The major concern of the investors today is on how to finance a property as it can be a long term commitment and needs to be carried out diligently. There are many reasons why people want to invest in real estate. It can prove to be a long-term financial commitment and there are chances that you do not have enough cash ready to make the payment. In such cases, you have to look for other ways to finance a property such as loans, mortgages, etc.
There are different methods in which you can finance a property as different kinds of financing options are available to you and evaluating them based on their merits and drawbacks will help in choosing the right option to finance a property. It is very important that you chose the right option as the wrong financial option can put you in unnecessary trouble. Real estate financing is a term that describes the various methods in which the investor carries out his investing processes. In this method, we have an outsider that is lending out the money to help the investor to put in the correct amount of money to carry out the investing and removing activities on the property.
As an investor, you must consider the various pros and cons associated with the different financial options that are available to you. However, the choice of the financial option should be made after considering the type of property you are purchasing along with the situations in which you are making the purchase. Understanding the financing aspect of investment helps your investment strategy.
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What are the different options available to finance a property?
There are different methods in which a buyer can finance a property such as:
Cash financing:
Financing through cash can be the easiest way to carry out the investment process. It is the most significant way to finance a property for those investors that has significant capital to go about with their investment process. This can help the purchaser to carry out their purchasing process clear and free. Investing using cash is one of the most preferred ways to invest because this helps the investor save money spend on interest and can receive better cash flow and quick equity in their property.
Seller financing:
There are certain instances in which the seller and buyer strike an equally benefiting financing deal. In this case, the buyer makes the payment directly to the seller and not via the bank. This is a good method to finance a property for those sellers to sell their property quickly and also to the buyer as it helps the buyers to get rid of the hassle of traditional procedures required such as meeting minimum credit score, few or no closing costs, and may not require an appraisal. The main advantage of this is that the process is much quicker compared to other methods of financing and the closing process can be carried out quickly.
Private money lender:
One of the most common ways that new investors finance a property, is through private money lenders. They are people that have the means and interest to invest in your property, just like the way you are interested in investing. They provide the borrower with the money to invest in exchange for some interest. This option of financing is quite common in cases wherein the buyers are of the opinion that they can resell the property at a higher rate, mainly after renovation.
This strategy cannot be used freely like the way you use cash or seller financing and is recommended only if the buyer has a clear exit strategy.
Conventional loan:
It is a kind of loan that is granted to a home buyer. In a conventional financing setup, the expected standard down-payment is 20% while in the case of an investment property, the expected down-payment may go up to 30%. In case the buyer wants to opt for a conventional loan, then his credit score along with his credit history is studied. The interest rate that could be applied to the mortgage is also studied. Before giving out the loan, the lender also considers the borrower’s assets and income.
The borrower should thus prove to the lender that he can afford the property in which is he investing and that he can make the monthly payment of the loan installment. Future rental income is not considered in the debt to income calculation and mostly the lenders expect the borrower to have a minimum of six months money to repay the mortgage obligation.
Home equity loan:
Home equity is a kind of loan that is preferred by investors in the long run. Using equity to finance has its pros and cons. In some cases, taking a loan on equity is similar to taking a loan through the credit card and has monthly interest attached to it. The rate in such cases is quite variable which means that the rates can increase in cases of change in the prime rate. However, in the case of cash-out refinance, the amount payable is fixed but in this case, the life of your mortgage may also be extended.
This implies that the longer the duration, the larger is the amount that is payable as interest. Thus the lender will weigh the expected income to be generated out of the property.
Other loans:
Banks also provide various ways to finance a property such as home loans, land loans, etc. To obtain these types of loans, the bank checks through your documents and also through your credit score and history.
The following table shows the comparison of the financing options stated above. It is important to cross-check various options to finance a property before finalizing the source.
| Parameters | Seller Financing | Conventional Loan | Private Money Lenders | Home equity Loans |
| Nature | The seller gives credit facilities to the buyer to finance the payment on the property. The buyer also signs a promissory note. | Loan granted to the home buyer. It also considered a mortgage. The loan provided before acquiring equity | They provide loans on a short term basis to the investor to purchase or renovate the property | Loan granted after considering the equity that the buyer has in the property. |
| Interest Rate | Fixed by the seller and buyer by negotiating. However, the rates are higher. | 8-10% interest is charged. The interest rates can be flexible or varied. | The interest rate depends on the risk associated with the property. The rates are higher than the traditional method. | Interest rates are lower than other loan options. |
| Tenure | The term for this method is short. | Fixed tenure. Usually 15-30 years. | The period is fixed by the money lender | No fixed tenure. The loan period ends on repayment |
| Repayment | Monthly basis. In accordance with the timetable prepared by the seller | EMI is payable | Monthly installment | Monthly installment |
| Credit history | Not applicable | Very important | Credit score plays a huge role as the lender grants money on lesser regulation. | The lender checks your credit score before giving a loan. Scores above 750 are considered excellent. |
| Procedure | Simple procedure. The buyer just has to get the consent of the seller for the same. | The lengthy procedure as the banks usually conduct an inspection, verification of the document, etc. before granting the loan. | Easier than traditional loan facilities. | This method can also be time-consuming as you have to prove your equity in the property before acquiring the loan. |
| Resale | The property can be resold after getting the permission of the seller. | The resale is possible only after getting a non- objection certificate from the bank. | It is easy to sell the property in case of private money lenders. It is often advised to not opt for financing through this method unless you have an exit plan. | Resale of the property is possible however a lien may be held by the lender. |
| Consequences of non-payment | The seller can retain the title of the property and even keep the down payment made on the property. | Property can go into foreclosure. | Foreclosure can be exercised. | Foreclosure can be exercised. This method is considered as the second mortgage and hence will be repaid after the principal lender is settled. |
Summing up, investing in real estate can be a long term commitment. There are times when the investor does not have enough money to carry out the entire investment process. Thus there is various other financing option through which the buyer can opt to finance a property. Some buyers negotiate it with the buyers and try to finance a property through seller financing. Some buyers also use techniques such as money lenders and hard money lenders. However, they as an option should be chosen only if the buyer has a clear exit strategy. Buyers normally finance a property through banks by obtaining loans such as land loans, home loans, or conventional mortgage.
Thus there are several methods in which you can finance a property as different kinds of financing options are available to you and evaluating them based on their merits and drawbacks will help in choosing the right option to finance a property.
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