Welcome back for part 2 of our series on Investing with Other People’s Money- Part 1 is right here. Let’s pick back up with our discussion of funding options.
These loans allow a homeowner to purchase a house that is in need of some rehab work and finance necessary repairs. Like the standard FHA loan, a 203K loan requires a down payment of just 3.5 percent. This loan can finance duplexes, triplexes, and four- plexes, but requires owners to live in one of the units. It also requires private mortgage insurance for loans under 20 percent down.
Home Path Mortgages
Home Path Mortgages are offered by Fannie Mae to help investors and homeowners buy Fannies’ foreclosed properties. Down payments can be as small as 5 percent but you must have a credit score of 660 or better. You can also borrow up to $35,000 for renovations. There’s no mortgage insurance requirement but you can only use a Home Path mortgage to buy a Fannie Mae foreclosure.
Home Equity Loans and Lines of Credit
Many investors choose to tap into the equity in their own primary home to help finance the purchase of their investment properties. Banks and other lending institutions have many different products, such as a Home Equity Installment Loan (HEIL) or a Home Equity Line of Credit (HELOC) that allow you to tap into the equity you’ve already got. For example, an investor may purchase a property, but instead of going through the normal hassle of trying to finance the investment property itself they can instead take out a HELOC on their own home to pay for the property.
The collateral for a HELOC is your existing home, not your new one, so the lender is concerned only with the value of your existing home- typically, they don’t even look at the new property. With a HELOC, you can make cash offers on new properties and as a result, you will have a higher chance of getting your offers accepted at a lower price. Home equity lines and loans may also have certain tax benefits, such as the ability to deduct the interest paid on that loan.
Owners are increasingly willing to finance some- or all- of the sale of their home. Property owners cannot have an existing mortgage or home equity loan on the property. If the seller does have another loan, and then sells the home to you – the seller’s loan must be paid back immediately or the seller may face foreclosure.
Owner financing can also be a good tool for selling your properties in the future as well.
While most of the above options focus primarily on the residential side of loans, the world of commercial lending may also be viable option for your investing. In fact, if you are looking to buy a property other than a one to four unit residential property, you will need a commercial loan.
Commercial loans typically have slightly higher interest rates and fees, as well as shorter terms and different qualifying standards. Commercial lenders are more focused on the property than an individual’s ability to repay. They will look at your income, credit, and other personal financial indicators only to gain a picture as to your skills financially. What’s more important in the vast majority of cases, is the amount of revenue a property generates. Commercial lenders can often extend a “business line of credit” to finance flips or other investments.
Short term financing that is obtained from private businesses or individuals for the purpose of investing in real estate (known as “hard money” loans) has a number of forms but several defining characteristics. These include:
- Loan is based on the value of the property.
- Shorter term lengths than a mortgage (due in 6 – 36 months.)
- Higher than normal interest (8-15 percent.)
- High loan “points” (fees to get the loan.)
- Many hard-money lenders do not require income verification.
- Many hard- money lenders don’t require credit references.
Private Lenders (“Soft Money” Loans)
Typically with “private money,” the lender is not a professional lender like a hard money lender but rather an individual looking to achieve higher returns on their cash. Often times there is a close relationship with a private money lender ahead of time, and these lenders are often much less “business” oriented than hard money lenders. Additionally, private money usually has fewer fees and points, and the term length can be negotiated more easily to serve the best interest of both parties.
Generally, private money is financed by one investor. Private lenders will lend you cash to buy property in exchange for a specific interest rate. Their investment is secured by a promissory note or mortgage on the property, which means if you don’t pay they can foreclose and take the house (just like a bank, hard money, or most other loan types). The interest rate given to a private lender is usually established up front and the money is lent for a specified period of time, anywhere from six months to thirty years.
Use Debt as a Tool
In the hands of the successful investor, debt is a tool to be used to make dreams come true faster. By never borrowing money they don’t need, by paying back loans on time and by always having an exit strategy before borrowing money, good investors make sure that even if a deal doesn’t work out they’ll be well-positioned for the next one.