Looking for ways to buy income-generating property but don’t have the cash?
As a new real estate investor with big dreams but little capital, I was clueless about how I could finance my first investment property. Traditional loans were out of reach. Then, I discovered creative real estate financing strategies that changed everything.
Seller financing, private money loans, and other alternatives to traditional lending opened the door for me to start building my real estate portfolio, even with limited funds.
If you want to invest in real estate but don’t have piles of cash, you need to learn creative financing hacks that most newbies overlook.
This article shares insider tips on real estate financing so you can find funding, purchase income-producing properties, and succeed in real estate investing.
- Real estate finance is crucial for property purchases, offering two options: upfront payment or financing with a small down payment and a loan.
- Traditional loans (conventional, FHA, VA, conforming) are common, each with varying terms and requirements.
- Understanding financing methods is essential for informed decisions, improved management skills, and financial security in real estate investment.
What is Real Estate Financing?
Real estate finance describes an investor’s method of securing funds for an upcoming purchase, construction, or renovation of a property. It is the most commonly used structure for real estate deals.
When purchasing a property, you have 2 options: either pay the entire purchase price upfront or finance it by making a small down payment and paying the remaining balance through a loan.
Real estate financing makes it possible for people who don’t have cash to purchase investment property.
What Are My Real Estate Financing Options?
A traditional loan in real estate refers to a conventional financing arrangement offered by a financial institution, such as a bank or credit union.
This type of loan is commonly used by homebuyers to purchase residential and commercial properties. Here are 6 of the most secure real estate financing options:
Conventional loans are typically offered by non-government financial institutions such as banks, credit unions, and private lenders.
Conventional loans are the most prevalent financing option in the real estate industry – accounting for 71.9% of the market – because they offer very competitive interest rates, flexible loan terms, and lower monthly payments.
However, a conventional loan often requires a down payment and is subject to the lender’s approval, resting on the borrower’s financial history.
A Federal Housing Administration (FHA) loan is a mortgage loan intended to assist low to moderate-income borrowers in obtaining home financing.
FHA loans are a very popular financing option for first-time home buyers since they have more lenient credit requirements and lower down payment options compared to conventional loans.
Additionally, since an FHA loan is government-backed, it reduces the overall risk for lenders, making it easier for borrowers to qualify for homeownership.
A United States Department of Veterans Affairs loan or VA loan, in short, is a mortgage loan program specifically designed to help qualified veterans, active-duty military personnel, and their surviving families buy a home.
VA loans typically require no down payment, no mortgage insurance requirement, have competitive interest rates and have more lenient credit score requirements than conventional loans. However, VA loans are typically not used for investment properties.
There may be scenarios where a property with a VA loan can eventually be used as an investment. For example, if you buy a home with a VA loan and live in it as your primary residence, you may rent it later if you move. In this case, you’ve satisfied the occupancy requirement by living in the home first.
It’s also possible to use a VA loan to buy a multi-unit property (up to four units), as long as you live in one of the units as your primary residence. The other units can be rented out.
Always consult with a VA loan specialist or financial advisor for the most current and applicable rules for your specific situation.
A conforming loan is a mortgage loan that meets the criteria set by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac.
The criteria can include specific loan limits set by the Federal Housing Finance Agency, down payment requirements, and other guidelines such as to loan-to-value ratio, debt-to-income ratio, credit history, and documentation requirements to promote stability in the mortgage market.
Home Equity Loan
A home equity loan is a type of loan that allows homeowners to borrow money against the equity they have in their homes. Equity is the difference between the home’s current market value and the outstanding balance on the mortgage.
Home equity loans work best for homeowners who want to use the equity in their homes to finance real estate investments since they carry a fixed interest rate (lower, too) and fixed monthly payments.
Cash-out refinancing is a type of strategy that involves the homeowner replacing their existing mortgage with a new one that is higher than their current amount, receiving the difference in cash. The property serves as collateral for the loan.
The loan comes with a new interest rate and repayment terms for the entire loan amount, including the cash-out portion, which may be tax-deductible, depending on how the funds are used.
Non-traditional loans refer to financing options that deviate from conventional mortgage structures offered by traditional lenders. These alternative lending options are often sought by individuals who may not qualify for traditional loans or who prefer more flexible terms.
Here are the most common types of non-traditional loans:
Private Money Loans
A private money loan is a type of real estate financing provided by individual private money lenders or non-banking companies when traditional financing is off the table.
Private money lenders provide these short-term loans with higher interest rates (when compared to traditional loans), but have more flexibility when it comes to credit score requirements.
Private money loans are a great alternative for investors who have unique property types that traditional lenders shy away from and need to take them off the market as quickly as possible.
Also referred to as owner financing, seller financing is a type of real estate financing where the property owner/seller functions as the bank and provides financing to the buyer.
Seller financing is great for buyers who do not qualify for traditional loans from a financial institution since they’re directly loaning and making payments to the seller.
This strategy is how my husband and I got started in real estate investing several years ago. We didn’t have money for down payments, and we couldn’t qualify for regular financing.
