In a strong economy with low-interest rates, real estate becomes a very attractive investment opportunity. It makes sense to think about your options for financing before you look into properties for your portfolio. There are many options for financing, from conventional bank mortgages to private or hard money loans that use the property to secure the loan. Some investors use a mortgage broker to find the best loan for their investment property.
Here are some of your options for financing:
1. An All-Cash Deal
If you have the means, you might be tempted to invest your cash in an investment property to pay for it all at once. As a matter of fact, it is estimated that nearly a quarter of investors in the United States finance their investments by providing all of the funding on their own. However, an all-cash deal may not be your best option because you won’t be able to deduct your interest payments for a mortgage on investment property, a tax shelter you will miss out on if you pay all cash.
Another consideration is how to invest your money for a favorable return. With $150,000 to invest, you can buy a property for that amount in an all-cash deal and collect rent for a decent cash flow. However, you may decide to put $30,000 down on five properties for a total of $150,000 and finance the remaining 70% for a chance to realize greater returns. You can grow your investment portfolio much quicker with leverage.
2. A Conventional Mortgage
Conventional mortgages or bank loans conform to Fannie Mae or Freddie Mac guidelines. For a private residence, most lenders require a 10-20% down payment, while 25% or more is typically required for an investment property. Your lender will look at your credit history, credit score, and property factors (potential income, location, condition, etc ) for approval and to determine the interest rate of the mortgage.
To obtain a conventional mortgage, you must show that you have sufficient income and assets to meet your current debt and make the payments on the loan for the investment property. Lenders may look for cash that will cover six months of mortgage obligations for your current mortgage and the new mortgage. Cash flow from anticipated rent from the investment property is not used in these debt-to-income calculations for a conventional mortgage.
3. A Hard Money Loan
A hard money loan is financing obtained from a private lender who is more interested in the value of the property than your personal credit score. These short-term loans are sometimes called bridge loans, and they are often used by investors who buy property in need of improvements. The hard money lender will base the loan on the After Repair Value (ARV), an estimate of how much the property will worth after renovation and your experience in managing the property.
While hard money loans are convenient, there are some downsides. You may have to pay for an array of fees and closing costs, and the loan rate will probably be substantially higher than that of a conventional mortgage. This type of loan offers short repayment terms, so they are suitable if you “flip” houses – that is, you buy a property, fix it up and sell it quickly. The benefits are that hard money loans can take just weeks instead of months, the terms may be flexible and the property is used as collateral.
4. A Private Money Loan
A private money loan can be from anyone – a relative, a friend, or a neighbor. Another potential source of private money is the seller of the investment property. As hard money lenders, private money lenders are more interested in the strength of your deal and your experience in dealing with investment property.
5. A Credit Union
While credit unions may be a little more flexible in terms of the loan, generally speaking, they abide by the same strict Fannie Mae and Freddie Mac rules as banks.
Tips for Financing your Investment Property
If you are thinking about traditional financing, look into mortgages from smaller local banks where you may get better rates. While a mortgage broker can offer advice about a wide range of financing instruments, all brokers are not the same. Make sure to check out his or her experience and reputation. A mortgage broker will charge you a commission of typically 0.5-2% of the loan amount when the loan is closed. Ideally, you want to obtain at least 3 quotes and compare rates, terms, etc side by side to make a decision.
Real estate is a popular investment choice because it can offer a stable asset that produces an immediate cash flow. You can leverage the capital investment to build wealth faster…
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