How to Finance Your Next Real Estate Deal, Part 2
You've heard about going through the banks and government programs, but what other options are out there? Here are three alternative ways to finance your next real estate deal.
Last week, we looked at different ways to finance real estate investment properties through the banks or federally backed government programs. Today, we’ll look at alternative methods.
For investors who have saved up enough, putting down all cash can make your offer much more competitive. While it’s a lot of money up front, investors choosing to pay with cash save on interest. Not having a mortgage gives investors instant equity in their homes and eliminates the risk of foreclosure. Cash buyers enjoy greater peace of mind knowing they own the property outright. Closing times are also quicker with cash offers, meaning you can buy the property and get a new tenant set up more quickly.
However, despite the advantages, paying in cash does have some drawbacks. If this is an investment property, investors paying in cash have tied up a large amount of money in a single investment. Many experienced investors know they can put their money to work elsewhere and earn significant returns. Using all cash also makes it more difficult to acquire new properties, since you are not leveraging other people’s money for your investment.
While you may be saving money by not paying interest, you also aren’t able to deduct interest payments on your taxes. If your property has tenants, their rent should cover your mortgage principal and the interest.
Deciding whether or not to pay in cash depends on your savings, your market, and also your real estate goals. If the goal is to add more properties as quickly as possible and diversify your portfolio, paying in cash may not be the best solution. It does not allow you to leverage other people’s money for your real estate deals, and it makes the process of adding more properties exceedingly slow.
However, cash financing may be appropriate for investors who want to make a quick sale and not miss out on an amazing deal. It may also work for more conservative investors who are not as comfortable with debt. Whatever you decide, run the numbers to see what makes financial sense. Also consider which scenario will give you more peace of mind.
Rather than going through the banks for financing, investors can take advantage of private money lenders. These lenders include individual investors, family, friends, or personal connections. Obtaining financing from these lenders is a much more informal agreement than going through the banks. As such, the terms are usually more flexible and subject to whatever you and the lender can agree upon.
There are not as many requirements for credit scores or other business related criteria with private money lenders. You only find someone who shares your vision and is willing to back it with capital.
Term lengths for private money loans are much more flexible than a bank loan. Usually, terms can be negotiated to serve the best interest of both parties. Having a private money loan allows investors to receive funding in a short amount of time (much quicker than the banks) so that they can put in an offer sooner.
Furthermore, private money loans allow investors to offer cash at the time of sale, making their offer more competitive.
Private money loans are easier to obtain, but they come at a cost, usually in the form of higher interest rates (7%-12%). Loans terms are usually shorter, which makes them less ideal for buy-and-hold investors and better for investors looking to flip houses.
Finally, the often-cited advice of not going into business with friends or family may still apply. If anything goes wrong with the deal, the relationship you have with the person could become strained. In all cases, having a contract drawn up (even between friends and family) can help clarify everyone’s expectations from the start.
A hard money lender is similar to a private lender. Some even use the terms interchangeably. The main difference is that a hard money lender has a more formalized lending system in place, advertises their services, and will take the property as collateral in case of default.
Hard money lenders typically charge high interest rates (7%-13%) and will include other fees, such as loan origination fees, loan servicing fees, and closing fees. The loan is primarily based on the property’s value, and the term lengths of hard money loans are usually short (around 12 months), but they can be extended.
Advantages of this type of loan are quick funding, especially when you need to jump on a deal before it slips by. The terms are usually more flexible than going through the banks, and these types of loans are available for investors with recovering credit.
One type of hard money loan is known as a Fix-and-Flip loan. These are short-term loans that allow the borrower to buy distressed properties, complete necessary renovations, and put the home back on the market.
Advantages of this loan are that it’s easier to obtain than conventional loans. Since the primary focus is on the property’s profitability (rather than the applicant’s credit score), funds can be obtained more quickly.
Drawbacks include higher interest rates (around 18%) with a short amount of time to pay back the loan. Since this type of loan is for funding renovation projects, the timeframe for paying back the money is usually less than a year. In addition, origination fees and closing costs may also be higher compared to conventional financing, which could chip away at returns.
Going through private or hard money lenders comes with higher interest rates, but it may be just what you need to close quickly on your next deal. While cash financing doesn’t allow you to leverage other people’s money, it can help the seller weigh your offer more favorably.
Remember, you can still go through banks or federally funded programs to finance your next deal. With so many options, investing in real estate doesn’t have to be out of reach.
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