If you're thinking about buying an investment property but don't have the cash in your bank account, don't despair. Fortunately, there are more financing options than you probably realize. Choosing the best option for your real estate investment strategy and situation can even save you thousands of dollars. In this article, I will explain the different ways to finance real estate transactions and the pros and cons of each.

In this Guide:

1. Conventional Loans

A conditional loan is the most common type of mortgage. You provide a down payment and the bank gives you the rest of the money against the mortgaged property. While many banks allow some borrowers (those who plan to occupy the property as their primary residence) to put down 5% of the purchase price, investors usually need to put down more. Most investors charge a 20% down payment, so your loan is not subject to private mortgage insurance (PMI).

Conventional loans are a good solution for buy-and-hold investors, building a portfolio of rental properties that generate income. They are generally not used to sell homes, as these mortgages are written for 15, 20 or 30 years. Conventional lenders are not interested in short-term financing.

You can use a service like Monevo to compare loan options. Although they don't offer mortgage comparisons, you can use a personal loan to pay for repairs or renovations to your new home.

Or you might consider a service like HomeLight, which not only connects buyers and sellers with agents, but also offers home loans with no lender fees.

 Pros

• The widest range of financing available, so you can easily shop around for the best rates and terms
• It's easy to understand
• Conventional loans usually have the lowest interest rates of any loan option
• In most cases, the required PMI (private mortgage insurance) payment automatically expires when you take ownership of the property.
• Less onerous provisions than FHA, VA or other loans
• If you have a credit score of 720 or higher, you may qualify for even lower interest rates than FHA or VA loans.
• No PMI if you put down 20% of the purchase price

 Cons

• You may have a limit on the number of regular loans
• You need a good credit score (640 or higher for most conventional loans) to qualify
• It is difficult or impossible to qualify if you buy property through an LLC (limited liability company) instead of putting it in your personal name.
• Conventional mortgages typically take three to four weeks to complete the underwriting process. This is a disadvantage because investment properties often go to “cash buyers” who don't need to delay closing by adding a mortgage approval contingency to their offer.
• You may have to pay a loan origination fee

2. Federal Housing Authority (FHA) Loans

FHA loans are government-sponsored loans that encourage people to buy a home by offering a loan option where the buyer only has to pay 3.5%. FHA does not lend money. guarantees the loan to the lender. Because the FHA assumes some of the financial risk by ensuring the loan is repaid if the borrower defaults, it is easier for borrowers to qualify for an FHA loan than for a conventional loan, and the lender can offer a competitive interest rate.

 Pros

• Low down payment. 3.5% is all you need for a down payment. You still have to pay closing costs, but many of those costs can often be financed through the loan itself.
• Easier to qualify. many banks only require a minimum credit score of 550 or 600 to qualify

 Cons

• You must personally live in the property for at least one year.
• The FHA version of PMI (Private Mortgage Insurance) is the MIP (Mortgage Insurance Premium) and you must pay it over the life of the loan. That's the price you pay for getting a mortgage with such a low down payment. (You can avoid the MIP by putting down a 10% down payment, but that defeats the purpose of getting this loan: a low down payment).
• You can only have one FHA loan at a time, and the loan must be in your personal name, not in the name of an LLC or other entity.
• There is more paperwork at closing and it usually takes a little longer than a conventional loan.
• In addition to the rigorous appraisal required for loan approval, the home must pass an inspection by the US Department of Housing and Urban Development (HUD) to determine the home's market value. These additional health and safety inspection guidelines can be quite strict. And if the home requires repairs to pass inspection, those repairs must be done before the sale closes. You must make the repairs before you own the property (not recommended) or ask the seller to make the repairs at your expense before the sale.
• The stricter appraisal and inspection requirements make it nearly impossible to buy a home to renovate with an FHA loan. That means you'll likely have to pay market value because the home essentially has to be move in and ready to pass a HUD inspection.

