03/24/2022
Financing Options for Real Estate Investing
What’s stopping you from growing your wealth through real estate investment? The answer I hear most often from clients is money. Many don’t think they can afford an investment purchase. It’s one of the biggest stumbling blocks to—and largest misconceptions about—real estate investing.
With financing more readily available and easier to get than clients think, the question I ask is: Can you afford NOT to invest?
Real estate is one of the most popular vehicles for producing wealth. According to the IRS, about 71% of Americans who declared more than $1M on their income tax returns in the last 50 years were in real estate.
When you’re looking for money to fund a real estate investment, you have a number of options. Which one you choose will depend on the type of investment you’re making and your personal financial situation.
Traditional Mortgage Lenders: Conventional home loans financed by banks still remain one of the most popular methods of financing real estate deals. There are hoops to jump through that don’t exist with other types of loans. Borrowers need a sufficient down payment, good credit score, and documentation of income. Many investors are turning to traditional lender financing in today’s market because interest rates are at historic lows. Your Realtor® is one of your best resources for trusted lenders who work with you to get the best terms available.
Hard Money Lenders: These lenders provide short-term loans at high interest, because the loan doesn’t meet typical bank standards for lending. The loan is based on the After Repair Value (ARV), and the amount of the loan can be from 50-70% of the ARV. Lenders charge fees, in addition to interest on the loan. Terms vary among lenders, so work with a Realtor® with quality resources and relationships with trusted hard money lenders. Hard money loans are typically used by rehabbers looking to renovate and resell a property. They are an option for investors who have less-than-perfect credit or financial history, and/or are in need of short-term cash.
Self-directed IRA Accounts: Self-directed IRAs (Individual Retirement Accounts) are different from other retirement savings in that the owner has control over investment options, including real estate. In addition to providing for the purchase of real estate, you can defer taxes on any gains realized. An investment advisor can help you set up a self-directed IRA, and should be consulted as you consider withdrawals. If you already own a self-directed IRA, you may decide to tap into your account as a way to fund a real estate investment. It’s important to note that if you’re under 60, you will likely be subject to a penalty for withdrawing funds early.
Seller Financing: A motivated seller may be willing to finance your purchase. In seller financing, the buyer makes payments directly to the seller rather than going through a bank. This can simplify and speed up the buying process, while also allowing both buyer and seller to avoid costs and fees typically associated with the closing process. Work with a trusted Realtor® who has a good reputation, large network, and strong relationships with sellers.
Home Equity Loan: If you already own property and have built up equity, a home equity loan, known as a Home Equity Line of Credit (HELOC), may provide the cash you need for real estate investment. Your home equity serves as collateral for your loan. Common uses for home equity loans include home repairs, education, or paying off debts, but HELOC money can also be used to finance real estate investments.
Government-backed Lenders: Government loan programs are places investors can find money. Popular options include:
• 203K Loans, backed by the FHA (Federal Housing Administration), are designed for buyers who plan to rehabilitate older or damaged properties and who plan to live on-site following renovation. 203K loans are attractive because they require a low down payment and can deliver funding that covers the purchase price plus repairs, but they’re intended for owner-occupied purchases and not available for investors planning to fix-and-flip a property.
• FHA Loans offer a down payment requirement as low as 3.5 percent, making them an attractive option for investors. The program is meant for buyers with less-than-perfect credit and those who do not have the financial means to save up for a large down payment. As with 203K loans, FHA loans are intended for owner-occupied purchases.
• VA Loans, guaranteed by the U.S. Department of Veterans Affairs, may be available to U.S. veterans, service members, and their spouses. The VA will guarantee a maximum of 25% of a home loan amount up to $113,275, which limits the maximum loan amount to $453,100.
Understanding financing options—and determining which works best for you—is an important step toward building your investment portfolio and growing your wealth. With so many options out there, what are you waiting for?
