Investing in real estate is a great way to diversify your portfolio and hedge against market volatility. There are many perks associated with owning an investment property, from flipping a property to creating a passive income stream by renting it out. The start-up cost is generally high, so it is important to do research and find the right deal.
There are four main types of loans to consider: conventional bank loans, hard money loans, private money loans, and home equity loans. Each has their own requirements and it is important to understand which works best for you before approaching a lender. With the right loan and the right investment, real estate can be a profitable investment.
Points of Emphasis:
- There are several methods of financing investment properties, such as drawing on the equity of your own home.
- Hard money loans provide short-term financing, usually with a quicker payback period than conventional mortgages.
- If you do not have the money to make a down payment, it is possible to use gifted funds, but it must be recorded.
- Purchasing properties and renovating them to be sold for a profit is termed 'flipping' in the real estate industry.
- Banks do not provide hard money loans, only conventional mortgages.
If you are the owner of a primary residence, you likely know about conventional mortgage loans. As opposed to FHA, VA, or USDA loans, which are backed by the federal government, conventional mortgages meet the criteria of Fannie Mae or Freddie Mac. Generally, when it comes to a conventional loan, a 20% down payment is expected for the purchase of a home. However, if purchasing an investment property, the lender may require 30% of the cost as a down payment. In order to qualify for a loan, the borrower must show a good credit score and credit history, as well as sufficient income and assets. Keep in mind that future rental income cannot be factored into DTI calculations, and lenders expect borrowers to have at least six months of cash on hand to cover both mortgages.
A hard money loan is a short-term financing option best suited for flipping an investment property. Investors often use a hard money loan to purchase a property and later pay it off with another loan. This refinancing allows investors to recoup the 'sweat equity' they've put into the project as cash.
One of the upsides of a hard money loan is that it may be easier to qualify for compared to a conventional loan, as the primary focus is on the property's profitability. Money may also be provided quickly, as opposed to waiting weeks or months for a conventional mortgage closing.
The main downside of a hard money loan is the relatively high cost. Interest rates at The Hard Money Co. are 15% with a repayment term of 6 months. Additionally, origination fees and closing costs are typically higher than those associated with conventional financing, which can reduce returns.
You can access the equity in your home to finance an investment property in four ways: taking out a home equity loan, a home equity line of credit (HELOC), a cash-out refinance, or a combination of these. In most cases, you can borrow up to 80% of the equity value of your home to be used towards the purchase, repair, and rehabilitation of an investment property. Each type of loan has its own advantages and disadvantages. With a HELOC, for example, you can use it in the same way as a credit card, and make monthly payments that are often just interest. The biggest downside is that the interest rate is usually variable, which means it can increase if the prime rate changes. On the other hand, a cash-out refinance would come with a fixed rate, but it may extend the life of your existing mortgage. This would mean paying more in interest for your primary residence, so you need to weigh the anticipated returns of an investment property against it.
Private money loans are loans that are given from one individual to another. The most common source of these loans is usually from family and friends of an investor. If you do not have anyone close to you who is willing to loan you money for a property purchase, you can look into attending local real estate investment networking events. There are a variety of directories that can help you find local investment clubs that you can join for networking. The terms and interest rates of private money loans can be very varied, from being very generous to predatory, depending on the borrower and the lender. These loans are usually secured with a legal contract that gives the lender the right to foreclose on the property if you do not pay. If you are new to real estate investing, think carefully about how your relationship with the lender may be affected if you default before signing an agreement with someone you know.
What are the financing requirements?
The requirements for each lender and type of financing may vary greatly. For example, private lenders may only require some sort of connection with the borrower, while hard money lenders may only require a strong real estate market and a good estimated after-repair value (ARV). On the other hand, home equity loans, home equity lines of credit (HELOCs), and conventional loans typically have much stricter requirements in terms of income and credit scores.
At The Hard Money Co., we look at the deal itself. If you bring a quality opportunity to the table and have the strategy to execute it, we'll do everything in our power to close the loan. This means no credit checks, no income verification, and no property appraisals. This expedites the process and gets you the funding you need fast.
What is better, a home equity loan or HELOC?
If you are looking to purchase one property and need a specific amount of money, then a home equity loan is the best option. However, if you plan to buy and sell multiple properties in a short period of time, then a HELOC is the better choice. This is due to its revolving access to cash, allowing you to draw from and pay down your credit line with each purchase and sale, instead of taking out and paying off multiple home equity loans.
Investing in a rental property or taking on a house-flipping project can be risky but they offer the potential for a great reward. Obtaining the funds to take advantage of an investment opportunity is no problem if you know where to look. As you assess different borrowing options, be mindful of both the short-term and long-term costs and how they might influence the return on the investment.