Investors make up about one-sixth of the current real estate market. Investor activity rose by 15% between the first and second quarters of 2021.
Many real estate investors are trying to take advantage of a hot real estate market. Others are looking to diversify their investments since the stock market is so volatile.
If you want to jump into the world of real estate investing, you need to get your financing in order before you start shopping for properties.
You’ll come across a lot of terminologies, such as private money and hard money. These are a couple of ways to obtain financing. What’s the difference between the two?
Read on to discover what private lending and hard lending are and the differences between the two.
What Is Private Money?
The terms private lending and hard money lending are thrown around real estate investment circles. They’re often used interchangeably and there isn’t a clear definition of what those terms really mean.
In very general terms, private money loans are financed by private individuals or organizations. They’re sometimes called peer-to-peer (P2P) loans.
These loans can be funded by a friend, relative, or private investment company.
Private lenders tend to be advantageous because you can negotiate terms that work in your favour. These lenders generally don’t require a lot of documentation or a minimum credit score. You can use private loans for rehab, where you usually can’t with other types of loans.
Private lenders do have higher interest rates. The loan period is shorter than a conventional loan. Before you accept private lending, think about the negative implications it can have on your relationship.
What Is Hard Money?
A hard money loan is one where the interest rate and loan amount get determined by the value of a hard asset. The real estate property you want to purchase is a hard asset.
Hard money lenders operate on a level similar to banks in that you have to meet certain requirements to get a loan. The real estate asset is also used as collateral, where it isn’t in private money loans.
Hard money lenders are willing to fund projects that banks shy away from. This can be a good option if you can’t get traditional financing.
Private hard money lenders are organizations that have the flexibility of a private lender with the standards of a hard money lender.
Both private and hard money lenders aren’t bound by the same financial regulations that traditional banks have to comply with. They do need to comply with federal and local lending laws, though.
The similarities don’t end there. You can obtain bridge loans through private lenders, banks, and hard money lenders. Bridge loans are used to bridge a financing gap in a project.
For example, you can fix and flip a property with a bridge loan. A loan is a short-term loan that you pay back when you sell the property.
You might have another property that you want to buy and can’t wait to sell another property to finance the transaction. A bridge loan helps you finance the new property purchase.
How to Get a Real Estate Investment Loan
Now that you understand the basic options for real estate financing, you need to know how to go about getting a loan.
Start by getting your finances in order. You’re going to need a down payment, which is about 15% of the purchase. You might be able to negotiate a lower down payment for the loan with a private lender. If you’re having trouble coming up with the down payment, a private lender could loan the money for that purpose.
You also need to have enough cash on hand to cover the closing costs. If the property is a rental property, you need to make repairs before you rent it out.
Don’t forget to budget regular maintenance costs of the property. Add a contingency budget, which covers unexpected issues.
Lenders want to make sure that you have a stable source of income. You’ll want to gather your documents to show your income, whether you use W-2 forms or other investment income.
Assess the Property
Your real estate investment is a business. You have to show investors that the property is profitable. This exercise protects you from bad investments as well.
Calculate how much you think you can rent the property for. Look for similar rentals in your area and use the average price as an estimate. Calculate what your rental income will be for the year.
The estimate your operating expenses. These include maintenance, advertising, taxes, utilities, garbage, and insurance. Again, come up with an annual amount.
Subtract the annual operating expenses from the rental income. That’s your net income.
Divide your net income by the mortgage loan amount. You have your estimated return on investment.
What’s a good ROI to target? Some investors target an ROI as high as 10%-12% for rental properties. You should target about 7%.
Find Your Financing Path
As you learned earlier, there are plenty of ways to finance your real estate investment. You have to assess your situation and decide which one is right for you.
You might like the flexibility that private lenders offer, but you want the security that hard lenders offer. Private hard money lenders tend to offer the best of both worlds.
Private Money vs. Hard Money Lenders
Real estate investing is a different world than a regular residential real estate purchase. It helps to understand that you have more financing options than traditional banks offer.
Private money and hard money lenders are common in real estate investing. Both the basic options for real estate financing provide more flexibility and better terms than traditional lenders. They’re both great options for your real estate investment.
Check out the Business and Finance section of this site for more financial insights.
