Creative financing can offer real estate investors options beyond traditional lending from banks. If you have less-than-ideal credit or lack a sizeable down payment, clever funding can help you purchase property when you might not be able to otherwise. By leveraging methods like seller financing, hard money loans, or partnerships, investors can buy properties with less upfront capital and more flexible terms.
Keep reading as we explore different creative financing methods to help you start or scale your real estate investment portfolio when traditional financing isn’t an option.
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Creative financing in real estate means purchasing properties using methods other than traditional lending through banks or mortgage lenders. It typically involves less formal lending requirements and focuses on what’s in the buyer’s and seller’s best interest.
In effect, alternative financing options could mean flexibility on the loan terms and even the down payment. By using these strategies, investors who might not qualify for a traditional loan could still receive the capital they need.
Most people think of traditional financing when purchasing real estate. These loans typically originate through a conventional bank or mortgage lender. However, they come with a lot of requirements. You need to have strong credit and a sizeable down payment. Plus, as a real estate investor, there are limitations to the number of traditional loans you have, making growing your business difficult.
Creative financing is designed to make real estate investing easier. It’s a more flexible way to raise capital when traditional funding is unavailable. However, because most creative financing methods are less regulated, it’s important to understand the agreement’s details to ensure you don’t get in over your head.
One of the easiest ways to obtain the cash needed to purchase real estate is through a home equity loan or home equity line of credit (HELOC). Each option allows you to borrow up to 80% of the equity in your personal home.
With a home equity loan, you’ll get a lump sum for the down payment on a real estate investment. It’s important to understand that home equity loans are second mortgages. You’ll make a monthly payment on the loan, just like you do on your first mortgage. In terms of interest, a home equity loan often has a fixed rate.
Rather than receiving a lump sum of cash, a HELOC enables you draw on your equity during what’s known as the draw period. The draw period typically lasts for up to 10 years. You usually pay a variable interest rate on the borrowed amount during this draw period. Once the draw period ends, the loan will convert to the repayment period with a fixed interest rate.
Using a cash-out refinance is another way to use the equity in your home to purchase investment properties. A cash-out refinance replaces your existing mortgage with a new mortgage with a higher principal balance. The bank gives you the difference between the two loans in a lump-sum payment, which you can use to cover the down payment on an investment.
One benefit of using a cash-out refinance rather than a HELOC is that cash-out refinances typically have lower interest rates. Plus, the interest paid on a cash-out refinance loan is tax deductible, which isn’t true for most of the loans on this list.
A personal loan is an unsecured loan that borrowers can use for many different things, such as debt consolidation, home improvements, and even capital to purchase an investment property. Because personal loans aren’t tied to specific collateral like a home loan is, they have higher interest rates. Ultimately, they’re best for more minor expenses. For example, if you need a little extra down payment to qualify for financing, a personal loan could be a way to bridge the gap.
You must have very good to excellent credit to qualify for a personal loan. The higher your credit score, the lower the interest rate. Personal loans also have shorter repayment periods than home loans, meaning they’ll have a higher monthly payment.
With seller financing, the buyer makes monthly payments to the seller, who acts as the lender instead of a traditional financial institution. Because the buyers and sellers agree to the loan terms, seller financing options can provide excellent opportunities to investors who might not qualify for a traditional loan.
The biggest downside to seller financing is that the terms are usually for a shorter period of time and include a balloon payment at the end. At this point, you’ll either need to pay off or refinance into a traditional loan.
When using private money loans, you’ll borrow money from individuals as opposed to traditional lenders. These individuals could be friends, family members, neighbors, or other investors in the area with whom you may have a personal relationship. Like seller financing, private money loans have flexible loan terms that work for both individuals. Private loans make it easier for borrowers who may not qualify for traditional loans and provide investors with a passive income stream.
Hard money loans are short-term loans secured by the property itself. Unlike traditional financing, which focuses on creditworthiness, hard money lenders consider the value of the collateral. Often, investors use hard money loans to close fast or complete a quick flip.
Using an FHA loan to fund a real estate investment is also possible. However, there is one stipulation. You’ll need to live in the property for at least 1 year. It’s an ideal scenario if you’re looking to purchase a multi-family home, live in one of the units, and rent out the others.
One benefit of an FHA loan is that they’re available with a much lower down payment. With a credit score of at least 580, you can qualify with a down payment of just 3.5% of the property’s price. Even if you have a lower credit score, between 500 and 579, you can qualify for an FHA loan if you have a larger down payment or 10% or more.
The biggest downside to an FHA loan is that you must have mortgage insurance, which will cut into your cash flow. Mortgage insurance has two parts: the Upfront Mortgage Insurance Premium (UFMIP), which is 1.75% of the loan amount, and the Annual Premium, which varies depending on your loan-to-value and down payment. Most people end up paying 0.55% of the loan amount each year.
