Creative financing has enabled many investors to get into real estate even with little money and poor credit.
Not only does creative financing allow investors to purchase properties using less of their own money, but it also enables them to secure more deals. By having these tools in your toolbelt, you will be able to buy houses where a cash offer would never make sense.
What Is Creative Financing?
In real estate, creative financing is a non-traditional or uncommon means of buying land or property. The goal of creative financing is generally to purchase, or finance a property, with the buyer/investor using as little of his own money as possible, otherwise known as leveraging. Using these techniques an investor may be able to purchase multiple properties using little, or none, of his “own money”.
Many people don’t realize it, but it is entirely feasible to purchase a house while leaving the seller’s loan in place. It is also possible to make a large amount of money from a property without ever owning it.
Most creative financing strategies focus on “terms” rather than price only. When buying on terms, the seller typically doesn’t receive the bulk of the proceeds of the sale upfront. Instead, they receive a small portion upfront, monthly payments along the way, and the remainder at a date in the future.
Creative Financing Options
Today’s investors should be equipped with not one but several financing options before approaching a deal. Going straight to a traditional lender for a mortgage may seem simple, but this approach will not always guarantee the best loan terms. In many cases, finding the best financing will require investors to get a little creative. That being said, there are so many unique ways to finance real estate it can be hard to fully understand what’s out there. The following creative financing options are a great place to start, but know there are many more creative ways to finance your next real estate transaction, however this is a starting point.
Disclaimer: This article is intended for information purposes. Before applying for a loan or financial assistance, please get advice from a financial professional to determine if a financing option is right for your situation and determine your tax and legal responsibilities.
- Loan Types for Wholesalers
- Transactional Loan
- Loan Types for Flippers
- Fix and Flip Loan
- Renovation or Personal Loan
- Loan Types for Buy and Hold Investors
- Conventional Loan
- FHA Loan
- VA Loan
- Blanket Mortgage
- HELOC or Home Equity Loan
- Seller Carryback
- Subject To
Loan Types for Wholesalers
In most wholesale transactions, the wholesaler will assign the contract rather than sell the property themselves.
In this type of transaction, the wholesaler (in most cases) never technically owns the property. Because this is the easiest and least complex option for a wholesaler, assigning contracts is the ideal method of closing a wholesale deal.
However, in some contracts, the seller does not permit the wholesaler to sell the contract. Instead, the wholesaler must purchase the property for a very short period (typically 1-3 days) before selling it to the buyer they’ve found.
In this situation, a wholesaler will need a transactional loan.
A transactional loan is a short-term loan that allows wholesalers to close a deal without tying up their own assets in the transaction.
With a transactional loan, the wholesaler will use it to purchase a property before turning around and selling it to their buyer. Transactional funding for wholesalers is beneficial because it typically doesn’t require a certain percentage down, a credit check, or proof of employment.
As long as the deal is strong, a transactional lender will likely provide wholesalers with the short-term funds they need to close their next deal.
Loan Types for Flippers
For flippers, securing a funding source that will cover both the property purchase and renovations is important. Many beginners don’t have enough cash for a down payment and to pay for labor, materials, etc.
A fix and flip loan is a form of short-term financing that enables flippers to finance both the property they want to flip and the necessary renovations.
Also known as a “rehab loan,” a fix and flip loan is a subset of a category of loans known as “bridge loans.” While fix and flip loans have higher interest rates, investors can typically pay them off once they’ve sold their flip.
Additionally, these loans often have more flexible terms than conventional loans, and the flipper may be able to access the funds sooner. To receive the necessary funds for your flip, your lender will typically use the ARV (after repair value) of a potential flip to determine how much they can lend. This ensures they aren’t losing money on the deal.
Renovation or Personal Loan
Some fix and flip investors like to perform “live-in flipping.”
With live-in flipping, an investor will make the house they’re flipping their primary residence, often selling for a higher profit after about two years. Once they sell the live-in flip, they will repeat the process. Eventually, this method may help investors save the funds they need to begin purchasing separate properties to flip, eliminating the need to move every couple of years.
This flipping method works well for investors who are just starting and only need to use flipping as a side hustle. Full-time flippers will need to perform more flips to make a livable income.
With a live-in flip, you may be able to lean on a renovation or personal loan to afford your renovations. Since you don’t need to account for the purchase price if you already own the home with a conventional loan, you can take out a smaller loan to fund renovations separate from your mortgage.
If you’re looking at buying a property to live in for a couple of years to flip, you may be able to have a renovation loan added to your mortgage so you can get the funds to renovate right when you purchase the property.
Loan Types for Buy and Hold Investors
Conventional loans are long-term loans with lower interest rates than private or hard-money loans, often provided by a bank, credit union, or other financial institution.
Because these loans enable you to pay off the mortgage over a longer timeframe and the interest rates are lower, it is an ideal loan for rental owners if they fit the stricter criteria to qualify for a conventional loan
FHA (Federal Housing Administration) Loan
An FHA loan is a type of home mortgage backed by the Federal Housing Administration.
It’s meant to help buyers with low-moderate income levels afford homeownership with fewer up-front costs. It is considered a non-conforming loan.
While FHA loans aren’t technically supposed to be used for investment properties, there are ways you can get around this technicality. For example, you can’t use an FHA loan to purchase a new property solely for investment purposes, but you may be able to rent out parts of a property you buy to live on.
Many investors purchase multi-family properties with up to four units and live in one of the units. This is also known as “house hacking.”
If you can have your mortgage paid off by your tenants, an FHA loan doesn’t enforce pre-payment penalties, so you may be able to sell your home for a significant profit if it appreciates in value. If you can profit from these tenants in addition to having your mortgage paid each month, in time, you could use these extra funds for a down payment on a separate rental property.
