Do you need capital for your next investment deal? Maybe you're just starting out in real estate or you've been investing for a while, but your portfolio is at a standstill. Either way, there are many creative real estate financing techniques that can jump-start your real estate career here in Alaska – if you know where to look.
A typical real estate transaction looks like this: a potential homebuyer finds a property they love, applies for a mortgage and, once approved, they close on house. While common, this process isn't a one-size-fits-all model. Investors will need to get creative to find the best way to fund a real estate deal.
This can open a lot of questions, such as "What real estate financing options are out there for newbies?" "Which financing methods are the best fit for which exit strategies?" and "How do you avoid all of the common creative financing real estate mistakes that plague investors?"
Below are six creative real estate financing methods to help you get closer to your next investment deal.
6 Creative Financing Techniques for Savvy Real Estate Investors
Today’s investors should be equipped with not one, but several financing options before approaching a deal. It may seem simple to go straight to a traditional lender for a mortgage, but this approach won't always guarantee the best loan terms. In many cases, finding the best financing will require investors to get a little creative. With that being said, there are various unique ways to finance real estate that it can be hard to fully understand what’s out there. The following creative financing options are a great place to start:
Home equity line of credit
A cash-out refinance for real estate is a transaction in which you tap into the equity of your home – you borrow enough to pay off the mortgage of your home and then pocket the difference – which can free up funds to invest elsewhere. A cash-out refinance happens to be one of the best real estate financing options out there... if you know what you are getting into.
A real estate cash-out refinance is different from a simple line of credit, in which you add a second mortgage to your home to take out cash. The interest terms on a cash-out refinance are much more favorable than a traditional home equity loan. And, unlike borrowing money from a hard money lender or traditional financial institution, the interest on a cash-out refinance is tax-deductible.
The risks with a cash-out refinance are that your mortgage term gets reset (the 30-year clock starts over again) and if something unforeseen happens, such as an illness or job loss, the new monthly payments can be difficult to contend with.
But if you have a great opportunity, and need some ready capital to make that opportunity happen, it can be a good source of investment dollars.
Home Equity Line of Credit
Unlike a cash-out refinance, with a home equity line of credit, you don’t pay off the original mortgage. Instead, you borrow against the value of your home – up to 80% of the home value, minus the amount of the mortgage.
HELOCs generally have a draw period, typically lasting 10 years, and a repayment period, often lasting no more than 15 years. Similar to a cash-out refinance, a HELOC’s interest is tax-deductible, but only up to $100,000.
So, when would you use a HELOC and not use a cash-out refinance? A HELOC is perfect for doing repairs to your primary home or a rental property, such as situations where you don’t need huge sums of cash for an entire property purchase. An example would be $10,000 to improve a bathroom in your rental property.
Though a personal loan doesn’t offer the same great tax benefits of a refinance or HELOC, there are some compelling reasons to consider it, among other creative real estate financing techniques.
For one, you aren’t required to put up your house as collateral. In some cases, you aren’t even required to put up any collateral at all. With a repayment term much shorter than a mortgage loan – five to seven years is a good benchmark – you’ll end up paying a lot less interest over the long term.
However, with that shorter repayment term comes a much larger monthly payment. In addition, you most likely have to have excellent (or at the very least good) credit to qualify for a personal loan. If you have good credit, but very little equity in your home, this can be an effective method of real estate financing.
If you ever hear an investor talk about buying something “on terms,” they're referring to seller financing. As any seasoned investor will tell you, the ultimate goal is to use as little of your own money as possible and instead rely on other people’s money. Seller financing is a great example of this philosophy.
In this method of real estate creative financing, the seller of a property agrees to hold on to the note of purchase. You then pay them a monthly payment until the note is paid off. Now, of course, this will only work with sellers who own their home free and clear, and don’t mind forgoing a bit of short-term cash for some long-term streams of passive income. Motivated sellers who are underwater with their payments won’t work here.
If you see a great investment opportunity and realize that you'll probably end up refinancing at some point, seller financing as a real estate investment option can be a great arsenal to add to your toolbox.
A common school of thought among real estate investors is that it is always better to buy than to rent. The problem with this sentiment is the word “always.” It ignores the fact that lease option contracts are a very viable route to homeownership. Real estate investors of all experience levels may occasionally encounter a property they're not ready (or sometimes able) to purchase, which is where lease option contracts come in.
A lease option property allows investors to work with landlords, so they're able to purchase the property at the end of the lease agreement. This allows investors to build equity through monthly rent payments and it provides landlords with the opportunity to generate interest income. Depending on the specificities of the contract, a portion of the rent payments will then count toward the down payment on the home.
The biggest challenge investors face when searching for a lease option contract is finding the right landlord to work with. This set up is most commonly introduced when an owner has difficulty selling a rental property, but that’s not to say it can’t happen under other circumstances. Investors hoping for a lease option scenario should simply be prepared to shop around, and know how to approach the conversation when they do find a potential property.
Investors with existing retirement savings can consider yet another creative way to buy real estate: a self-directed IRA. This technique allows investors more control compared to other retirement options and a number of tax benefits. It's worth noting that all returns must flow directly to the IRA instead of straight to the investor. Depending on your preference, this can either be a pro or a con.
What's important to remember is that a self-directed IRA can allow investors to amp up their retirement savings, one property at a time. Just make sure you have a good system in place for analyzing deals. While a self-directed IRA is largely beneficial, there are always risks involved when it comes to investing.
If you don’t already have an IRA, the setup process is relatively straightforward. Research different options and closely examine the fee structures involved. You want to make sure your cash flow covers the required costs of your account and with enough returns left over to be lucrative.
A traditional mortgage can be a great way to purchase real estate, but it's not always the best option. For example, seller financing could provide a lower interest rate, while a personal loan may have a faster approval process. The right way to finance will vary from project to project and property to property. What’s important to note is how many options you have available and how to use them. After all, real estate investors are required to get creative from time to time.