The starting point for any prospective deal is financing. How you plan on financing the transaction dictates just about everything else you do. Financing determines your offer price, the closing date, contract contingencies and earnest money deposited. On some deals the financing option is cut and dry. On others there are a handful of options that make sense but choosing the right one is critical. A slight change in a long-term interest rate or a percentage change in the potential profits can end up costing you thousands of dollars. Before you get too far with a prospective deal you need to know how you plan on financing it. Here are the five
main financing options, and when you should use each of them.
- Local Bank: There are pros and cons with every financing option. The key is to know when, and how, to use them to your advantage. Long gone are many of the purchase options available last decade. It is amazing to consider the number of programs there were with little to no money down coupled with stated asset and reduced credit score options. Today, you need above average credit scores with a sizeable down payment if you want an investment property loan. Local banks generally specialize in the basic, vanilla type loans. These can be ideal if you are looking for a long-term buy and hold rental property. Even with rates for these programs higher than a primary residence they are still well below historical averages. You can get a conventional investment property loan right around 5%, depending on the specific credit score and number of units. Lower interest rates means increased cash flow which can make even an average rental more attractive. If you have A+ credit, low debt to income and 20% down payment your first stop should be your local lender.
- Mortgage Broker: There are still plenty of mortgage companies out there in most markets. Almost everything about the mortgage business has changed over the last decade. In the past, anyone could work for a mortgage company and broker loans. Today, there are strict background checks as well as a difficult licensing process. There are also changes with how your loan fees and figures are presented, giving you confidence there will be no surprises at the closing. Mortgage brokers have a handful of lenders at their disposal, each with several different programs and options. Some lenders offer stated income programs on commercial properties only. Others have a reduced down payment option on multifamily properties. Some have bank statement programs if you are a self-employed borrower. If there is anything slightly out of the box with your application, you should reach out to a mortgage broker. There is a much better chance that you can get something done with a broker as opposed to your local lender.
- Hard Money Lender: As much as traditional loan options have changed there are still viable lending options available. One of the most common are hard money lenders. On the surface, these often sound intimidating and overwhelming but, they are much like any other lender. They have their own guidelines, fees and options. The biggest difference is that they do not adhere to traditional lending guidelines. A self-employed borrower who has trouble with their adjusted gross income can be a candidate for a hard money loan. Hard money lenders usually look at the overall strength of a deal as well as an ability to repay. These are typically short-term options for rehabs and quick flips. The double-digit interest rates make holding these loans for any longer than six months cost prohibitive. The fees are also much higher than what you would see on a traditional loan. If you are in need of quick capital, you should find a local hard money lender.
- Private Money Lenders: Private and hard money lenders are similar, but also have considerable differences. A hard money lender is an individual or a group where a private lender is generally a friend or family member. Right now, without even knowing it there are several people in your inner circle longing to get started in real estate, but not sure how. They have capital to invest but aren’t sure where to get started or have the time to do so. By sending out an email or texting your contacts you can probably find a few people who are willing to be financial backers. These private money lenders supply the capital and you do the heavy lifting with the transaction. You negotiate the terms of financing, but they are generally much more reasonable then hard money. There are certain other factors with investing with people close to you, but the upside is much higher as well.
- Personal Capital:There is more to personal capital than simply how much you currently have in the bank. Of course, savings is a big part but you also need to examine your portfolio. If you have equity in your primary residence you may be able to obtain a home equity line of credit. With a 10-year interest only payment these can be the ideal vehicle to fund your next deal. You should also at least explore the option of an IRA, 401k or even credit cards if the deal is right. With all these options you should view the capital as a short-term bridge loan and repay them asap.
Choosing the right financing for your transaction can make all the difference in your bottom line. Use these options as a guide on your next deal.
