Investing in Real Estate Using Creative Financing
The affordability of American homes has never been greater. Low home prices and low interest rates make buying a home cheaper than renting in many markets. So why do nearly a third of Americans choose to rent? For many people, financing can be a barrier. On CNBC.com’s Realty Check, real estate reporter Diana Olick writes, “The days of free-wheeling lending are over, and credit-worthiness is king. There are low down payment options, like the FHA, but too many potential buyers don’t meet the credit qualifications either for the great low rates or for the loan itself.”1
Homebuyers and sellers and investors on either side of a transaction have found viable alternatives in the form of creative financing. In three types of creative seller financing—installment sales, seller carryback loans, and wraparound mortgages—the seller becomes the lender and accepts payments from the buyer over an agreed upon period of time. This is particularly lucrative for the seller because the payments are amortized; they include interest resulting in greater cash flow. Along with the higher returns, however, comes risk as the seller assumes the burden of dealing with default. It’s always best to consult with an attorney to minimize the risk and also to ensure legal compliance.
In another type of creative financing, called a lease option, the interested buyer rents the home with the option to buy at the end of the lease. The seller becomes a landlord and charges a higher rent, a portion of which will go toward the down payment. The lease agreement includes a nonrefundable deposit that will also go toward the down payment. If the renter decides not to buy at the end of the lease, however, the seller keeps the deposit and extra rent paid. Investor organizations believe that less than 20 percent of all lease options result in a closed transaction.
Creative financing can be a great option on the buying side, too. Many investors who purchase fixer-uppers with the intent to renovate them and resell them for profit use private or “hard-money” lenders. Hard-money lenders, as opposed to traditional lenders, will loan on properties needing minor and/or major repairs and have quicker turnaround times. The downside to using hard-money, of course, is the high interest rate. The interest on a loan from a hard-money lender can be three to four times higher than the interest on a traditional loan. But if an investor is able to turn a property around within the term of his loan, he’ll be in good shape and will likely make a fantastic return on his investment in a very short period of time.
Whether buying or selling, knowing the options available to you as a new—or even experienced—real estate investor can open doors to new opportunities and put more money in your pocket. Creative financing can be a useful tool in executing an investment transaction. Be sure to consult with a qualified attorney; you don’t want to let an unlawful contract ruin a great deal.