Have you ever wondered how some people are able to own dozens of rental properties? Or maybe you have seen some of the flipping shows on television and asked yourself how these people are able to buy a house seemingly every other week. Today we will look at five ways that both retail buyers and investors can buy a house. Some of these ways are probably familiar to you, but there might be a couple that some people have not heard about or considered.
Five Ways to Buy a House
One of the most common ways to buy a house is through a traditional mortgage from a bank or credit union. These normally come with low interest rates and 15 or 30 year terms. These loans are great for retail home buyers and investors as well. For most Ventura County residents who will only own a primary home and maybe one or two rentals, traditional financing may be all they ever need to buy a house. However, most banks and credit unions do not like the risk that is involved with real estate investing, so they will either prevent investors from getting loans or limit the amount of loans they will give out to an investor. If an investor is unable to get traditional financing, they usually look for one of the financing mechanisms below to buy a house.
I am sure in the past few years most of you have heard about the rising number of homes that are being bought for cash. Cash offers are used by those looking to buy a house because they know that this represents a stronger offer than one needing bank financing. When a buyer has to use bank financing, there is always a chance that the loan will not go through and then the seller has to start from square one. Sure, there are some people with millions of dollars hiding underneath their bed, but this is not the only form of a cash offer. The next two methods, hard money and private money, are often considered to be cash offers as there is no bank approval process when using them to buy a house.
A hard money loan is a type of financing that is offered by investors or companies for the purpose of investing in real estate. It is called “hard money” because the loan is secured by a “hard” asset, in this case, the piece of property that is being bought. Whereas most traditional banks tend to shy away from lending to investors looking to flip homes, hard money lenders understand the risks that are involved and are willing to lend money that is secured by a piece of property. However, the terms you will find from hard money lenders are vastly different than those from a traditional bank. It is not uncommon to find hard money at anywhere from 8% – 15% interest rates and 2 to 7 points. These numbers would not make any sense to your average Ventura resident looking to buy a house, but investors who use hard money know how to find deals that take these high costs into account. These investors look to purchase and sell homes as quickly as possible to avoid racking up hundreds of dollars of interest payments for each day they hold the property.
Private money is very similar to the idea of hard money, except for the fact that the money is being loaned by private individuals vice professional investors or companies. When working with private individuals, the terms of the loan can be negotiated to be favorable to both parties. Anyone can be a private lender and most of the time they are individuals with either money sitting in a bank account or tied up in other investment vehicles. They see the opportunity to invest in real estate as providing greater returns than interest from their bank account while being safer than investing in stocks. Using private money is usually a win-win situation for both the lender and the borrower and can be used by both retail home buyers and investors. If a potential homebuyer is unable to get approved for a loan by a bank and has a wealthy friend or family member, this person may agree to lend the money and have the borrower make monthly payments to them. The private lender might ask for a higher interest rate than a traditional bank would, but if this allows the borrower to buy a house for an amount they could afford, then both parties are happy. When an investor uses private money, the borrower receives a loan that usually has more favorable rates than when using hard money and the lender gets a reasonably safe Return on Investment (ROI).
For instances where a homeowner has a high amount of equity or owns the property free and clear, seller financing might be a good option to pursue. Seller financing is when instead of obtaining a loan from a bank or other financial institution, the buyer and homeowner agree that the homeowner will carry the financing. In essence, the homeowner is acting in place of the bank and the buyer will be making payments directly to the homeowner. Another term for this is “subject to,” meaning that the home is purchased subject to the existing mortgage. This means that the title changes hands to the buyer while the original mortgage stays in the seller’s name. This can be a win-win situation when the buyer cannot obtain traditional financing to buy a house (for whatever reason) and the seller would prefer to get monthly payments from the buyer instead of one large lump sum. Advantages to receiving monthly payments could include steady monthly income, a better ROI, and the ability to spread out or defer taxes. Seller financing can also be used in instances where homeowners are behind on payments. A buyer could purchase the home “subject to,” make any back payments to bring the loan current, then repair the home and sell it for market value. Once the house is resold, the buyer would then pay the original homeowner their agreed upon price and walk away with any profits resulting from the repair and sale. This could also be a win-win situation by helping the homeowner avoid bankruptcy or foreclosure while allowing the buyer to buy a house at the agreed upon price.
When considering using seller financing, both the homeowner and buyer must be aware of the due-on-sale clause. This clause gives the original lender the right to call due the full balance of the loan upon transfer of ownership of the home. While many argue that a bank will not call a loan due when payments are being made on a regular basis and are being kept current, everyone must be aware of the risk that it could happen. More information about this clause can be found here.