If you’re planning on becoming a real estate investor, the first thing you should do is educate yourself on everything real estate! One of the most important things that beginner property investors have to understand is the different investment property financing methods available for real estate investing. Financing is, in fact, a major concern for many beginner property investors, and knowing which investment property financing option works best for you is a key to a successful real estate investing career.
Investment property financing is actually not as hard as some might think. You can finance the purchase of an income property with little or even no money at all! The world of real estate investing is vast, and you’ll find plenty of financing methods which you can choose from depending on your financial situation and your goals as a real estate investor. To narrow down options for you, here are the 4 most efficient investment property financing methods.
Investment Property Financing Method 1 – Mortgage Loan
Getting a mortgage is the best and the most common investment property financing option used by property investors. Basically, a mortgage is a bank loan specifically aimed at buying real estate. Property investors go to a bank (or a mortgage broker) and apply for a loan which requires them to put a down payment. In general, most lenders require property investors to pay a minimum of 20% of the purchase price of the income property as down payment. So, for example, for the purchase of an income property that is worth $100,000, a real estate investor would only have to put down $20,000 in cash, and the mortgage will cover the remaining $80,000 – which is obviously better than paying for the income property fully in cash.
Related: Buying an Investment Property: Cash or Mortgage?
One reason that makes investment property financing method common in real estate investing is the fact that some income properties are easier to finance with a mortgage. Applying for a loan for the purpose of real estate investment property financing also makes it easier to qualify for one. Property investors have to keep their credit score in mind when applying. A credit score of at least 620 is what most banks require in order to qualify for a mortgage loan. Another thing to remember is that a mortgage loan comes with interest rates and long-term conditions. Thus, property investors looking for lower interest rates and an extended payment period (up to 30 years) should have a credit score of at least 660.
Investment Property Financing Method 2 – Private Money Lenders
Another common real estate investment property financing method is private money. In simple words, private money lenders are people you know whether a friend, a family member and even a colleague or co-worker. This method of investment property financing comes with fewer formalities between the lender and the real estate investor. In addition, it doesn’t have strict conditions – interest rates are often low, and the length of the loan is fixable and negotiable based on the relationship between the lender and real estate investor.
However, one thing which property investors should keep in mind when using this real estate investment property financing option is that they need to provide some kind of guarantee. Some lenders might not require a guarantee, but, as a real estate investor, you should make sure to stay professional. After all, there is the risk of losing your relationship with that lender if any disagreements occur. So, the best approach to take is to make things clear from the beginning and sign a repayment agreement.
Investment Property Financing Method 3 – Hard Money Lenders
Hard money lenders are professionals when it comes to real estate investment property financing. These professionals are individuals or companies that lend money specifically for real estate investing. Although this is a good real estate investment property financing option, it comes with a never-ending list of formalities, documentation, and guarantees.
Related: Where Can You Find the Best Hard Money Lenders for Rental Properties?
The best thing about hard money lenders is fast money – meaning once property investors are approved for a loan, it’s only a matter of days to get the money. Despite this fact, there are few things to consider before using this real estate investment property financing method, most importantly that this is a short-term loan (up to 36 months only!) and it requires higher interest rates. This is why hard money is not suitable for just any type of real estate income property. For example, it makes sense to finance a fix-and-flip with hard money, but not a long-term residential income property since it would be impossible for property investors to pay off the loan in only 3 years.
Therefore, this investment property financing method is recommended only to experienced property investors who know how their business is going to perform and whether or not they’ll be able to pay off the loan in due time. For a beginner real estate investor, we suggest private money lending as a better investment property financing option if you don’t want to find yourself in a financial bind.
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Investment Property Financing Method 4 – Seller Financing
This real estate investment property financing method is like taking a loan from the seller of the income property instead of a bank! In simple terms, seller (or owner) financing is another financing option for real estate investing in which the seller of the income property agrees to provide financing to the buyer in order to close the real estate transaction. This doesn’t mean that the seller hands over cash to the income property buyer. Instead, the seller extends a kind of credit, and the income property buyer makes monthly payments. So, basically, it’s similar one of the previously mentioned investment property financing methods – mortgage – but the real estate investor will pay directly to the seller on monthly basis instead of paying for the purchase of income property through the bank.
This is the best real estate investment property financing method for a real estate investor who can’t qualify for a bank or use other financing methods. However, keep in mind that compared to a mortgage, the payments for seller financing are paid over a shorter time period (typically 5 years) and the seller might set a higher price as a form of interest.
Related: Everything You Need to Know About Selling and Buying a Home with Owner Financing
Final Words on Investment Property Financing
Whichever real estate investment property financing method you opt for, remember that what works for one real estate investor won’t necessarily work for another. Make sure you evaluate your financial standing, conduct a financial analysis, and understand all requirements and outcomes of each method before deciding how to finance your income property. To learn more about all aspects of real estate investing, continue reading our blog.
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