Also known as rent-to-own, lease-to-own is a type of real estate financing arrangement where the buyer (now a tenant) has the option to purchase the property they are renting after a certain period.
This arrangement is a viable option for investors looking to buy a property but lacking the immediate financial wealth to fully purchase it.
Peer-to-peer lending is a type of real estate financing that allows investors to borrow money from other individuals or multiple investors. Peer-to-peer lending can be similar to hard money loans or private money loans, but they differ from requirements.
While peer-to-peer lending comes with a lower loan-to-value ratio when compared to other loan types (which makes investors unable to borrow the full amount they need to buy a property), it still gives real estate investors some much-needed flexibility since they can bypass conventional financing requirements thanks to their investment portfolio.
Why Learn Real Estate Financing?
A very common misconception people seem to have when it comes to real estate investing is that you need to have substantial capital as a prerequisite to get started, but this is not true.
Many different real estate financing options are available to make investing accessible. The only thing you have to do is to understand each and every financing option to utilize its advantages and drawbacks.
Why? Not all financial options are created equal, and what may prove effective for one investor may not be suitable for you.
Becoming knowledgeable about the different types of options that exist, as well as how to fully leverage them will help you build your real estate investing business.
Reasons You Need To Know Real Estate Finance
Learning your real estate financing options grants you several benefits for your investing business. Here are three of the most important reasons to learn about these strategies:
Better Investment Decisions
Knowledge of real estate financing allows you to make informed decisions when purchasing investment properties and entering the real estate market.
Not only does it help you assess the financial options available to you and help you choose the one that best aligns with your goals, but it also helps you familiarize yourself with the complexities that come with real estate transactions — enabling you to negotiate better terms.
Better Management Skills
Real estate financing can help you learn and improve your risk management, which helps safeguard your portfolio and teaches you to become resilient when faced with uncertainties.
How? Real estate markets can be dynamic. By learning how to diversify your investment capital across different property types, you can minimize risk and control the impact of external factors like market fluctuations across your portfolio.
Awareness of your available financing options can also help you manage the costs associated with your real estate investments. This includes understanding factors that can impact the financial consequences of your investment such as interest rates and closing fees.
Improved Financial Security
Real estate financing requires a long-term commitment, and possessing expertise in this field enables you to prepare for your financial security strategically.
Real estate financing teaches you how to effectively leverage your available resources through mortgages and other financing tools to optimize your portfolio. From managing your optimizing your mortgage & cash flow, applying tax benefits, and managing debt effectively — all of which contribute to your financial security over time.
Factors To Consider To Improve Your Real Estate Financing Options
Knowing the factors to improve your real estate financing options is crucial to cut costs, maximize savings, and negotiate better loan terms. Here are three of the most important factors you always need to consider to improve your real estate finance options:
Lenders prefer borrowers who provide a very clear picture of their income, employment history, and debt-to-income ratio. Lenders might consider approving your loan application depending on your eligibility and standing credit score.
Different financing options require different credit scores altogether– that’s why it is essential to pick a real estate financing option that matches yours.
Loan terms refer to the duration of time in which the borrower has to repay the loan. A longer term can result in lower monthly payments and higher interest rates and a shorter term often means paying less interest throughout the loan.
Down Payment Requirements
Down payment requirements are the money you need to front to secure the loan. These requirements vary from option to option, so it’s essential to consider your amount when choosing a suitable real estate financing option.
Additionally, the larger your down payment, the more your financing is to lenders since you’ll have a lower loan-to-value (LTV) ratio.
Alternatives You Can Use To Invest In Real Estate
Real Estate Investment Trusts (REITs) are publicly traded companies that allow investors to own, operate, or finance income-producing real estate without directly owning them.
While not technically a loan and is categorized as an investment vehicle, REITs are great alternatives you can use in their place as a real estate investor.
REITs can offer investors a higher return on investment than traditional financing options since they are tax-efficient and liquid. Plus, they provide investors with a way to diversify their real estate assets.
Using real estate financing can offer several advantages, depending on your financial situation, investment goals, and the specific circumstances of a real estate transaction.
That said, If you don’t have the capital to facilitate a cash purchase, real estate financing can help you out a lot – I used seller financing to kickstart my real estate career (and I still do!) Now, I own multiple hotels in my investment portfolio.
But there is no one-size-fits-all answer. The “best” investment strategy depends on your financial needs and goals at the time.
What are the methods of financing real estate?
As a real estate investor, you have two options you can use to finance your upcoming purchase. Either you go with a traditional loan or a non-traditional one.
Examples of traditional loans are FHA loans, VA loans, and USDA loans while non-traditional loans include hard money loans, private money loans, seller financing, and lease-to-own agreements.
What is the most common form of real estate financing?
Buying a property is expensive and most buyers do not have the capital to purchase one in full. A mortgage loan is the most common way for people to finance a residential or commercial property.
How do I avoid a 20% down payment on investment property?
You can avoid paying a 20% down payment by exploring financing options available to you like seller financing or cash out refinancing.
What is a good ROI on rental property?
According to Forbes, a good ROI for a property in the US market is somewhere around 10% for residential properties and 9.5% for commercial properties.