A Guide to Real Estate Financing Options

Depending on the property type, some funding vehicles may be better suited to your project than others.

Real estate investment can be a lucrative venture, but it requires a significant amount of capital. Whether you are a seasoned real estate investor or a first-time homebuyer, you’ll want to consider different financing options depending on the type of property you want to invest in.

If you require financing immediately or need advice on finding the best financing options for you, speak to our team at L4B. Our specialists discuss your requirements and pair you with only the most relevant, affordable, and reliable lenders.

The Main Property Types

There are three main real estate investment property types:

1. Residential properties. These include single-family homes, condominiums, townhouses, and multifamily homes with up to four units.

2. Commercial properties. These include office buildings, retail spaces, industrial properties, and multifamily homes with five or more units.

3. Land acquisition. This category differs from residential and commercial property financing because it involves the purchase of undeveloped land, commonly held for appreciation purposes.

Financing Options

Let’s examine the main financing options available for the three property types and the common criteria used to evaluate investors.

Conventional loans. Conventional loans are the most popular type of mortgage loan. These loans are not guaranteed or insured by the government. The interest rate for conventional loans depends on the borrower’s credit score and debt-to-income ratio. The basic default criteria for a conventional loan include a good credit score (typically 620 or higher), a low debt-to-income ratio, and a down payment of at least 3%.

Federal Housing Administration (FHA) loans. These loans are insured by the FHA and are suitable for low-to-moderate-income borrowers. The loans require a down payment as low as 3.5% and have more lenient credit scores and debt-to-income ratio requirements than conventional loans.

FHA loans are designed to help first-time homebuyers, those with lower credit scores, or those needing to make smaller down payments to buy a home. The basic default criteria for an FHA loan include a credit score of at least 500 (although a higher score is recommended), a debt-to-income ratio of no more than 43%, and a down payment of at least 3.5%.

Veteran Affairs (VA) loans. VA loans are guaranteed by the Department of Veterans Affairs and are available to eligible veterans, active-duty military personnel, and surviving spouses. These loans require no down payment and have lower interest rates than conventional loans. The basic default criteria for a VA loan include a good credit score (although there is no minimum score requirement), a debt-to-income ratio of no more than 41%, and a certificate of eligibility from the VA.

USDA loans. The U.S. Department of Agriculture guarantees USDA loans for borrowers in rural areas. These loans require no down payment and have lower interest rates than conventional loans. The basic default criteria for a USDA loan include a credit score of at least 640, a debt-to-income ratio of no more than 41%, and a property located in a qualifying rural area.

Home equity loans. Home equity loans are secured loans that allow homeowners to borrow against the equity in their homes. Equity is the difference between the home’s current value minus the remaining mortgage or any liens on the property. Home equity loans are typically used for significant expenses like home renovations, medical bills, or debt consolidation. These loans have fixed interest rates and are suitable for homeowners who need a large amount of money upfront.

To be eligible for a home equity loan, homeowners must have a certain amount of equity in their property. Lenders usually require a minimum of 15-20% equity in the home. Additionally, lenders will consider the homeowner’s credit score, income, and debt-to-income ratio to determine their eligibility for a home equity loan.

Home equity lines of credit (HELOCs). HELOCs are similar to home equity loans but are a revolving line of credit. These loans have variable interest rates and are suitable for homeowners who need to access money over an extended period. Instead of receiving a lump sum of cash, borrowers are given a line of credit that they can draw from as needed. HELOCs are often used for home renovations, education expenses, or other large purchases.

To be eligible for a HELOC, homeowners must have a certain amount of equity in their property. Lenders typically require a minimum of 15%-20% equity in the home. Additionally, lenders will consider the homeowner’s credit score, income, and debt-to-income ratio to determine their eligibility for a HELOC.

Unlike a home equity loan, a HELOC allows borrowers to withdraw funds on an as-needed basis up to a certain credit limit. The borrower can then repay the borrowed amount over time with interest. HELOCs also typically have a variable interest rate, meaning the interest rate can fluctuate over time.

Private lenders. Private lender financing in real estate refers to loans that are provided by individuals or private companies instead of traditional banks or financial institutions. These lenders often provide financing for real estate investments like fix-and-flip properties or rental properties.

The eligibility criteria for private lender financing varies depending on the lender, but they typically do not have as strict an eligibility criterion as conventional loans. They would likely evaluate credit score, a low debt-to-income ratio, and a track record of successful real estate investments. Private lenders may also require borrowers to have a certain amount of cash reserves or collateral to secure the loan.

Private lender financing can be a good option for real estate investors who may not meet the strict requirements of traditional banks or who need quick access to funding. However, private lender financing often comes with higher interest rates and fees than conventional loans. Additionally, because loans from private lenders are not governed by strict regulations, it is important to read the fine print, terms, and conditions in detail before accepting a private lender loan.

