Investing in rental properties can be a great way to build wealth, but sometimes it requires a significant amount of money upfront as down payment. Fortunately, there are many financing options available to real estate investors. In this article, we will discuss the different types of financing options.
Primary Financing Options
According to the National Association of Realtor’s survey from 2022, 90% of the loans that buyer’s used to purchase properties consisted of conventional financing, FHA, and VA loans.
In 5% of the cases, the buyer did not know the type of loan they got and in the remaining 5% of the time it was another type of financing. We’ll be focusing primarily on this last 5% here since we’ve covered the primary financing options elsewhere. But, here’s a quick recap of the primary financing first.
Conventional financing is the most common type of financing for rental properties. These loans are usually offered by banks and require a down payment of at least 15% with private mortgage insurance (PMI) for non-owner-occupant purchases. You can eliminate PMI if you put 20% or more down.
They typically have a fixed interest rate and a term of 15 or 30 years. One of the benefits of conventional financing is that it is readily available and has lower interest rates than some other types of financing.
If you’re looking to house hack or utilize the Nomad™ strategy there are low down payment conventional loan options available as well starting as low as 3% for first time homebuyers but more commonly 5% down.
FHA, VA, and USDA Loans
FHA, VA, and USDA loans are government-backed loans that require a lower down payment than conventional financing. These loans are intended for owner-occupied properties, but they can also be used for certain real estate investing strategies like house hacking and Nomad™. One of the benefits of these loans is that they require a lower down payment, which can make it easier for first-time investors to get started.
Portfolio loans are loans that are held by the lender and not sold on the secondary market. These loans are typically offered by smaller banks and credit unions. They may have more flexible underwriting guidelines than traditional loans. One of the benefits of portfolio loans is that they allow for more individualized underwriting, which can make it easier for investors to qualify for financing.
Investors tend to gravitate toward portfolio loans after they’ve filled their portfolio is long-term, fixed-rate financing offered by the other primary loan types described above.
Other Financing Options
Now that we’ve quickly reviewed the primary financing options for real estate investors, let’s look at the other financing options starting with the creative financing family of options.
Creative financing is a way to finance a rental property using non-traditional methods. This can include seller financing, lease options, and subject-to financing. Creative financing can be a good option for investors who may not qualify for traditional financing or who want to structure a deal in a unique way.
Private money is financing that comes from individuals rather than banks. Private lenders may charge higher or lower interest rates and fees than traditional lenders. However, private money can be a good option for investors who need to close a deal quickly or who cannot qualify for traditional financing.
Hard money is typically from professionals in the business of making loans secured against real estate that are typically used for short-term financing. Hard money lenders may charge higher interest rates and fees than traditional lenders. However, hard money can be a good option for investors who need to close a deal quickly or who cannot qualify for traditional financing.
A HELOC, or home equity line of credit, is a loan that is secured by the equity in your home. HELOCs can be used to finance a rental property, but they may have higher interest rates than traditional loans. One of the benefits of a HELOC is that it allows investors to tap into the equity in their home without having to sell the property.
Life insurance policies can be used as a way to finance a rental property. Some policies allow you to borrow against the cash value of the policy. This can be a good option for investors who have a life insurance policy with a significant cash value.
Self-Directed Retirement Accounts
Self-directed retirement accounts, such as a self-directed IRA or 401(k), can be used to finance a rental property. These accounts allow you to invest in non-traditional assets, such as real estate. One of the benefits of self-directed retirement accounts is that they offer tax advantages that can help investors save money.
Cash is always an option for financing a rental property. This can include savings, inheritance, or the sale of another property. One of the benefits of cash is that it allows investors to avoid the fees and interest associated with traditional financing.
Partnering with someone else can be a way to finance a rental property. This can include a joint venture, where both parties invest money and share in the profits, or a loan guarantor, where one party provides the financing and the other party signs on the loan. One of the benefits of partnering with someone else is that it allows investors to pool their resources and expertise.
In conclusion, there are many different financing options available for real estate investors. Each option has its own pros and cons, and it is important to understand the details of each option before making a decision. By considering all of the available options, investors can find the financing that is best suited for their needs and goals. Regardless of the financing option chosen, it is important to have a solid understanding of the rental market and to carefully evaluate potential properties to ensure a successful investment.