4 ways to finance your next investment property
If it wasn’t for the hundreds of thousands of dollars it takes to actually purchase real estate, I bet most of us would have plenty of investment properties. Unfortunately that’s not the case and many of us just don’t have $100k of liquid cash to invest with. That brings us to the ever-lasting world of investor financing! After all, this country was built on debt, right? Here are 4 ways you can leverage debt and finance your next rental or flip.
Conventional loans are solid options when going after rental properties right away. While they can offer down payment options as low as 5%, usually that’s only if you do not own a primary residence. If you already own a home, you can expect to have to put down 20% in order to finance your next investment property. Conventional lenders are also less stringent on the condition the house needs to be in – unlike FHA (they’ll raise a red flag even if they find something as simple as chipped paint!).
I wouldn’t recommend obtaining a conventional or FHA loan for rehab projects simply because you would be responsible for the monthly mortgage payments immediately after closing and as you begin your rehab project. If your rehab project takes 2-3 months, you can expect to pay 2-3 months’ worth of mortgage payments which could eat into your profit potential. This type of loan can be a sound alternative when pursuing your next investment property, just be careful of the pitfalls.
I had a conversation with a friend of mine who has invested in a rental property with a FHA loan that changed my entire outlook on the infamous FHA loan. The conversation left me with thoughts on how consumers usually apply their FHA “credit.” FHA borrowers surely love to take advantage of the low 3.5% down payment that the organization offers and they usually use the loan on a single family home they use for their primary residence. At that point, if they wanted to go after an investment property, they would be looking at a 20% down payment for sure. While you can own multiple properties using a conventional loan, you can only have one property under a FHA loan, at a time. Therefore, the individual that purchased the single family home would have to sell that home in order to free up their FHA “credit” to purchase a new home. I challenge FHA borrowers to take a different approach to the FHA loan. The way I see it, would you rather take advantage of the low 3.5% down payment for a single family home, one that causes you an expense, OR, a rental property, one that causes you income?
The main pitfall with FHA loans is that they usually do not lend on extremely distressed properties therefore the home better be in decent shape to avoid the meticulous red flags that FHA are known for. One way to combat this is with FHA’s 203k renovation loan which will allow you to roll the costs of renovations into the amount of the mortgage. There are various conventional renovation loans that are available, however, FHA’s 203k will still offer the low down payment of 3.5%
There’s the age old saying in the world of real estate, “Cash is King.” Simply put, those who will be purchasing with a mortgage, whether FHA or Conventional, will face headwinds if they find themselves competing with another offer of all cash. Why? Two main reasons: The time period to close with a FHA or conventional loan can take anywhere from 45-60 days AND the transaction itself now becomes the vulnerable to various inspection, mortgage, and appraisal contingencies that can put extreme strain on the transaction and even cause delays. If the seller sees an all cash offer, they know they can eliminate many, if not all, stresses and close as early as two weeks.
So the question now becomes, where can I find the cash??
Hard Money Lenders
This is probably the easiest, and most omnipresent opportunity to find access to straight cash to fund your investment deal. Whether it’s a rental or a rehab, a hard money loan will get the job done. Hard money lenders are either a pool of investors or company that will lend you the money to fund your deal. Much different than banks, hard money lenders charge a higher interest rate, points and will be expecting their money back within the year – sometimes two years depending on which lender you choose. Hard money lenders are more interested in the deal you propose to them rather than how “qualified” you are as borrower. Sure they may check your credit score and review your track record, but nowhere near as demanding as applying for a conventional or FHA loan. The best part is, it won’t even show up on your credit report! That’s right, you could essentially buy a home, and your credit score would remain unaffected — for a flip that is, you would have to eventually refinance your rental property.
Another perk going with a hard money lender for flipping is they usually will cover up to 70-95% of the purchase price and 100% of the rehab. For simplicity of understanding, say I’m working with a lender who is offering me 85% funding of the purchase price and 100% of the rehab. If I were to find a home currently priced at 100k and needs 50k worth of work put into it, I would only have to come out of pocket 15k in order to start the project. Do you see the leverage? My $15k now started a $150k project.
Remember, that’s the simple way of looking at it. Don’t forget hard money lenders are notorious for the points (interest charged up front), fees, and higher interest rates they charge in order to get the transaction moving. As long as the numbers still work in your favor, I look at it as the cost of doing business. Rob K. Blake from Biggerpockets.com, an excellent real estate investing education site and forum, has a very useful hard money spreadsheet great for analyzing a hard money deal. You can find it here!
Similar to hard money, this is another way to get direct access to cash. The difference is that these individuals aren’t part of a hard lending company. These are individuals that have more than enough cash to invest in real estate. Private capital’s lending terms are usually less abrasive considering your dealing directly with an individual(s). Imagine your doctor, who has had an extremely successful career, now beginning to think about retirement and wants more passive income to support his family. Assuming he built a very healthy nest egg over the years of his career, he now has $250,000 to work with and doesn’t want to put it in the stock market. As his patient, he knows you also have had a successful career in real estate and decides he’s willing to lend you some money if you can help him get a return on his investment. This is just an example for you to get an idea of private funding, there are various scenarios in which private funding can help you. Could you imagine negotiating interest rates, fees, and terms with your doctor? Probably a much easier conversation than a hard money lender. Ideally, private capital is usually the best source of cash other than using your very own money. You’re more in control of the financing terms which in turn, puts more money in your pocket.
As you head towards your investing goals, analyze which lending strategy will for you and your game plan. While your lending strategy is an important spoke in your business, don’t undermine the fact that if you find a great deal, you can be sure that the money needed for funding will always find a way to you. These 4 will give you some solid go to options that you can count on just as long as you’re aware of the pros and cons of each financing strategy. Add these to your toolbox and take one step closer to your goals!