Show me the what? Creative financing demystified.
One of the most common sentiments we hear when real estate investing comes up in conversation is, "I would love to invest, but I don't have the money."
And it just so happens that one of the most annoying things that real estate investors say is, "Money is not the limiting factor. There are always lenders to finance a good deal." And it's annoying because it feels untrue. "Money's not a limitation? Of course it is! What world do you live in?" is the natural gut response.
In this post we're going to give an overview of financing as it relates to real estate. By understanding a few simple terms and concepts, you can set out on your own, dive deep and explore this endless topic to your heart's content.
Money (for our purposes) can be divided into two categories.
1. Your money
2. Other people's money
1. Your money is, well, your money. It's the cash in your bank account, wallet, under the mattress, etc. You can take that cash and do anything you want with it, like buy a house.
2. Other people's money is money that you borrow from other people. You'll hear "OPM" thrown around a lot — just an acronym for Other People's Money. (Side note: whenever you don't understand jargon, regain the upper hand by throwing back some jargon of you own that neither of you understand, "I've considered using OPM but the L-Ratio doesn't justify the CBR. All things considered, this feels like a BS situation").
If you've purchased a home, you've likely borrowed money from a bank. You do have to bring some cash to the table, but depending on a number of factors (credit score, condition of home, market conditions), a bank will lend a large percentage of the purchase price of a home in order to earn interest over the life of the loan.
Super easy-to-understand example of OPM
You want to buy a $300k single-family home with blue trim, apple trees and bunnies living in the backyard. You put down 3.5% ($10,500) for a 30-year FHA loan and pay the bank $1,569/month, and the home with the bunnies is yours.
Investing with OPM
Just like in the above example, when you want to buy an investment property you find a lender and negotiate terms. These terms will involve points (up front cost of loan), investment percentage, interest rate, repayment period, and any special provisions.
This is where things start to get interesting.
Banks/Credit Unions do more than just be too big to fail and manage checking accounts and issue the kind of conventional home loans we already discussed.
Portfolio loan: a loan that becomes part of a lending institution's portfolio. Because they're not bundling and selling these loans on the secondary mortgage market (see: The Big Short), you can find lenders who will listen to a proposal and make their own determination based on the strength of the deal.
Home Equity Line of Credit (HELOC): a line of credit secured by the equity in your home.
Cash-Out Refinance: similar to a HELOC in that you are borrowing against the equity in your home, but in this case you get the cash as a lump sum and more conservative repayment terms.
Private Money Lenders: people in your network — family, friends, coworkers, acquaintances and on and on out from that inner circle of intimacy. These partnerships are the most relationship-driven of the financing options
Hard Money Lenders: individuals or companies that make private loans as a business. This can be a good option for a short-term project like a house rehab, as the money is expensive and repayment terms usually strict. These lenders are savvy investors, and so the deal you propose has to meet their criteria.
Peer-to-Peer/Crowdfunding: Real estate crowdfunding is pretty similar to other types of crowdfunding. A quick web search can provide a growing list of real-estate specific platforms for your evaluation.
Owner/Seller Financing: this works best when an owner owns their home outright and is open to receiving monthly payments rather than one lump sum. However, if the owner is open to exploring it, everything is negotiable.
Credit Cards: Believe it or not, credit cards aren't just for airline points and lock-picking and racking up soul-crushing debt. Sometimes, credit cards can have a place in real estate investing.
There it is, a 30,000 ft view of some of the financing options available in real estate investing. Of course, the option that makes sense for you and your deal is going to be entirely dependent on the situation, your goals and strategy. In future posts we'll get more into the weeds on a few of these avenues that we personally prefer and employ often. Until then, we are always standing by to talk real estate and answer any questions you may have.