What is the Best Kind of Loan for Real Estate Investors?
As a real estate investor, securing loans for your properties is the first—and often most difficult—step in the process.
Investment property loans are risker than those for primary residencies, so they tend to be harder to obtain. Plus, each lender has different requirements and terms you need to consider, compare, and negotiate.
Between all your options, what kind of financing is the best choice?
Fortunately, there are several ways for investors to get loans to fund their projects. You can think of each type of loan as a tool—by making the loan work for you, you can further your goals.
Here are four different types of loans for real estate investors and their advantages and disadvantages.
Commercial vs. Residential Loans
Before we dive into the different types of loans, it’s important to understand the difference between commercial and residential loans.
Commercial loans are granted for commercial properties. They are typically larger with shorter loan terms, and granted to businesses (LLCs, S Corporations, etc.). You’ll need to obtain one of these titles for your business before applying for a commercial loan.
Residential loans are smaller, longer-term loans for properties intended for residential living. These are sought by individual borrowers looking to buy a home for their primary residence or investors renting out units to individuals and families.
Residential loans typically have lower interest rates than commercial loans.
Keep these differences in mind when considering your investment property and loans.
Conventional Mortgage Loans
Conventional loans are the most common type of loan for real estate investors.
A typical conventional mortgage loan requires at least a 20% down payment, a minimum credit score, and some cash reserves to prove that you can make your first few months of mortgage payments. Higher credit scores will help you lock in better interest rates.
One downside of conventional loans is that they are difficult to obtain for properties in need of renovations, since the permitted loan amount is dependent on the appraisal value of the property you intend to buy.
If you’re interested in obtaining a conventional mortgage loan, be sure to check the specific requirements in your state.
Private Money Loans
Private money loans are a second popular type of loan. These are offered by private investors unaffiliated with a lending institution (regular people who want to invest their money) in exchange for a portion of the return.
Private loans have many benefits: they have quicker approvals, flexible terms, and many don’t depend on your credit history. As these loans are based on person-to-person interaction, formalities are limited. You’ll also likely get lower interest rates and more say in the loan terms.
Since these loans are private, you’ll need to hone your persuasive skills and build relationships with investors who have the resources to fund your deals. This is also why it’s important to build an interconnected network of partners and acquaintances in real estate.
Despite its attractive qualities, remember that a private money lender can still foreclose on your property if you don’t pay off the loan.
Hard Money Loans
Hard money loans are loans offered by companies or professionals who lend money specifically to real estate investors.
These are faster to obtain and typically don’t rely on your credit score. Rather, they focus on your property’s value potential.
One downside of hard money loans is that they are short-term loans with higher interest rates and tend to have firmer financing terms and rules.
However, hard money loans are great for investors who plan to house flip – or buy a cheap property, renovate it, and sell it quickly before interest builds up.
If you’re a house flipper looking to secure a short-term loan that you know you’ll be able to pay off in a few years, a hard money loan might be suitable. But be sure to prepare an analysis of the deal you’re planning, with convincing numbers to back your claims.
Home Equity Loans/HELOCs
A fourth type of loan for investors is a home equity loan or home equity line of credit (HELOC).
These loans allow you to borrow against the equity you’ve already built in one property to buy another. You can use up to 80% of your home equity value to invest in your next property.
Home equity loans are generally easy to obtain, and the interest you accrue on them is tax-deductible.
However, there is the danger that if you don’t pay it off, the lender will keep the money you earned on the original mortgage as well as the home equity loan.
Refinancing your Loan with BRRRR
Among all the real estate investing strategies out there, refinancing is a popular choice among experienced investors. Refinancing a rental property requires knowing that a new loan will help you achieve lower interest rates or pay off the loan faster.
BRRRR is a specific refinancing strategy that leverages the refinanced loan to establish permanent cash-flow. The steps are buy, rehab, rent, refinance, and repeat. The BRRRR method real estate helps you capitalize on the renovations you made by achieving a higher appraisal value before refinancing.
Conclusion
Ultimately, there is no one best loan for real estate investors. The loan you choose depends on your individual goals, resources, and strategies. By understanding each of the above loans, you’ll have more information on which to base your decision.
