There are many different ways to find financing to buy a home. But most folks are only aware of just one or two options. Generally, financing for a home can be broken down into two major categories: “Traditional” and “Non-Traditional“.
The Traditional financing category is the one that everyone hears about the most. The traditional category includes government insured loans like FHA, VA, and USDA. (to name a few) Since these loans are “insured” they generally require the borrower to jump through a number of “hoops” in order to qualify.
These loans require better credit scores, documented income, a careful review of your bank statements and any other information the lender may happen to require. These loans generally offer the lowest down payment options as well. If you are looking at homes for sale, and working with a real estate agent, chances are you’ll be using a traditional, government insured loan to finance your purchase. The “traditional” real estate business uses primarily “traditional” financing methods.
In the traditional category, the various loan types have a variety of qualifying criteria.
USDA loans for example, are designed for “rural” properties, located within specific geographic areas outside of city limits. If the property is not located in a rural district, it would not qualify for the USDA program. But you’d be surprised just how much territory qualifies as “rural” under USDA.
FHA loans are probably the best known of the traditional loan programs. FHA can be applied to almost any home, in any location, as long as the home meets certain condition requirements and the buyer can meet the credit and income requirements.
VA loans are for veterans. If you are a vet, you may be eligible for a zero down payment, on a VA loan.
Traditional loans such as these have limits on the amount you may borrow, because they are designed for homes in the lower price ranges. But because prices for homes vary widely from one state to another, the loan limits can vary by location. Down payments for each of these loan types are usually below 20% of the contract price. All typical licensed loan originators and mortgage companies offer the traditional loan types.
FHA, VA and USDA are “government insured” to protect lenders from a borrower default. This allows borrowers to buy with a low down payment, and still avoid a higher interest rate. In return the lender can make a “claim” for insurance if the property goes into foreclosure.
Here’s a tip if you are planning to buy with a low down payment, government insured loan: These loans are very expensive. Even with today’s low interest rates, there are “funding fees” and other costs that are rolled into the loan, that will add to the cost of your home. It’s best to buy a little less than you can qualify for, and plan to pay down additional principal on your mortgage each month, so that you can pay off these loans as quickly as possible. This will help you save thousands of dollars in interest and loan funding fees.
Within the traditional category, there is also the “conforming” loan. These are the traditional “old-fashioned” loans, in which the borrower puts down 20% or more to purchase their personal residence. 20% down used to be the norm in the days before FHA and VA made lower down payments widely available. Generally, the higher your down payment is, the easier it may be to qualify in the traditional sector.
The other major category for real estate financing is the “non-traditional” sector. This includes all of the ways to finance a home purchase without the hassles of qualifying for a traditional loan. While these non-traditional options are open to all buyers, they are not very well known to the general public.
This is what’s known as “creative real estate finance” in the investing world, and real estate investors spend a great deal of time studying and practicing these strategies. Most of these strategies will not require good credit, and a few don’t even require the buyer to have any money of their own.
Here are some of the most common financing ideas from the non-traditional sector:
“Subject-to the existing mortgage” – The buyer purchases the property by essentially taking over the payments on the sellers existing mortgage. The mortgage stays in the sellers name for some period of time, which allows the buyer to make the original purchase without qualifying and in some cases without even making a down payment. During the 1980’s when interest rates for traditional loans were sky-high, buyers began taking over existing mortgages that had been created years earlier at much lower rates. This strategy is most popular when interest rates are going up.
“Hard Money” – When an investor or a potential owner occupant want to buy a property that needs lots of repairs, one option is to turn to “hard money lenders” who offer loans based on the “After Repair Value” of a property. This is a specialized world best known to investors who buy fixer uppers, repair them and then resell them for a profit. But any buyer can use a hard money loan to purchase and repair a property. Once the rehab is completed, the buyer gets a new appraisal, and refinances the property with a new, long term mortgage. Hard money loans are relatively expensive, but they are designed for short term use, for this special purpose. They help borrowers buy fixer-upper properties that cannot be financed by traditional loans in their current condition.
“Seller Financing” – If a seller has a lot of equity in a property, they may choose to finance a buyer themselves. This is a good selling strategy when a property is difficult to sell for some reason, or the seller just wants to realize a good cash flow on a property that they own free and clear. Personally, I like selling property with seller financing to good buyers that have good income but may not be able to qualify for a traditional mortgage. For a seller it’s better than renting, and for a buyer it’s a great way to buy a home without qualifying.
When looking for this type of seller financing, focus on homes that are “For Sale By Owner” first.
Any seller who has a property for sale may consider financing the purchase for a buyer, but homes listed on the MLS are controlled by real estate agents who may not be friendly to this type of offer. Unfortunately agents are not trained in “non-traditional” or “creative-finance” options. They focus primarily on the traditional loan types. As a result, they may be difficult to work with when you are looking to purchase a home with seller financing.
Another popular category that has recently gained a lot of attention is “Self-Directed IRAs“. Many folks are unhappy with the returns on their savings or their existing IRA’s, so they are looking for other ways to earn more money. Self-directed IRA’s can be a great way to use your savings to purchase property and increase your retirement income. But there are specific rules and requirements to avoid taxation of your profits. And there are many scammers out there who are using Self-Directed IRA’s as a gimmick to part inexperienced investors from their money. Be sure to do your research carefully before you invest with a self-directed IRA.
“Lease with an Option To Buy” is a popular strategy for buyers who don’t have good credit and don’t have money for a down payment. The tenant/buyer finds a property to rent, with a landlord who is willing to credit them with a portion of the rent towards a down payment. If the buyer pays their rent on time, and accumulates credit towards a down payment, they can then “exercise their option” and purchase the property at a price that was agreed upon when they rented the property.
This strategy is commonly used by investors to sell properties. Buyers should have their lease and option agreement reviewed by a competent attorney to insure that the deal is structured properly. When done correctly this is a very effective way for a seller to sell in a tough market, and a great way for a tenant/buyer to accumulate credit towards a down payment.
This article is running long and I haven’t even mentioned other forms of private financing, designed for various situations, such as “transactional funding” and using a private loan from a friend, relative or investor.
Whether you want to own your own home, or you are a real estate investor searching for funding for your first investment property, there are dozens of options. This article has only touched on a few of the most common ones. It pays to do your research and find out about creative ideas for real estate financing. There are many books and courses available on the subject of creative real estate financing.
Donna S. Robinson is a 16 year veteran of the real estate industry. She specializes in coaching and consulting for real estate investors. Read more about creative ideas and buying with no cash or credit on her website at www.RealtyBizConsulting.com