Financing the purchase of investment properties
is one of the biggest challenges facing investors. Many investors find that using a combination of financing options produces a well-rounded real estate investment portfolio, especially as existing properties are leveraged to purchase additional investment properties.
So, here is a top 10 list of financing methods to purchase real estate investments.
#1 All Cash
24% of US investors use 100% of their own cash to finance real estate investments, which is the easiest and quickest method of purchasing investment properties.
Most importantly, investors can often times purchase a property at a lower price with all cash and a quick close, which increases their profitability.
When paying all cash, an investor typically pays the title company with certified funds or a wire transfer, and the title company pays the seller.
#2 Delayed Financing
Delayed financing enables real estate investors to quick purchase properties for cash, rehab the property to add value, then immediately finance the property to recoup their cash.
The exact amount of cash an investor can receive from delayed financing of a property depends on a number of factors, so it’s advisable to consult a lender before purchasing the property.
Most importantly, real estate investors can boost their profits with delayed financing, because they are able to quickly purchase properties for cash and rehab them, then get the cash back out of the property to redeploy on another project.
#3 Hard Money
Hard money loans are backed by the value of the property, rather than the credit worthiness of the borrower.
Real estate investors usually use hard money loans on a short-time basis, perhaps while rehabbing an investment property or securing longer term financing. These loans have a lower loan-to-value ratio than traditional loans, and most often have a higher interest rate than other forms of financing.
#4 Private Money
Private money loans are very similar to hard money loans. The difference is that private money loans are from people who personally know the investor such as family and friends, while hard money loans are made by professional lenders.
Private money loans are often informal agreements, and can be from individuals with a vested interest in the investor, such as parents. As a result, the interest rates and terms of repayment for private money can be the most attractive form of financing.
#5 Portfolio Lenders
Portfolio lenders offer specialized loans for investment property with different income, debt, and credit requirements than traditional mortgage lenders. These lenders do not sell the loans to larger institutions, but keep them in-house for the term of the loan.
These lenders tend to be local financial institutions loaning their own money, so they do not have to meet lending guidelines of government institutions such as Fannie Mae. Therefore, portfolio lenders tend to be more flexible than traditional lenders.
#6 Self-Directed IRA
Using a self-directed IRA to finance investment property is a great way to diversify retirement savings while creating a portfolio to generate passive income throughout retirement.
Perhaps most importantly, investors can finance investment properties with non-recourse loans when using a self-directed IRA.
There are several rules involved with a self-directed IRA, so be sure to consult your financial and tax advisors for options, including setting up a Self-Directed IRA LLC (also known as a checkbook IRA).
#7 Self-Directed Solo 401(k)
A Self-Directed Solo 401(k) is another method of financing real estate investments with retirement savings.
Different from a traditional 401(k), a Self-Directed Solo 401(k) allows investors to choose investments held in the 401(k), which can include precious metals, real estate, stocks, bonds, etc.
Self-Directed Solo 401(k)s allow you to invest virtually tax-free, like a traditional 401(k) plan. But with a Self-Directed Solo 401(k), you personally direct which investments are made, and you have the option to invest in real estate.
Like a self-directed IRA, Self-Directed Solo 401(k)s have rules that must be carefully followed, so consult your financial advisors for options.
Partnerships to finance investment property are very helpful, especially when you are unable to personally finance the property.
Partnerships can be structured to fit the needs of the individuals involved. A partner can be used to purchase a portion of the purchase or the entire purchase, with profits typically split according to each partner’s contribution.
#9 203K Loan
A 203K loan combines the traditional “home improvement” loan with a standard FHA mortgage, and is available to both buyers and refinancing households, allowing homeowners to borrow the money to pay for renovation costs.
This FHA loan allows homeowners to finance repairs and improvements of the property with a mortgage. Since this is a FHA home loan, there is a low down payment option. The downside for investors, though, is that the property must be owner occupied to qualify for a 203K mortgage.
A conventional mortgage can be used to finance investment property, but there are more restrictions with these loans than owner-occupied home loans.
The down payment to finance investment property with a conventional mortgage is 20% or more. Additionally, most lenders limit the number of investment properties they will finance with a mortgage for a single investor, while also limiting the total amount of money they will lend the investor. Therefore, a conventional mortgage is usually an option only for smaller investors who have a few properties.