Financing Real Estate Investment Property – Guest Post
In my experience, a lot of people want to own real estate investment property, but few people know how to get financing for real estate investment property. Below are some options available for real estate investors.
Cash – According to Realtor.com’s latest data cash buyers represented 32% of home purchases. There are some obvious benefits to this method. However, there are two key negatives. One negative point is the tax consequences as there is no interest expense to deduct. The second negative factor is that this option minimizes your liquidity.
HELOC’s (HOME EQUITY LINES OF CREDIT) – HELOC’s usually have an interest rate from 2%-6%. This is a very wide range because some banks use this product as a tool to get you in the door for more products. HELOC’s are a great option to utilize existing equity in your house to buy an investment property.
Margin Account – If you have a significant investment account with stocks and bonds, you can pledge this for collateral so your bank can have a property LTV (Loan-to-Value). Another option would be to borrow directly from the account. Note, some brokerage houses do not allow this. By borrowing from the account, you have the advantage of not selling and paying capital gains taxes. Additionally, the investment account will hopefully continue to increase. The rates on margin accounts vary significantly.
FHA (Federal Housing Administration) – FHA loans are only for investors that will live on the property. You can buy a multi-family up to four units with a FHA loan. The primary benefit of a FHA loan is the down payment requirement is only 3.5%. However, you will need to pay PMI (private mortgage insurance) since you are not putting down the standard 20%. PMI usually costs around $100 for every $100,000 you borrow.
Commercial Loan – Rates usually approximate 4%-7%. The biggest benefit with utilizing a commercial loan is that sometimes you can negotiate “non-recourse.” An additional benefit is that commercial lenders have significant flexibility and can structure a loan according to your needs. For instance, I bought a triplex and was going to spend three months renovating the property before I rented it out. My commercial banker generously offered for the first three months to be interest only.
Hard-Money Loan – full disclosure – I am very biased AGAINST this type of loan. These lenders usually charge 1%-3% for origination and then charge 10%-18% interest. The profit margin on a rental is usually around 15%. Therefore, it is very hard to make money, after taxes and holding costs, with these types of loans. The reason I am biased is that I have seen multiple real estate investors use this type of lending only to not make any money due to the high interest rates.
In summary, there are a number of ways to finance a real estate investment. The key is to research your funding options before you get a contract so you are well informed and are in a good negotiation position with both the seller and the lender.
Jimmy Moncrief is an underwriter at a bank that specializes in real estate lending and is a real estate investor.