Real estate investing can be a tricky endeavor. There are so many variables that come into play when you’re looking for financing for a property that it’s easy to get overwhelmed. If you’re new to the game, the terminology and methods of real estate financing can seem daunting, but don’t let that stop you from jumping in.
There is plenty of help available out there to guide you through your first deal—here’s just a sampling of what you need to know to get started.
Different Types Of Real Estate Financing
The first step to learning about financing your real estate purchase is understanding the different financing types available. The most common types of real estate financing are:
These are mortgage loans that conform to guidelines set by Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA). They’re typically for single-family homes or multi-unit apartment buildings, though some conventional lenders also offer commercial mortgages for office buildings and other commercial properties.
Leases With Option To Buy
You sign a lease with an option to purchase the property at the end of the term. This is often used as a way to buy properties that aren’t listed on the market yet, but you can also use it if you want to own property while living in it, such as renting with an option to buy.
Also known as the “debt service coverage ratio,” this is the ratio of net income to total debt payments. DSCR loan requirements are often expressed as a number, so if you have an NNN lease on your property and the rent covers all expenses, including principal, interest, and taxes plus 20% profit, then your DSCR would be 1.2 (or 120%.) If you have a loan with a DSCR of 1.0 or below, it’s considered low-risk.
These involve multiple investors pooling money together into one investment property. For example, you could partner with several friends or family members who each contribute $10,000 toward buying a building worth a $100,000 total price tag.
Working With Hard Money Or Soft Money
Hard money loans are short-term, high-interest loans. The lender is willing to take on the risk of your project because the property is already worth a lot more than what they are lending against it.
Soft money loans are long-term, low-interest loans. The lender will not want to lend against an asset that is worth less than what they are being offered as collateral.
Hard money lenders require you to have some equity in the property before they will loan against it. Soft money lenders can provide financing even if you have no equity in the property (other than their own).
In many cases, hard money lenders will only provide financing up to 70% of the value of your real estate investment while soft money lenders can provide 100% financing with little or no down payment.
Pros And Cons Of Using Credit Cards
If you already have a few credit cards and/or a good credit score, this can be an easy way to get started. You’ll need to pay off your balance in full each month, but if you can do that, it’s possible to use your card for financing and avoid paying interest charges.
However, using personal credit cards can be risky if you don’t know what you’re doing, especially if you don’t have any cash reserves. If you need managing help, consider using a service to track your spending and help you create a successful plan.
Crowdfunding As An Option For Financing
The main benefit of using real estate crowdfunding platforms is that they help investors build their portfolios without having to put up large sums of money upfront. These platforms can help lower risk by diversifying your holdings across multiple properties and borrowers instead of just one or two deals.
Most also offer some form of collateral protection for the borrower’s payments so that if something goes wrong with the loan, the borrower still has something to lose (e.g., their home).
Understand How Selling Mortgages Can Generate Income For You
Mortgages are great investments because they’re relatively safe and provide steady returns over time. Mortgage lenders charge high-interest rates on these loans so that they can make money off them even if homeowners default on their payments. Investors buy up these mortgages from lenders at a discount and then collect interest from homeowners over time until they pay off their loans in full with interest.
Financing can be difficult for a new investor, and working with a property that is worth tens or hundreds of thousands of dollars can cause a lot of headaches. Instead, pick up a small starter home in a decent neighborhood and see where it’s going to take you. The experience will give you valuable perspective and knowledge to apply to your next deal.