Complete Guide to Finding Commercial Real Estate Financing
06 26 2017
While commercial real estate can offer many benefits including increased cash flow, home appreciation, and certain tax benefits, there’s an important consideration you must first make: how to fund it.
The Hunt for Commercial Real Estate Financing
One of the many misconceptions of commercial real estate investing is that you need a lot of money to get started. While there are actually a variety of different real estate financing options out there, some may suit different situations and deals much better than others. Most importantly, you must understand each option thoroughly.
Your financial advisor is probably well-versed in all of them, so we recommend consulting with them – they’ll be able to help you determine which (if any) of these may fit your financial goals. To help you with some talking points, here’s our guide on the seven different types of real estate financing.
1. Federal Housing Administration Loans
A Federal Housing Administration Loan, better known as a FHA Loan, is a mortgage insured by the Federal Housing Administration where borrowers are protected by the lender from a loss if the borrower defaults on the loan. These types of loans usually have lower down payment requirements, typically around 3.5%.
The requirements for these loans are simple; however, the borrower needs to have a 580-credit score or higher to qualify, with lower scores unlikely to qualify for a FHA loan. The FHA will occasionally make allowances under certain circumstances for applicants who have what it refers to as "nontraditional credit history or insufficient credit," if they meet other requirements.
There are a few things to keep in mind about FHA loans. The fees for FHA loans can be a bit higher than other loan programs, and the closing process is generally slower. Additionally, these loans aren’t usually intended for major fixer-upper properties, and associated borrowers probably won’t qualify.
2. Conforming Loans
A conforming loan follows strict underwriting rules and stays within the limits established by Freddie Mac and Fannie Mae. Freddie Mac and Fannie Mae are two financial entities created by Congress that operate under the umbrella of the Federal Housing Agency. Freddie Mac and Fannie Mae provide stability in the housing market and give access to funds to the banks and mortgage companies that issue the loans that meet their lending criteria. For this reason, these loans tend to be lower risk, translating to lower mortgage rates and more favorable terms for borrowers.
Be mindful of your credit score – the better your credit, the lower you mortgage rate will be. While conforming loans often have attractive terms with low interest over 15-30 years, the downside is that they often require a larger down payment and are limited to 4-10 loans.
3. Veteran Administrations (VA) Loans
A VA loan is a mortgage loan that is guaranteed by the United States Department of Veterans Affairs. VA loans do not require a down payment and are relatively easy to qualify for, as most members of the military, veterans, reservists and National Guard members are eligible to apply. Spouses of military members who died while on active duty or due to a service-connected disability may also apply.
There are a few advantages of getting a VA loan. The loan doesn’t require mortgage insurance like FHA and conventional loans, which increases your monthly savings. However, VA loans are available only to finance a primary home, and cannot be used to purchase or refinance vacation and investment homes. Like FHA loans, the closing process won’t be too quick and fixer-upper homes won’t qualify.
4. Portfolio Loans
A portfolio loan is serviced by the lender that issued the money, like a small bank or a credit union. In many cases, loans that are issued by a lender are packaged together with other loans and sold in the secondary market. With a portfolio loan, the lender that initially wrote the loan is going to hang onto it and keep it as part of their investment portfolio.
If a lender keeps your loan as part of their portfolio, there can be overall benefits. Instead of having to work with a lender that is going to service your loan from another location, you will be able to keep your relationship with the lender that you originally worked with, ensuring you can easily contact them whenever you have a problem. You’re also generally able to take out as many loans as you’ll need, which can be an advantage over a fixed limit of 4-10 loans like you are with a conforming loan. Investors who use portfolio loans generally use them for flipping houses or fixer-uppers.
5. Hard Money Loans
Hard money loans are one method of borrowing without using traditional mortgage lenders. These lenders, private individuals or companies, are typically less concerned about credit and instead lend you the money using the property (or another asset) as collateral. If something were to go wrong and you are unable to repay the lender, they would seize your collateral.
Hard money loans could be the only option if you need the deal to happen quickly or don’t get approval from a traditional lender. These loans are generally short-term, lasting from one to five years. The interest rates for hard money loans are usually around 12-18%. Hard money loans are popular among developers and house flippers, who frequently work on tight closing timelines and resell within short periods of time.
6. Private Money Loans
Private money loans are exactly how they sound – private. There are two ways to obtain capital in private loans, either from a private investor or a personal one. A personal investor could be a family member, a friend or a business associate. A private investor could be any company that manages capital and issues loans (similar to a bank). Regardless of the type of lender, their role as a provider is based on the terms you both set, not by anyone else, making these loans flexible.
The benefits of these loans are that they close much faster than the banks and can have lower interest rates. However, the terms are usually longer, ranging from years to decades. Furthermore, whether it’s private or personal, you need to have a relationship with an investor to get a loan. Private lenders are usually in the business of making money, so risk is a top priority for them. They typically consider the real estate market value, the borrower’s credit and equity, pricing, and exit strategy – and they’ll do their homework on your past real estate ventures. While private money loans are certainly one financing option, they’re not as “beginner-friendly” as certain other financing options.
7. Seller Finance
Seller financing is when the seller of the property is also the lender. To be clear, the seller doesn’t just hand over the money to the buyer in the form or a loan. In this case, they allow the buyer to make payments on the property instead. If a buyer has a track record of paying their loans on time and keeping their house in tip-top shape, they’ll likely be eligible for a seller-financing deal.
Typically, the buyer requires that the seller signs a promissory note, which serves as a contract, listing the interest rate, repayment schedule, and default consequences. These arrangements are typically short term, have a quick and cheap closing process, and allow for agreement on the down payment by the buyer and seller. As an important note for buyers, the interest rate may be higher than in typical loans.
8. Bottom Line
Should you be looking at an investment property, there are a variety of ways for you to fund the purchase. You can find most of these loans at the mortgage department at your bank, a mortgage broker, a credit union, or a large mortgage lender. Be sure to do you research and understand what each loan entails – and take this knowledge to your financial advisor for a full and thorough discussion. Before you know it, you’ll be on your way to financing.
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