Real Estate Money Basics – 10 Ideas For Financing a
Home
There are many different ways to
find financing to buy a home. But most folks are only aware of just one or two
options. Generally, financing for a home can be broken down into two major
categories: “Traditional” and “Non-Traditional“.
The Traditional financing category
is the one that everyone hears about the most. The traditional category
includes government insured loans like FHA,
VA, and USDA.
(to name a few) Since these loans are “insured” they generally require the
borrower to jump through a number of “hoops” in order to qualify.
These loans require better credit
scores, documented income, a careful review of your bank statements and any
other information the lender may happen to require. These loans generally offer
the lowest down payment options as well. If you are looking at homes for sale,
and working with a real estate agent, chances are you’ll be using a
traditional, government insured loan to finance your purchase. The
“traditional” real estate business uses primarily “traditional” financing
methods.
In the traditional category, the
various loan types have a variety of qualifying criteria.
USDA loans for example, are designed for “rural” properties, located
within specific geographic areas outside of city limits. If the property is not
located in a rural district, it would not qualify for the USDA program. But
you’d be surprised just how much territory qualifies as “rural” under USDA.
FHA loans are probably the best known of the traditional loan
programs. FHA can be applied to almost any home, in any location, as long as
the home meets certain condition requirements and the buyer can meet the credit
and income requirements.
VA loans are for veterans. If you are a vet, you may be eligible for
a zero down payment, on a VA loan.
Traditional loans such as these have
limits on the amount you may borrow, because they are designed for homes in the
lower price ranges. But because prices for homes vary widely from one state to
another, the loan limits can vary by location. Down payments for each of these
loan types are usually below 20% of the contract price. All typical licensed
loan originators and mortgage companies offer the traditional loan types.
FHA, VA and USDA are “government
insured” to protect lenders from a borrower default. This allows borrowers to
buy with a low down payment, and still avoid a higher interest rate. In return
the lender can make a “claim” for insurance if the property goes into
foreclosure.
Here’s a tip if you are planning to buy with a low down payment,
government insured loan: These loans are very expensive. Even with today’s low
interest rates, there are “funding fees” and other costs that are rolled into
the loan, that will add to the cost of your home. It’s best to buy a little
less than you can qualify for, and plan to pay down additional principal on
your mortgage each month, so that you can pay off these loans as quickly as
possible. This will help you save thousands of dollars in interest and loan
funding fees.
Within the traditional category,
there is also the “conforming” loan.
These are the traditional “old-fashioned” loans, in which the borrower puts
down 20% or more to purchase their personal residence. 20% down used to be the
norm in the days before FHA and VA made lower down payments widely available.
Generally, the higher your down payment is, the easier it may be to qualify in
the traditional sector.
The other major category for real
estate financing is the “non-traditional”
sector. This includes all of the ways to finance a home purchase without the
hassles of qualifying for a traditional loan. While these non-traditional
options are open to all buyers, they are not very well known to the general
public.
This is what’s known as “creative real estate finance” in the investing
world, and real estate investors spend a great deal of time studying and
practicing these strategies. Most of these strategies will not require good
credit, and a few don’t even require the buyer to have any money of their own.
Here are some of the
most common financing ideas from the non-traditional sector:
“Subject-to
the existing mortgage” – The buyer purchases the property by
essentially taking over the payments on the sellers existing mortgage. The
mortgage stays in the sellers name for some period of time, which allows the
buyer to make the original purchase without qualifying and in some cases
without even making a down payment. During the 1980′s when interest rates for
traditional loans were sky-high, buyers began taking over existing mortgages
that had been created years earlier at much lower rates. This strategy is most
popular when interest rates are going up.
“Hard
Money” – When an investor or a potential
owner occupant want to buy a property that needs lots of repairs, one option is
to turn to “hard money lenders” who offer loans based on the “After Repair
Value” of a property. This is a specialized world best known to investors who
buy fixer uppers, repair them and then resell them for a profit. But any buyer
can use a hard money loan to purchase and repair a property. Once the rehab is
completed, the buyer gets a new appraisal, and refinances the property with a
new, long term mortgage. Hard money loans are relatively expensive, but they
are designed for short term use, for this special purpose. They help borrowers
buy fixer-upper properties that cannot be financed by traditional loans in
their current condition.
“Seller
Financing” – If a seller has a lot of equity in a property, they may
choose to finance a buyer themselves. This is a good selling strategy when a
property is difficult to sell for some reason, or the seller just wants to
realize a good cash flow on a property that they own free and clear.
Personally, I like selling property with seller financing to good buyers that
have good income but may not be able to qualify for a traditional mortgage. For
a seller it’s better than renting, and for a buyer it’s a great way to buy a
home without qualifying.
When looking for this type of seller
financing, focus on homes that are “For Sale By Owner” first.
Any seller who has a property for
sale may consider financing the purchase for a buyer, but homes listed on the
MLS are controlled by real estate agents who may not be friendly to this type
of offer. Unfortunately agents are not trained in “non-traditional” or
“creative-finance” options. They focus primarily on the traditional loan types.
As a result, they may be difficult to work with when you are looking to
purchase a home with seller financing.
Another popular category that has
recently gained a lot of attention is “Self-Directed
IRAs“. Many folks are unhappy with the
returns on their savings or their existing IRA’s, so they are looking for other
ways to earn more money. Self-directed IRA’s can be a great way to use your
savings to purchase property and increase your retirement income. But there are
specific rules and requirements to avoid taxation of your profits. And there
are many scammers
out there who are using Self-Directed IRA’s as a gimmick to part inexperienced
investors from their money. Be sure to do your research carefully before you
invest with a self-directed IRA.
“Lease
with an Option To Buy”
is a popular strategy for buyers who don’t have good credit and don’t have
money for a down payment. The tenant/buyer finds a property to rent, with a
landlord who is willing to credit them with a portion of the rent towards a
down payment. If the buyer pays their rent on time, and accumulates credit
towards a down payment, they can then “exercise their option” and purchase the
property at a price that was agreed upon when they rented the property.
This strategy is commonly used by
investors to sell properties. Buyers should have their lease and option
agreement reviewed by a competent attorney to insure that the deal is
structured properly. When done correctly this is a very effective way for a
seller to sell in a tough market, and a great way for a tenant/buyer to
accumulate credit towards a down payment.
This article is running long and I
haven’t even mentioned other forms of private financing, designed for various
situations, such as “transactional funding”
and using a private loan from a friend, relative or investor.
Whether you want to own your own
home, or you are a real estate investor searching for funding for your first
investment property, there are dozens of options. This article has only touched
on a few of the most common ones. It pays to do your research and find out
about creative ideas for real estate financing. There are many books and
courses available on the subject of creative real estate financing.
