Getting your hands in the real estate market is a great way to make money. In fact, real estate is still widely regarded as the best investment one can make. But whether you are flipping a property, buying rental property for passive income, or holding purchased property to sell or develop later, getting started can require money from the jump. As the old saying goes, it often takes money to make money, and in no other industry is this more true than in real estate.
Not only does it cost money to purchase a piece of property, it also costs money to make improvements to a property in order to add value. However, even if you do not have the capital to get started, you can still make your real estate dreams a reality through investment property financing. Surprisingly, investment property financing is a method of financing commonly used by even the wealthiest among us.
Investment property financing is when an individual or entity receives a loan to put towards their investment property, with the assumption that the investment will be lucrative enough to not only pay off that loan, but also to return profit for the borrower. This determination is called return of investment, and is critical for lenders and borrowers when assessing the risks associated with giving and receiving loans. As pointed out by Utopia Management, it is also critical for borrowers to understand the real estate market of the area they are investing in, especially before taking out a loan. If market trends do not point towards growth and profitability, taking out a loan can have devastating consequences.
You may seek these loans from banks, private investors and lenders, the individual or entity you are purchasing the property from, and more. Below is a break down of the main investment property loan types.
Also Read: How much does it cost to build a house in USA.
Conventional Bank Loans
Conventional bank loans for investment property financing are most similar to regular mortgages, requiring a down payment plus monthly payments with interest over period of time. The bank will determine the interest rate of the loan using the credit score of the borrower, and will sometimes even require credit score minimums (currently 620) for borrowers.
Like any loan type, the borrowing terms will depend on both parties, but it is often understood that conventional bank loans are ideal for those with good credit scores who have the capital for a down payment and can keep up with monthly payments for a longer time period. This makes them ideal for those investing in rental property, because they can use their rental income to make money while also paying off their loan.
Hard Money Loans
Hard Money Loans are secured by real property and are determined by assessing the value of the property. Unlike other loan types, they are meant to be paid off quickly, and are usually given by lending companies, not banks.
Because they are not determined by the financial standing of the borrower, hard money loans are a good option for those without high credit scores. However, they do tend to have higher interest rates and are short-term loans, which can be burdensome to an individual who is unlikely to make money from their investment for some time. Hard money loans can be especially risky for the borrower if they default on the loan, which could result in losing the property altogether.
Hard money loans are then generally best suited for those who plan to fix and flip a property for a profit. The lenders will assess the ARV, or after repair value, of the fixer-upper, and expect that the increased value of the flipped property will enable the borrower to quickly pay off the loan they used to make those repairs.
Private Money Loans
Private money loans are similar to hard money loans in that the lender will place greater consideration on property value than on credit scores. However, the loan is not secured using the property. This means that the penalties of not paying back the loan within the agreed payback period will not result in losing the property, but it can mean that the borrower has to pay fees to have their loan repayment window extended.
These loans are great options for those who want the flexibility to use the loan for multiple investment properties. On the one hand, because these loans are only given by private lenders, they are more readily available and come with fewer hurdles (like credit score minimums) than loans given by banks. On the other hand, the short-term nature of these loans means that they are more suited to borrowers who can foresee a quick return on their investment(s).
Home Equity Loans
Borrowers can also use the equity in their homes to finance investment property. If a borrower has been paying a mortgage on their current home, and therefore own “equity” in the home, they can exchange this equity for a lump-sum loan that can be used towards an investment property. In order to be approved for this kind of loan, though, a good credit score is often required. Home equity loans are available through banks, savings and loans associations, mortgage companies, and investment companies, to name a few.
When one is approved for a home equity loan, the mortgage lenders will refinance the loan to ensure that the borrower continues to pay off what remains of the home in addition to the lump-sum loan received with home equity. Because the borrower has put up your equity as collateral, thereby lowering the risk associated with the loan, this often means that the mortgage refinancing will lower the interest rate.
However, there are a few drawbacks to home equity loans. For example, if one is unable to pay back the loan secured using home equity, they can lose their home. Further, if the value of the home were to suddenly decrease, they may end up owing more on the home than it is worth.
