An obstruction many would-be investors have with investing is the amount of money it costs. For some reason, many people think you have to have cash just lying around to be successful in investing in real estate. This is not the case at all. Most investors only start out with a small chunk of money, and some have almost nothing to their name. The trick to real estate investing isn’t the amount of money you have on hand, but how you leverage debt.
Hard Money Loans
Hard money loans are loans given by private investors or companies with no pre-approval process. These are usually short-term loans, and the people generally have a way of getting the money back quickly, such as rehabbing a home or building a house to sell. The interest on hard money loans get determined by the individual or company loaning the money and is legally binding. The people backing these loans are less concerned with your credit and debt history as they are with the collateral you use to back up the loan. Collateral can be anything that has a value equal to or greater than the amount you borrow. For example, A small business owner could put his store up as collateral for a house that he wants to build. If he is unable to pay the loan back by the predetermined date, he will default on the loan and the investor will own the rights to his business.
What happens when the banks are being stingy approving loans? Buyers turn to the seller for financing. The idea behind it is this: the seller gives credit to the buyer for the purchase amount of the home along with a promissory note. The promissory note outlines the terms of the agreement, such as interest rate and the term of the loan. The term is usually less than five years with a balloon payment at the end. The plan is for the buyer to refinance and pay the seller back within the five years to avoid the balloon payment. This type of loan is most common when credit is tight, and there is not enough money to lend, usually in poorer countries.
A construction loan is not your typical mortgage. It is a short-term, high-interest loan to cover the costs of building or rehabbing a property. In a construction loan, the person holding the loan pays the money back to the contractor working on the property rather than a lender.
A conventional mortgage is a loan that is not guaranteed or insured by the Federal Government. They are usually given through Fannie Mae or Freddie Mac Mortgage Loan Companies. In a conventional mortgage, you must have a down payment of at least 3%, although many put down 20% to avoid paying costly insurance premiums on the mortgage.
Only those in secure financial standing can get a conventional loan, and credit scores in the high 600’s and above are highly recommended. Those who can put a higher percentage of the loan cost upfront experience lower monthly payments as well. These loans are appealing to buyers in good financial standing with a substantial down payment who have already used the FHA loan.
If you are purchasing your first home and have credit that’s less than stellar, this loan is for you. With a low down payment and credit scores into the low 550’s accepted, it’s a great way to get your first investment property. These loans are insured by the Federal Housing Administration, which means you will need to pay mortgage insurance. A great perk to this mortgage is that the down payment can be a gift from family, an employer, or charity. It does not have to come out of your bank account.
Using FHA mortgages for investing can be a bit tricky, though. There are penalties for flipping a home and selling it without living in it for at least a year. The best way to invest in a home using the FHA mortgage is to purchase a duplex or quadplex that needs some love. You then can fix it up and live in one unit while renting out the other unit, allowing for the other tenant's rent to cover the mortgage payment.
Veterans Affair (VA) Mortgages
If you have served in the military, you are probably eligible for a VA loan. Veterans Affair loans are provided through the Department of Veteran’s Affairs, but you take them out through a regular lender. You are only able to use them in your primary residence, but you may use this type of loan as many times as you need.
Even bankruptcy isn’t an issue with VA loans. You may qualify for VA loans as early as two years after you take out bankruptcy. VA loans allow low credit and don’t require a down payment or mortgage insurance. The drawback to VA loans is the Funding Fee. It can be rolled into the life of the loan but causes the interest rate and loan amount to rise anywhere from 1.25%- 3.3%. Putting a down payment of at least 5% lowers the funding fee, however, and makes the loan more affordable.
Using VA Mortgages for investment properties is a bit more difficult than other loans. Although you can use VA loans as multiple times, you can only use it on your primary residence. You can either sublet some of the home out, rent out a unit, or rehab the home while you live in it for a greater profit down the road.
Home Equity Lines of Credit (HELOCs)
A Home Equity Line of Credit takes a loan out on the part of the home you own. For example: If you have a home worth $300,000, and your loan amount is $200,000, then the HELOC would be against the $100,000 you own.
HELOC works like a credit card. Upon refinancing, the lender puts the money in an account and gives you a credit card the same way any other bank does. Unlike other mortgages, HELOC’s interest rate isn't locked. Your payment on the loan depends on the amount you withdraw and the interest rate you have at that time. When you go to sell your house, you must pay off the HELOC in its entirety.
Home Equity Lines of Credit are great for investors looking to expand their portfolio using the BRRR method. More information on that can be found here.
Money is a tool. Looking at money the same way you look at the wrench used to fix that leaky faucet, it changes things. Money and debt can also be a vice if you let it. Understanding the types of debt you can leverage in real estate, that’s when the debt works for you.
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