REtipster provides real estate guidance — not tax or investment advice.
This article should not be interpreted as financial advice. Always seek the help of a licensed financial professional before taking action.
It’s perhaps the simplest question of all:
“Where can I get funding for my next deal?”
(…or first deal, as the case may be.)
Sure, investors can shoot for a conventional mortgage (if they have strong credit, and only one or two mortgages already reporting under their belt), but when an investor has over four mortgages, it gets substantially harder for investors to qualify for a conventional residential loan.
And yes, hard money is always an option, but it’s also expensive, and typically a short-term solution at best.
What options are available for real estate investors who aren’t looking to use ONLY the traditional financing options?
Here are eight more creative routes you can take to finance real estate investments. They each come with their own drawbacks… but hey, if there were a silver bullet, we’d all be using it, right?
Put your vintage “Think Different” black T-shirt on and let’s talk creative financing!
1. Retirement Accounts
Have a hefty 401(k) balance?
You can borrow up to 50% of your 401(k) balance, with a maximum loan amount of $50,000 (if your 401(k) administrator allows loans, that is – not all do).
Typically, 401(k) loans must be repaid within five years. Since it’s your own money you’re accessing, 401(k) loans are among the fastest and cheapest loans available.
While your 401(k) administrator will almost certainly charge you borrowing fees, any “interest” charged actually goes back into your 401(k). So you're basically paying interest to your future retired self.
These 401(k) loans come with several nasty disadvantages though.
First, loan repayments are not tax-free – they’re subject to normal income taxes. That means you’re paying income taxes on the re-contribution and then paying income taxes again when you withdraw the contribution later in retirement.
Second, you’re pulling out money that was already hard at work for you, earning returns in the market. Read: Opportunity Cost.
And then of course, there’s the risk you’ll lose your job. If you borrow money from a 401(k), the entire balance generally has to be repaid within 60 days of you losing your job (since 401(k)s are tied to your employer). Failure to repay means the loan becomes a distribution in the eyes of Uncle Sam, which comes with penalties and other ugly tax ramifications.
2. Credit Cards
Buying real estate with credit cards is not as crazy as it sounds. Hear me out.
Yes, credit cards tend to charge GI-NORMOUS interest rates. That makes them a short-term option, used for acquisition and/or renovation financing.
And no, title companies won’t whip out a card reader at the settlement table, just because you ask nicely. That means for acquisition purposes, you’ll need to take a cash advance – which costs an additional fee (often 3% – 4%).
Let’s frame this in the context of a hard money loan though: hard money lenders typically charge 12% – 18% interest. Credit card interest ranges from 8% – 24%. That puts them both in a similar ballpark, depending on the card and the lender.
Hard money lenders charge 2 – 8 points, compared to credit card cash advance fees of 3% – 4%.
So… not exactly cheap money, but also not as crazy as you thought, eh? Credit cards also don’t charge junk fees the way that hard money lenders do – the “Processing Fee” and “Administrative Fee” and “Document Stamp Fee” and “Loan-Officer’s-Trip-to-Vegas” fee.
Credit cards won’t force you to use their title company, or their appraiser, either.
And that’s just for acquisition. For renovations, the benefits are even better – you can swipe the card to pay for materials directly (no cash advance fee), and many contractors now days accept payment by credit card as well.
Which says nothing of the reward points.
Just make sure you pay the balance back with all haste or risk a first-hand introduction to the word “usury.”
3. Crowdfunding Websites
Generally speaking, crowdfunding websites occupy a similar market niche as hard money lenders. They're not quite a mainstream borrowing option and they tend to be expensive, but they also tend to be relatively quick and provide a shorter-term funding solution.
That makes them a strong option for acquisition and renovation financing. For rental investors who like to pay back their loans over an abbreviated time horizon (say 5-10 years), they may find a crowdfunding option that suits their needs, but don’t expect a standard 30-year mortgage.
4. The Friends & Family Plan
After your first few (successful) deals, you may start to hear from friends and family members who are curious about your real estate investments.
Yes, they’re interested in your life because they like you. But chances are, they’re also genuinely interested in your investments and your results.
The Average Joe is intrigued by real estate as an investment in a way that can’t be said for stocks, bonds, ETFs or REITs. Those are paper investments. They may perform well, but they’re also conceptual. Most people only grasp them in a vague, nebulous way.
But real estate is, well, real. It’s tangible and physical; you can walk up and touch it. You can watch it transform and improve with your own eyes.
For that matter, you can make it transform and improve with your own hands.
Right around the point where you hit the ceiling on conventional residential mortgages, your friends and family may be willing to start entrusting you with their money. It might be small at first – $1,000 here, $3,000 there – but if you stack up enough small investments, it may provide enough funding to buy your next investment property (or perhaps a down payment on one).
Using borrowed funds for a down payment may cause issues with most conventional lenders, but hard money lenders, on the other hand, tend to be much more flexible with allowing you to have partners and investors.
