros and cons for each.
The simplest, and most straightforward, way to finance a real estate purchase is to buy it outright. While this option requires the buyer to have all the money up front at the time of purchase, the buyer then saves a great deal, both on interest and on the overall price. However, if you are buying real estate as a business investment you may see a better return using other methods such as loans to buy more property. For capital rich investors this can be a very safe option.
Many first-time investors will be looking to acquire a loan from a bank. The most common of these is the Conventional Mortgage Loan for financing a home loan. An investor provides a down payment of 20% of the home’s value and pays the rest off over time along with interest. This sort of loan is underwritten by government backed mortgage institutions (the famous Freddie Mac and Fannie Mae) and they come with strict guidelines for the bank to follow. An investor’s credit score, assets, and income will be considered; and those with credit scores under 680 will likely be rejected. However, strict guidelines mean the banks can offer lower interest rates and for many investors a traditional mortgage offers safe way to acquire real estate with a minimum of interest.
Hard Money loans are short term, high interest rate loans provided by individuals or private investors. The benefit of these loans is that they rarely take the investor’s finances into consideration when determining the deal; relying solely on the value of the property. However, because they aren’t as tightly regulated, they can be acquired very quickly. These loans are most often used for properties that need substantial repairs or commercial building maintenance. Any investor looking at a Hard Money Loan should have a clear strategy to exit the loan and should avoid keeping such it for more than a few months.
If you’re looking to break into the real estate business, Private Money is an essential part of building your business. In most situations like these private companies or individuals will agree to loan the investor funds to buy real estate in exchange for interest paid off in a set period. Like Hard Money this sort of loan is usually used for increasing a properties value in a short time through renovation, and the investor should have a clear strategy for paying off the loan. The terms of these loans will vary depending on the lenders trust in the investor, so would-be investors should build their professional connections and reputation.
Finally, an investor can sometimes find sellers or real estate developers who are interested in entering a mutually beneficial deal. Here the buyer pays installments directly to the seller, rather than a bank. Investors should keep an eye out for these sorts of deals, they often indicate that a seller is having trouble selling the property and might be ready to sell for less.
These five are by no means the only financing options out there. In the end each investor must be proactive in finding the solution that is right for them. However, most first-time investors looking to either start a real estate business or looking for that first place to call their own will find these five a solid foundation in the subject of Real Estate Finance.