let’s talk : FINANCING
A few weeks back we discussed setting up our business. Now that we have done that, it is important to figure out how we are going to finance our business ventures. Before we can start analyzing & pursing deals, we need to have an idea as to how we are going to pay for them. Investors are constantly finding different ways to finance their projects. While, I have not had to pursue my own high-volume financing as of yet, I want to highlight the different methods I have learned about, and see what your thoughts are on the topic.
SO, as we do, let’s talk real estate, let’s talk FINANCING…
I have pulled in this table from a couple of weeks ago as a guideline;
I often hear about investors making all cash offers, and while one can sometimes get better deals for making a cash offer, it is important to consider if this is truly the best way to allocate our funds. Here is an example I was given in class a few weeks back;
Let’s say Lindsey has $100,000 to invest. How should she invest this $100k…
|Option 1||Option 2|
|Lindsey could use $100,000 cash to buy ONE house that flows $1,000/ month in income.||OR, Lindsey can use that $100,000 to invest in FIVE $100,000 homes. With $100,000, Lindsey can put 20% down on each home. Now with a mortgage, the homes are only cash flowing $300 per home vs $1,000 per home without a mortgage, however with 5x homes at $300/ month per home, Lindsey is now making an income of $1,500/ month.|
|Final Return: 1 home, 12% ROI, $12,000/ year income||Final Return: 5 homes, 18% ROI, $18,000/ year income|
Option 2, mentioned above, illustrates the power of using a conventional mortgage vs all cash. Typically the banks require a 20% down payment for primary residence, or 25%-30% down payment for an investment property. Because banks do not typically use their own cash to fund these mortgages, and often sell them back to government sponsored institutions, there are very strict requirements as to how these mortgages are structured.
Portfolio lenders are banks / credit unions that have the ability to lend their own funds. Because they are lending their own funds, they can have more flexible loan terms, as opposed to the rules a conventional lender must follow.
A private money lender is not a professional lender and typically knows the borrower on a personal level. Because of this relationship, private money lenders typically have lower fees and points than hard money lenders, and the terms tend to be a bit more flexible. While there are no hard and fast rules to private money, investors will typically use private money short-term to fix up a property, and refinance with a conventional mortgage later on.
Hard money is financing provided from a private business / individual for the purposes of investing in real estate. Hard money lenders are typically the most expensive lenders, and can have very hard terms to follow; short term (6-36 months), high interest rates (8-15%), and high points (fees to obtain the loan, typically a % of the loan value).
So, if they are so expensive why do investors use them?
- Loan is given based on property value vs based on the person obtaining the loan – no income verification or credit score required
- Does not show up on your personal credit report
- Can fund a deal in just a few days vs weeks / months a bank may take
I have included the links to a couple of hard money lender source sites below:
HOME EQUITY LOANS & LINES OF CREDIT
Investors can choose to tap into the equity of their primary residence to help finance the purchase of their investment properties via a Home Equity Line of Credit (HELOC). The tricky part of this is, you must have substantial equity in your primary home already. For young investors, this could be hard. A conventional lender will typically lend you only a certain percentage of your home’s value.
Lindsey’s primary home is worth $100,000. She learns her primary lender will allow up to 90% debt on her home. Because of that rule, Lindsey can borrow a total of $90,000 on the house. If she already owes $50,000 on her primary mortgage, the HELOC would be capped at $40,000 to ensure the total debt didn’t exceed 90% of her primary home value.
Some of the perks of using equity to finance your project include;
- Loan is based on the value of your primary property vs your personal finances OR the value of your future investment,
- You have the freedom to do what you want with the loan,
- Low interest rates, AND
- Tax benefits (consult your accountant!)
Now let’s talk less conventional ways to finance your projects…
With a low down payment requirement (3.5%), FHA loans are designed for first time home buyers who plan to live in the property they are purchasing. While only having to save 3.5% vs the traditional 20% for the down payment is great, it also comes at a premium. If you are using an FHA loan, you will also have to purchase private mortgage insurance (PMI). Furthermore, I mentioned that these loans are only for buyers who intend to live in the property, making it difficult for investors to take advantage of. HOWEVER, you can use FHA loans for duplexes, triplexes and fourplexes. SO, if you live in one unit, and you rent out the other units, you can apply your FHA loan to your property.
This is essentially an FHA loan + extra $$$ for rehabbing the home. A 203k loan allows a homeowner to purchase a house that is in need of some TLC and gives them the ability to finance those repairs and improvements into the loan. Similar to an FHA loan, the 203k loan is for owner occupants only, allows for the 3.5% low down payment (with PMI), and can be used to purchase duplexes, triplexes, and fourplexes.
Seller financing is just that, the seller finances your purchase of the property. This can only really happen if the seller already owns the property outright, due to the “Due on Sale” clause. This can be a great way to purchase a home without having to use a bank, OR can be a great way to make extra $$$ (via interest) if you the seller can afford to be the “bank” for your buyer.
Equity partnerships can be used to fund a down payment, or repairs, or an even an entire project and in return that partner would get a percentage of the profit. Partners can have an active or passive role in the project based on the goals of each partner. These partnerships are typically secured by an operating agreement vs a lien on the home itself. Equity partnerships are much more high risk high reward than money lending.
Commercial loans are for anyone investing in a building with 5+ units. Higher interest rates, and larger down payment requirements are offset by the fact that loans are given out not so much based on the borrower, rather based on the property itself. While the lender may take a look are your personal income, it is really only to get an idea of your financial intelligence. The most important way to value a commercial property is to look at the revenue it produces. On top of a standard commercial loan, investors can also obtain business lines of credit to help finance their flips and other investments.
Typically short term (~up to 7 years), ~5%-15% interest rate, no fees, up to $100,000
I have included a link to a personal lender below:
NOW, I know this week’s note was long (sorry!)… but I find it helpful to have a list of options in one place! Let us know if you have any creative financing methods of your own! Feel free to comment on the post here (https://lets-talk-re.com/blog/).
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