3. 203(k) Loan

A 203(k) loan is similar to an FHA loan in that it is geared more toward homeowners than investors. It's a 3.5% owner occupied down payment loan that allows you to roll the cost of restoration into your mortgage. For example, you might consider a 203(k) loan if you want to buy a distressed property for $100,000 that needs $35,000 in renovations. Your loan amount will be $135,000 including restoration costs.

 Pros

• You can finance the entire project with a lender
• You can expand your options to include distressed and foreclosed properties as well as move-in ready properties
• You can get a better deal on a property that needs restoration, which means you can probably take advantage of instant ownership.
• By sealing the restoration work yourself, you can negotiate costs below retail prices; it will cost you less and build capital faster.
• There's no need to find extra cash for renovation costs, and when you're done, the home is likely worth more than the loan amount.

 Cons

• Available to owner-occupiers only. you must live in the property as your main residence
• Any work you do yourself will not be covered by the 203(k) loan. You need to have licensed contractors fill out the necessary paperwork
• Contractors must be vetted and approved by your lender
• There is usually more paperwork involved before, during and after settlement

4. Veteran Affairs (VA) Loan

Qualifying for a VA loan is one of the great benefits of serving in the military. This loan does not offer payday loans to select veterans, service members and military spouses. As with an FHA loan, you will need to live in the property for at least one year. A big advantage of VA loans is that you can buy as many homes as you want as long as you don't exceed your qualifying fixed amount and live in each one for at least a year. The limiting factor is not the number of houses. is the amount of duty. (In addition to offering banking services, USAA is a popular VA mortgage lender.)

 Pros

• No down payment. (You'll have some closing costs and fees, but you don't have to pay anything down to get a VA loan.)
• VA loans offer the lowest interest rates available
• PMI is not required for VA loans
• Lower closing costs. With VA loans, the seller pays some of the closing costs that are usually paid by the buyer. In Maryland, for example, the seller must pay the full 2% property transfer tax instead of the usual 50/50 split between buyer and seller.
• Not limited to one property; You can buy multiple properties with one VA loan as long as you qualify
• The highest debt-to-income ratio allowed
• You can effectively build a portfolio of no-down payment rental properties by living in each one for a year, renting each one, and moving on.

 Cons

• Not everyone has access to this type of loan
• Included in your loan is a VA financing fee that the VA collects to keep the program going
• You will be required to live in the property for one year.
• More paperwork in regulation

5. Adjustable-Rate Mortgage (ARM)

An adjustable rate mortgage is exactly what it sounds like. a loan whose interest rate fluctuates with the general market interest rate. There are many variations on ARMs.

With most ARMs, your rate is adjustable for the entire term of the loan, but there are “hybrid” ARMs where your rate is fixed for a certain number of years before switching to an adjustable rate. Personally, I stay away from ARM financing because of the risk of increased costs on my investment properties.

 Pros

• ARMs typically have lower initial interest rates than fixed mortgages
• There is a chance that your interest rate will decrease over time
• Ideal for short term financing needs as interest rates do not fluctuate much in the short term. (Historically, interest rates rise or fall slowly over time.)

 Cons

• The interest rate (and therefore cash flow) is more difficult to reliably predict with an ARM. So there is an element of risk that you will have to consider and worry about.
• ARMs are somewhat more complex to understand and analyze
• Interest rates have been at historic lows in recent years, but are now steadily rising. There's a good chance your interest rate will increase over time, increasing your monthly payment

6. Private Money

Private money is exactly what it sounds like. funding from individual (private rather than institutional) investors. Seeking financing from family, friends, colleagues, or people you've met at your local real estate investment meetings are potential sources of private money. Private money will usually be more expensive than a conventional mortgage, but the terms are much more flexible. In addition, the requirements for obtaining this type of financing are much more relaxed.

 Pros

• Few qualifications are needed. You just need to find someone who is willing to invest with you
• Very flexible credit structure. The terms of the loan can be whatever you and the individual agree on.

