Susan Kelly
Jan 29, 2024
Are you considering purchasing an investment property? Are you thinking about getting a loan to finance your purchase? If so, this article is for you.
Loan types are just one aspect of the equation when it comes to investing in real estate. Here, we'll go over six different types of loans that are available to people looking to purchase properties — providing a complete guide and helping make the whole process easier than ever before.
Let's start with the most common kind of loan used to fund real estate purchases — the conventional loan. Think of a conventional loan as "borrowing from a bank." The bank pays off the property's outstanding mortgage (the interest and principal on what you owe), and you pay back the loan with the interest that accrues over your lifetime. If you use cash, you'll also have to make additional mortgage payments for the life of your mortgage — which is how it's still sometimes colloquially referred to as a "mortgage note."
These loans are pretty simple, so we won't spend too much time going over them here. The basic idea is that you pay off your principal balance, so you don't owe as much as the property is worth. As a result, the interest you'll pay back over that same period of time is higher than if you made monthly payments over a shorter period of time.
A secured loan isn't really a loan at all; it's an agreement between the lender, borrower, and real estate asset. In this case, the note issued against that asset is considered a securement note (or less formally — a lien). The lien offers the promise of repayment in the event of default on your part — which can be secured with collateral like your car or personal property.
A secured loan is typically only a good idea if the collateral is worth more than the value of your debt. On top of that, you usually have to pay a fee on top of your interest payments. In fact, there's also a little extra cost for the lender who buys the asset from you after you default — their profit margin on this type of loan is pretty low.
This one's not so simple either... Real estate assets can be quite illiquid and difficult to sell. So if you default or want to sell before the end of your loan, it can be very difficult to find someone willing to buy your collateral from you at fair market value.
Called "cash-out refinance" loans, these are the loans you see advertised on TV. They're essentially just a home equity loan — or as it's sometimes called a second mortgage. In a nutshell, you give up your existing home equity (in the form of cash) in exchange for that cash. This can be both good and bad:
If you have bad credit, this type of loan could be an option for you... after all, you're essentially just selling your home to a lender. But, interest rates on these kinds of loans are much higher than on prime loans.
Of course, some people are willing to pay that price. Especially if they don't have any other assets to invest with.
Private loans could be an option for you if you want to avoid taking out a standard mortgage with a bank. While it might seem like an option for folks who don't want that kind of oversight — it also comes with its own potential drawbacks:
If you're looking to invest in a property at the time of construction — or shortly afterward — a builder/developer loan might be the way to go. This is essentially just an extension of your initial investment budget, giving you one less thing to worry about financing.
As the name suggests, hard money loans are considered risky. These are loans that are given out under strict terms with high-interest rates and short schedules for repayment. While there are considerable risks involved — and borrowers frequently have to pay upfront before the funds are released — hard money loans can be used in a number of different ways.
Hard money loans can be used to:
If you think these types of loans may be right for you, then we recommend asking around to see what kind of deals are floating around and where your local real estate community is getting them.
There are a lot of different ways you can finance your real estate deals — but not all of them are right for you. The best way to decide which loan is right for you is to consider your options and pick which one makes the most sense for you. And, as we mentioned earlier, every one of these loans has an upside and a downside, so it's important to weigh those against each other and see what works best in your case.
What are your thoughts on financing options in real estate? Share your thoughts with us in the comments below!