As an investor, there are several ways that you can finance a deal. There are a few conventional ways, but investors can also get quite creative in how to fund projects. This will cover a couple basic ways to support deals, but numerous creative options consist of a combination of strategies. No matter how you choose to fund a deal, it’s best to have a financing plan lined up before finding a suitable property. It’s always best to run any creative ideas by your lawyer to make sure you are not breaking any laws.
Investors may choose to pay all cash to pay for an investment property. When investors use terms like “All Cash,” in actual, no “cash” is traded. In many cases, the buyer brings check or transfer money through wire transfer to the bank. This can be considered as the very most straightforward form of financing, and there are no complications. For many investors, all-cash payment is not an option, especial when just starting out. The return that is earned from an all-cash deal, will not be the same when leveraged, such as taking out some sort of loan. Using other people’s money has its advantages. If you take out loans for your projects, you can take on multiple deals at the same time and use your cash reserves to make the payments instead of tying it all up in just one project.
A hard money loan is financing, which is received from a private business or individual for a reason for investing in real estate. The terms and styles of hard money change often but has various defining characteristics:
Hard money can prove to be very beneficial for short term loans and situations. Many investors have used these hard money lenders and run into trouble when the project requires additional repair costs or can’t be completed on time. It’s important to use hard money with caution and make sure that you have multiple exit strategies before you take out a hard money loan. If you can’t meet the terms of a hard money loan, they will not hesitate to foreclose on the property, and you can lose everything.
Private money is very much similar to hard money in many respects. It is distinguishable due to the relationship between the borrower and the lender. With “Private Money,” the person who lends money is not a professional lender as in case of hard money lender, but it is an individual who is looking to achieve higher returns on their cash. Private Money lenders are less business oriented people as compared to hard money lenders. Private money has fewer fees and points, and also the term length can be negotiated much more quickly to serve the best interest of both parties. Cost or time overruns are quite common, so it may be a safer option. Private money lending is between two parties that trust each other. Use caution if you are trying to obtain a loan through an unfamiliar party. Unfortunately, the real estate field is wrought with folks that work to take advantage of inexperienced investors.
Private lenders lend cash to buy property in exchange for a specific interest rate. The investment of private lenders is secured by a promissory note in regards to the property. The price of interest is negotiable for a specified period ranging from six months to thirty years. If the terms of the note are not met, it is easier to renegotiate, unlike a hard money situation where you are dealing with a business.
A final, common strategy is leveraging a retirement account to finance deals. This is especially nice if you have an account that you can no longer contribute too. If you have a traditional IRA, the only way to utilize funds is to borrow from it. Typically, you can borrow up to 50%. The interest that is charged on loan has to be returned to the account. Given the high rates involved in real estate deals, it’s an excellent way to increase the value of an otherwise stagnant account.
Traditional accounts can be rolled over into a self-directed account that is more easily used for real estate financing. The only limit would be the associated bank accounts that hold the money. Many times, these type of bank accounts require a minimum balance to prevent month fees. Even so, you more than likely can lend out more than 50% of your funds.
Regardless of which retirement account that is used, all the earned interest and principal must be return back into the account. This type of investing may be another option for private lenders who have these type of retirement accounts. There are rules with investing in your own deals. While you may be able to leverage your own money in a loan situation, it would be a prohibited transaction to lend from your own self-directed IRA to yourself. If you do have an account of your own, you can find a fellow investor in the same situation to trade investments. You can invest in their deals, and they return the favor in investing in yours. Meanwhile, your retirement nest egg grows over time.
Have a plan: Regardless of the financing option, you plan to use, it’s best to have the strategy in place before finding the property. A crucial part of finding good deals is to be able to purchase the property quickly. Real estate investors deal with motivated sellers who are usually on a compressed time schedule for a multitude of reasons ranging from unexpected relocations to pending foreclosures.