A Guide to Financing Your Next Investment Property
There are many perks beyond additional income when it comes to owning investment properties. Whether you are buying to fix and flip for profit, purchasing land for a future endeavor, or acquiring property to rent out for a steady flow of income, the cost to get started can be high and seemingly unattainable. But there are ways in which you can obtain the finances to move forward on your investment and diversify your income. Here are some common methods:
Conventional Bank Loans
This is the most common method of financing and can be obtained from a bank or lending institution. If you own a home already, you are probably familiar with this method of financing. With conventional financing for a home, the down payment is 10-20% of the home’s price. But sometimes a lender may require 30% of the home’s price when it comes to an investment property. Just like financing a home, your credit score and credit history are evaluated before getting approved and then determine your interest rate.
Hard Money Loans
Hard money loans are popular in “fix and flip” investments and are often obtained from real estate investors. They are short-term, high-interest loans. Lenders focus on the property’s profitability in addition to the purchaser’s credit scores and history. While these can be easier loans to obtain than conventional bank loans, the interest rates can be as high as 18% and may require payback as soon as one year from borrowing. You can see why this makes sense for a quick turnaround sale, however keep in mind that unexpected events such as a market turn or extensive repairs can occur. If you choose this route, be sure to have a backup financing plan to pivot to if the situation changes.
Funding from a private individual, perhaps a friend or family member willing to assist you in your real estate investment ventures, eliminates the need to qualify for a traditional or hard money loan. You might also find a private investor through local real estate investment clubs and through networking events. The terms and conditions of private loans can vary significantly from one to the next depending on the relationship between lender and borrower and will be secured through a legal document. Always consider these loans carefully as some can be incredibly favorable while others can lean towards predatory.
If you have the funds to finance your next investment, this may be a great option to avoid accruing debt or interest. Of course, risks should be evaluated to avoid tying up your capital, and this method should only be pursued if you’re certain the investment is worth it. Investors will weigh the pros and cons of paying cash for a home in full vs. breaking that money into 3 or 4 down payments for homes or other diversified investments. Using your own cash certainly has upsides: the ease and speed of closing, your cash offer is more attractive to buyers, and no interest expense.
Tap Your Home Equity
If you own property already, you can use that equity to finance your next real estate investment. There are a few ways to go about tapping your home equity:
- Home Equity Loan – Interest rates tend to be lower since these loans are secured by the equity of your house and allow for repayment of up to 30 years.
- HELOC – Home Equity Line of Credit is also an option. While also secured by home equity, funds are drawn as needed rather than as a lump sum. HELOC typically offers a lower interest rate than Home Equity Loans but the rates are variable.
- Cash-out Refinance – This method involves cashing out your existing mortgage and replacing it with a larger one. You then have access to the difference between the old mortgage and the new one in the form of cash which you can use to finance another property.