The Beginner’s Guide to Financing Rental Properties

Getting your real estate deals financed can be one of the largest barriers to entry for new investors. It can also be one of the largest hurdles to growing and scaling your business. If you've already gotten started, there's multiple different financing options out there, and it can be a little overwhelming understanding the pros and cons of each. So in this video, I'm going to break down several of those options so you can help make the best decision for your financial situation. What's going on everybody. It's Henry Washington here from bigger pockets. And today we're going to be talking about financing. And on that note, did you know that bigger pockets has a directory of hard money lenders and mortgage brokers for you to choose from? Just head over to biggerpockets.com and check out the network tab at the top of your screen. And you can pick and search on your state to find hard money lenders and mortgage brokers in your area. We'll also put a link to those down in the description. And as always, thank you so much for joining us. Please don't forget to like, and subscribe to this channel. We love when you do that. It helps the algorithm. It helps us. And it helps you because the YouTube is then going to put more of this awesome content in front of you. So you're ready to start getting your deals financed, but it's a little overwhelming trying to understand what are my financing options? How am I going to find the option? That's not only going to allow me to buy the property, but will allow me to continue to grow and scale my business. That's exactly what we're going to be talking about in this video. When I got started investing in real estate, I just had no clue what financing options were out there. So I literally remember taking my first contract for the first house I had put under contract. And I just walked into a local bank because I didn't know where else to go. It was down the street from my work. And I walked in there and I asked, could I speak to a lender? Because I had a deal that I was looking to get fined. I literally had the contract in my hand and I was like, can someone help me get this financed? It turned out it worked. I financed it with that bank, but I had no idea that there were other options out there that I could even go somewhere else to get lending. And so I don't want you to have to go through those same struggles. So today I'm going to talk about what different financing options out there for you. What are some of the pros and some of the cons of each one so that you can be smart about which financing option is best for you and your financial situation. All right, let's jump into it. So when it comes to traditional or institutional type financing, there are typically four buckets of financing that people look into. Now, I know there are way more creative options out there for creative financing, and maybe we'll focus on that in another video. But for this video specifically, we're going to be talking about the more institutional type lending options out there for you. So those four options are one conventional money. That's a typical conventional mortgage from a bank. We have small local banks, so they do more commercial type loans for lending on investment properties. We have hard money lenders, hard money lenders are people who are in the business of lending money. And so it's typically money that a person has or that a person has raised from other investors. And then they are in the business of lending that money out. And the fourth option is private money. That's just money that somebody you like know or trust has, and you borrow that money to do your deal. So let's talk about each one in a little bit of detail and the pros and cons of each. All right, let's start off with conventional mortgages. Now conventional is probably the most popular way people go to get their deals financed because it's the most well-known way to get deals financed, but it may not be the best option for you. And so we'll kind of dive into the pros and cons of the strategy. So conventional mortgages, they're typically going to be a 30 year fixed rate mortgage, which means your interest rate is fixed over the term of the loan. And that loan is typically 30 years. Now origination is what is it going to cost you to get that deal done? And so I put that as a pro because it's a fairly minimal cost or closing costs to originate alone. Um, it can vary, but it's pretty low cost to you to get the deal closed. Now the interest rate is probably going to be the cheapest interest rate on this list, uh, give or take private lending, depending on what you and your, and your private lender decide, but your interest rates are just slightly above prime. And so whatever the prime or primary interest rate is at the time, this is typically going to be close to that, or just above it, maybe a half a point above it or a full point above that. So right now rates are at about somewhere between three and 4%. So you can expect this to be three and a half to four and a half percent credit score. Now this is the credit score requirement that they're going to want for you to have in order to get a deal financed this way. And so I put it as a con because it's a, it's a pretty high credit score, right? They're, they're typically going to want six 80 or higher. They obviously want to see something closer to 700. And, um, this can also vary, um, based on what's on