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.
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.