4 Strategic Financing Tips for Real Estate Investors
Many prospective real estate investors may hesitate to get into the game because they don’t realize the financing options available. If you don’t know how to finance a fix and flip or rental property, it’s time to consider your investment property loan choices.
The success of your real estate investment will depend on your capability to finance your property successfully, which often means understanding what loan terms fit your goals. Understanding how to finance investment properties without risking too much is important, as is knowing the key strategies for financing real estate investments and how to make them work for you.
Strategic financing options and tips for real estate investing
1. Hard Money Loans
Hard money loans are short-term and long-term loans for investment properties that don’t come from traditional lenders. Instead, a hard money loan is offered by private lenders or individuals who accept assets or properties as collateral instead of the worthiness of the borrower. Real estate investors might apply for a hard money loan after having a loan denied or not having to deal with the long process of getting loan approval through a traditional lender.
Unlike secured loans and traditional mortgages, a hard money loan comes with a quick and less rigorous approval process, making it the best option if a purchase needs to take place quickly.
With a mortgage, it can take more than four weeks, from application to closing, to buy a property. With hard money loans, closing in a couple of days is possible.
2. Peer to Peer (P2P) Lending
Peer-to-peer lending (P2P lending) connects borrowers with a network of individual investors, a company or a group of people (peers) who determine whether to fund your loan.
Peer-to-peer lending brings investors directly to individuals who want to borrow money. Traditional personal loans come from legacy institutions, like credit unions, banks, or online lenders. Many peer-to-peer loans are offered through online sites, which often has a quick turnaround time.
Be aware that some peer-to-peer lenders charge an origination fee of around 8% of your loan amount. This fee is either deducted from the total amount of your loan or charged upfront. This also means that you could be hit with late fees if you miss a payment.
Do your research to check the lender’s terms and conditions for other hidden fees. These can rapidly add up and reduce the value of your loan.
3. Fix and Flip Loans
Fix and flip loans provide short-term financing to real estate investors who are using the funds to purchase and remodel a property and then resell it for a profit.
These small-business loans are commonly used to buy residential real estate and pay for any extra costs related to rehabbing, listing, and selling the property.
Your lender can help you configure a fix and flip loan to suit your financing needs, whether a line of credit or a term loan. You’ll hear them use terms like the loan-to-cost ratio (LTC) or loan-to-value ratio (LTV).
How does a lender use LTC to determine your loan? Think of it this way: LTC is determined by the loan value divided by the construction costs. In many cases the loan is structured at as much as 90% LTC and 100% of the rehab budget. These are sometimes subject to an ARV (after-value repair) cap of 75%.
4. DSCR Loan
A Debt-Service Coverage loan (DSCR) lets borrowers use the cash flow from an investment property instead of their income to pay the loan. Real estate investors frequently use DSCR loans to purchase investment properties and qualify for mortgages.
So what does DSCR mean? It’s the ratio of an investment’s total debt service to its net operating income. It’s a way of deciding whether the property will provide enough cash flow to cover the loan.
The DSCR measures your ability to repay the loan, but unlike a traditional or owner-occupied mortgage, a DSCR loan isn’t underwritten based on your personal income. Instead, it’s underwritten based on the property's expected cash flow.
However, like a traditional mortgage, DSCR loans still require a downpayment and a decent credit score. Also, like traditional mortgages, these loans will charge annual interest.
When it comes to rental investments — buy-and-hold properties — DSCR loans provide a long-term financing strategy.
Real estate investing can be a lucrative way to build wealth but requires careful planning and strategic financing. By following these tips and staying informed, real estate investors can increase their chances of success and build a strong portfolio of properties over time.