Unlocking Funds For Your Next Investment Property

Investing in real estate can be a great way to build wealth and generate passive income. However, it often requires a large amount of upfront capital, which can be a significant barrier for many aspiring investors. The good news is that there are several strategies you can use to secure funding for an investment property, even if you don't have much money of your own.

One popular option is to take out a loan, and there are various types of loans available for financing investment properties. Conventional bank loans are a common choice, but they typically require a higher down payment of around 30% and have strict credit score, income, and asset requirements. Hard money loans are short-term, high-interest loans often used for flipping properties, while private money loans come from individuals like friends or family and should be carefully considered due to the potential for default. Home equity loans and lines of credit (HELOCs) allow you to borrow against the equity in your primary residence to finance investment properties. Commercial loans are another option for financing multi-unit residential or commercial properties.

In addition to these traditional loan options, you can also get creative with your funding sources. House hacking, for example, involves buying a small multi-unit property, living in one unit, and renting out the others to cover your mortgage and housing costs. The BRRRR method (buy, renovate, rent, refinance, repeat) uses a purchase-rehab loan to finance the initial purchase and renovations, and then you refinance with a long-term landlord loan to pull your original cash back out. Seller financing is another option where the property owner acts as the lender, and you can also assume the seller's existing mortgage or negotiate a seller-held second mortgage.

Collateral-based lenders, such as landlord lenders and hard money lenders, focus more on the property's value than your personal finances, giving you more flexibility in where you get your down payment from. Gap lenders will cover your down payment but will either charge high interest and fees or take an ownership stake in the property. You can also borrow from friends and family or even partner with them on the investment. Using credit cards or business lines of credit is a riskier option but can provide quick and flexible funding. Lastly, don't underestimate the power of saving and investing your own money; it may take time, but it's a more sustainable approach than relying on borrowed funds.

Conventional bank loans

When applying for a conventional bank loan, your credit score and credit history will play a significant role in determining your eligibility and interest rate. Lenders will also review your income, assets, and existing debts to ensure you can afford the monthly loan payments. It's important to note that future rental income is usually not factored into these calculations, and lenders may expect you to have cash reserves to cover the loan for at least six months.

There are three main types of conventional bank loans: adjustable-rate mortgages, fixed-rate mortgages, and jumbo loans. Adjustable-rate mortgages offer a lower fixed interest rate for an initial period, which is then adjusted periodically based on market conditions. Fixed-rate mortgages, on the other hand, provide a stable interest rate and monthly payment throughout the loan's life. Jumbo loans are used for purchasing high-value properties and come with stricter credit requirements and higher interest rates.

Compared to alternative financing options, conventional bank loans offer lower interest rates and longer repayment periods, making them more affordable in the long term. However, the approval and underwriting process can be lengthy, and the requirement for larger down payments may pose a challenge for investors without substantial cash reserves.

Hard money loans

The approval process for hard money loans is faster and less strict than for traditional loans. Lenders approve borrowers based on the value of the property being purchased, rather than their credit history. This makes them ideal for borrowers who have been denied a loan or mortgage through traditional methods, or who need financing quickly.

However, hard money loans are more expensive than traditional loans. They have higher interest rates, and lenders may require larger-than-average down payments. They also have shorter repayment periods, usually just a few years.

Private money loans

However, it is important to carefully consider the potential risks involved with private money loans. These loans often have higher interest rates and fees than traditional bank loans due to the increased risk taken by private lenders. Additionally, there may be less oversight and protection for borrowers because these loans are not regulated by traditional financial institutions.

If you are new to real estate investing, it is crucial to contemplate how your relationship with the lender might be affected if you default on the loan. Borrowing from friends or family can have significant personal repercussions, and even the best investment prospects may not be worth risking these relationships.

To find private money lenders, you can start by reaching out to your network of friends and family. If that is not an option, consider attending local real estate investment networking events to connect with potential lenders.

Home equity loans

Lenders perceive home equity loans on investment properties as riskier than those on primary residences. This is because, in the event that you are unable to repay the loan, you are more likely to walk away from the investment property than your primary residence. As a result, lenders may require a stronger-than-average financial profile and substantial assets.

The requirements for home equity loans on investment properties vary by lender but generally include a minimum credit score of 700 or higher, a maximum debt-to-income ratio of 43% to 50%, and a maximum loan-to-value ratio of 70% to 80%. Lenders may also consider the property's income-generating history, with a steady, positive cash flow and high occupancy viewed favourably.

Before pursuing a home equity loan on an investment property, it is important to carefully consider the risks and ensure that you meet the eligibility criteria and understand the requirements and potential costs.

Commercial loans

One of the advantages of commercial loans is the ability to finance large-scale real estate projects. These loans often have higher borrowing limits, allowing investors to purchase more expensive properties. Commercial loans may also offer longer repayment terms, resulting in lower monthly payments and improved cash flow. Competitive interest rates are also possible, especially if you have strong credit and a solid business plan.

However, one of the main drawbacks of commercial loans is the rigorous qualification process. To qualify, you typically need extensive documentation, including detailed financial statements and business plans. Commercial loans often require larger down payments, which can be a significant financial burden. The approval process can be lengthy, potentially causing delays in acquiring the desired property. Furthermore, commercial loans may have higher interest rates and fees than residential loans due to the increased risk associated with commercial real estate investments.

When considering a commercial loan, it is important to carefully evaluate your financial situation, the intended use of the property, and the specific requirements of the loan. Consulting with financial experts and comparing different lenders' offerings can help you make an informed decision.

Frequently asked questions