your credit score. And so you need a pretty high credit score, uh, to qualify for these types of loans. And then your down payment, this is how much money you're going to have to spend out of your pocket in order to get the deal financed. Banks call it skin in the game, right? So they want you to have some money in the deal too. They don't want to just have their money in the deal. And so typically on a conventional, they're going to want you to put 20 to 25% down, which can be pretty expensive, especially if you're in an expensive market. If you're buying a property for $500,000, having to put down 25,000 of that, I'm sorry to having to put down 25% of that is pretty expensive. And so this is probably a good option for your first deal or second deal, because it's the most widely available and almost any bank can get you in contact with somebody that can help you with this. But if you're going to try to grow and scale and do multiple deals at a time, having to put down 20 to 25% is pretty costly. And so this may not be the best option for you if you're looking to grow quickly. Okay. Next up are hard money loans. Now hard money lenders are people who are in the business of loaning their money. So they're technically like a company, but they're not a bank. So they will have their own rates and terms and qualifications that you will have to meet in order for them to want to lend you money. So some of the pros and cons of hard money lenders are your origination. So what it's going to cost you to get the loan done. Typically it's pretty expensive with hard money. They're going to want two to 4% of the purchase price. And so they call these points as well. So you may be, you may hear them referred to as points. And a point is just one percentage point of your total loan amount. So if you're buying an expensive property, 1%, 2%, 3% is pretty expensive. So if you're, let's say you were buying a house, that's a hundred thousand dollars. 1% is a thousand dollars. So two, 2,000, so 2,000 to $4,000, just to pay to get them to loan you the money. Next is your interest rates. I put that as a con as well because your interest rates are going to be typically higher and they're typically higher because their credit score requirements are probably lower than most. And so because they're taking on more risk and because they are willing to lend you more money, they're going to get paid for that through their interest rates. So typically you're going to see somewhere between seven and 10%. You can get lower and it can get higher. It just depends on the deal and it depends on what your credit score is. When you're looking at these hard money lenders, remember they're also going to have different products for the different types of projects you're going to do, right? So they may have a product that's a fit for you doing a fix and flip and a different product that's fit for you doing a buy and hold or a cash out refinance. And each one of those is going to have a different interest rate requirement. And they'll have a different amount that they're willing to lend to you. So as you're shopping through hard money lenders, just make sure that you pay attention to the product that you're going to be needing and then what the interest rate for that product is. But you can expect to pay higher interest rates with hard money again, because they take on more risk because on the credit score side, it varies for them, right? Each hard money lender is going to have a different credit requirement. Some of those credit requirements can be substantially lower than what a bank is going to require from you. And that's because they value the deal as well as your credit. And so a hard money lender is typically an investor or someone who is associated with an investor in real estate. And so they understand the value of a good deal. They understand that if you buy something under the market value, and then you default on your loan, then they can foreclose and get that asset and then sell that asset for a profit. And they'll actually probably make much more money if you foreclose and they do that than just by paying them the interest rate. And so they're willing to let you have a lower credit score to get a deal done because they understand the power of buying an under market value deal. So they're going to also analyze your deals. And they, even though you may have a great credit score, if you don't bring them a good deal, they probably won't do it. And your down payment requirements, these again can vary by product, but I've seen some hard money lenders that offer up to 90% loan to value, meaning that they will give you 90% of the money that you need, leaving only a 10% down payment. And some of those will even require less money from you. If you have more experience. Now, this again, is going to vary from hard money lender to hard money lender. So make sure you're asking the questions about what they require for money into a deal, but typically 10 to 20% is what you're going to see. If you're looking to grow and scale your business, a hard money lender is not a terrible option. If you can afford to pay these interest rates and the way you afford to pay those interest rates is by ensuring you're buying a good deal. That's going to produce the cashflow to cover the larger interest rates, but because it requires less money out of your pocket to get into the deal, you can potentially do more deals at a time through hard money lending. So