Of the many financing methods, only one matters.
In order to understand why this is the only Real Estate Financing that matters you must first understand the different financing options available.
Real Estate financing is the most creative and artistic part of real estate investing. There is virtually no limit to the number of options available for funding a solid real estate investment. The trick is understanding how these different financing options can be utilized to best fit your investment style.
Understanding the Different Real Estate Financing Options
There are many different ways to fund Real Estate investments. I have broken them down into three main categories: cash, traditional financing, and non-traditional (creative) financing.
Cash is the simplest form of Real Estate financing because it is as simple as signing a check. This method avoids taking on debt to purchase investment properties. When a property is purchased in cash the monthly cash flow will be higher.
The downside to this is that your cash earns a smaller return on investment because of how much money you have in the deal. Another downside is the lack of leverage, which we will cover in the traditional financing section! Purchasing Real Estate in cash can be a great strategy and is the method that Rich Carey used to become financially independent.
A close cousin to purchasing in cash is the use of a Home Equity Line of Credit (HELOC). a HELOC is basically a loan that you take out on your primary residence. This loan has extremely low interest, and you are basically paying yourself back. For that reason, I included it in this category.
You can reuse the HELOC every time it gets paid off to buy another property. This can also be used as a down payment in conjunction with other financing methods!
The term traditional financing refers to the more conventional loan categories. The lenders for this financing are usually a normal bank, and there isn’t anything complicated or sexy about this form of real estate financing.
Traditional financing allows for the use of leverage to grow your portfolio much quicker than the cash methods above. If I had $100k to invest with I could either buy:
– (1) $100k house in cash
– (5) $100k houses with a 20% down payment!
The power of leverage can be harnessed to purchase more Real Estate in less time and reap the benefits of a higher return on investment
The typical conventional loan requires a 20% down payment for the purchase. This loan is not too complicated to obtain, and financing can be approved for fixer-upper properties. One of the main provisions is that you must attain an appraisal proving it is not worth less than the purchase price.
Conventional loans can be used to purchase investment properties as there is no requirement for you to occupy the property! Depending on your lender a typical conventional loan will only allow you to have up to 5-10 personal loans out on property at any given time.
Veterans Affairs (VA)
The Veterans Affairs (VA) loan is a phenomenal option available to those of us in the military, or government, career fields! The VA loan is a form of traditional financing that allows you to purchase a house with no down payment! That means you could walk into a new home without paying a dollar aside from the home inspection! This allows you to purchase a home without money in the bank and is great for your first property.
A VA loan can be used on any property with four units or less. These loans can only be used for a primary residence so you must occupy the property for at least a year (unless you are relocated by your job). Another benefit to this form of Real Estate Financing is that there is no requirement for mortgage insurance which creates a little more cash flow each month.
One of the only downsides to this loan is that you can’t buy a property that requires some work. That makes it a better loan choice for home-owners than investors sometimes but it is still a great option to use for a house-hack or primary residence!
^^^ This has changed! There is a VA Renovation loan now!
Federal Housing Assurance (FHA) loan
The Federal Housing Assurance (FHA) loan is similar to the VA loan except it requires a 3.5% down payment and is available to anybody! I used an FHA loan to purchase, and house-hack, my first duplex. This loan also has to be used on a primary residence, but the lenders are not as strict about the properties condition.
That means you could buy a live-in flip with a small down payment and then force the appreciation through some renovation!
This is a version of the FHA loan that utilizes the same guidelines. The main difference here is that a 203k loan can be utilized to purchase a fixer-upper and include the renovation costs into the original mortgage! That allows you to buy a live-in flip without needing to fund the renovation out of your own pocket.
If I purchase a $100k property that needs $20k worth of remodeling. The 203k loan would allow me to borrow $120k with a 3.5% down payment ($4,200). If the property is worth $150k then you have built a substantial amount of equity with a minimum entry price! After a year you could refinance and actually get more cash out of the property than you initially invested!
Non-Traditional, Creative Financing
The term non-traditional financing refers to the creative and fun forms of Real Estate financing! The lenders for this financing can be anyone, and the only limitation to this financing is your imagination!
