How to Finance Your Next Real Estate Deal, Part 1
What's the best way to finance your next real estate deal? There are several attractive options for bank and government-backed loans.
You just found the perfect real estate deal! Now how do you finance it? One of the biggest myths of real estate investing is that you need to have a lot of money. The truth is, real estate is a great industry for using other people’s money to finance your deals. Today we’ll look at several ways to use banks and government programs to get funded. We’ll look into alternative funding methods next week.
This is one of the more popular financing options, mainly because there are many options and it’s easy to shop around for the best rate. To secure a conventional bank loan, buyers provide a down payment (usually 20%, but not always) and the bank lends the rest of the money in exchange for a mortgage.
If you cannot put 20% down, some banks will allow a lower down payment with higher interest rates and private mortgage insurance (PMI). The PMI helps insure the bank against default, and it ceases to be a requirement once you’ve gained at least 20% equity in the home.
Bank loans have several requirements in order to apply. You will usually need proof of income, employment verification, a list of your assets, and some form of identification such as a driver’s license or a state ID. The bank will run a credit check to determine whether or not you qualify.
Conventional loans offer long-term financing, usually for 15 or 30 years. They can be good for buy-and-hold investors looking to keep the property long-term.
They also have the advantage of lower interest rates, especially if the applicant has a high credit score. Applicants with lower credit scores (under 640) are at a disadvantage when it comes to qualifying for a conventional loan.
The underwriting process can take longer than other loans, usually about three to four weeks. While this may be fine for investors who aren’t in a rush, a longer underwriting process may mean you miss out on a great property if you can’t get the money quickly.
Home Equity Loans
While conventional loans work well for first time homebuyers, home equity loans are specifically for homeowners who have already built up equity in their homes. It’s based on the difference between the homeowner’s equity and the property’s current market value. If your home is worth more than what you owe on it, banks can lend you money with your home as collateral.
Homeowners often use this type of loan to pay off major expenses like medical bills, college tuition, or home remodels. Investors can use a home equity loan to obtain a second property.
To qualify, the lender will usually run a credit check and get an appraisal of your home’s value. An advantage of this loan is that it’s relatively easy to obtain since it’s based on the value of your primary residence. It’s also an easy source of cash, which is advantageous if you want to make a cash offer on a second property. Furthermore, interest rates on home equity loans are typically much lower compared to hard money or private money lenders. You can also write off interest payments as a tax deduction.
A major disadvantage is that in some cases, the ease of obtaining home equity loans allows borrowers to take on a lot of debt and be caught in a cycle of spending and borrowing. Also, since owners are borrowing against their home equity, it will take longer to gain full ownership of their home.
Unlike conventional loans, government loans are backed by the federal government. Should the borrower default on the loan, the lender will still be compensated. Because of this, the requirements for government loans are often less strict than conventional bank loans. Two popular government loans are FHA loans and VA loans.
FHA (Federal Housing Administration) Loans
These loans are insured by the Federal Housing Administration and are targeted toward first-time home buyers or buyers who plan to use the property as their primary residence.
Advantages include low down payments (as low as 3.5%) and more relaxed credit score requirements (500 or higher). Disadvantages include the required mortgage insurance premium (MIP) which can add 0.5 to 1 percent of the loan’s balance to your payment each year.
FHA loans can work for investors looking for rental properties, but there are several factors to keep in mind. One is that you will be required to live on the property as your primary residence for at least twelve months after the sale. Some investors choose to do this and then move after a year, renting out the FHA-financed property to tenants.
FHA loans have a maximum dollar amount which varies depending on the region. Investors using FHA loans are also limited in the types of property they can buy. While FHA loans can be used to buy single family homes, duplexes, triplexes, and fourplexes, they cannot be used to buy anything larger than a fourplex.
VA (Veteran Administration) Loans
Another type of government backed loan is a VA Loan. Created by the U.S. government in 1944 to help returning veterans buy homes, this type of loan is only open to veterans, current members of the U.S. armed forces, reservists, and eligible surviving spouses.
The advantages are many. VA loans have no required down payment. Mortgage insurance is not necessary, and lenders do not require high credit scores to qualify. This makes the loan incredibly accessible to people who might otherwise be disqualified.
One disadvantage is that there are loan limits. The specific amount varies depending on the region. Borrowers who receive VA loans must pay a funding fee between 1.25% and 3.3% of the amount of the loan. However, this fee helps ensure the program has enough funds to continue.
Getting your start in real estate doesn’t always mean you need a lot of cash up front. Take advantage of different financing options to leverage other people’s money for your real estate dreams.
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