Four Different Ways to Finance Your First Deal
Real estate investing truly is the path to financial freedom and long term wealth accumulation. That being said, your first deal can be the most difficult. If you’re like most people, you don’t have $800,000 laying around to buy your first triple-decker in Dorchester.
Good news – you can always turn to financing options for your first real estate deal and gradually build up your cash reserves over time. Today, let’s break down four of the best ways to finance your first investment deal in detail!
Why Consider Financing?
Put simply: because, as mentioned, you probably don’t have enough money in your pocket to pick up your first real estate investment property right now! If you do, then what are you reading this page for?
There’s no need to worry if you don’t have enough cash to pick up a great investment property right now. Most investors start with very little liquid cash – they use the below financing methods and others to scrape together enough to purchase their first property, then snowball that success into more money they can use to build their portfolios over time.
Sounds simple, right? That’s because it is… but, similar to losing weight (eat less, workout more), simple does not always mean easy. It’s important to educate yourself and better yet, align yourself to a real estate team who can help guide you through these processes.
Decide on Your Investment Strategy First
Before you start the pre-approval process with a bank or credit union, you should decide on the investment strategy you want to pursue. There are two basic schools of thought:
- You purchase an investment property that you will not live in yourself.
- You purchase an investment property that you will live in, and then rent the other units to tenants.
Both strategies can work great, but deciding on which you prefer will help you narrow down your financing options, and more importantly, how much money you need to bring to the table.
Top 5 Ways to Finance Your First – But Not Last! – Real Estate Investment
With all that out of the way, let’s break down four of the best ways new real estate investors can finance their first (and hopefully not last!) real estate investments successfully.
Your first accessible choice is an FHA or Federal Housing Administration loan. These popular loans are excellent for most new investors and homeowners since they are federally subsidized and have lower than average down payment requirements.
For you, the aspiring real estate investor, that means you need to scrape together less cash to purchase the property than you would otherwise. However, keep in mind that these loans are only available for owner-occupied properties, so you can’t take out these loans for a quick fix-and-flip. You’ll need to plan to live in the property for at least a year to qualify.
Tip: One other consideration when it comes to FHA loans, the property you are purchasing must pass what is called a ‘Self-Sufficiency Test’. In other words, the total rental income you receive from this property, multiplied by 75% must be equal or greater to the mortgage payment for the property.
Bonus Financing Type – FHA 203(k) Loans
We know, this is supposed to be the four best ways to finance your real estate investment. But we’d be remiss if we didn’t mention this unique option.
An FHA 203(k) loan is a variation of the above federally-backed loan. But it’s only available if you want to buy or refinance a home that needs substantial renovation or repair work. Through taking out this loan, you can roll the costs for renovations into the mortgage – so the resulting loan amount covers the cost of any upgrades or repairs and the purchase price for the property overall. Sweet, right?
This can be a great way to purchase your first investment property if you’re willing to put in the work and create some equity right out of the gate. Beware though – you will need to find a general contractor who is able and willing to work around the 203(k) guidelines!
Hard Money Loans
You may wish to consider hard money loans if the above two options don’t align with your goals. As asset-based loans, the property you purchase will serve as collateral for any hard money loan.
While that may sound risky or scary, don’t worry; hard money loans move fast and you can purchase investment deals rapidly if you find a willing lender. These are great for fixer-upper properties and will also allow you to forgo any inspections or obstacles that may slow down your closing.
That said, hard money loans do come with high-interest rates and may come with ancillary fees. So we’d only recommend hard money loans if you know that your first investment property is going to be a fix-and-flip, not a property you plan to live in. Otherwise, you’ll be putting up your own shelter as collateral for the loan!
Private Money Loans
Naturally, you can always do what investors have done for generations: turn to private investors for a loan! Private money loans can be from friends and family members, acquaintances, or even your college professor – they just need to have enough money to cover the cost of your real estate purchase (and rehab, if applicable).
Of course, the terms and conditions for a private money loan are impossible to predict. It all depends on the lender and what they want out of the deal. Still, this could be a good way to get financing for your first property… provided you can convince the lender that you know what you’re doing and have a great property in mind!
Last but not least, you can take out a conventional loan. This is a more traditional mortgage where you place a down payment on the property and a bank gives you a mortgage loan in exchange for a lien on the property. This can be a great alternative to the FHA option if the property you are looking for does not pass the Self-Sufficiency test.
Similar to the FHA option, Conventional loans also provide the ability for low money down to get started and allow your payments to be spread over a 15-30 year period.
Tip: Both FHA and Conventional will allow for low money down, but will then require you to purchase Private Mortgage Insurance, or PMI. This comes in the form of a monthly payment (similar to your mortgage) and is typically .58-1.86% of the original loan amount per year.
There you have it – 4 (technically 5) solid ways in which you can secure financing for your first real estate investment property! Consider your options carefully and try to choose your financing method based on your broader investment strategy or the type of property you plan to purchase in the future.
Still don’t know where to start or which financing type is right for you? Fortunately, we’re here to help! Contact us today and get on a call with our real estate advisors for more information and personalized assistance!