By Tod Snodgrass (short term funding specialist)
There is an old saying: If you have the right deal, the money will come. Well, if you are an old experienced hand with lots of contacts that is one thing. But if you are new to this field, the money may not be so easy to find. Don’t let anyone fool you: to be a successful real estate investor takes money. The chances of getting a no money down deal are limited, or nonexistent to the vast majority of REIers (Real Estate Investors). It can be your money or someone else’s money, but it has to come from somewhere.
"A bank is a place that will lend you money if you can prove that you don't need it." – Bob Hope
The good news is that there are a wide variety of different financing resources and tools available.
Standard (and not so standard)) sources include:
- Hard Money (asset based) loan
- Equity in your own home via a HELOC loan or a refi
- Tap your retirement funds, such as an IRA, 401k
- Friends, relatives
- Conventional Mortgages; some even allow you some extra money for rehab. See FHA loans below.
- Equity investors
- Credit card advances, etc.
- Joint venture (you bring the deal, they bring the money, split the profits at the end)
- Personal (bank) loan, assuming you have a successful track record with your banker
- Construction (bank) loan, assuming your profit projections hold up on paper
- Seller financing. Not every seller needs 100% cash out from the sale of their home.
- Partnership with another investor; you do the work, they bring the money; split profits
- Specialty, short term funding for EMD (Earnest Money Deposits), rehab, etc. See more below.
Low or No Money Down vs. All Cash
So, is it imperative that you have access to gobs of cash to speculate or invest in RE? Short answer: No. The real (longer) answer, is much more complex and complicated. First off, yes there are lots of REI strategies used to invest in real estate without having a lot of cash. And yes there even some deals that can be pulled off without using any money at all. By way of background, as recently reported in a study published by BiggerPockets, and co-authored by Memphis Invest, about one-quarter (25% or so) of US investors use 100% of their own cash to finance their real estate investments.
True 100% investor funds is by far the easiest form of financing (it usually has the fewest complications), but that isn’t much comfort to the other 75% of investors (and probably 99% of REI newbies) for whom 100% cash is not an option. Additionally, all cash deals mean you are sacrificing the leverage you could/would gain by using your funds in a way that spreads them around to several deals, thereby potentially increasing your overall yields. The alternative is to use your precious cash resources to make multiple down payments, and borrow the rest. If you have penciled the costs of the deal (purchase cost, rehab expenses, selling costs) out properly, you should be able to extract a decent profit, despite having to pay debt service on the borrowed money. Bottom line: Using OPM (other people’s money), i.e. financing your investment property, can produce significantly higher returns than putting all your available cash into one deal.
FHA (Federal Housing Administration) Loans: Potential Advantages
- Tax Free: These loans can be very attractive if you qualify, i.e. you are actually going to live in the house for at least two years. Some REIers use this funding source to buy a run-down house, move in, fix it up, then flip it after living in it for two years. The beauty of this method is the profits you make on that type of flip are actually tax free (for up to $500,000 for a couple).
- Multiple Units: FHA-financing can include up to four separate units. Put another way, assuming you plan on living in one of the units, you can buy a four-plex, triplex or duplex with FHA money.
- 3.5% down: Another big benefit of an FHA loan is the very low-down payment requirement: it is currently 3.5% Yes you will be required to take out Private Mortgage Insurance (PMI) to make up for the low down payment, but it is still one heck of a deal compared to 20% down.
- A 203K FHA loan can also be a winner for REIers. If done right (often not an easy task), it allows a potential homeowner to buy a house in need of (some) rehab work, and provides extra funds to accomplish the improvements, repairs, etc. and roll that extra amount into the loan itself. Like the normal FHA loan, a 203K loan allows for a 5% down payment.
Which financing option is best for you? It depends on your needs, how well the deal in front of you pencils out, and how much experience you have in this business.