A VA loan is a type of mortgage loan available to eligible military borrowers.
The VA loan is available through the U.S. Department of Veterans Affairs. This loan is meant to help service members, veterans, or their surviving spouses purchase a property without a high down payment or interest rate.
Like the FHA loan, you can’t use a VA loan to purchase a separate investment property. Instead, you can use it to purchase a multi-family property in which you live in one of the units and rent the others out to tenants, either breaking even and having your mortgage paid for or earning a profit.
A blanket mortgage is one mortgage that covers two or more separate pieces of real estate.
This type of mortgage loan is ideal for developers or real estate investors who plan on investing in several properties at once, as it allows them to finance multiple properties under one loan. Many borrowers use blanket mortgages to purchase several properties before building on them or flipping the structures that already exist on them. They’ll then sell each piece of property for a profit.
If you already own several properties with different loans, you may even be able to consolidate those loans into own blanket mortgage. This can help you lower your interest rate and increase your capitalization rate.
Another benefit of using a blanket mortgage is the ability to cut down on upfront fees you have to pay to take out separate loans. If you take out several mortgage loans, each will come with its own application fees and closing costs, whereas a blanket mortgage only requires one.
Additionally, many blanket mortgages have what’s known as a “release clause.” The release clause allows you to sell individual properties at separate times before putting the profits from the sale toward a new investment property.
With blanket mortgages, you may have to pay a larger down payment to secure your bundle of properties, or you may need to pay off the entire loan within a designated period. Also, if you fail to make the mortgage payment, the lender may be able to take control of all of the properties under that one loan.
HELOC or Home Equity Loan
f you own your primary residence and you’ve built up a decent amount of equity in it, you may be able to tap into this equity to purchase an investment property using a home equity loan or line of credit (HELOC).
A HELOC is a line of credit from which a homeowner can withdraw to perform renovations, fund a personal expense, or even invest in a property. The amount of equity you have in your property will determine your credit limit.
A home equity loan is similar to a HELOC because it allows you to use home equity to borrow money. However, where the HELOC allows you to put expenses as they come up on credit, a home equity loan is provided to you in a lump sum that you can use as you see fit.
While a home equity loan and a HELOC have several similarities, they differ regarding interest rate percentage and payment plan options. For example, a HELOC may require a variable rate, and the monthly payment will depend on what you’ve borrowed, while a home equity loan may have a set monthly amount with a fixed interest rate.
It’s important to note that just because you have a certain amount of equity built up in a property, that doesn’t mean a lender will offer you the funds to invest in a rental property. Willingness to lend using home equity on an investment property will vary from lender to lender as they may consider it a riskier investment. Also, they may have stricter requirements when it comes to credit, debt-to-income ratio, number of open accounts, and more to qualify.
Important: With the HELOC and the home equity loan, you’ll likely need to use your home as collateral if you can’t make your payments on what you’re borrowing. We recommend extensive research and consulting with a financial advisor before committing to anything.
Let’s face it, selling your home can be pretty difficult, and even if you do find a willing buyer, who knows if they can actually obtain financing to purchase it.
In a buyer’s market, home sellers often entice buyers with special concessions such as seller paid closing costs and seller carryback financing.
To do this, the homeowner will carry a second mortgage on the subject property, which the buyer will pay down. Seller carryback financing is often called “owner financing” or “seller financing” as well.
For the buyer, seller carryback financing is helpful if you can’t convince a bank or lender to provide the funds you need to purchase the property. Additionally, the homeowner may be flexible with what they require.
For the homeowner to make the deal worthwhile (they’re taking a pretty large risk by attempting to offer this financing option), they will need to charge a higher-than-average interest rate.
In real estate, subject to means that you’re buying a home that’s subject to an existing mortgage.
Under normal circumstances, what happens when a homeowner sells a property in which the mortgage hasn’t been fully paid off?
Most often, the proceeds of the sale are used to pay off the remaining mortgage, and the seller pockets the rest. Or, the buyer may take over the remaining mortgage, a process called “mortgage assumption.”
Subject to is a middle-ground between both options. Under a subject to, the buyer agrees to make payments to the seller’s mortgage company until the mortgage is fully paid off. The mortgage remains in the original owner’s name, but the buyer pays it off.
Sometimes, the buyer may be required to pay off the remaining mortgage balance within a short period, but the buyer may also make recurring payments over a longer period.
When using subject to for a property investment, a real estate investor takes over the homeowner’s existing mortgage.
This type of deal can be beneficial for the homeowner and the investor for various reasons. For example, a homeowner may be unable to make payments on their mortgage. If an investor can take over that mortgage, the homeowner can avoid having the property foreclosed on, which would negatively impact their credit score.
For the investor, a subject-to deal saves the trouble of going through a lender and securing financing themselves. When working with a bank, credit union, or other financial institution, an investor will often have to meet somewhat strict credit, income, and borrowing history requirements. While a private or hard-money loan has looser requirements for qualification, the interest rates may be extremely high.
If an investor can secure subject-to financing, they may be able to get a lower interest rate if that’s what the original mortgage had without qualifying for a conventional loan.
Additionally, in a subject-to deal, the investor may have fewer closing costs and they may be able to gain ownership of the property sooner, allowing them to start making money on it immediately. Once an investor owns a property with subject-to financing, they can either rent out the property and begin making passive income or sell the property and get a lump sum of profit.
What’s The Right One For You?
Every situation is different and I recommend researching your options as each state is different and every financing option has its pros and cons. Before attempting any creative financing option, make sure you understand the restraints and conditions of each!