That dreaded word… Financing.
(Wait, what did you think I was going to say?)
Financing your real estate investments is an essential part of your business. But it can be a tough and confusing process.
Especially as a new or new-ish investor, finding ways to fund your property deals can feel overwhelming. Most investors don’t start off with a huge chunk of change that can be used for an all-cash purchase. So the only other option remains… finding the financing solution that will work well for you.
When it comes down to it, you have 3 primary options:
- Hard money lenders
- Private lenders
- Conventional lenders (banks/mortgage companies)
Just like a portfolio of various property types creates a strong business, various financing options also typically foster a more profitable business.
So, let’s take a quick look at each of these 3 financing choices, so you can get the gears turning in your brain…
What’s the Big Difference? Hard Money vs. Private
You’ve probably heard the terms “hard money lender” and “private lender” used interchangeably. So let me clearly define what I’m talking about here.
A hard money lender is either a person or a company that is in the business of financing property deals (in other words, this is their primary business – to fund deals). They operate from a business standpoint, and their business can only be sustained if they continue to fund successful real estate transactions – as opposed to a private lender, who is looking for personal opportunities for financial growth.
Hard money lenders also finance deals based on the property itself. Private lenders, on the other hand, might finance a deal more so because of their relationship with you – the real estate investor (of course, that doesn’t mean they don’t consider the property too, but the relationship is usually the dominant determining factor).
Hopefully that’s clear as mud. To summarize:
- Hard money lenders = business-oriented + lend based on the property
- Private lenders = interested in personal gain + lend based on the relationship
Now, let’s get into more detail.
Hard Money Lenders
A few other characteristics of hard money lenders can be:
- They’re National Mortgage Licensing System (NMLS)-licensed
- They comply with their respective state lending regulations
- They sometimes have a formal application process, similar to conventional mortgage lenders
- They may fund the loan themselves or via their own set of investors
Hard money lenders, in general, will be more flexible with their lending guidelines than a traditional lender. They typically don’t use a “one-size-fits-all” underwriting system, and will evaluate deals on a case by case basis.
On this same note, they usually lend based on collateral, not based on your credit score/income/etc. So, if you don’t have a pristine credit history, this won’t matter as much to a hard money lender; they’re more concerned about the value of your collateral (the property itself).
Also, because they don’t follow a rigid underwriting process, they usually make quick decisions – meaning you aren’t waiting forever to find out if they’re interested in financing your property deal.
The disadvantage? The cost, obviously. Those super-high interest rates could become a nightmare for unprepared, inexperienced investors.
The bottom line: Hard money loans can be ideal for investors who fix and flip properties, because you’re not holding on to the property for an extended period of time. Once you increase the value of the home, you can quickly sell it and pay off your high-interest, short term loan – and have a good chunk of profit to walk away with.
Anyone who you personally know who is willing to lend you money for a property would be considered a private lender. It could be your doctor, your former co-worker, a guy you bump into regularly at the gym, your son’s soccer coach, or your wealthy great aunt Bertha – you get the idea.
They might lend you money because they have past real estate experience and are interested in your work, or they simply have extra money and are ready to multiply it. In any case, they are using their own personal money.
One advantage of working with a private lender is that they’re the most likely to be lenient and flexible with you, should your timeline or circumstances change. A hard money lender or conventional lender will often drop you in a hot minute if you have any roadblock along the way, but a private lender will probably be more patient.
Another huge benefit is the expertise your private lender can share. Even if they don’t have past real estate experience, they are financially successful – and have probably held prominent roles in their companies (or even started their own business). The connections and knowledge they can provide you will be invaluable as you build your investing business.
The downside of private lender? Because they are investing their own, hard-earned money, they may expect to have a significant amount of control over the decisions concerning the property. Still – by outlining your expectations upfront, you can avoid any uncomfortable misunderstandings that might jeopardize the relationship with your private lender.
The bottom line: Private loans can be a great choice for a variety of investing situations – whether you’re looking to fix and flip, buy and hold for rental income, or a combination of the two.
And now, at the opposite end of the spectrum, we have conventional lenders – such as banks and mortgage companies. These often get a bad rap with investors, but there are some situations where a loan from a conventional lender is a great choice.
One of the most significant advantages of working with a conventional lender is that they know the industry inside and out. They have all the connections you could possibly dream of: title companies, agents, appraisers, and more. Plus, local conventional lenders will know your market well, which means they could potentially help you steer clear of areas where investing might not be as profitable.
Plus, with a conventional lender, you’ll likely get a good interest rate (although they are higher for investors than for owner-occupants). If you plan to keep a property long-term, this means your rental income from tenants could far exceed your mortgage – maximizing your cash flow.
Now for the bad stuff… conventional lenders can be painstakingly slow when it comes to approving you for a mortgage. As an investor, it’s highly likely you don’t have time to waste – and the slower pace of a conventional lender could jeopardize your chance to score an awesome property deal.
They’re also not lenient – like, at all. If your credit score, income, etc. doesn’t fit their guidelines, you’re probably not getting a mortgage from a conventional lender. Another roadblock you might run into: many traditional lenders have a maximum # of loans that investors are allowed. If you own more than 10-ish properties (the exact number varies state to state), you’ll be hard-pressed to find a conventional lender who is willing to finance your next property.
The bottom line: Conventional loans probably won’t be your #1 source of financing, but they do have their merit. If you plan to hold onto a property for many years to come, a conventional loan with a low interest rate could be a good fit for you. As long as you can establish a positive cash flow, you’ll be easily able to pay off your loan and still make a solid profit.
Finding Your Finance Solution
In the end, your choice of a lender will depend on your business model, the property itself, and your long-term goals. As I mentioned before, many investors benefit from using a combination of private lenders, hard money lenders, and conventional lenders.
Just make sure you do your due diligence and never make a decision in a rush. It doesn’t matter if your lender is ABC Mortgage Corporation or great aunt Bertha – you should still ensure that the lender has a trustworthy reputation and a proven track record. Because, if you can’t rely on your source of funds, you can’t continue to run your business. It’s as simple as that.
How About You?
What has been your experience with private lenders, hard money lenders, and/or conventional lenders? Comment below to let me know the pros and cons I might have missed.