So you have the perfect plan: you’ve identified the best property on the market, determined a high potential for profit, and established your team to help get you started. Congrats! You’re off to a great start. What you need now is a source of real estate funding.
Remember, for the most part: no money = no deal.
There is no shortage of options to consider when evaluating different sources of financing for real estate investments.
If you are a new real estate investor or one who has completed many deals, having a clear understanding of your options for real estate funding can only benefit you in future transactions. Knowing which funding options work best will increase your profit potential in any type of deal: whether it be a fix and flip property or a buy and hold investment.
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[addtoany]Funding Option #1: Private Money Loans
Private money loans are often the first source that real estate entrepreneurs turn to for funding their investments, but this turn may be misguided. Most private loans come directly from a friend or family member– someone in your immediate circle. While these loans might seem like the easiest route to secure funding for your purchase and rehab costs, these providers come with their own potential concerns: they may not understand the intricacies of real estate investments, and are not bound by any sort of set company policies. Often times these lenders lack adequate knowledge to recognize a bad deal, even though they are assuming much of the risk. The personal nature of your relationship puts more than just financial risk at stake.
Private lenders’ interest rates vary. The private lender creates rates at his own discretion. That is to say, a friend may give you exceptionally low interest rates, or another may try to charge as much as possible. Loans from private lenders are often secured by a promissory note or mortgage on the property. In simple terms: if you don’t pay, they take your investment away from you. For some private lenders, foreclosing and taking ownership of the property is a more profitable business model for them, so be sure to do your research before deciding who you do business with.
Funding Option #2: Partnerships
Some real estate investors may form a legal partnership with a fellow investor. These types of arrangements take the form of what is known as an equity partnership . Unlike private funding, there is no promissory note or lien on the property. In this type of agreement, when one partner fails or succeeds, so does the other.
In a partnership, you are not responsible for making interest payments to your financing partner. Instead, they receive a piece of the deal’s profit.
Partnerships do not come without their issues, though. First: finding a partner that is both trustworthy and financially successful enough to fund a real estate investment may be difficult. Also, think twice before partnering up with a real estate investing partner who has no knowledge of, or interest in learning the industry unless you’re prepared to be responsible for the entirety of the execution.
To be on the same page, it is important that both you and your partner are aware of all possible risks and rewards associated with taking on an investment property. One way to help make this happen is to create a formal operating agreement that states all of the risks, responsibilities, and compensation structures for everyone involved.
A problem you might run into with a real estate partnership
Consider you and a partner team up on a fix and flip deal. The exterior structure of the house is fine and only requires an interior rehab. In the initial budget, the two of you only account for the interior renovation. However, once completed, you realize that the condition of the exterior, while acceptable, does not reflect the quality of the interior renovation. You might ask your partner for more money to clean up the exterior of the property to increase its curb appeal .
As a knowledgeable fix and flipper, you know that curb appeal is one of the most important factors in selling a home quickly. As a savvy investor, you understand the importance of getting in and out of a deal fast. However, your partner may see this as a useless investment and refuse to advance more cash. Avoid these issues by partnering with an investor who has a strong background in real estate investments, or clearly outlining roles and responsibilities.
Funding Option #3: Home Equity Loans & Lines of Credit
As an investor, you also have the choice to leverage the equity in your primary home to purchase a new property. A popular bank offering is the Home Equity Line of Credit, or HELOC.
Home Equity Credit Lines can sometimes offer a Loan To Value (LTV) of up to 90% of the equity in your existing home. For example: if your home is worth $1,000,000 and the bank is willing to lend 80% of your home’s value you would qualify for a loan of up to $800,000. However, if the mortgage on your primary residence is not paid off, the bank will deduct it from the loan amount. So, if in the above instance you have $50,000 left on your mortgage, you would only qualify for a loan of up to $750,000.
Pros and Cons
If you have an established primary residence with a solid market value, the bank will be willing to lend you money for a real estate investment project. The bank, for the most part, is completely disinterested in the value of your investment property in this loan scenario. Rather, they are more interested in the value of your home as collateral. Not only are these loans easy to get approved for, their interest rates are also lower than other real estate lending options.
However, taking out a home equity line of credit to fund a speculative real estate investment project like a fix and flip is extremely risky. Although the loan is easy to acquire and interest rates are low, fix and flips and real estate investmenting in general can be a risky endeavor. Putting your primary residence on the line is a lot of added pressure and risk, should the deal go south.
Funding Option #4: Conventional Mortgages
When determining how to get money for a real estate investment, conventional mortgages are also a popular option. Most traditional mortgages come from a bank with a requirement of a minimum 20% down. Interest rates are low for conventional mortgages hovering around 5%.
These mortgages seem great on paper, but may be extremely difficult to qualify for. Banks often require:
- A Credit Score above 700
- At least a 2 Year Profitable Track Record in Fix & Flip Deals
- No recent bankruptcies or foreclosures
Additionally, banks take a very long time to approve loans due to their extensive underwriting process. As an investor in fix and flips, this may be a deal breaker due to the speed and changing nature of the real estate market. Once an investor identifies a profitable property, most look to move quickly to acquire the property before another investor beats them to it.
That leaves us with last, but not least….
Funding Option #5: Hard Money Lenders
Many real estate investments (and fix and flip properties specifically) are funded with hard money. Hard money lenders are private lending firms that specialize in financing real estate investments.
While hard money interest rates may be slightly higher than other avenues, this type of loan is geared toward real estate investors, and therefore easier to secure. These lenders care less about a potential investor’s income and credit score, and more about facilitating a profitable deal. For this reason: hard money lenders are highly invested in helping borrowers identify high value properties and proceed through any necessary rehab.
Both new and experienced investors can secure financing through a hard money loan. For newer investors specifically, a good lender can be a trusted advisor and keep you from taking on a deal with too much risk or not enough profitability. Also, unlike conventional mortgages, hard money loans can be approved in anywhere from 5-10 days (but our record is just 48 hours!).
If you think hard money is the best route for your next investment, fill out our quick pre-qualification and chat with one of our experienced loan officers!
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