Many options abound…
There are many ways to finance investment properties. If you’re not paying all-cash for a property, and you want to utilize leverage to greatly increase your prospective ROI (return on investment), you’ll find many options available to you. Which one you choose is a matter of personal taste. And deciding among different investment property loans available, that will suit your temperament and pocketbook, will be critical to your bottom line.
The OPM concept
I have always been a big advocate of trying to use OPM, or other people’s money. Certainly, as you search for investment properties, it is always a smart idea to ask each and every time if the seller will carry paper – that is, if they will hold a mortgage note on the property you’d like to purchase. This may be the most advantageous form of investment property loan you can obtain.
A key example of seller financing
As an example, I once purchased a four family house where the seller was willing to offer a first mortgage if I put twenty percent down on the sales price. Now, he wanted to get his price, so at first blush, it looked like a terrible deal. But when I asked if he would take my terms for a mortgage, the deal became a whole lot better. At the time, he was willing to offer a first mortgage with an interest rate almost four points less than any commercial bank would have offered. In addition, investment property loans from banks traditionally require at least thirty percent down by the buyer. So I was able to leverage an additional ten percent by going with the seller financing. This was a great way to get a business loan for rental property.
On top of this, the seller offered me a thirty year amortization schedule, with a ten year balloon…plenty of time in which to reap the benefits of an unbelievably low monthly payment, and resultant high cash flow – and even greater net income. This four family house quickly became a huge cash cow for me. And I had plenty of time in which to refinance to a traditional loan. So while I ended up paying about ten percent higher in market value than the property was worth, the difference was more than made up for (while I held the property) in net cash flow income and capital appreciation when it came time to sell. So my advice: if you can find seller financing, take it. And don’t be afraid to give the seller “their” price” in return for “your” financing terms. It could end up being a major financial windfall for you in the end.
Going the hard way
Sometimes it makes sense to go the hard money lender way of financing when looking for a loan for investment property. If you have poor credit, or poor cash reserves, you’ll pay for the privilege of doing business with hard money lenders. Their investment mortgage rates are usually at least double conventional mortgage loan rates. And their points charged (pre-paid interest) can be triple or quadruple conventional points charged.
I have written in a prior article here how “the average hard money investment property loan is supplied with capital put up by private investors – usually as a pool of money that is used to drive much greater profits for its investors. This private capital is traditionally unregulated, which gives the hard money industry a kind of “Wild, Wild West” feel to it’s practices and reputation. Pejoratively, many consider hard money lenders as sharks feeding off the misery of those in bad financial straits. As a property investor, you will certainly need to approach any hard money investment property loan with a great deal of caution and foresight prior to signing on the dotted line.”
The typical hard money loan
That said, don’t be totally scared off by trying to obtain a hard money loan. You need to know ahead of time that typical hard money loans carry interest rates that can run anywhere between 12 and 18 percent. Balloon payments are de rigeur, and these mortgages usually come due within 1 to 3 years. In all but rare instances, hard money lenders require being in the first mortgage position, so they can get their money out first if you default.
In addition, typical loan-to-value (LTV) ratios on hard money investment property loans range between 50% to 65%. And this LTV is based upon the “quick sale” market value of the property…that is – what the property will fetch today – not three months from now after you’ve fixed it up. Another potentially scary cost to take into account are points (up front interest charges). Typically, they can run anywhere between 4 to 8 percent of the total mortgage amount.
Going the more conventional route
As I have noted in the past here, “most conventional investment property mortgages are standard income and asset verified loans. They can be conventional 30 year terms, or short-term adjustable rate mortgages (ARMs) with balloon payments. These loans usually require a minimum of 30% down in most instances. In that case, you’d be obtaining a loan of 70% of the purchase price. Your loan-to-value ratio (LTV) would therefore be 70%. When buying investment property, you’ll usually want to try to obtain the greatest return on investment (ROI). Leverage (also known as cranking) is one of the ways you can purchase multiple properties over time, and thereby maximize your ROI. Depending upon your credit rating, as well as the type of property you’re purchasing, the down payment required may be higher, and could go up to 50% – and therefore your LTV would be a low 50% as well. In addition, the points charged on the loan (pre-paid interest) are roughly twice as high as for a conventional home loan.”
A word about commercial loans
If you’ll be looking to acquire strictly commercial buildings (these include office buildings, retail stores, warehouse buildings, or rental homes or apartment buildings with at least five units in them, the you’ll definitely need a commercial loan from a lender. Lenders have separate divisions to evaluate and extend credit on these type properties. Since commercial properties are much more specialized, their inherent risk need to be evaluated as a niche within most banks. Unlike conventional residential mortgages, you can expect that underwriting requirements will be much more stringent by comparison. For example, a commercial lender will be poring over your financial statements with a fine toothcomb, and you can certainly count on much more scrutiny of your assets and income, as well as the existing income statement of the property you’re considering purchasing. Also expect rates and points to be higher than standard residential loans.
Going the personal home equity line route
I have also made note here before how it’s a good idea to utilize a home equity line of credit (HELOC) on your own home as a way to leverage investment property acquisitions. First of all, it’s a very inexpensive way of financing. Interest rates are usually as low as you can obtain from any lender. Second, the interest is tax-deductible as a business expense. And third, you can choose to make interest-only payments monthly on the outstanding balance, usually for a period of ten years, knowing that you’ll have a balloon payment looming down the road. Most times, the balloon will be incorporated into a second ten year payback period, where you’ll be making monthly principal and interest payments. In this way you can utilize the equity in your home to create a credit line for further property investments. You’ll find this a great way to finance further investment property acquisitions. Also, you can structure the loan as a revolving credit line. So when you sell a property, you can pay off the credit line. Then you can take it out again when you’re ready to purchase the next house.
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