Creative Financing Strategies: Every Type of Real Estate Financing Method Explained
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Despite widespread belief, there is no such thing as free real estate. As you’ll learn as a real estate investor, one of the most important tools you have to master is real estate financing. Financing will become more and more challenging as you build your portfolio, even with the most basic single-family homes. You’ll also find yourself using a multitude of financing options because you’ll need all kinds of properties, goals, and investment styles.
In order to make a successful real estate investment work, you’ll need an investment vehicle, strategy, and financing method for each property. As you’ll read here, there are many options out there for you to use when financing, so don’t feel like you’re limited! The beauty of real estate financing can be found within the creative strategies of others. Read on to see what method could fit your financing situation.
What are your real estate finance options?
As mentioned above, there are plenty of financing options out there for you! You don’t have to go for the most common if it doesn’t work for you. This overview will provide you with a wide variety of financing methods, whether you want a property that doesn’t fit the norm or you want to renovate. Feel free to use this as a base for the financing types, but you should also explore to see what else is out there.
The most common finance methods:
Start here if your property fits the bill of normality, you’re beginning your investment journey, or you know you have the cash and credit score to back you up!
Most people choose to finance their investments with a cash down payment and conventional mortgage. Conventional mortgages are the most common type of mortgage and generally provide the lowest interest rates. Head on over to a mortgage broker to find the perfect lender and best rates for yourself.
Many investors, especially in today’s market, choose to pay in cash for an investment. An all-cash offer provides the quickest close for buyers and sellers. It’s an attractive option for the seller because they see you mean business and know the process will take less time.
To be clear: even when investors use terms like all-cash, the truth is no cash is traded. In most cases, the buyer brings a cashier’s check to their closing attorney, where the cash is held in trust. The closing attorney then transfers the money to the seller’s closing attorney.
While all-cash is typically the easiest form of financing, most new investors find that it isn’t an option. The return given from an all-cash deal isn’t the same as when the amount is leveraged.
Finance Methods for ‘out of the norm’ properties and situations:
These methods suit you if you’re buying something a little more risqué or know you need more support to purchase.
This real estate financing method is great for anyone interested in purchasing unique properties or properties that don’t fit conventional mortgage terms.
Portfolio lenders are banks and credit unions that lend entirely from their own funds without reselling the loans to a larger institution. Because they can keep the loans in-house, they don’t have to adhere to lending guidelines used by major government lenders. That’s why they’re great for the unconventional buyer!
You’ll find that conventional mortgage loans originate from various sources, such as credit unions, banks, and mortgage brokers. In most cases, these lending sources don’t actually use their own capital to fund the loan but rather acquire or borrow the funds from another party or resell the loan to government-backed institutions in order to replenish their funds. Most lending institutions adhere to a strict set of guidelines and rules when it comes to financing an investment. These rules often make it difficult to obtain financing for real estate investors and other self-employed borrowers.
Hard money loans
Hard money loans are used for properties in poor condition. Instead of borrowing from a bank, you obtain the loan from a private business or individual. In this way, they allow you to bypass the normal requirements so you can secure a loan quicker. Due to their shorter terms (6-48 months) and higher interest rates (8-15%), hard money loans are great if you’re planning on house flipping with a fast turnaround.
It’s safe to say many investors who use hard money lenders find themselves in tough situations when the short-term loan runs out, so make sure you have multiple exit strategies in place before taking the loan.
If you want to invest in a property, but the price range is beyond your reach, an equity partner may be your answer. An equity partner is someone who you bring into a deal to help finance the property.
There are no set rules to partnerships, so they can be structured in diverse ways. A partner’s cash could finance the entire property or simply fund the down payment.
Equity partners take a higher risk than a private lender might, but they have the potential to make significantly more if the investment is successful. An operating agreement between both partners secures the equity partner’s investment.
Methods to benefit the seller and the buyer:
While this isn’t a normal method of financing, it can be valuable in the right situation. With owner financing, the owner of the property funds your purchase instead of a lender, and you make your monthly payment to them instead of a bank. This usually only happens if the seller owns the home outright, with no existing mortgage on the property to pay off.
Owner financing can be a wonderful way to gain ownership of real estate without using a bank. Both the seller and buyer can bypass multiple fees, and it can equal a quicker turnaround. This strategy can also be a valuable tool for selling your properties in the future.
Methods that work with equity:
Home Equity Line of Credit (HELOC’s)
This form of loan is a go-to if you’ve built up equity in your primary residence. A HELOC allows you to tap into that equity. You use the equity to create a loan, which will be taken out as a line of credit. You can use this line of credit on anything, like financing another property or completing big renovations for an investor. While banks and credit unions have numerous different products, they all operate on the same principle.
In order to obtain a home equity loan or line of credit, you need to have equity in your home and enough income to qualify for the loan. Banks will only lend a certain percentage of your home’s value. While this percentage differs between lenders, it’s uncommon to find a lender that will offer past 80% of the appraised value of your home.
Methods for commercial properties:
Multi-family properties with more than five units are considered commercial properties when it comes to lending. If this fits your purchasing bill, then you may need to look at commercial loans for larger residential properties. This doesn’t apply to commercial real estate, which is covered in our Commercial Real Estate Survival Guide.
Commercial loans have slightly higher interest rates and fees, shorter terms, and different qualifying standards.
Commercial lenders still look at your income, credit score, and other personal financial indicators, but only to gain a picture of your skills finically and as an investor. Typically, the amount of revenue the property generates will be more important to the lender.
What You Need to Know…
One of the best skills you can develop as an investor is finding creative ways to finance real estate deals. No two deals are the same, so you’ll find yourself using many different financing strategies throughout your career.
Now that this overview has shown you what’s out there and how to use different financing methods in various situations, you’re ready to talk to the GMT team and talk options! It doesn’t matter whether you’re just starting to build your portfolio or a seasoned house flipper. There’s a creative financing option out there!