Fourteen Financing Options for Real Estate Investors to Grow Their Wealth

01 Apr Fourteen Financing Options for Real Estate Investors to Grow Their Wealth

It takes skill to find and negotiate a deal. It takes another type of skill to come up with the money to buy that deal. Here is a list of the types of financing available to real estate investors.

1. Traditional purchase money mortgage loan. Also known as a government-backed loan, this family of products include FHA (Federal Housing Administration), VA (Veterans Administration), and USDA (United States Department of Agriculture) loans. Other government-backed financing includes conforming loans, which meet criteria set by Fannie Mae and Freddie Mac. There are even Farmer Mac loans. FHA, VA, USDA, and many Fannie and Freddie conforming loans require the borrower to occupy the property as their personal residence. FHA and VA loans could be used to buy a 2-4 family property, which provide great starting points for aspiring landlords. There are also Fannie and Freddie loans that are for non-owner occupants. For instance, there are loans that an investor could use to buy a non-owner occupied single family house with as little as 15 percent down. Check out this article about using an FHA loan for investment purposes.
2. Conventional loan. This is a loan that is not government-backed. Typically offered by a bank or mortgage lending institution, an investor may only have to put down 10 to 20 percent. The 10 percent down option is usually for a second-home type of loan, which some investors utilize to purchase a home that they will use for short-term rentals when they are not staying there.
3. HELOC. A home equity line of credit allows an investor to tap into the equity of their own home or another property. A HELOC usually comes with an interest rate that fluctuates, yet interest is only charged on the money that is withdrawn. In other words, a lender may state the maximum amount of money that a borrower could pull out, and the borrower may pull out any amount within the limit. Some HELOCs have a short time limit. For example, a bank may require that the HELOC be paid back within 12 months, and the bank may state that the HELOC must “rest” for at least a month after the 12 month period. Other HELOCs are good for a decade or more, and some allow the borrower to make interest-only payments for several years. The HELOC is secured by a lien against the property. In economic downturns, many banks will reduce the amount of a HELOC or take it away entirely.
4. Hard money. A hard money loan is a short term loan backed by real estate. It typically involves a high interest rate, 2-4 points, and a 6-12 month period to repay the loan in full. The source of a hard money loan can be from a private lender or a non-bank institution. Many hard money lenders do not require as complete an application as a traditional lender would. The hard money lenders focus on the As-Is Value and the After Repair Value of the real estate. Many hard money lenders make it simple for a borrower to use their Limited Liability Company or other entity as the borrower. Some hard money lenders do not care about the source of the borrower’s down payment. Hard money is typically used by house flippers, borrowers with credit challenges, or borrowers who do not have the down payment but can obtain the down money from another source.
5. Private money. A private money lender could be your rich Uncle Jimmy, a busy business owner who wants to place money in real estate but doesn’t have the time to find and manage deals, a friend who wants to partner with you, or anyone else with the cash or financing. Private money lenders could be involved as a business partner, a silent partner, a mortgage lender, or any of a number of other ways. Check out this blog on how to structure a deal with a private money lender.
6. Cash-out refinance. If an investor has sufficient equity, they could ask a mortgage lender to value their property and place a loan against it. The cash-out refinance could be against a personal residence or an investment property. For an investment property, the Loan-to-Value (LTV) might be 65-80 percent. For a personal residence, the LTV could be 75-100 percent. A cash-out refinance could be amortized over 15 or 30 years for a residential (1-4 family) property that is owned in a person’s name. A cash-out refinance involving a commercial owner or commercial property may involve a loan that is amortized over 20-25 years yet has a rate reset around the 5-year mark. In other words, the rate jumps up after 5 years, and many borrowers may try to refinance at that time. A cash-out refinance usually provides money at a lower rate than a HELOC, and unlike a HELOC the loan can continue for many years. In the case of a residential loan, the interest rate can remain fixed for the life of the loan. The drawback to a cash-out refinance is that an investor must make the payments even if they do not use all the money.
7. Portfolio loan. A portfolio loan is a mortgage loan originated by a bank and kept in the bank’s portfolio instead of being sold on the secondary market. In other words, the loan is held in the bank’s portfolio over the life of the loan. This is typically granted for customers with a number of assets. Portfolio loans can work for people with a high net worth but low credit score; or are self-employed; or need more than what a conforming loan will allow; or are buying a major fixer-upper that a traditional loan won’t work for; or for a variety of other reasons. The loan may be secured by a number of assets, such as stock, real estate, businesses, and money held in bank accounts. A portfolio loan could even have highly favorable terms because the loan does not have to conform to government standards.
8. Second mortgage. A second mortgage could be placed against a property with a lot of equity. This works when the first mortgage has a low interest rate or the borrower simply does not want to conduct a refinance of the first lien. Typically the second mortgage will be at a higher interest rate because that lender takes on more risk. A second mortgage is a tool used by banks, non-bank lenders, and private lenders.
9. Commercial mortgage loan. A real estate investor with more than 10 government-backed residential loans, or an investor using an entity, or an investor with a commercial property can seek a commercial loan. These types of loans typically involve a larger down payment than a residential loan, a higher interest rate, a shorter amortization period, a higher appraisal fee, and a balloon or rate reset after 3-7 years. Some commercial loans must be paid back in full in several years. Others involve an interest rate reset in which the rate jumps up well above the prime rate.
10. Credit cards. An investor buying an inexpensive property could conduct cash advances on a number of credit cards. Credit cards typically have higher interest rates than all types of mortgage loans, including hard money loans. Credit cards are not secured against the property. Sometimes an investor may be able to obtain a credit card with an introductory zero or low interest rate for the first 6-12 months.
11. Straw party loan. A straw party obtains a loan and takes title of a property for the benefit of another, known as the principal. Here is a detailed blog on straw parties. The straw party may complete a loan application and buy a property. The principal is supposed to reimburse the straw party and pay all the expenses associated with the property. The principal might even take title later on. Some straw party transactions can be illegal, particularly transactions involving a mortgage loan whereby the lender is deceived about the source of funds and who is actually controlling or using the property. A straw party can be used by a savvy investor who wants to buy a property yet wishes to conceal their true identity from the seller and the owners of the adjacent parcels.
12. Owner financing. Banks make a lot of money. When an owner provides the financing to the buyer, the owner can also earn the interest that a bank might have earned. Owner financing can be lucrative for the seller, as they commonly command a higher price, attract lots of potential buyers, and make money even after the sale. Buyers won’t have any origination fees. Many people who would not qualify for traditional financing would love the opportunity for owner financing. It can take the form of a land contract (also known as an installment contract), a lease-to-purchase agreement (also known as a lease with option to buy), or a seller-held mortgage loan. Unfortunately, many owner financed deals fail to consummate due to the buyer not making all the payments or failing to eventually qualify for a mortgage loan.
13. Syndicates. Developers or high-level investors may create a syndicate to bring together a large group of investors. A syndicate is a group of individuals or entities that invest together for a common purpose, and they hand control over to a manager. Let’s say that a savvy developer goes under contract to buy a 300-unit apartment complex in need of work. That developer does not have all the money they need for the project, so they form a syndicate and promote it to accredited and sophisticated investors. Those investors each contribute money to fully fund the project, knowing that they will not have access to their money for two or more years as the project is underway. The developer maintains control and runs the project. The end goal could be to sell the apartment building or to hold it for the long term. Regardless, the returns could be substantial for the developer and the investors.
14. Crowdfunding. Crowdfunding has grown in the past few years, thanks in large part to social media and other exposure on the Internet. In the old days, the concept of crowdfunding was limited only to accredited investors. However, the Securities and Exchange Commission has lifted the restriction preventing non-accredited investors from participating. The SEC does have rules for non-accredited investors that are viewable here. Crowdfunding can help an investor diversify and be involved in one or more projects with huge potential upside. Drawbacks are that the company’s operations can be murky, and an investor will not have much, if any, of a say in how business is handled.