5. House Hack!
Who wouldn’t want to live for free?
You’ve probably heard of house hacking, in a multifamily context. You buy a 2-4 unit property, move into one of the units, and rent out the other(s) to cover the mortgage.
One of the great advantages to this strategy is, you can use a conventional, owner-occupied loan, or even an FHA or VA loan. That means a down payment in the 2-10% range, rather than the 20-40% range.
Here's a fun case study of a how someone with no real estate experience house hacked a duplex and now lives for free.
But house hacking doesn’t stop with multifamily properties. You could also bring on a housemate. When I bought my first home, my housemate paid around 75% of my mortgage, and she remains one of my closest friends to this day.
You could also rent out a room on Airbnb. Even better, you can rent out your entire home, whenever you're not using it yourself.
Want to get even more creative? How about building an in-law suite, or a casita, or an above-garage apartment?
Or my new favorite house hacking idea – my partner Denise has a foreign exchange student living with her and her husband. The company she went through pays over half her mortgage. (Contact me if you want to be connected with the company.)
Even if you don’t use a house hacking tactic to help you secure easier financing, the money you save on housing will quickly accumulate to help you buy your next property.
6. Sell Your Stuff
Your spouse may not love this idea, but no one says you have to keep living “the lifestyle to which you've become accustomed.”
Do you need to drive a car as nice as you're driving (or have a car at all)?
There is always room to shave down your spending. My wife and I currently share one car, and it's the cheapest car available to lease where we spend nine months of the year in Abu Dhabi. Before moving overseas, I drove a ten-year-old Hyundai.
I'm not trying to show off my frugality credentials; my point is that quality of life is not tied to the value of your car.
Do you need to live in a home as large as yours is, or in as fancy a neighborhood? How much could you be saving every month by living in a less expensive home?
Do you need all the clothes in your closet? All the furniture in your home? All the jewelry in your jewelry box?
What's sitting around your basement or garage that you could sell?
The best question of all is simply this: What are you willing to do, to create more income for yourself and build long-term wealth?
Selling your home isn't the only way to capitalize on its equity. If you have some equity, but don’t want to sell or go through the hassle and expense of a second mortgage or HELOC, you may have another option.
Offer it as additional collateral when you get financing!
Imagine the following scenario: you call up “Hard Money Harry” and ask for a loan to buy your next investment property.
Hard Money Harry says you’ll need to come up with 30% down.
“Well, I don’t have that much in cash, but I do have $75,000 in equity in my primary residence. How about a second lien position on it, as additional collateral?”
Many hard money lenders are flexible enough to consider cross-collateralizing additional properties in lieu of a down payment.
Of course, if you default, they take your home, not just your investment property… so think long and hard about this option before offering your home as collateral!
8. Borrow Against Life Insurance
The first thing you need to know about borrowing against a life insurance policy is that it's only available for whole-life policyholders. That is, policies that are good for the rest of your life.
Term life insurance policies, which are only valid for a certain period (e.g. a term of one year), cannot be borrowed against.
Like borrowing against your 401(k), you're effectively borrowing from yourself, so the approval process tends to be quick and easy. These loans also tend to be cheap, for the same reason.
Life insurance loans usually don't report on your credit, and often don't require a credit check to borrow. If you have a whole-life policy, talk to your insurance company to get more details about how they handle loans.
9. Bring in Equity Partners
Most people want the lion's share of any property they have partial ownership in (especially when they're partnering with someone else).
As they say, 50% of something is better than 100% of nothing.
There are a lot of wealthy individuals who utilize this strategy to build and buy large-scale projects (assisted living facilities, apartment buildings, self-storage facilities, etc). In many of these cases, the individual who has the money (the financier) will contribute all the cash to finance the project, and the individual who knows how to make the deal happen (the real estate investor) will do all the legwork to bring the many moving pieces together.
Both parties are crucial to making the deal happen – and since the real estate investor is so instrumental in putting the deal together, they can oftentimes negotiate to keep the majority control.
10. Private Lending or Hard Money
Hard Money is not ideal for many investors because it is very costly. Private Lending also comes with strings attached. However, both of these are feasible options to get funding for your next deal WITHOUT tolerating the dreaded 80% LTV rule.
Ever More Options
The options don’t end with this list. I alluded to HELOCs above, which are a viable option for drawing on equity as needed.
We mentioned crowdfunding websites, but peer-to-peer loans are another new-ish option available.
Seller financing is an oldie-but-goodie, if you can negotiate it. Even better, you could buy a property subject to the seller’s mortgage, and keep their (potentially cheap) financing!
Thinking of selling an existing property? Use a 1031 Exchange to put the proceeds tax-free into a new property.
The world is FULL of people looking for a lucrative place to put their money. If you have a track record of winning with your real estate investments, then finding financing probably won’t be a challenge for you. You might just need to get a little creative.