The reasons for investing in real estate may be many and varied. For instance, you may want to purchase real estate so that it can act as a hedge against market volatility. Another reason may be to diversify your investment portfolio. Many investors are also attracted by the potential to earn a passive income.
Whatever your reason, it’s important to know how best to finance the purchase. Choosing the wrong financing vehicle can have a serious impact on your bottom line. As a real estate investor, you have multiple financing options to consider. It’s, therefore, important to understand the requirements of each option before making a decision.
This post will cover what you need to know about financing an investment property.
Bank Loans
This is a conventional way of financing a real estate property. They are backed by collateral or guarantees. Usually, one of the requirements to get bank financing for a home purchase is a 20 percent down payment. However, when it comes to an investment property, you may have to put down as much as 30%.
Lenders will also want to check your credit history and credit score before approving financing. These two metrics may not only determine whether or not you’re approved, but also how much interest rate to pay.
Pros
The following are the pros of conventional bank loans:
- Require much less paperwork
- Can be obtained much more quickly
- Low-interest rates
Cons
Here are the cons of conventional bank loans:
- Require a high down payment
- You need collateral against the loan
- A good credit score is required
Hard Money Loans
This is a type of financing that is provided to real estate investors by non-banking institutions or private lenders. These are often considered loans of “last resort” or short-term bridge loans. A hard money loan is backed by the property used as collateral. If you default on the loan, the lender can recoup back their money by selling the collateral asset.
Pros
The following are the pros of using hard money loans to acquire an investment property:
- The approval process is much faster than loans offered by traditional lenders
- Loans are typically flexible and convenient
- There are no prepayment penalties
Cons
Here are some cons of using hard money loans:
- The lender faces considerable risk
- The interest rate is high
- They come with a lower loan-to-value ratio
Private Money Loans
Private money loans are just that – private loans. They are loans that are given to an individual by a private organization or a wealthy individual. Private money loans are usually a quick solution for financing or refinancing a real estate investment. This is particularly true if you need financing quickly or don’t qualify for traditional financing.
Pros
The following are the pros of using private money loans to finance an investment property purchase:
- They’re more flexible than traditional financing
- Qualifications are usually fewer and less strict
- No prepayment penalty
- Fast turnaround
Cons
- Consider the cons of using private money loans to finance an investment:
- Fees and penalties can be high
- Interest rates can be higher than alternatives
- Default on payments can be costly
Home Equity
This is a type of loan that can enable you to use the equity you’ve built in your home as collateral to borrow money. In the simplest terms, a home’s equity is how much a home is worth, minus how much is owed in debt. Usually, you may be able to access up to 80% of your home’s equity value towards the purchase of an investment property. And just like other financing options, using a home equity loan has its pros and cons.
The pros of this financing option include:
- Tax-deductible interest rate
- A lower interest rate than other loans
- More easily obtained
- An easier way to get a large sum of money in a short time
On the other hand, the cons include:
- Risk of losing your home should you default on the repayment
- Needing a good credit score for a chance to qualify for a lower interest rate
- Closing costs can range from 2% to 5%
Approval Requirements for Investment Property Financing
Depending on the investment financing option you choose, lenders will often have varying requirements. To get financing from a private lender, you may only need to have a solid relationship with them. As for hard money lenders, there are no minimum credit requirements. They tend to rely solely on the value of the collateral property securing the investment property.
Generally speaking, home equity loans and bank financing tend to have the strictest requirements in regard to credit scores and income. Typically, you’ll need to have a credit score of at least 680 for a one-unit investment property.
If you have a lower credit score, all hope isn’t lost. The following are some of the things you could do to boost your score and potentially qualify for financing:
- Make regular payments on time
- Build your credit history
- Keep your credit utilization low
- Limit requests for new credit
- Use 30% or less of your available credit
Which Financing Options are Best for an Investment Property Purchase?
Comparing different borrowing options is the best way to know which one fits your specifications. As you do the comparisons, make sure to keep in mind both the short-term and long-term costs, as well as how they may impact your investment’s ROI.
Bottom Line
Real estate investing can be incredibly rewarding. However, it’s a long-term game that requires due diligence with every step you make. When financing a property, make sure you do due diligence.
If you need expert help, look no further than Keyrenter Property Management New England. We understand the New England real estate market like the back of our hands. We’ll not only help you make the right investment purchase, but we’ll also manage it. Get in touch to learn more!