10 Types of Financing That All Real Estate Investors Should Know About
10 Types of Financing That All Real Estate Investors Should Know About
There's more than one way to finance real estate
Financing an investment property isn't always as easy as financing a primary residence. Thankfully, just because it's not as straightforward, doesn't mean there aren't ample options. If you're a real estate investor, here are 10 types of financing you need to know about.
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1. Conventional loan
Conventional loans are the most common type of financing for an investment property. This loan is issued through a bank, credit union, or non-bank lender and will require a minimum of 20% down. Residential conventional loans usually have a fixed-rate mortgage that can be anywhere from 15 years to 30 years, similar to a primary residence loan.
Commercial conventional loans are usually for shorter periods and may or may not include a balloon payment. It's also common to have an adjustable interest rate that fluctuates over the life of the loan.
This is a great route for investors who are well-qualified for a loan, have 20% of the purchase price to use for a down payment, and have found a property in good enough condition as-is that it will pass inspections and standards for financing by a traditional lender.
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2. Hard money loan
Hard money loans are a popular financing option for fix-and-flip investors because they provide short-term financing for properties that would not meet traditional lender requirements because of the condition or borrower qualifications.
Because hard money loans are done in the private sector, each lender will have their own down payment requirements, borrower qualifications, and criteria for underwriting the loan. Still, they are less stringent than a bank in almost all cases.
Hard money loans are much more expensive than traditional loans -- with interest rates in the double digits and, usually, points (fees added to the total financed amount) -- but can still be a worthwhile financing option for rehabbers who can get in and out of the loan quickly.
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3. Private money
Private money loans are loans made from one private party to another; for example, when a friend or family member loans money to purchase an investment that is repaid over time according to the terms negotiated in the mortgage and note.
Interest rates and the loan length will depend on what is negotiated between the parties. Professional private lending companies have strict underwriting and borrower criteria, while a more relaxed agreement between friends or family members can have more flexible and affordable terms.
Private money is a great alternative for those who may not want to pay the higher fees associated with a hard money loan and have access to people with money to lend but won't qualify for traditional financing.
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4. Seller financing
Seller financing, also called owner financing, refers to when a property owner carries or holds financing for the buyer, acting as a bank. The buyer repays the seller according to the negotiated terms in the mortgage note.
Depending on what's negotiated, terms will vary greatly and can have extremely flexible and favorable terms. Buyers can negotiate no money down or low interest rates, although some sellers may not be open to that and will require larger down payments or high interest rates with balloon payments.
Seller financing is a worthwhile financing option if you cannot secure traditional financing because of your qualifications or the property's condition or when the terms negotiated are more favorable than a conventional mortgage can offer.
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5. Bridge loan
A bridge loan is a type of financing used for temporary transactional funding. For example, if the property needs to close by a specific date, but the bank won't have the financing approved in time, you can use a bridge loan to help bridge the gap between the sale date and the final long-term financing solution.
Like hard money loans, Bridge loans often charge points and will have much higher interest rates than a conventional lender, with only short-term loan periods ranging from a few weeks to a few months.
Bridge financing is a good solution for investors who need financing quickly before securing more long-term financing and are willing to pay an upcharge to secure the deal.
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6. Small Business Administration (SBA) loans
Small Business Administration (SBA) loans are government-backed commercial real estate loans guaranteed by the SBA. There are two types of SBA loans available to investors, depending on the purchase price and use of the property: SBA 7a loan and SBA 504.
Both are popular options for investors because they require low down payments (as little as 10%), offer long-term loans (up to 20 years), have relatively low-interest rates, and can even include renovation, development, or land acquisition costs in the loan. So, the property doesn't have to be in pristine condition or operating at full capacity to get approved.
SBA loans are a great option for investors looking to purchase and develop a commercial property or who want to purchase an existing commercial property and have good loan qualifications.
ALSO READ: Small Business Loan vs. Personal Loan: Which Is Right for Me?
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7. Crowdfunding
Crowdfunding real estate is when a group of investors pools their money to fund an investment project. This collaboration is usually done through a crowdfunding platform that vets the investor, referred to as the sponsor, who wants to acquire and manage the property.
The platform then opens the investment to third parties, who may or may not be required to be accredited investors. The investors do not actively own or manage the investment but instead are paid a return on their investment through equity sharing or interest over time.
Crowdfunding is a great option for investors who are purchasing a property that provides enough room to pay investors a higher interest rate or are willing to share a portion of the equity at the sale.
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8. Syndication
Syndication works similarly to crowdfunding because it uses multiple investors to fund a single investment. But instead of using a crowdfunding platform to raise capital for the investment, the investor actively works with people in their private network to raise the money.
To use syndication to fund an investment property, you must establish a fund and register with the Securities and Exchange Commission (SEC) to market the security (aka the investment). This is usually done with an experienced syndication attorney and costs tens of thousands of dollars to establish.
For this reason, syndication is best for investors who want to fund a larger investment, such as a commercial property, and won't qualify for an SBA or conventional commercial loan.
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9. Home equity line of credit (HELOC)
A home equity line of credit (HELOC) loan is a popular loan for homeowners or investors who own property with at least 25% equity. This loan taps into the property's equity, the difference between the current value of the home and the balance of an existing loan, and gives the borrower cash to draw on.
These can be great financing solutions for those whose portfolios have existing properties with lots of equity. But it's important to remember that if you use a HELOC to purchase another property, you are increasing your overall debt related to the existing property.
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10. Portfolio or blanket loan
A portfolio or blanket loan refers to a mortgage on more than one property. Investors who own multiple properties with equity or that are owned free and clear can obtain a mortgage for one amount, using one or several properties as collateral for the loan. This simplifies the loan process, giving one set interest rate and term for all the properties rather than varying loans for each individual property.
Portfolio or blanket loans can be offered in the private market or with a traditional lender but often have higher interest rates than a conventional loan would.
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Financing options are plentiful
Hopefully, you've learned that there are several ways to finance your next real estate investment. Ideally, securing the lowest possible interest rate and longest term will reduce your monthly payment, making it more feasible to earn a higher return or maintain the debt obligation over the long haul.
However, if the property or you cannot qualify, there are plenty of other viable options. Just make sure you fully understand your obligations and financial requirements before entering into any financing agreement.
The Motley Fool has a disclosure policy.
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