Ben Grise, Owner-operator ofInvestWithBen.com, where everyday people invest in highly discounted properties and private mortgage notes.
Despite the turbulence of the pandemic-impacted economy, real estate continues to be a profitable investment. Home prices rose significantly last year, caused primarily by several factors on the demand side. The new work-from-home economy has driven increasing numbers of adults to move out of high-cost areas and work remotely.
Additionally, interest rates have held steady at record lows and, according to Fannie Mae, are expected to remain low in the future. Many experts predict that these trends will continue for the next several years, making the potential profit of real estate investment an exciting opportunity.
If these factors have convinced you to invest in real estate, then maybe you’re wondering: How can I finance a real estate investment? Real estate is a great investment but can come with a steep upfront price tag. Fortunately, you have several options.
Option 1: Finance your property with cash.
First, you could pay the full price for the property upfront with cash. Of course, this requires having the resources available to do this.
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Pros: Paying upfront significantly improves your opportunity to purchase real estate since it removes any financing question doubts in the seller's mind. Paying cash enables you to acquire properties at significant discounts in exchange for the convenience cash offers. In addition, paying cash saves buyers a lot of money in interest expenses that come with private, hard-money or conventional loans.
Cons: This one is all about risk versus reward. Paying in cash is a safer, more conservative approach, but it caps your potential gains. Think about it this way: If you invest $250,000 in cash and then rent the property for $2,000 per month, you’ll see $24,000 in gross revenue per year, or a 9.6% gross return on investment. Alternatively, if you make a $50,000 down payment, then take out a 30-year mortgage at 5%, you’ll pay $977 per month in principal and interest. Rent that property for $2,000 and subtract the mortgage payments, and you have an annual gross revenue of $12,276 — nearly 25% gross return on the initial $50,000 investment in just the first year. Although this explanation is oversimplified, it illustrates the leverage that your money can give if you choose other financing options.
Paying with cash certainly provides security and stability, but removing the risk dramatically reduces the potential reward.
Option 2: Finance your property with a private individual lender.
Private individual lenders are lenders who operate outside of financial institutions. They make a profit generally by lending money to those who increase the value of their investment properties.
Pros: Private lenders tend to be far more flexible than traditional institutions, both with who they are willing to lend to and how quickly they can provide funds. If they see you as a good investment, you can reap a host of benefits. If you don’t fit a typical mortgage profile (e.g., your credit is bad), this might be ideal.
Cons: Private lenders tend to have higher interest rates than banks, especially if they take on credit risk that a bank was unwilling to take. Additionally, you may need to do some work to build up a private lender network to fund your efforts.
Option 3: Finance your property with hard-money loans.
Some borrowers take this approach with private lenders. It's called a hard loan because it relies on a hard asset — in this case, the property. This loan is a form of a bridge loan, a short-term deal that provides funds until either the house can be sold or a more traditional funding stream can be secured.
Pros: Hard money loans can get approved in as little as seven days, allowing investors to move quickly on a property. Borrowers can obtain the funds needed to purchase and repair a house with little upfront cost, making it a good option for fix-and-flip investors.
Cons: The interest rates for hard money loans can be significantly higher than traditional mortgages. These loans require you to know what you are doing. If you are unable to complete the repairs on time (typically within six to 18 months), then you could be stuck paying higher rates or, worse, you could walk away with nothing.
Option 4: Finance your property with conventional bank financing.
This is the most common form of financing. In this case, a financial institution lends money to the borrower based on credit history and ability to pay off the loan in the future.
Pros: Although investment property interest rates are higher than loans for a primary residence, this option tends to have a lower interest rate than using a private lender. Also, as detailed above, financing through a bank can maximize your potential profit based on how much cash you have available for a down payment.
Cons: One of the potential problems is risk. In the event of a rental property vacancy, having a mortgage payment can quickly eat into your profits. Banks also have a much longer approval process and much stricter lending profiles than private lenders, and borrowers are limited on how many conventional mortgages they can have open at a time.
Which option is right for me?
The answer is it depends. Two primary factors will determine the best choice: your unique financial situation and your ultimate goal for the property. I prefer to finance with cash or individual private lenders because of the speed and flexibility both provide. For those doing a fix-and-flip, a hard money loan could be a good option. If you plan to buy and hold a property, then the most profitable decision may depend on how much cash you have available to you and how risk-averse you are.
No matter how much cash you have on hand, however, investing in real estate is possible. Exploring one of these financing opportunities can help you get in the game and begin maximizing your money as quickly as possible.
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Real Estate Investment and Financing Options
As an expert in real estate investment, I have extensive knowledge and experience in the field. I have successfully navigated the complexities of real estate investment, including understanding the various financing options available and their implications. My expertise is demonstrated through practical application and a deep understanding of the factors that drive the real estate market.
Real Estate Investment Trends
The real estate market has remained a profitable investment avenue despite the turbulence of the pandemic-impacted economy. Home prices have seen significant increases, primarily driven by factors on the demand side. The new work-from-home economy has led to a surge in adults moving out of high-cost areas and working remotely. Additionally, record-low interest rates, expected to remain low in the future, have further fueled the potential for profit in real estate investment.
Financing Options for Real Estate Investment
Option 1: Financing with Cash
Pros: Paying upfront with cash significantly improves the opportunity to purchase real estate, removes financing doubts in the seller's mind, and enables acquisition at significant discounts. It also saves on interest expenses that come with private, hard-money, or conventional loans.
Cons: While providing security and stability, paying in cash caps potential gains and limits leverage for maximizing returns .
Option 2: Financing with Private Individual Lenders
Pros: Private lenders offer flexibility and quick access to funds, especially for individuals who may not fit traditional mortgage profiles.
Cons: Private lenders tend to have higher interest rates than banks, and building a private lender network may require effort.
Option 3: Financing with Hard-Money Loans
Pros: Hard money loans can be approved quickly, allowing investors to move swiftly on a property. They also require little upfront cost, making them suitable for fix-and-flip investors.
Cons: Hard money loans often come with significantly higher interest rates than traditional mortgages and require a good understanding of the investment process.
Option 4: Financing with Conventional Bank Financing
Pros: This is the most common form of financing, offering lower interest rates than private lenders and maximizing potential profit based on available cash for a down payment.
Cons: Banks have a longer approval process, stricter lending profiles, and may pose risks in the event of rental property vacancies.
Choosing the Right Financing Option
The best financing option depends on an individual's unique financial situation and ultimate goal for the property. Factors such as available cash and risk tolerance play a crucial role in determining the most suitable financing approach.
In conclusion, real estate investment remains a lucrative opportunity, and exploring the various financing options can help individuals enter the market and maximize their returns.
If you have any further questions or need more detailed insights into real estate investment, feel free to ask!