The real estate investment market is ever changing and can be complicated at times. One of the most basic aspects of this business is securing the needed financing to close the investment deal. A big part of this is understanding how the lenders make their profit. With this knowledge, you begin to understand why certain loans are offered by certain lenders.
Real estate investors use their mortgage loans to increase the leverage on the property. The more money that can be borrowed, the more the investor can leverage on the investment. There is the rare occasion when the investor uses an all cash deal to purchase properties. But this is a short term solution. Those choosing this option usually refinance the property to get their cash back or they flip the property quickly.
The challenge for real estate investors is that lenders see investment loans as high-risk compared to financing owner-occupied properties (non-investor loans). Lenders especially look at leveraged investments as risky and are therefore less willing to loan money to real estate investors wanting these loans.
Lenders assume the the less of your own money you have invested in the property, the more likely you are to walk away from a bad property. So, the ultimate goal of the investor is to put in as little cash as possible, pay the smallest amounts in loan costs and interest, while keeping their personal risk at a minimum.
As a real estate investor obtaining your mortgage financing may seem straightforward on the surface, but often it can become quite complicated. It is the financing that can make or break the deal and the profitability of any of your real estate investments. It pays to do business with brokers who deal strictly with real estate investors.
Here are a few of the more traditional sources of real estate capital and the pros and cons of each...
Mortgage Loans: Most new real estate investors are very accustomed to borrowing money from their local bank or saving & loan. So, this is the first place they think of because it's how their home is financed and that's what they are the most familiar with.
At first, this may seem like a good choice, but these sources of real estate money have all but dried up during the recent mortgage crunch. Banks are no longer offering sub-prime loans or no-doc loans as they had. Even when they do issue these loans, they will want an excellent credit score over 700 and a sizable down payment in the 30% to 40% range. You will have to be financing quality properties with little or no rehab involved.
This isn't always possible if you are just starting out as a new investor. Keep in mind that these loans are very costly with high interest rates. Not only will you need 30% to 40% down, but the closing costs can run several thousand dollars and will dramatically reduce your profit upon the sale of the property.
Since the collapse and takeover by the Feds of Fannie Mae and Freddie Mac, mortgage loans are harder to come by. Plus Fannie and Freddie have now imposed some severe restrictions to what investors can be loaned on. You will most likely have to be more creative with your financing these days and look beyond the traditional, mortgage loans.
Hard Money Lenders: Hard money lenders have been very popular for real estate money despite their high cost. However, even hard money lenders are having problems getting money to lend in the housing market collapse. As a result many markets no longer have hard money lenders doing business in them.
Hard money loans have always had several drawbacks. Many will only lend to about 65% of the home's value and you have to come up with the balance of the money from somewhere else. In addition, to obtain these hard money loans you will see 5 to 10 points up front and generally 5 points on the back end.
The net effect is investment money that will cost in the 20%+ range and you still have out of pocket money running you almost 1/3 of the purchase and rehab costs.
Private Lenders: Private lending is through individuals and not banks. It is a much better option for real estate money in this post-bubble market. Private lenders are more willing to negotiate for both the terms and amount of the loan. You are more likely to find a loan that will both fit the deal and your needs.
Private lenders will do either a first mortgage loan where they put in the their dollars or a second mortgage where they are subordinate, behind a bank or other lender. The cost of private lending is very low compared with other traditional methods as there are almost no closing costs and the interest rates run in the 9% to 15% range with no back-end fees.
Portfolio Loans: Portfolio loans have become a popular means of obtaining financing in this post Fannie and Freddie collapse. These a loans through small, local banks and credit unions that remain as assets of the institution. Investors deal directly with the institution with no broker or middleman. You need to know how to make these deals correctly for them to go through (see the resources below).
You will also find other specialized options available. These you need to work out with your broker. But if you are not aware of them, you will be pushed a more traditional mortgage.
My suggestion is that you educate yourself on the process of financing investment properties, with its challenges and pitfalls, even if you are going to use a competent broker. I would even go as far as to advise you learn all you can about investment financing before you ever make any offers on properties.
Real estate investing will make you money if you learn all that you can about investment techniques and apply yourself diligently. Investment financing is a big part of this learning process. An education on this aspect of your business will help you avoid mistakes and close your deals.
You can learn much about investing from from books and seminars on real estate investment but you'll find that many real estate gurus teach you little about actually financing the deal properly. You'll learn much more about this aspect of your business by talking to other investors that have already gone through the process of obtaining loans for themselves.
There are good books out there that focus strictly on the aspect of financing your loan. Many are academic and hard to wade through... but I can recommend Mortgage Secrets for Real Estate Investors as an easy to read, easy to comprehend, comprehensive book on the subject of investment financing.
The more you learn about investor loans and financing, the easier your job as an investor will be. And the more money your investment business will make for you.