We used imagination as children; pretending that we were saving the world from dragons by waving sticks around in the air. The more you are able to tap into your imaginative and creative side the more successful you can be while utilizing non-traditional financing!
Non-Traditional financing allows for the use of leverage to build your portfolio as well. Depending on the methods utilized it could even allow you to purchase a property when you have no money!
Typically, creative financing will have higher interest rates than the above methods, but it can still be very beneficial!
Seller financing is an extremely flexible method of Real Estate Financing that I just used to help purchase my 10-plex! This is basically paying the seller back over time for a portion of the property, or for all of the property. If the seller owns the property outright you could basically negotiate any payment plan that you want with them and not need to involve a lender.
In my recent purchase I paid 5% down, the seller financed 10%, and the bank financed the remaining 85% of the purchase. Using seller financing I was able to buy a 10 unit apartment building for only 5% down!
The best part about seller-financing is that the buyer and seller get to choose the terms! There is no other limit to this. I have even heard of people doing 10% APR interest with no payments for the first 24 months.
This allows the seller to receive a steady income from the property without any liability or expenses associated anymore! You will generally pay a higher interest rate for seller-financing, but it isn’t amortized which can allow for great cash flow!
Forming a partnership can be very lucrative because there are now two (or more) people bringing money and experience into the deal! This can allow for the purchase of more properties due to the additional access to capital and knowledge!
This is pretty cut and dry but you should set up the partnership with a lawyer to protect both of you. I recommend ensuring that you get along with this partner because you might be stuck “working” together for years!
Other People’s Money (OPM)
You can use other people’s Money (OPM) in a myriad of ways to grow your portfolio. One method would be to form a partnership where you bring the experience, and your partner brings the money. This allows your partner to benefit from your experience and deals, while you benefit from his capital!
Another method to utilize OPM is to pay a set interest rate on money loaned to you. An investor could give you $100k to use as you like for Real Estate investments. You could pay this investor 8% interest and it is a win-win situation for both parties!
The more deals you have completed the easier it will become to get OPM because you will be credible. If you have a strong enough deal it won’t be hard to find investors to bring the cash!
Hard Money Lenders
Hard Money lending is a specific type of asset-based loan. In this loan, the borrower receives funds secured by real property. Basically, the lender will give you the money, but they get the property if you fail to make payments. Hard money lenders charge a higher interest rate but have some flexible loan programs.
There is one hard money lender that I know of that will fund 85% of purchase price, and 100% of the rehab price on a property. Hard money lenders are great for fix-and-flip operations!
Commercial loans are the best! I discovered this during our recent 10-plex acquisition. Commercial loans are based on the properties performance rather than the owners’ financials. This simplified the lending process greatly because I just forwarded the information I used for analysis to the loan officer. Commercial Real Estate financing is easy to use and demonstrates how easy it is to add value to a commercial rental property.
A lot of commercial lenders require a 25% down payment but as I stated above I only paid 5% down through the use of creative financing! The interest rates for commercial loans are a little higher, and they often require a balloon payment around the 5-year mark.
That means you will either need to pay the property off completely at year 5 or refinance. I will refinance our 10-plex because we will have added significant value to the property before the balloon payment is due! You can use commercial loans on rental properties with more than five units.
So, what is the only Real Estate financing that matters?
The financing that gets approved is the only Real Estate Financing that matters!
The beauty of Real Estate Financing is that you get to make it as simple or creative as you want. You can mix/match as many traditional and non-traditional lending opportunities as you want! Learn as much as possible about these loans and use them to leverage your wealth.
You can use the financing to achieve the most cash flow, equity, or leverage. I thoroughly enjoy learning new ways to combine different forms of real estate financing. I learned about this initially from Brandon Turner’s book “The book on Investing in Real Estate with no (and low) money down.”
After that my learning has primarily taken place from google searches and phone calls to lenders. Get out there and take action!
What other ways have you found to fun your real estate investments?
Recommended reading: Becoming a Military Millionaire