Financing Options for Investors
Money makes the world go ‘round. The property game in some respects is more about numbers than it is about timber and roof sheeting; more so for the investment realtor or property investment companies than the retail buyer.
The universal definition of profit applies to investment property the same way as it does to selling a cake. After you have made the sale, the money left in your hands after all the expenses have been paid is your profit. For the investor, the ingredients are not only the purchase price of the property, the renovation costs, legal fees and so forth, but also the interest payable on money that was borrowed. Think of it as the electricity you need to bake the cake.
Given the high value of even a bargain property, this adds up to a princely sum of money. This is where the lenders come in and with each lending option, pros and cons, not to mention different costs.
Conventional Mortgages
This is normally how residential and investment properties are funded. A mortgage is a loan secured against an asset, typically a property, granted by a bank or financial institution. The term or length of the bond, interest rates charged and other terms and conditions are fairly standard and do not vary all that much. Legal parameters and competitive market forces result in few differences between the various banks.
It is worth differentiating between applicants though. Private investors might apply for a loan secured against their primary residence or directly against the second property they intend on purchasing. The usual affordability requirements need to be met such as credit scores and proof of income, tax records and so on. Investment companies on the other hand are effectively applying for a business loan, secured against a property. The rules are slightly different but the principle is the same. Terms do tend to be shorter and interest rates tend to be higher.
Hard Money Loans
This sounds a lot more Tony Soprano than what it is. ‘Hard Money’ is so called because it is a cash loan from a private source and not a bank or similar institution. The upside is that credit scores and other checks may be a bit less rigid; less corporate paperwork could mean faster access to the money; payment terms that suit both parties can be worked where banks are a lot less flexible in this regard. Of course, there is a downside. Those seeking to finance this project this way knock on the door of the Hard Money lender because banks have turned them down. This happens for a variety of reasons but amounts to traditional financial institutions perceiving the borrower as being too risky. Higher risk means the borrower will be paying a higher interest rate.
As mentioned, these lenders are private and as such, not bound by the same code of ethics as banks. Hard money lenders have a vested interest in getting their money back, unlike banks where only the corporate machine is at work. The loan is secured against the property being funded and creditors will typically only finance a portion of the value of the house, to ensure that the debt is well covered.
Private Money Loan
Technically, this is the same as a Hard Money Loan. The lender is not a financial institution. The difference here is more in the intention of the creditor. A lender in this context is not in the business or habit of lending money. A relative, a friend or a neighbor can be one. The legalese is more or less identical; lender, borrower and mortgage on the property or promissory note. Motives for lending the money may vary; retirees seeking safe investments; private investors who prefer bricks and mortar to the stock market and so on. The advantage is that these lenders are the least strict in terms of lending criteria and may even give you a favorable rate. Depending on the circumstances of the lender, the lending term may be very short. Negatives are that they are hard to find and due to the often personal nature of the transaction, not as clean cut and emotion free as facing the corporate veil.
Summary
If you prefer to separate business from pleasure, skip the Private Money and go for one of the other options. A bank loan might be the most laborious to obtain but is the most straightforward. Hard Money makes sense when a bank won’t lend you the money, you are convinced you can make a profit despite the higher interest rate and you can afford the higher repayments due to the shorter repayment period. All three options have their place and patience and a good deal of homework are required in each case.
For more information on Private Money and other financing options, contact Ken Glidden at Next Door Properties.