keep that in mind as you're shopping through financing options and hard money lending options. All right, y'all let's talk about private loans or private lending. Now a private loan is just a loan between you and someone you know, like in trust. And so this can be anybody that has money that's willing to loan it to you on a deal. And so the rates and terms that are associated with that learn are between you and the lender, you guys get to decide. And so that makes this a pretty favorable tool when lending. The con you can say is it's probably harder to find somebody who has the type of capital that they're willing to throw at multiple deals for you. Now, is it impossible? Absolutely not. Tons of investors use only private money to get deals done because of the lending favorability, but let's go over it. So pros origination, what's it going to cost you to get the loan done? Well typically it's pretty minimal cause it's just a loan between you and somebody, you know, and so it can cost you nothing or it can be a very low cost to get that deal done. It's just a fee. You would pay them for lending you the money interest rates. Now the interest rate is up to you and the lender, right? So that's why I put it here. It kind of goes across the pros and the cons because if it's somebody who is more uncomfortable with lending to you, then they might want you to pay a higher interest rate. And if it's somebody who is much more comfortable with you, then sometimes your interest rates can be fairly low. They can be at the prime rate below the prime rate sometimes, or even slightly above the prime rate. So it really just depends and it's up to you and your borrower's comfort level. I'm sorry. And your lender's comfort level and your credit score. Again, it's up to the comfortability of your private lender. If they are comfortable lending to you because they know, like and trust you and they don't care about your credit score, then it's not applicable. It doesn't matter. Some private lenders are still going to want to see a credit score from you and a credit report. And you can send that to them and they may be okay with a lower credit score, especially if what you're bringing them is such a good deal. Again, if they're a savvy investor and they're lending you the money, the deal's going to be important to them. So it could be a minimal to low credit score to get a deal done. Or if it's a more savvy investor who doesn't know or trust you, but trust the deal, they may want you to have a higher credit score and down payments. Again, this can be as little as no money out of your pocket because it depends on what the private lender wants to get out of the deal. Each private lender is probably going to want something a little different. Some want cashflow and residual income. So they're going to want those interest payments every month. And some want to just get paid out in full at the end of the deal and kind of get that, that lump sum payment. And so the down payment on the front side may be less of a concern to them. And some are going to want you to have that skin in the game and it just makes them feel more comfortable. So they may want you to put some money down, but you guys get to kind of talk about that. What makes them comfortable, what makes you comfortable and come to an agreement on what that down payment should be. Now, once you have all this, you just write it up in what's called like a promissory note, and then they can file that as the, the lien against the property. And so that if you don't pay your mortgage or your loan to them, they can foreclose and get the property. So that's the safety net for them is that it's backed by the real estate that you're buying. All right, now let's jump into my personal favorite, the small bank loans. And I also put commercial loans because sometimes that's how they refer to. So these small local banks have loan products that are favorable to real estate investors. And a lot of people don't know that and don't think of this as an option. So you can go to a small local community bank and you can ask to speak to the commercial lender and then ask them what types of loan products that they have for the real estate investors. And so let's talk about the pros and the cons, right? So the origination fee, this is typically going to be minimal, similar to like a conventional loan. It's about 250 bucks to a thousand bucks. That origination fee varies from lender to lender. So if you talk to one and you feel like their fees are high, you can shop around until you find one that has lower fees, or you can ask them, can they lower that fee, right? The benefit to small local banks is that they are what's called a portfolio lender, which means the loans that they do or originate they keep in their own portfolio in house. And since they're not selling those loans like the larger banks do, they don't have as strict of a criteria that they need you to meet. Now they do have criteria they want you to meet and, but it's their lending committee that decides if you meet that criteria and they can be a little more flexible than some of the larger banks. And so you can ask and say, Hey, you know, a thousand dollars seems kind of high for origination. Can we do something a little less? And they can say yes or no interest rates. Now your interest rates are typically going to be about a point to a point and a half above the prime rate. So right now primes at about three and a half to 