Financing Investment Property: Top 3 Options, Pros and Cons

The benefits of purchasing and owning investment real estate are well known or you wouldn’t be here in the first place reading this post. But in order to make that ownership happen, you have to be aware of your financing options and know their pros and cons so you can put them to work within the right investment strategy. One financing options may be a perfect fit for one strategy and Nightmare on Elm Street for another. During our consultation sessions with our clients, this question comes up every single time as it very well should. And we always say, there’s no one-size-fits-all solution – you just have to know your options so you can pick the perfect fit.

1. Conventional Investment Property Loans – This is your plain vanilla, walk-into-Bank-of-America, same as your home mortgage but for income properties, option. With this option, you can finance up to 75% of the purchase price (not ARV!) meaning you have to put down at least 25%. Closing costs are your normal 3-5% of the purchase price depending on whether you escrow your payments (put taxes, insuance and mortgage all in one payment). Interest Rates are the best you can get for investment property, which is typically 1% higher than the rates available for a regular mortgage, so currently they run anywhere from 6.25-6.75%. Credit and Income Requirements are stiffer as lenders typically view these loans as riskier. PROS: Great interest rates keep your expenses low and help your income property cashflow better. All the initial equity in the property you get to keep. Closing costs are lower than other options. CONS: Capital Requirements are high due to high down payment, and this may limit the number of properties you can do depending on your liquid capital (cash).
2. Hard Money Loans – This is your high risk roller, use other people’s money, you don’t need cash or credit (not quite), option. The basic concept behind hard money loans is the idea that the lender is not making the loan based on your credit worthiness but on the quality of the property itself. Depending on the lender and the market conditions, you can get up to 80% of the After-Repaired-Value (ARV) of the property. So if you were to get a property with enough equity (say 70% of ARV) you could effectively get financing to cover the purchase price plus required repairs and closing costs getting in with little or no money of your own. If that sounded great and you’re ready to sign, read the next few sentences. Closing costs on hard money loans tend to be much higher than conventional mortgages (typically normal costs + additional 5% off the top). Interest rates on hard money loans are anywhere from 12-18%. Let that sink in for a moment. The reason for that is risk – hard money lenders are taking a big gamble that you actually know what you’re doing so they will price their money accordingly. High rates and short terms make hard money loans the preferred product for house flippers or rehabbers when they don’t have the working capital to float the deal conventional. This product could be disastrous for an income property as the high interest rates would surely eat any potential cashflow and thrust you into the barren land of negative cashflow. Credit Requirements for hard money loans are much more lax than conventional but there are some minimums you have to meet. PROS: You can use little to no money of your own to purchase and rehab investment real estate. Even investors with challenged credit can qualify. CONS: Excruciatingly high interest rates and closing costs eat up your equity and cashflow. Short  loan terms make it necessary to refinance in the near future (more closing costs). A bad product for income producing real estate.
3. Construction to Permanent Loans – This is your halfway between the first two, use other people’s money but lose the usury, leverage heaven, option. Here’s how it works: Say you found a property for $65k that’s worth $100k. Under this option you would go through two processes – First, the lender would give you a conventional construction loan for say 75% of ARV or $75k. This temporary financing allows you to purchase the property, pay closing costs and have some money left over to rehab the property using a new home construction loan product. Once the property is rehabbed, rented and ready, the lender refinances that mortgage into a 75% conventional mortgage based on the ARV (since now the property has been brough back up to condition). Voila! You were able to purchase the property using very little of your own capital without incurring pawn shop like charges. Closing costs on these loans are quite  bit higher than the straight conventional option but not nearly as high as the hard money option. You are essentially doing two loans so costs should be higher just because of that. Interest Rates are about the same as the conventional option. Credit requirements are high as well. PROS: Cash Requirements are much lower that conventional so you may be able to swing more deals for the buck. Interest Rates are low so this option would be perfect for an income property. CONS: This option utilizes some of the built in equity in the deal to allow for low cash out of pocket so by the time it’s said and done you have less equity in the deal than when you started.

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So there you have it, folks. The top three options for financing investment real estate dissected and thrown in a clear jar full of fluid for you. If you want to discuss local lenders that offer these options, the code is 713.952.3200. Also, here’s where you go to look at some Houston Foreclosures to get pumped before you call.