 Cons

• It usually carries a higher interest rate than any of the more common types of loans listed above.
• You should probably hire a lawyer to draft the financial agreement (or at least review the final agreement if you're using a template)
• Terms are usually shorter (3 to 5 years). This, along with the high interest rates, makes the monthly payment much higher.
• If things don't work out, it could cause bad blood between you and the lender.

7. Hard Money

Hard money is similar to private money, but instead of coming from an individual, the financing comes from a hard money lender. The term “hard money” is appropriate because lenders use hard assets (property) to secure the loan. Hard money loans are short-term loans that are most often used by borrowers who are buying for renovations and remodeling. You'll typically get hard cash to cover 70-80% of the property's purchase price before rehab, so lenders need to be sure the property is worth more than the loan and the cost of paying off the property in the event of a default. Hard money lenders usually charge high interest rates and include other fees such as loan origination fees.

 Pros

• Very flexible credit structure
• It's easy to qualify because the loan is backed by the property, not your personal finances and your ability to repay the loan over time. However, if you are considered a higher risk borrower, you will pay more than a borrower considered less risky.
• Hard money lenders understand the unique needs of real estate investors and offer fast financing and loan approval. A very quick turnaround from application to financing allows for more favorable negotiations during bidding. it's the closest thing to having cash on hand.
• Hard money loans are easy to find

 Cons

• Higher interest rate than other loans: 10-12%
• Hard money loans can be even more expensive if you are perceived as risky (unless you have a good credit score and extensive real estate experience).
• There are shorter terms. hard money loans are usually made for a period of one year or less, in which the entire amount must be repaid.
• If you decide to rent the house instead of flipping it after you restore it, you'll need to refinance with a hard cash loan. And because of market fluctuations, it can be difficult to refinance the entire purchase price (plus rehab) into a traditional mortgage.

8. Home Equity Line of Credit (HELOC)

A home equity line of credit, popularly known as a HELOC, is something people can use if they have already purchased a home and have some equity invested in it. For example, let's say you lived in your primary residence for 10 years while paying off the mortgage and benefiting from appreciation. The assessed value is now $500,000 and your mortgage payment is $250,000. You can take out a HELOC to take advantage of the $250,000 equity you have in the property ($500,000 value minus the $250,000 outstanding loan). You can then use this $250,000 to purchase an investment property.

You can also use a service like Hometap, which is an alternative to getting a loan. Hometap does not make loans, but invests in property equity. You get money to spend however you want, such as buying a second home or buying a rental property. You then liquidate Hometap's investment in your home or sell the property before the 10-year term is up.

 Pros

• It is an inexpensive financing option in terms of interest rates and closing costs.
• You can pay it whenever you want. You pay on the outstanding balance, not the entire HELOC
  The closing cost of a HELOC is much lower than the cost of obtaining other financing
• HELOCs are the most flexible type of financing. You only pay interest on the amount you currently borrow. In the example above, you would have $250,000, but if you only used $100,000, you would only owe interest on that outstanding amount.
• When used strategically and well managed, HELOCs are a great way to further build your wealth.

 Cons

• Essentially, you are spending equity in your original home, which essentially increases the cost of maintaining it.
• Most HELOCs have adjustable rates. This can be difficult when trying to predict your financing costs over time.

Conclusion

There are many ways to get financing to invest in real estate. It is beyond the scope of this article to detail the nuances and provisions of each. Hopefully, I've introduced you to one or two that you'll want to explore on your own.

I encourage you to consider all of your options rather than just jumping into traditional financing like a conventional loan. Discuss your strategy and options with an experienced loan officer who has worked with investors and find the best financing deal for your specific circumstances, understanding that those circumstances change over time.

I have used several different forms of financing depending on my cash flow situation and the unique circumstances of each particular transaction.

I started investing in real estate by rolling over my 401(k) funds into a Self-Directed Individual Retirement Account (SDIRA). Once I deployed those funds and wanted to continue investing in real estate, I took out a HELOC on our primary residence to purchase and renovate the property. A HELOC is probably my preferred strategy because it is very flexible and inexpensive.