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Tips for financing investment property

Are you an investor considering jumping into the residential real estate market again?  You need to consider that the days of quick-and-easy financing are over. The tightened credit market can make securing a loan on investment properties challenging.  But with some creativity and preparation, you can bring loans within your reach.

Prepare for financing: Financing your investment property can produce significantly better returns than paying all cash. Most investors, instead, choose to finance their investments with a cash down payment and a traditional conventional mortgage.  Most traditional conventional mortgages require a minimum of 20% down but may extend higher to 25-30% for investment properties, depending on the lender.  Conventional mortgages are the most common type of mortgage used by home buyers and generally provide the lowest interest rates.

Have additional funds and a strong credit score: Investors should check their credit score before attempting to obtain a loan. This will have the greatest impact on a loan’s terms.  In addition to the loan-to-value ratio and the policies of the lender, you need reserves in the bank, savings, or investment account to pay all of your expenses for personal and investment-related, for at least six months have also become part of the lending equation.

Maybe a smaller bank will work better for you: If your down payment isn’t quite as big as it should be or if you have other extenuating circumstances, consider going to a neighborhood bank for financing rather than large financial institutions.  Some banks and credit unions have the ability to lend from their own funds entirely, which makes them portfolio lenders. Because the money is their own, they can provide more flexible loan terms and qualifying standards.

Most lending institutions must adhere to a stringent set of rules and guidelines when it comes time to finance an investment. These strict rules can make conventional financing challenging to obtain for many, especially for real estate investors and other self-employed borrowers.

The HomePath Mortgage was introduced by the government-owned mortgage giant Fannie Mae in an attempt to help turn their non-performing loans (properties they have foreclosed on) into profitable loans again. Like the FHA loan, the Home Path program allows for smaller down payments (currently as low as 10%) but unlike the FHA, no mortgage insurance is required, and the loan is available for investors and non-owner-occupied properties. The HomePath program also includes the ability to finance repairs into the purchase, like the 203K FHA loan, which is for owner-occupants only. The catch, however, is that these loans are only available on Bank Repos, which is owned by Fannie Mae.

Owner financing or other possibilities: For a seller whose home isn’t selling or when traditional lender guidelines are tightened, owner financing suddenly becomes very popular. Owner financing is definitely a viable option in buyer’s markets.  If the property is free and clear, meaning the seller has a clear title without any loans, the seller might agree to carry all of the financing. In that instance, the buyer and seller agree upon an interest rate, monthly payment amount, and term of the loan, and the buyer pays the seller for the seller’s equity on an installment basis.  Some variations of owner financing include land contracts, promissory notes, mortgages, and lease-purchase agreements.

A riskier source of funds could be securing a down payment or renovation money through home equity lines of credit, credit cards, or even from some life insurance policies.  Research your investment thoroughly before turning to these options.

Hard Money and Private Money: Hard Money is financing that is obtained from private businesses or individuals to invest in real estate. Hard money can benefit short-term loans and situations, but many investors who have used hard money lenders have been placed in challenging situations when the short-term loan ran out. Use hard money with caution, making sure you have multiple exit strategies in place before taking out a hard money loan.

Private money is similar to hard money in many respects but is usually distinguishable due to the relationship between the lender and the borrower. With private money, typically, the lender is not a professional lender, but rather an individual or even a group looking to achieve higher returns on their cash.  Private money usually has fewer fees or points, and the loan term length can be negotiated more easily to serve the best interest of both parties.

Home Equity Loans and Lines of Credit: Investors can choose to tap into the equity in their own primary residence to help finance the purchase of an investment property or properties. Investors can use a Home Equity Installment Loan (HEIL) or a Home Equity Line of Credit (HELOC) that allows them to tap into the equity in their primary residence.

But of course, you must first have equity in your home in order to obtain a home equity loan or line of credit. Banks will typically only lend up to a certain percentage of your home’s value, and this percentage will differ between lenders.

Selling with a Real Estate Agent: When you are ready to sell your investment, you will choose a real estate agent with whom you want to list your property, and then you will sign a “listing agreement.”  This agreement gives them (the brokerage) the right to earn the commission (typically 6%) if they sell the home.  You will decide what price the property should be listed for.  The pricing is essential, as you do not want to list too high, adding months to your holding time or too low, and leaving money on the table. A real estate agent should be able to look at other similar properties and determine the best price to list.

Once priced right, your investment will be sold soon after, and you will be able to move on to more real estate opportunities and grow your portfolio.

When you sell a property that you own, chances are you will have significant taxes due.  Several rules need to be followed, but if done correctly, you can re-use the money you would have paid for towards capital gains tax and can use it as part of your next property. Essentially, this is the government’s way of “partnering” with you on your investment deals. Many complicated things go into a 1031 exchange, so be sure to talk to a qualified tax specialist before making any decisions.

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