With subject to financing creative financing strategies, buyers will take over the monthly payments on the seller’s loan without actually assuming the loan. The property’s deed will transfer to the buyer, but the mortgage will remain in the seller’s name.
Because the existing mortgage stays in place, subject to financing can be beneficial if current interest rates are high and the seller has a much lower interest rate on their loan.
If you already own investment properties and plan to expand your business, you could use cross-collateralization to finance the purchase. Cross collateralization allows you to use an existing property as collateral for a new investment. Unlike with a home equity loan, you won’t take out a loan on your existing equity, and you’ll also avoid the need for a sizable down payment.
Another way to purchase an investment property is to tap into your retirement account. Unlike a traditional IRA, which restricts the investments it includes to stocks, bonds, mutual funds, and ETFs, a self-directed IRA can consist of alternative assets like real estate. This flexibility gives investors more control over their retirement accounts beyond the select funds available through many traditional IRA providers.
When using a self-directed IRA, all returns generated must flow into the self-directed IRA. For investors looking to realize cash flow, this requirement might not be ideal. However, there can be several tax benefits to enjoy.
Self-directed IRAs have some pitfalls, though. They need active management because they’re a more complex retirement product. In other words, you’ll need a custodian to ensure compliance with the IRS, which means a higher cost than a traditional IRA.
Crowdfunding offers newer way to raise capital for real estate projects. By using crowdfunding platforms like Hatch My House or Feather The Nest, you can raise money from others, effectively reducing the out-of-pocket cash you’ll need for a down payment.
While crowdfunding is an effective way to find a large number of potential outside investors, it will require work. You can’t just say, “I want to purchase this investment property. Will you donate?” Instead, you need to tell your story. Let people know why they should trust you with their money.
If you have a 401(k) retirement account through your employer, you can take out a loan against it to cover the down payment on a property. You can borrow either $50,000 or 50% of your vested account balance, whichever is less.
Because your remaining 401(k) secures these accounts, they usually feature lower interest rates. However, not all 401(k) plan administrators allow you to take a loan, so you’ll want to check with yours before moving forward.
The most significant risk of using this creative finance method is that if you use your 401(k) to purchase real estate and the property isn’t successful, you could impact your retirement.
Partnerships with other real estate investors are popular ways to get creative when securing capital for real estate deals. If you’re an experienced investor, but your cash is tied up in other investments, you could bring on a partner to help with funding.
You can structure partnerships in many ways. For example, you might be looking for someone to handle the 20% down payment to secure the property. In exchange for the capital, you could oversee any needed renovations and split the monthly profits.
Through partnerships, you contribute your expertise, your partner contributes the cash, and you split the profits. It’s a win-win situation for both parties.
If you’re investing in lower-income areas, government grants are available to help fund projects. These grants can benefit investors and the cities where the development takes place. In effect, you’re receiving capital to update the property, and the city gains renovated properties that will hopefully make the neighborhood more desirable to residents and businesses.
For example, I had a friend invest in multi-family buildings just off the Drake University campus in Des Moines, Iowa. This area is a lower-income part of the city, and he was given capital to update the buildings’ interior and exterior to make them more desirable. While he still needed to fund some of the project, the grant reduced his renovation costs.
Securing a loan can be stressful if you’re new to real estate investing. However, a clear understanding of what you’re looking for and the steps you need to take can make the entire process smoother.
Here are a few tips to get you started on the right track.
First and foremost, you need to understand your goals. Do you already have a down payment available, or are you looking for creative financing that can help fund the entire project? Understanding your needs can help you narrow down the methods you should consider.
Once you know your goals, you can choose the method that makes the most sense for your business. Weigh the pros and cons of each, and then proceed with the best fit.
As you begin your journey of finding creative financing for real estate, start building your network. Many cities have real estate investor meetups (investment clubs), which are great ways to meet other investors in your area. These individuals can be excellent resources for funding future deals.
Because most creative finance options have fewer regulations, hiring a real estate attorney or financial advisor is important to help you through the process. An attorney will help you draft or review contracts to ensure everything is legally covered. They can also help you understand your state’s landlord laws. Then, a financial advisor will help you assess the deal to make sure it fits within your investment plan.
There are many creative financing methods available for real estate investors. These can help you secure the capital needed for projects when traditional lending might not be an option. As you consider each of these, make sure you understand the pros and cons.
After you receive your financing and start moving toward closing on the property, it’s essential to have your accounting in place to ensure your investment stays profitable. In addition to lease agreements and rent collection, this is just one of many things TurboTenant can help you with.
If you’re already managing properties, consider signing up for a free TurboTenant account. With it, you can streamline the manual day-to-day tasks that get in the way of researching that next deal.
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