Being able to find sources for real estate financing is a little known secret of the wealthy. Very frequently, they do not use their own money, at least using sources of leverage and other people’s money in order to maximize their own wealth.
Robert Kiyosaki (Rich Dad Poor Dad) famously bought his first rental property entirely through financing. Even the down payment for the house was paid for using credit.
What are the benefits of financing real estate, and what are 13 options for financing real estate?
Key Takeaways:
- Real estate financing allows investors to control 100% of a property with a small down payment, leading to increased cash flow and tax benefits.
- Financing can reduce taxable net income through interest deductions and diversify investment risks across multiple properties.
- Some financing options include conventional, FHA, VA, and SDIRAs for real estate.
- Home equity loans, HELOCs, and blanket mortgages can help investors leverage existing properties to finance new investments.
- LLCs provide an alternative way to finance real estate, with members earning income through loans or equity investments.
- Owner financing allows sellers to act as a bank, receiving down payments and installment payments from the buyer.
- Cash value life insurance policies, such as whole or universal life insurance, can be used for real estate financing with flexible repayment and low-interest rates.
Why Investors Finance Real Estate
There are 2 options for purchasing real estate. You can either pay the full amount of the purchase price in cash or by making a small down payment and financing the real estate with a loan.
Benefits of Using Financing
Real estate financing is commonly known as leverage due to the way a down payment is utilized. If you purchase a piece of real estate, you can control the entire asset by putting down a small percentage of the total cost, often around 20%. This allows you to claim 100% of the cash flow and tax benefits, as well as any appreciation in the value of the property.
For an investor, some of the biggest potential benefits of using financing to purchase rental property include:
- Control of 100% of a rental property with a small down payment.
- The ability to deduct interest and reduce taxable net income.
- Potential risk reduction through diversification of investment capital across several properties instead of a single property.
- Boosted returns on the amount of cash invested by using financing.
If you’re worried about future interest rate hikes, you can lock in today’s rates on a 30-year mortgage for your rental property.
This calculator can help you figure out what your monthly mortgage payments might be on a rental property, based on different factors like how much of a down payment you make, your credit score, and the length of the loan. Investors can also work with experienced, third-party investment lenders and get preapproved for financing online.
13 Options for Real Estate Financing (And A Bonus 14th)
Here are 13 options to consider for financing a real estate purchase:
1. Savings and Loan Associations
While they are not the largest financial intermediary in terms of total assets, savings and loan associations (S&Ls) are the most important source of funds in terms of dollars made available for financing real estate. S&Ls have seen a large increase in assets in recent years, and currently the total assets of the 3,900 associations is second only to commercial banks. They have historically been the primary supplier of residential loans to single-family homeowners, although S&Ls are not restricted to this type of financing. Savings and loan associations are also willing to give loans for home-improvement projects as well as to investors for apartments, industrial property, and commercial real estate. As a result of deregulation, lending activities have been restructured and the average S&Ls assets invested in mortgages has decreased. Until 1980, most associations had 80% of their assets in the form of loans on real estate. The percentage had dropped to below 60% by late 1983.
An S&L is either federally or state charted. Approximately 40% of the S&Ls are federally chartered. The association must be a member of the Federal Home Loan Bank System (FHLBS) if it is federal, and its funds must be insured by the Federal Savings and Loan Insurance Corporation (FSLIC). All savings and loan associations that are federally chartered are owned by their depositors and must include the word “federal” in their title. There are two types of state chartered S&Ls: those that are mutually owned and those that are stock associations. The individuals who buy stock in a stock association provide the equity capital for the organization. These individuals have the option to join both the Federal Home Loan Bank System (FHLBS) and the Federal Savings and Loan Insurance Corporation (FSLIC). In some states, these lenders are known as building societies or cooperative banks.
The lending policies of different associations can vary, but most S&Ls engage in similar activities and have comparable lending requirements. The following are common lending policies:
- The bulk of their mortgages are in conventional loans for single-family residential real estate.
- Most S&Ls provide both FHA and VA financing, although these loans typically comprise a small percentage of total assets.
