What is Creative Financing?
Creative financing for real estate is a non-traditional approach that real estate investors use to fund the purchase of a property. The aim is to create an agreement that works for both the buyer and the seller, and that’s outside of the typical lending requirements.
Creative financing methods can help get your next project off the ground
Key Takeaways:
- Investors aren’t always able to find the necessary funds from traditional lenders
- Out-of-the-box thinking can lead to new funding opportunities
- Creative financing options include crowdfunding, cash-out refinancing, FHA loans, and more
Today’s dynamic economy has left many investors needing more capital for the real estate projects they want to get involved in. Many traditional lenders aren’t offering as many opportunities as they did before the pandemic began, interest rates have risen, and funding options are often limited. The good news is that, with a little creativity, investors still have options.
It doesn’t matter if you’re a real estate investment newbie or a seasoned pro; creative financial options are everywhere. This guide walks through several unconventional funding techniques you may want to consider.
Innovative Ideas for Real Estate Acquisition
Securing financing for real estate can be difficult for many, and if you’re looking for new ideas, you’re not alone. The good news is that an out-of-the-box approach to funding has many benefits (such as dodging substantial interest rates) for those needing help finding funding.
One great way to close a real estate deal is to approach it with more than one financing option. Don’t let a “no” from one person or lender stand in your way. Here are several creative financing options to consider:
Crowdfunding
The bare-bones definition of crowdfunding is using money from the public to finance your purchase. GoFundMe and Kickstarter are two of the most well-known crowdfunding platforms that allow people to post their projects and request financial support. Feather the Nest is another crowdfunding platform, only it’s designed specifically for buying and renovating homes.
Cross Collateral
This option can work well when you’re trying to expand your real estate investment portfolio. The gist is that you tap into the existing equity in another property and use it for financing your new project. This becomes additional collateral, so you don’t have to borrow against your equity, and you can then finance the new project without a loan.
Seller Financing
The phrase “on terms” is often used when discussing seller financing. This is another example of using other people’s money for your investments. The property seller agrees to hold the purchase note, and the buyer pays them monthly until the note is paid in full.
This method will only work with sellers who own unmortgaged homes and don’t mind relinquishing short-term cash for long-term passive income streams. When you find the perfect investment prospect and realize you will probably refinance soon anyway, seller financing can be the solution you need.
Lease Options
A lease option as a financing mechanism means it’s a rent-to-own situation. Renting allows you to build equity with steady monthly rent payments. This is one of the easiest ways to become a property owner, but keep in mind that it can sometimes be hard to find a reputable seller interested in the arrangement.
Self-Directed IRA
Tapping into retirement savings is another unconventional way to get capital for a real estate deal. It offers a few significant tax breaks and more control than other retirement options. It’s worth noting, however, that returns must go directly to the self-directed IRA instead of the investor with this option, which is a disadvantage to some.
Hard Money
Hard money is what most people think of when discussing creative financing. It is essentially just borrowing money from a business instead of a bank or other financial institute. This can be an attractive option for some investors because the requirements are typically much less stringent than you would find with a traditional lender.
One example is that this type of loan rarely requires a specific credit score.
Private Money
Private money means you are borrowing funds from friends, family, and other people in your life. Investing entrepreneurs can negotiate more accommodating loan terms with this type of lender because the transaction tends to be personal. Private lenders seldom receive additional revenue based on equity other than the designated interest rate.
FHA Loan
Federal Housing Administration (FHA) loans are ideal for first-time homebuyers who don’t qualify for traditional funding. Investors are still strictly borrowing from a conventional lender in this case, but an FHA loan allows those with credit scores of at least 580 to pay as little as a 3.5% down payment.
This type of loan does require an upfront mortgage insurance premium of approximately 1.75%, as well as a yearly insurance premium that depends on the loan amount. New investors who are looking to get a foot in the door may find it easier to get an FHA loan.
Cash-Out Refinance
A cash-out refinance for real estate transactions is when investors tap into their home equity (borrow enough to pay off the home’s mortgage and then pocket the difference). This can produce cash to invest elsewhere.
This type of refinancing transaction differs from a simple line of credit. You typically add a second mortgage in order to take out cash with a line of credit. The interest terms for a cash-out refinance tend to be more advantageous than you can find with a traditional home equity loan. This interest is also tax-deductible, unlike a loan from a conventional financial institution or hard money lender.
There are risks to consider with a cash-out refinance, however. The most significant is that mortgage terms are reset, and the term of your loan period starts again. This may not be a problem, depending on an investor’s financial situation.
Think through your long-term plans before jumping into a refinance, as some property owners find the payments become tough to make when something unexpected happens, like a death, illness, job loss, or other financial hardship.
The economy has been going through a chaotic period over the last few years, and without a crystal ball, it’s impossible to say what will happen in the near future regarding lending and financing options. The good news is that a little bit of ingenuity and unconventional thinking can lead investors to great opportunities when it comes to creative financing for real estate.
Final Key Facts about Creative Financing
Here are some important points to keep in mind.
- Creative financing is a form of real estate investing. Investors use it to pay for properties without relying on traditional mortgages or loans.
- Creative financing can take many forms, including owner financing, lease-purchase agreements, and partnerships.
- Owner financing is a common form of creative financing. It works by having the seller act as the lender and carrying the note on the property for the buyer.
- Investors can use lease-purchase agreements to acquire properties. They rent the property from the seller with the option to buy it after a set date. The rent paid goes towards the purchase price.
- Partnerships are another way to use creative financing in real estate deals. Multiple investors can come together to buy a property, sharing the costs and profits.
- A key benefit of creative financing is the flexibility it offers. Investors can create agreements that aren’t bound by traditional lending requirements and can be customized to fit the specific needs of the buyer and seller.
- Creative financing can be a good option for investors who may not qualify for traditional loans or who want to avoid the rigorous lending requirements and fees that come with them.
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