Like food, real estate is one of those human essentials for which there will always be a demand. After all, real estate is where we stick our shelters. As an investment, however, real estate is notoriously capricious, a marketplace that generates big winners and big losers. So, whether your eye is on some hulking home in Houston, or on some artful Edmonton apartments, make sure your due diligence is done before betting the family farm.
With that said, here are some things to consider in financing your real estate investment.
Debt Based Financing
The first thing to keep in mind is that, broadly speaking, the financing of real estate investments falls into two categories: debt-based and equity-based. In the former, you borrow money from a creditor, agreeing to pay it back over a specified amount of time – say thirty years – at a given interest rate with the creditor having no ownership interest in your business. The drawback, of course, is that it’s all your money, or at least the money you bought with that interest rate. If the market goes down, then so too does the value of your investment. Here is a detailed article on debt financing for investment real estate.
Equity Based Financing
In the latter type of financing, equity based, you have two options as well: privately financed equity or publically financed equity. In privately financed equity, you secure a group of venture capitalists and identify properties you feel are undervalued. The advantage here, obviously, is that it becomes possible to invest in real estate without using your own money. In other words, if you’re the one putting the deal together, then you can take a percentage of the ownership based upon the amount of “sweat” equity you’ve put into it.
The other form of financing is public equity, one in which you form a corporation and sell shares. Unless you’re a particularly sophisticated investor, this option has more drawbacks than it’s worth: tax laws and investment banking fees to name just two come to mind.
So, if you’re like most other people, without your group of venture capitalists or publically traded real estate investment trust to turn to, here are some tips to help you own that home.
The first thing you can do is look into owner financing. Say your credit rating with all the recent economic twists and turns is below 650, going through a traditional mortgage lender might either be impossible or exorbitantly expensive. However, if you’re employed with a steady income, you can still do owner financing, even if the first lien isn’t fully paid off.
Here’s how it would work. Say you want to buy a modest three bedroom for $200,000 but can’t get the financing. However, since the owner wants to sell and only has $20,000 left on the note, you could propose that he or she use the $180,000 in equity – assuming the house appraised for the full $200,000 – to pay off the original mortgage.
Because the loan is backed by the equity, the interest should be at prime or at least nearly so, say about three and three quarters. The owner, in turn, could charge you a standard four and three quarters. Further, if you have ten percent to put down, then the owner could pay off the equity loan immediately at closing and forgo paying the interest on the equity loan.
With owner financing, you also circumvent the often outrageous fees tacked on at closing, fees such as appraisal, credit report, tax service fee, underwriting fee, processing fee, etc. (Real estate agents often deride these costs as “junk fees,” essentially made-up costs that the lending agencies attempt to foist on unwary buyers.) However, one fee that is not a junk fee is the one for the owner’s title policy – it is most wise to pay an attorney to make sure that there are no liens or encumbrances on a property before closing.
Use Life Insurance as Collateral
Even if you can’t get an owner to finance and the bank just won’t do it or is too expensive, there are other strategies you can use to own that home. One option is to consider borrowing against your life insurance. In essence, your policy becomes your collateral. If you do have life insurance and are buying a home, make sure to check with your company first to see what kind of rate you could get on the note; oftentimes it will be cheaper than a traditional mortgage lender.
Use a Credit Union
Another strategy to employ is to consider joining a credit union. Most have free memberships and often offer cheap loans to their members which can be used for down payments. (And not just on homes either, it may be worth it to join a credit union to get a loan to pay off credit card bills and raise your credit score!)
Use a Mortgage Broker
Also, consider hiring a mortgage broker, particularly if you are not adept at all the various options. The benefit here is twofold: one, a reputable mortgage broker will know all the ends and outs of the local market and can find you the cheapest loan; and, two, you pay nothing until closing. In other words, if the broker doesn’t find you a cheap loan, he or she doesn’t get paid. Often, if you do an honest cost / benefit analysis between the time involved in finding your own cheapest loan and hiring a mortgage broker to do it for you, the mortgage broker will emerge as the most cost effective and headache free solution.
Regardless of your investment strategy, the key to remember is that building equity is a good thing and well worth facing and overcoming the many challenges involved.
About the Author: Kevin was introduced to personal finances management by his father at the early age of 14. By the time he was 17 he had already saved up enough money (through doing chores for family members) to start a small export business in the IT industry. At age 20 he began his stock trading journey with his own capital.