Financing your first investment property does not need to be as complicated as far too many inexperienced investors make it out to be. There are not only more ways to finance your first real estate investment than many people realize, but there are also several tips and tricks that can endeavor a lot less arduous. That said, it is those that know the options made available to them that stand to realize the most success in finding and securing financing for their first deal.
There are several ways of financing your first investment property with other people’s money, not the least of which include:
Whether you are brand-new to the real estate investing landscape or a seasoned veteran, there is at least one fundamental thing every deal must have in place: money. At the risk of sounding obvious, no deal will be completed in the absence of capital; it is as simple as that. It is worth noting, however, that the money for a respective deal does not have to come from your own pockets. I maintain that financing your first investment property should be done with other people’s money.
Even if you have the cash reserves to buy a house, it’s usually better to use someone else’s money for a deal. That way, you remain liquid and retain a “safety net” in your coffers.
There are several creative real estate financing methods investors can use for acquiring properties, but there are six main strategies that have withstood the test of time:
Conventional Or Traditional Loans: As their names would lead you to believe, traditional loans originate from the most familiar of places: banks and institutionalized lenders. These loans can have some of the lowest interest rates, but the application process can be lengthy. Those applying for traditional loans often need to have a minimum credit score in the 600’s and have a down payment between 5 and 20 percent of the purchase price.
Private Money Lenders: Private money lenders are essentially anyone in your inner circle, or close to it, that isn’t institutionalized and have some extra cash they are willing to invest. That said, just about anyone you know can be a private money lender if they have the funds available.
Cash-out Refinance and Home Equity Loans: If you are purchasing your second property, you may be able to use existing equity to do so. This involves borrowing against the value of your home through a home equity line of credit (HELOC), home equity loan, or cash-out refinance. The biggest benefit to this method is the potential for low-interest rates, though there are some risks.
Hard Money Lenders: Hard money lenders are organized semi-institutional lenders who should be licensed to lend money to investors. They specialize in providing short-term, high-rate loans with fees that allow residential redevelopers to purchase properties fast and painless.
Seller Financing: Seller financing strategies will witness the homeowner you intend to buy from act as the bank, offering to lend you the money on their terms. So instead of making payments to another lender, you would make payments to the seller in the amount you predetermined.
1. Lower Rates Are Not Always Better
I want to make it abundantly clear: lower rates are not always better when financing your first investment property. That is not to say you do not want to secure a loan with the lowest interest rate, but rather that there are a lot more things to consider. Take private and hard money lenders, for example; they often have rates that are often four and five times higher than that of a traditional lending institution, but I would argue that they are better sources of capital for investors. Namely, because of their ability to act fast. While the interest rate on a private money loan may be higher than your bank, the speed of implementation they offer investors is invaluable. Whereas a bank can take upwards of several months to process a loan, private and hard money lenders can have the money in your hands in a matter of days. That said, those with access to funds right away stand a better chance at landing a deal. In a market as competitive as today’s, only those that can act fast will be able to realize success. So again: interest rates aren’t everything. I would rather pay more in interest (especially when loans are short-term) to have access to money immediately, as to be able to acquire the deals that are brought before me.
2. Have The Financing Lined Up Before You Look For A Deal
Far too many new investors make the mistake of trying to find a deal before they have the capital to purchase it; for several reasons, that’s a bad idea. For starters, you will not know which homes fit within your budget if you do not have access to capital. How can you possibly know which homes are in your price range if you do not have access to any money yet? There is a good chance you will waste time looking at properties if you aren’t yet approved for a certain amount. It is worth noting, however, that those with the proper funding on hand will know exactly how much they can afford to spend. What is more, you will be able to act a lot faster once a viable candidate reveals itself to you. Again, the speed of implementation is everything as a real estate investor. If you find a deal and have to wait around to get your money, there’s a good chance the competition will beat you to it and close on the property before you can even make an offer. If, however, you already have the money lined up, you will find it a lot easier to make the first offer, which is a huge advantage in this industry.
Interest rates are the price we pay to borrow money — no more, no less. However, interest rates do not share a universal constant, and are even sometimes left open to interpretation. That said, it is common for interest rates to fluctuate in conjunction with the state of the economy and marketplace. Subsequently, interest rates will differ between individual loan originators. You see, each source of money has come up with what they believe to be a fair charge for borrowing their money, and investors must either choose to accept it, or look for an alternative.
If you are wondering what the average interest rate on an investment property is, the first thing you need to do is identify the source of where the capital is coming from. For a better idea of the interest rate you would expect to pay for a loan, refer to the following lenders:
Traditional Loans: The average rate on a traditional 30-year fixed loan is now 4.18%, according to Bankrate.
Private Money Lenders: Typically, private money lenders will ask for a high-interest rate: oftentimes between six and 12 percent. That said, I would not let the high rate scare you away. While it’s true, private money lenders’ services come at a higher cost, their ability to fund a deal in a relatively quick period is well worth the cost of admission. What is more, their term durations are not nearly as long as the 30 years bank loans typically coincide with. So, while interest rates are certainly higher, you will not be paying them for nearly as long — oftentimes just a few short months.
Hard Money Lenders: Not unlike their private money counterparts, hard money lenders will require borrowers to pay high-interest rates. It is not uncommon for hard money lenders to ask for 11 to 15 percent. On top of that, they might ask for points (an additional upfront percentage fee based on the actual loan amount). Again, do not let their high rates scare you away, because I can assure you their services are well worth it.
Seller Financing: Sellers financing their sale can ask for their terms, and oftentimes end up on the higher end of the spectrum for the inconvenience. However, it’s entirely possible to find a seller looking for incredibly low-interest rates. Just know this: sellers are often the easiest to negotiate terms with, so give it a shot.
Financing your first investment property can represent an intimidating step at the beginning of your career, but it does not have to be as scary as many make it out to be. If for nothing else, your first real estate investment should be exciting, and something you look forward to.
The best way to get started is to educate yourself on real estate financing. Only once you are familiar with the different real estate financing methods, can you move forward with one. Therein lies the reason we have compiled this information for you; hopefully, it’ll shed some light on an otherwise intimidating topic for new investors. Look into traditional loans, private or hard money lenders, HELOCs, and seller financing. Allow these options to guide your research as you make the best decision on upcoming deals.
Have you been wanting to invest in your first property, but are otherwise unsure of the best way to finance it? Perhaps you have had better luck with a different financing method we left out? Whatever the case may be, please feel free to share your thoughts in the comments below.