- The majority of loans are made locally. Funds are typically not available to faraway geographic areas. However, recently some of the larger associations have been engaged in lending funds to users in other states through service corporations and correspondent accounts.
- Residential loans are usually for 25- or 30-year periods calling for periodic (monthly) full amortization. The current average maturity for conventional mortgages on new homes is approximately 28 years.
2. Commercial Banks
Commercial banks are the largest financial intermediaries when it comes to total assets, and they’re directly involved in the financing of real estate. Banks provide loans for many different purposes. If someone is looking to take out a loan from a commercial bank for their home, it is most likely going to be a short-term loan used for construction or home improvement. These types of loans are typically only six months to three years. Most large commercial banks have a real estate loan department; their involvement in real estate is primarily through this department. Several of the biggest commercial banks are also involved in real estate financing, either through their trust departments, mortgage-banking operations, or real estate investment trusts.
There are two types of chartered commercial banks: those chartered by the federal government and those chartered by the state. National banks are chartered and supervised by the U.S. Comptroller of the Currency. The word “national” appears in the title of these banks, and they are members of the Federal Reserve System (FRS). However, only one-third of all commercial banks are members of the Federal Reserve Banks, even thought the member banks control the majority of total bank assets. National banks are required to have membership in the Federal Deposit Insurance Corporation (FDIC). Banks that are chartered by the federal government can give loans for real estate that are worth up to 90% of the property’s appraised value as long as the loan is not more than 30 years old. However, any government insured or guaranteed loans are not subject to these limitations.
Banks that are chartered by a state government are regulated by agencies in that state, and membership in both the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve System (FRS) is optional. Banks not covered by the Federal Deposit Insurance Corporation (FDIC) are typically required to be members of a state insurance corporation.
3. Life Insurance Companies
Real estate equity providers, such as insurance companies, plays an important role in the industry. When compared to a savings and loan association or a bank, insurance companies typically lend money to borrowers indirectly through local correspondents like mortgage brokers or mortgage bankers. Most insurance companies focus on large-scale projects and mortgage loans. In the past, between a quarter and a third of their assets were invested in mortgages.
Insurance companies make money by charging policyholders premiums, and since both the amount of premiums collected and the amount of claims paid out can be predicted with reasonable accuracy, insurance companies can invest in assets that have higher returns but are less liquid than what is available to banks or associations. This group typically seeks out long-term financing for their commercial and industrial real estate investments. The percentage of residential mortgages that insurance companies invest in has been decreasing over time. Few insurance companies presently originate residential mortgages.
Since there is no federal agency which issues charters, all insurance companies are state chartered. This results in less regulation of most states in comparison to savings and loan associations or banks. The less government regulation there is, the more lenient lending practices are, which in turn provides funding for a greater diversity of real estate endeavors. Although the insurance industry is predominantly made up of stock companies, the majority of its assets are actually held by mutual companies.
4. Mutual Savings Banks
Mutual savings banks, which are located primarily in northeastern states, are an important supplier of real estate financing. Banks that are owned by their depositors offer interest on deposits.
Mutual savings banks are state chartered and typically have less regulations than savings and loan associations. The average savings and loan has less of its assets invested in real estate mortgages than this institution does, although a higher percentage of its total mortgage portfolio is made up of FHA and VA loans. A greater percentage of mortgages held by mutual banks are typically higher than those of other banks. Mutual banks also offer personal loans, which can help transfer capital from areas where there is surplus to areas where there is deficit. Most mutual banks are part of the FDIC. The remaining accounts are insured by state savings insurance agencies. The authority to decide both what kind of real estate investments to make and how much of their assets to invest in them lies with these state agencies.
5. Conventional Financing
The three places where you can get a conventional loan for real estate are banks, credit unions, and savings and loan associations. All conforming conventional loans must meet the standards set by Fannie Mae and Freddie Mac. These standards include minimum credit scores and maximum loan amounts.
If you’re looking to buy a rental property and hold onto it for a long time, a traditional 30-year fixed-rate loan might be a good financing option. With this kind of loan, your interest rate and monthly payment amount won’t change.
6. FHA Financing
FHA loans are government-backed loans for financing real estate. FHA loans are not meant for people who are looking to purchase a rental property.
