If you’re interested in diversifying your asset portfolio with rental real estate, then chances are pretty good that you’re going to need financing. This is for two reasons:
1) You probably don’t have the money to buy rental real estate without financing and 2) Even if you do have the money, you wouldn’t be able to use leverage without financing.
How to finance your rental real estate investment and what financing alternatives are available for real estate? There are several, but here are some of the most attractive options.
1. Traditional financing. The most common means of financing rental real estate investment is with the old-fashioned, go-to-the-bank-and-get-a-mortgage option. You might be familiar with this option if that’s how you purchased your own residence. Using this option, you’ll need to have a good (if not great) credit history. You’ll also need to have a significant portion of the purchase price on hand as a down payment (this could be 20% and, in some cases, even more). The biggest disadvantage with this option is the number of hoops you have to jump through so that you can get the financing. You’ll need to have years of tax returns, paycheck stubs, proof of employment, and any number of other things that banks may require to ensure that they get their money back.
2. Seller finances the down payment. If you’re really strapped for cash but see what you think is an outstanding rental real estate investment opportunity, try asking the seller to finance the down payment. Here’s how that works: you’re going to pursue a traditional method of financing as mentioned above. However, instead of forking over the down payment cash from your own bank account, you’re borrowing the down payment from the seller. Basically, the property is 100% financed. You owe the seller the amount of the down payment, and you owe the bank the remainder. Be advised, though: some banks will not allow you to borrow the down payment. If that’s the case, you’ll have to find another bank or find an alternative means of financing.
3. Seller carry back. A seller carry back is different from the previous option in a significant way: no banks are involved. In this case, the seller acts as the bank. You’ll still need to come up with the down payment, which will sometimes be significantly higher (as a percentage of the property value) than would be required if you were using traditional financing. You would then enter into an agreement with the seller to pay back the amount financed over time, similarly to how you would pay it back with traditional financing. The advantage here is that you won’t have to go through all of the bureaucratic channels required when dealing with traditional financing.
4. Pyramiding. Suppose you already own a rental real estate that has $50,000 of equity in it. You can refinance that rental real estate to pull some money out of it (in some cases, more than the $50,000 in equity). Once you have that money, then guess what? That can be your down payment on another property. This is called pyramiding, and some people have used this method to build a fortune in assets. If you use this option, plus the seller carry back option mentioned previously, then you can possibly purchase a property with 100% financing.
Creative investing is an important aspect of successful rental real estate investing. Always remember to explore different options to ensure that your financial dreams come true. Think about ways that you can purchase investment property, rather than giving up when you think of a few ways that you can’t. Part of the fun of rental real estate investing is becoming innovative with your purchasing strategies. Understand that, and you’ll be successful.