Real Estate - Types of Financing
A Beginner’s Guide to Real Estate Financing Options
Whether you’re ready to buy your first home or are preparing to purchase yet another investment property to pad your portfolio, finding the right source of financing is the key to reaching your goals. And finding the right financing? Well, hat’s almost a full-time job in and of itself.
Want to buy a house to fix and flip? There’s special financing for that! Have you dreamed of living in a quiet rural area? There’s special financing for that! Are you a first-time homebuyer with a less than excellent credit score? You guessed it – there’s financing for that, too.
There are dozens of types of financing options available for those who are looking to buy a house – the challenge is finding the one that’s best for your situation. Not all mortgages and financing options are created equal. Our beginner’s guide to real estate financing discusses some of the most popular financing options, takes a look at their pros and cons, and outlines the down payments you can expect to make.
Finding the right financing makes all the difference when it comes to purchasing that dream home. Are you ready to take the first step? Here we go.
Breaking Down Mortgage Types: Fixed-Rate vs. ARM
As you research different financing options, you’ll likely see some familiar terms. While there are many different types of financing available, they will likely fall into one of two mortgage loan categories: fixed-rate and adjustable-rate mortgages (ARM). Before you decide on a financing option, it’s best to decide which of these two loan types are best for you. Let’s look at them more closely.
Fixed-rate mortgage loan
Fixed-rate loans simply mean that you pay the same interest rate on your loan for the life of the loan, which is often 15 to 30 years. While interest rates are often higher than ARM loans, you’ll never have to worry about increasing rates, which can greatly simplify your mortgage.
These loans also offer the advantage of knowing exactly how much interest you’ll pay over the course of your loan; this will allow you to budget accordingly. On the downside, fixed-rate loans are often more difficult to qualify for because monthly payments are often higher.
Adjustable-rate mortgage loan
ARM loans begin with a fixed term – which usually lasts three, five, or ten years – after which rates adjust based on market rates for the duration of the loan. These loans are appealing to many because the initial fixed rate is usually lower than that of a fixed-rate mortgage loan, which can offer serious savings for short-term investments. Additional savings may occur if market rates decrease during the life of your loan, as you’ll be able to enjoy them without needing to refinance.
These loans may be more confusing for new buyers as monthly payments may change drastically and frequently once the initial fixed term of the loan has expired. An even bigger downside? Interest rates are highly likely to increase after your fixed term is up and may end up costing you even more than a fixed-rate loan would.
7 Popular Real Estate Financing Options
Now that we’ve discussed fixed-rate vs. ARM loans, it’s time to talk about some of the most popular real estate financing options. Here are seven mortgage loan choices to consider.
1. Conventional Mortgage Loan
Expected down payment: 3%-20% down, depending on the lender
Conventional mortgage loans are one of the most popular homeowner loans – more than 50% of homeowners use a conventional loan to buy or refinance their house. These loans are not connected to any specific government program, which means they are widely available from a variety of lenders and you do not need to meet any special requirements. However, because these loans are not backed by another entity, they can be riskier for the lender and, therefore, more difficult to qualify for.
There are two types of conventional loans: conforming (where maximum loan amounts are set by the government) and non-conforming (which are less standardized and vary greatly from lender to lender).
These loans are great for buyers who have fair to good credit scores and are purchasing a home that doesn’t need repairs. No matter your situation, though, remember it’s a good idea to shop around before committing to a particular loan.
Advantages• Offers good interest rates for those with exceptional credit scores• Is the most popular type of loan, making it easy to find a lender• There are diverse repayment plans• There are no special criteria you must adhere to• Loan processing is fairly quick• Offers diverse length terms for fixed-rate mortgages• Offers diverse down payment optionsDisadvantages• Low down payments aren’t guaranteed• Often requires a higher credit score to qualify• Can be difficult to qualify for compared to other loans• MIP (Mortgage Insurance Premium) is required with lower down payments
2. FHA Home Loan
Expected down payment: As low as 3.5% down, depending on credit score
In an effort to boost homeownership, the Federal Housing Administration (FHA) offers FHA home loans to qualifying homeowners. Though these loans are obtained through a lender, the FHA insures them against default, which makes them less risky for the lender and opens up the market for those who might not qualify for a conventional loan.