It’s essential to ensure the lender is reputable and has a track record of successful lending. If you’re interested in private loans, speak to our REI News team. Our experts are specialized in pairing investors with reputable lenders who are affordable to specific investment needs.

Hard money loans. Hard money financing is usually a short-term loan often used by real estate investors who need quick access to capital. These loans are typically provided by private investors or companies that specialize in real estate lending.

Eligibility criteria for hard money loans can vary depending on the lender, but they generally require collateral in the form of real estate (e.g., a property the borrower is purchasing or an existing property they own). Lenders may also require a minimum credit score or proof of income to ensure the borrower has the ability to repay the loan.

Hard money loans typically have higher interest rates and fees compared to traditional loans, but they offer several benefits. For example, hard money loans can be funded more quickly than traditional loans, allowing investors to take advantage of time-sensitive opportunities. Additionally, hard money lenders may be more willing to work with borrowers who have a lower credit score or a higher risk profile.

Overall, hard money financing can be a useful tool for real estate investors who need quick access to capital and are willing to pay higher interest rates and fees for the convenience and flexibility of these loans.

SBA loans. SBA financing for real estate refers to loans backed by the U.S. Small Business Administration (SBA) and used to finance the purchase, construction, or renovation of commercial properties. These loans are available to small business owners who are unable to obtain traditional financing and may offer more favorable terms than other types of loans.

Eligibility criteria for SBA real estate financing can vary depending on the lender and the specifics of the property being financed. In general, borrowers will need to have a strong credit score, a solid business plan, and a sufficient down payment to secure the loan.

To be eligible for SBA financing, the property being financed must be primarily used for business purposes (e.g., office space, retail space, or warehouse space). Owner-occupied properties, such as businesses that operate out of a storefront or office building, may also be eligible for SBA financing.

These programs may be a good option for small business owners who need to finance a commercial property but cannot obtain financing through other means.

Commercial bridge loans. Commercial bridge loans in real estate refer to short-term financing options used to bridge the gap between the purchase of a new property and the sale of an existing property or other long-term financing options. These loans are typically used by investors or businesses who need quick financing to close a deal, renovate a property, or take advantage of a time-sensitive opportunity.

Eligibility criteria for commercial bridge loans can vary depending on the lender and the specifics of the property being financed. Generally, borrowers will need to have a solid credit score, a strong business plan, and a plan to repay the loan quickly. It’s important to note that commercial bridge loans typically come with higher interest rates and fees than other financing options. However, they can be a good option for borrowers who need quick financing and have a clear plan to repay the loan in a short period.

Mezzanine financing. Mezzanine financing in real estate is a type of hybrid financing that combines debt and equity financing. It provides a secondary layer of financing on top of a senior debt loan and is typically used to fill the gap between the borrower’s equity and the amount of financing they need to complete a project or acquisition.

Private equity firms, hedge funds, or other institutional investors generally provide mezzanine financing. A second lien on the property secures the loan and comes with a higher interest rate compared to senior debt loans. Eligibility criteria for mezzanine financing can vary depending on the lender and the project’s specifics. Generally, borrowers must have a strong credit score, a solid business plan, and a clear path to repaying the loan.

Lenders will also typically require the borrower to have some equity in the project, because mezzanine financing is considered a riskier investment. However, it can be a good option for borrowers who need additional funding to complete a project and have a clear plan for repaying the loan.

Land loans. Land loans are used to finance the purchase of raw land. These loans have higher interest rates and require a larger down payment than residential property loans.

Seller financing. Seller financing, also known as owner financing, is a type of financing where the seller of a property acts as the lender and provides financing to the buyer. The seller receives payments from the buyer over time rather than receiving a lump sum payment at the time of the sale.

Eligibility criteria for seller financing can vary depending on the seller’s preferences and the specifics of the deal being negotiated. In general, the seller will want to ensure the buyer has a good credit history and the ability to make regular payments. The seller may also require a down payment or collateral to secure the financing.

It’s important to note that seller financing may come with higher interest rates or other less favorable terms than traditional financing options. It’s vital for both the buyer and the seller to carefully consider the terms of any seller financing agreement before moving forward with a deal.

Summary

Financing options are essential to consider when investing in real estate. Different financing options are available depending on the property type, including conventional loans, government-backed loans, private lenders, and hard money loans.

Researching and comparing these options is crucial to finding the best financing option for your needs and budget. Note that the suitability of property type to loan type can vary depending on the specific lender, so it is essential to discuss your requirement in fine detail to ensure you get the best deal possible.

Our team at L4B is expert in matching affordable, trusted lenders with investors based on the investment’s specific requirements. Speak to our team today to find financing for your next real estate investment financing.