Although it may not be the best option for everyone, people who are looking to rent out part of their home or a unit in a multifamily property may find that an FHA loan is a good fit for them. This is because down payment requirements and loan eligibility criteria are usually less strict with this type of financing.
7. FHA 203(k) Loan
The FHA offers a 203(k) loan that allows a borrower to wrap the purchase price of a home, plus any needed renovations or repairs, into a single loan. FHA rehab loans are available with fixed or adjustable interest rates and 15- or 30-year loan terms.
FHA 203(k) loans are available to finance the purchase of a home and its necessary renovations. Projects that may be covered by the loan include installing roofing or flooring, making repairs to health or safety hazards, and replacing plumbing or electrical systems. 203(k) loans are only available for homes that will be owner-occupied.
8. VA Financing
Veterans Affairs (VA) loans are available to service members, veterans, and eligible surviving spouses to help make owning a primary residence more affordable. The V A guarantees a loan that is originated with a conventional lender.
(Source: https://www.nerdwallet.com/blog/mortgages/va-loans-101/) A VA loan requires no down payment, no private mortgage insurance (PMI), and has limited closing costs. VA loans also have low interest rates. Although VA loans are typically used to finance a primary residence, they can also be used for the purchase of a multifamily property. In this case, the borrower is only eligible if they live in one of the units.
9. SDIRAs for Real Estate
An SDIRA could be a great option for those with a lot of savings in a retirement account who want to invest in real estate. A self-directed individual retirement account for real estate is created by transferring a traditional retirement plan, like a 401(k) or SEP IRA into an SDIRA. The funds in a SDIRA account can be used to buy property or to make a non-recourse loan down payment.
When purchasing real estate with an SDIRA, investors should make sure there is enough money in the retirement account to cover any necessary capital repairs or operating expenses during periods when cash flow is negative.
10. Home Equity Loan and HELOCs
Home equity loans and home equity lines of credit are two ways of borrowing against the equity in an existing property without having to sell. An investor may be able to borrow up to 80% of the equity in their home to raise funds for a rental property, repairs, or renovations.
A HELOC can be a helpful tool for investors who may need to access equity in their homes. This type of line of credit allows investors to tap into the value of their homes as needed, giving them greater flexibility and financial security. A HELOC operates in a similar way to a credit card in that periodic payments of principal and interest are made in order to repay any borrowed funds.
11. Blanket Mortgage
A blanket mortgage is a single loan used to finance multiple properties. The individual assets serve as collateral for one another. A blanket mortgage generally has a release clause which allows the borrower to sell just one property while still owing on the mortgage.
12. Limited Liability Company
LLCs are another way to finance real estate. Rather than owning real estate directly, investors own membership shares of an LLC that owns the property. LLC members may earn income in two ways: by loaning money to the LLC in exchange for periodic payments, or by investing in equity and receiving a share of any net operating income and profits when the property is sold.
13. Owner Financing
Sometimes sellers who own the property outright or with a small outstanding mortgage balance are willing to provide owner financing. Rather than receiving a lump sum payment from a buyer for their home, a seller instead acts as a bank. The seller receives a down payment from the borrower, plus installment payments of the Principle & Interest amount owed. The seller cannot finance the buyer unless any existing loan is paid off, unless the loan has an assumption clause.
14. Cash Value Life Insurance Policies
As a bonus, here is a final, little talked about source for real estate financing is cash value life insurance polices. Also known as “Infinite Banking” or “Bank on Yourself” insurance policies, essentially what you are doing here is borrowing cash for either a down payment or full value of real estate from the insurance company itself. Typically these are whole life insurance policies, but in recent years, universal life insurance policies have also started to be used for this purpose.
These types of policies have many advantages, including flexible repayment, low interest rates, plus the advantage of dividends still accumulating on the original cash value of your policy.
Initially hesitant about the whole concept, but our mentors as Cashflow Tactics really emphasized the use of these and we are extremely grateful we took their advice.
Kurt has gone from the financial lows of the ’08 financial crisis to personal financial success. He is a professional real estate investor owning properties in multiple states.
One of his passions is financial education and the pursuit of financial freedom.
You can learn more about Kurt here.
