Understanding different types of loans, and knowing when to use them is essential for investing in real-estate. Different loans are used for different reasons. Specific loans may be used for holding property long term, and specific loans are used for short term holds. Each type of loan has a specific purpose when investing in real-estate. Learning each loans purpose is essential to ensure the right loan is being applied to the correct investing strategy. Investors can get crossed up very easily, costing them a lot of time and money. Knowing when to use a specific type of loan can be the difference between making a lot of money and losing a property to foreclosure. Below is a list of the most popular loans used by investors.
o Fixed Rate Mortgage – This loan is probably the most common loan used by average real-estate investors. It is also one of the safest to use. The interest rates are locked for the entire life of the loan. This loan usually comes in terms of 15 years, 20 years, 30 years, or 40 years. The longer the term, the lower your payments will be. Obtaining the lowest payments may sound good, but a longer term equals much more interest paid to the bank. Choose a term that will allow the most cash-flow out of your investment property. This is the perfect loan for a property that does not need rehab and is to be held as a long-term investment.
o Adjustable Rate Mortgage- This is the same type of loan that has recently been the cause for many foreclosures over the last couple years. People have been steered away from these loans. This is not a bad loan if investors understand how to use it correctly. These loans usually come in 10/1, 7/1, 5/1, and 3/1. The number before the one indicates the length of the first term. After the first term the payment will increase to a higher fixed interest rate. The first term payments may be cheaper than a conventional loan, but after it adjust the payments will significantly go up. This loan is best used for property intended to be sold before the end of the first term. The advantage is that the investor will have a low mortgage payment for the first term.
o Interest Only Loan- This loan can be used for property with a lot of equity already built into it. If investment property has a lot of equity in it, then paying down the principle and creating more equity may not be important. Accomplishing positive monthly cash-flow may be more important. For example, let’s say an investment property was brought, and the seller left $50,000 in equity for the buyer. The buyer decides to rent the property and then sell it in 5 years. The investor can make cheaper payment to the bank because he is only paying interest on the property and no principle. Therefore, the investor can make more money renting the property because he is paying less in mortgage payments. The investor has $50,000 in equity, 5 years of appreciation, and 5 years of profitable rental income. In this case an investor may want lower mortgage payments, instead of paying principle and interest on property that already has equity– and will be held for only 5 years.
o Seller Financing- This is good way to buy a property from someone who may own a property free and clear. A lot of times you can negotiate these deals with no money down and no credit check. People who own property that may need repair are more likely to agree to seller financing. Many people avoid buying property that need extensive repair. These properties are hard to sell, so the owner is probably open for different ideas of getting rid of the property. The goal is to get 0% interest and no payments. This may seem unlikely, but surprisingly some seller financed deals are structured this way. If the seller does not agree, then negotiate the cheapest rate and term possible.
o Hard Money Loan- This loan is normally used for property that is going to need repair. This type of loan allows investors to finance the money needed to buy and fix investment property. Be very careful. Be sure you are able to get out of this loan quickly. These loans are short term, and a balloon payment is due 6-12 months after the loan originates. Buy and fix the property, then refinance before the loan is due. Although, lately investors have been getting caught with their pants down. The banks have been making it harder, and harder to refinance out of these types of loans. In some cases, investors cannot refinance due to seasoning issues, and the loan becomes due before they can secure permanent financing. Before using this loan get pre-qualified for long-term financing, and be sure the investment property adheres to all guidelines and financial conditions for the new loan. In some instances, investors can walk away with money in their pocket if everything goes accordingly.
There are many other loan products on the market . Each loan is designed for a specific purpose and a specific person. Each loan has its own risk, some more than others. The important thing is to learn and understand the loan. Plan your strategy and choose the loan that makes the most sense for the strategy in place. Make it work for you and not against you.