4% so you can expect to pay about four to 5% on your interest rates for these loans, which is pretty reasonable. Now the difference between this and a traditional conventional type loan is these loans are going to typically be amortized over 20 years or 25 years instead of 30 years. And they're going to have a three year or five year adjustable rate period, meaning your interest rate isn't locked for 30 years. It's locked for three or five years. And then after three or five years, it will adjust based on what the new prime rate is. And so if the prime interest rate has gone up over the last three to five years, you can expect your interest rate to go up, but they do have some safety measures in place that that say that this rate can only go up by so much. So make sure you talk to them about that and make sure that this strategy fits your investing strategy credit score. Now I kind of have it on both sides here as a pro and a con, because again, because it's a local lender keeping the loan in house, they can be a little flexible with the terms and the, and the qualifications as well. And so they do care about the deal as well. And so if you're not buying a good deal, it'll be harder to get a small bank to want to fund it. But typically what they're going to want to see is somewhere closer to the 680. Will they loan to you with less of a credit score? They could, they could, and it is up to them and it's up to the deal that you're bringing to the table too. So you want to make sure that you're bringing good deals. Now your down payment, the typical range for a down payment for a loan from a small bank is about 15% they're doing a typically an 85% loan to value, which means you've got to bring 15% to the table when you're just starting out. But this is a relationship business. These small local banks needs your business. And so as you prove to them that you know what you're doing, that you're good at finding good deals, that you're good at providing the return to your investors on these deals, then you can maybe negotiate a lower out of pocket cost. I'm not typically paying a down payment when I use small local banks right now because I've, I bring them good deals and I've shown that I have experience and so you can work your way down from that 15% some small local banks are going to want you to put higher than 15% in. And I'd say if you find a bank that wants more than 15% keep shopping around because you can find one around this 15% range or sometimes even less. Here's some additional benefits that I threw in here that I wanted to touch on with small local banks. Now you can borrow the down payment. Think about that, right? So if you're putting 15% down and then you use private money, which we talked about previously to pay for the down payment, that's totally acceptable. And that private money then just becomes a second mortgage against the property. And so you can kind of piece together two different loans to get your deal 90 to a hundred percent financed. Right? And so that's a super cool benefit because when you're dealing with a conventional mortgage, it's a whole lot harder to borrow the down payment down payment funds cause they have to do a lot of verification about where that money comes and is it a gift or is it, are you borrowing it and they really don't want someone to have a second against that property. So a more difficult with those types of loans. You're not limited to 10 loans like you are with a conventional mortgage. You can have as many as the bank will allow you to have. And now if you're brand new to the game, the bank might only want to do one or two with you until you prove to them that you can get them done and get them done well. And then after that, there's a benefit to them to continue to fund you because you're bringing them business because they make money by lending you money and they only want to lend on safe investments. And if, so if you can prove that you do safe investments that you are good at what you do, then they'll be willing to do more loans with you. So it's a great tool for scaling your business. If you're good at what you do, are these all products you've heard of before? Have you used any of these before? If not, what are some of your favorites? What are some other options that you use? Or if you use one of these options and it's beneficial to you, let us know in the comments below, we'd love to hear about your experiences. All right, folks, there you have it. Today we covered four different financing options and what the pros and cons of each are to help you better understand what financing options are available to you and which of those financing options best fit your financial situation and your business model. We talked about using conventional loans. We talked about using hard money loans. We talked about using private lenders and we talked about using small local banks to get your deals financed. There was a lot of great information in there. I hope it was super helpful to you as always. Thank you so so much for joining me and spending your time listening to me. I love teaching and I love sharing this information with you. So please, please like and subscribe to this channel. If you like this content and you want to continue to see more valuable content, then please give us a follow here on bigger pockets and check me out on Instagram. I'm at the Henry Washington on Instagram as always. Thank you so much and I'll see you at the closing table.