Are you considering purchasing an investment property? Are you thinking about getting a loan to finance your purchase? If so, this article is for you.
Loan types are just one aspect of the equation when it comes to investing in real estate. Here, we'll go over six different types of loans that are available to people looking to purchase properties — providing a complete guide and helping make the whole process easier than ever before.
1) Conventional Loans
Let's start with the most common kind of loan used to fund real estate purchases — the conventional loan. Think of a conventional loan as "borrowing from a bank." The bank pays off the property's outstanding mortgage (the interest and principal on what you owe), and you pay back the loan with the interest that accrues over your lifetime. If you use cash, you'll also have to make additional mortgage payments for the life of your mortgage — which is how it's still sometimes colloquially referred to as a "mortgage note."
These loans are pretty simple, so we won't spend too much time going over them here. The basic idea is that you pay off your principal balance, so you don't owe as much as the property is worth. As a result, the interest you'll pay back over that same period of time is higher than if you made monthly payments over a shorter period of time.
2) Secured Loans
A secured loan isn't really a loan at all; it's an agreement between the lender, borrower, and real estate asset. In this case, the note issued against that asset is considered a securement note (or less formally — a lien). The lien offers the promise of repayment in the event of default on your part — which can be secured with collateral like your car or personal property.
A secured loan is typically only a good idea if the collateral is worth more than the value of your debt. On top of that, you usually have to pay a fee on top of your interest payments. In fact, there's also a little extra cost for the lender who buys the asset from you after you default — their profit margin on this type of loan is pretty low.
This one's not so simple either... Real estate assets can be quite illiquid and difficult to sell. So if you default or want to sell before the end of your loan, it can be very difficult to find someone willing to buy your collateral from you at fair market value.
3) Unsecured or High-Interest Loans
Called "cash-out refinance" loans, these are the loans you see advertised on TV. They're essentially just a home equity loan — or as it's sometimes called a second mortgage. In a nutshell, you give up your existing home equity (in the form of cash) in exchange for that cash. This can be both good and bad:
If you have bad credit, this type of loan could be an option for you... after all, you're essentially just selling your home to a lender. But, interest rates on these kinds of loans are much higher than on prime loans.
Of course, some people are willing to pay that price. Especially if they don't have any other assets to invest with.
4) Private Loans
Private loans could be an option for you if you want to avoid taking out a standard mortgage with a bank. While it might seem like an option for folks who don't want that kind of oversight — it also comes with its own potential drawbacks:
- Fees and Costs — There are tons of fees and costs involved in private financing — many lenders charge hundreds of dollars just for an application fee. Other costs include origination fees, title search fees, appraisal fees, credit report fees, closing costs, and more.
- No Lender Oversight — One of the big benefits of taking out a loan with a bank is that they hold you accountable for your financial decisions. In other words, they can help you make the right choices and avoid unnecessary risk — which is especially important when it comes to real estate investments. A private party doesn't have that same level of accountability.
- Limited Options — Because this type of financing isn't regulated by the government or a banking institution — your options are limited. You can't go to the local bank and take out a loan — you'll have to look elsewhere.
5) Builder/Developer Loans
If you're looking to invest in a property at the time of construction — or shortly afterward — a builder/developer loan might be the way to go. This is essentially just an extension of your initial investment budget, giving you one less thing to worry about financing.
6) Hard Money Loans
As the name suggests, hard money loans are considered risky. These are loans that are given out under strict terms with high-interest rates and short schedules for repayment. While there are considerable risks involved — and borrowers frequently have to pay upfront before the funds are released — hard money loans can be used in a number of different ways.
Hard money loans can be used to:
- Fund property renovations or expansions.
- Fund home improvements of all kinds.
- Acquire property immediately (often at steep discounts).
- Acquire properties that may not qualify for other types of financing (such as on-paper-only deals).
If you think these types of loans may be right for you, then we recommend asking around to see what kind of deals are floating around and where your local real estate community is getting them.
The Bottom Line
There are a lot of different ways you can finance your real estate deals — but not all of them are right for you. The best way to decide which loan is right for you is to consider your options and pick which one makes the most sense for you. And, as we mentioned earlier, every one of these loans has an upside and a downside, so it's important to weigh those against each other and see what works best in your case.
What are your thoughts on financing options in real estate? Share your thoughts with us in the comments below!