I have done all sorts of real estate deals. In my younger days when I did not have money, I was highly creative and engineered deals using other people’s money. In the buyer’s market caused by the Great Recession, creative financing was widely considered by sellers. I have done many deals a decade or more ago where I did not invest any of my own money. In the seller’s market of the early 2020s, fewer sellers are motivated to engage in owner financing because they can simply sell their property.

With experience as a guide, I can say that the cheapest and easiest money for a new real estate investor is to use an FHA loan (or VA if you’re a veteran) to buy a 2-4 family property. An investor looking to buy a single family home can also use a 15-20% down non-owner occupied loan. I recommend that an aspiring investor save up their money, build their credit, and use traditional financing. Not having any partners and obtaining a traditional loan gives you more control and financial stability.

Money chases deals. If you place a great deal under contract, private lenders and hard money lenders may be quite interested in working with you. If the numbers work, consider non-traditional financing.

For experienced and sophisticated investors, traditional financing is typically not an option anymore. Talk with banks and mortgage brokers. Tap into your equity. Explore syndication and private money funding. Collaborate with people who are at least two levels above you. Now is the time to take calculated risks.

Tai DeSa is a graduate of The Wharton School of the University of Pennsylvania.  He became a full-time real estate investor in 2004 after serving in the U.S. Navy.  Tai has made colossal mistakes in investing (and learned some things along the way).  He has helped hundreds of homeowners avoid foreclosure through successful short sales. Check out Tai’s books on Amazon.com. Tai may be available for coaching and speaking engagements on a variety of real estate topics.  Send an email to tai@investandtransform.com.