Investing in a property is always a risk, but it can be an incredibly rewarding investment if done correctly. Investing in property can contribute to financial growth, a potential source of recurring income, and offer the potential for tax benefits.
One of the most important aspects to consider before investing in a property, however, is making sure you have the means of financing it. There are many ways to finance an investment property, and we will outline four of the most common methods in this blog post.
Whether you decide to go with a bank loan, hard money loan, private money loan, or access your home equity, make sure you do your research and choose the option that is best for you!
Conventional Bank Loan
The most common way to finance an investment property is through a personal loan from the bank. You can apply for a loan through your local bank or credit union. If you do not have a good credit score or history, however, there is a high chance that you will not be approved. The good news is, you can monitor your credit score for free online and address just what is impacting it.
Furthermore, lenders will look into the borrower’s assets and income to ensure that they can actually afford their current mortgage. They will also look into your capacity to keep up with monthly loan payments on an investment property. Your lender will do so by comparing your gross income (before taxes are withheld) to your debts to calculate your “debt-to-income” ratios. While this can seem invasive, if you are prepared, the application for a bank loan should go smoothly.
The terms of the loan will vary depending on the lender, but you can expect to put down 20-30% of the home’s purchase price as a down payment. The interest rate will also be higher than if you were to finance a primary residence.
In the end, if you have invested in the right property, this home loan should be paid off by the rental income you are earning.
Accessing Your Home Equity
For some people, their investment property will be their primary residence. In this case, you may be able to finance your investment by accessing the equity in your home through refinancing your mortgage.
You can use the equity in your home to finance an investment property by taking out a cash-out refinance loan. This type of loan gives you cash upfront that you can then use for your investment. The amount of cash you can get depends on the value of your home and how much equity you have.
A home equity loan will give you a lump sum of money that you can use to finance your investment property. A home equity line of credit (HELOC) gives you a revolving line of credit that you can use as needed. This is similar to a credit card, but the interest rates are usually lower, making it a good option for financing an investment property.
It should be noted that this method of financing your investment property can be one of the riskiest. Both home equity loans and HELOCs use your home as collateral, which means that if you are unable to make the payments, the lender could foreclose on your home.
For more information, Joust breaks down how to refinance for investment property and how to leverage existing home equity in the most efficient way.
Hard Money Loan
A hard money loan is another option for financing an investment property. Hard money loans are given by private investors or companies, rather than banks. Therefore, because they are not regulated by the government, they can be more expensive and have higher interest rates. It can be hard to find a lender in your budget, so it is always best to educate yourself on the hard money industry before choosing.
The approval process for a hard money loan is also different. Lenders will focus on the value of the property you are hoping to purchase rather than your credit score or income. This means that even if you have bad credit, you could still be approved for a loan.
Hard money loans can be a great option if you are looking to purchase a fixer upper or investment property in need of repairs. Lenders will often give you a loan amount that covers the cost of both the property and the necessary repairs. That is why hard money loans are most popular with property flippers.
The downside of hard money loans is that they usually have to be paid back within 1-5 years. This means that if you are not able to sell the property or refinance the loan, you could be in trouble.
Private Money Loan
A private money loan usually does not come from a company or bank, but rather are loans from one individual to another. Commonly this loan is obtained from the investor’s family or friends who are in a position of financial wealth or security.
If these types of individuals are unable to provide a private loan, you can look outside your usual relationship sphere, or a private lending company. Local real estate investment networking events are an example of a social event where you can meet someone interested in financing your investment property.
If this does not feel secure, however, you can always reach out to a private lender company. They are often referred to as online lenders since they usually conduct their business on the internet.
When going the private loan route it is important to remember that this relationship is based on trust. You will need to have a well-written loan agreement that both parties sign in order to protect both the lender and borrower in case anything goes wrong.
Interest rates for private money loans will be higher than a bank loan, but lower than a hard money loan. The repayment terms are also more flexible than with other types of loans which can be helpful if you are not sure when you will be able to sell the investment property.
The biggest downside of a private money loan is that it can put stress on relationships if not handled correctly.
Each of these four ways to finance an investment property have their own benefits and drawbacks. It is important to weigh your options and choose the option that best suits your needs.
Whichever way you decide to finance your investment, make sure to do your research and create a strategy for investing so you are completely prepared to secure your property. To help get you started, head over to our guide on the best real estate to invest in Australia!
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