FHA loans are intended to benefit low-to-moderate-income individuals and families and are popular for first-time homebuyers, borrowers with low credit scores, and individuals who may have experienced bankruptcy or foreclosure in the past. However, even if you don’t fall into any of these categories, you may still qualify. Anyone wishing to use an FHA loan will need to meet certain requirements in order to obtain financing.
Advantages• Offers good interest rates for those with lower credit scores• Will lend up to 96.5% of the property value• Requires lower down payments and credit scores• Most borrowers are eligible• Accepts diverse forms of down payments, such as gifts or donations• Loans are assumable by other buyersDisadvantages• Must meet a set of requirements (e.g., two years of employment history, minimum FICO score of 500, DTI of less than 53%, etc.) in order to qualify• Only available through FHA-approved lenders• Requires MIP• Loan limits may apply in some cases• Property must be inspected and meet health and safety standards
3. VA Home Loan
Expected down payment: As low as 0% down
Created to help returning service members find and purchase a place of their own, VA home loans are intended for active service members, veterans, and even military spouses who want to own a home. While these loans are distributed by private lenders, they are guaranteed by the U.S. Department of Veterans Affairs and, therefore, often offer lower down payments, more favorable interest rates, and other advantages.
Along with VA-backed home loans, the VA offers many other types of loans, from the NADL program for Native American veterans to cash-backed refinancing loans. Anyone interested in obtaining a VA loan must have a Certificate of Eligibility (COE). You can visit the VA website to find out if you are eligible or to learn more about this type of financing.
Advantages• No down payments – up to 100% financing available• No need to pay MIP• Available for military spouses as well as active or retired military personnel• Refinancing programs are availableDisadvantages• Requires a VA funding fee, the amount of which is determined by your down payment and previous VA loan status• Borrower must meet all service requirements to qualify• Requires more paperwork than other loans might• Involves the extra step of obtaining a COE• Only primary residences are eligible• Not every lender will offer these loans• Some homes (such as fixer-uppers) may not be eligible
4. USDA Loan
Expected down payment: 0% down
USDA home loans are provided by traditional lenders (such as banks) but backed by the United States Department of Agriculture, meaning that the restrictions and requirements are more forgiving than other types of loans. In fact, USDA loans have some of the lowest interest rates and don’t require a down payment – but these benefits come with a catch.
If you choose this way of financing, be prepared to give up city life, as USDA loans must be used for houses located in rural or suburban areas. This is the USDA’s way of offering financial assistance to rural areas of the U.S.
There are three types of USDA loans available: Guaranteed USDA Loans, Direct USDA Loans, and USDA Home Improvement Loans. Each offers assistance to low-or-moderate-income Americans. To find out if you’re eligible for a USDA loan, or for further information, visit the USDA website.
Advantages• Most of the geographical U.S. is considered “rural” and is eligible for a USDA loan• Offers much lower interest rates – some as low as 1%• No down payment is required• Borrowers can have credit scores as low as 620• No prepayment penaltiesDisadvantages• Income restrictions apply• Houses must be located in a USDA approved area• There are strict eligibility requirements, meaning it may be harder to qualify• Not all lenders offer USDA loans• Borrowers may be required to pay an MIP• Only single-family homes are allowed
5. Property Investment Loan
Expected down payment: Generally, 20-25% down; varies by lender
Investing in real estate – either by buying houses to flip and sell or buying properties to rent – is a great way to earn some extra income, but these projects require extensive financing to become actualized. Investment loans can therefore be incredibly helpful for funding properties that aren’t intended as primary homes. These loans are similar to hard money loans, or loans in which the property is held as collateral for the lender, which is an individual or private group other than a bank or credit union. Hard money and investment loans are short-term solutions for borrowers who want to buy a property but intend to earn a return on their investment.
Advantages• The focus is on the value of the property rather than solely on credit scores• The process is generally very quick, often lasting days rather than weeks, and resulting in faster approvals• There is less paperwork involved• Loans are offered for almost every type of property• Often available when banks are no longer an optionDisadvantages• Interest rates are often much higher• Banks often require borrowers to have an excellent credit history (though private lenders may not)• Often require higher down payments• Higher monthly payments
6. Rehab and Renovation Loans
Rehab and renovation loans are intended to help homeowners improve their properties. These loans are unnecessary for homeowners looking at move-in ready houses but can be beneficial for borrowers on a budget or who are interested in fixer-uppers. Rehab loans offer immediate benefits by allowing you to customize your living space and can also offer advantages in the future – for example, by increasing property value if you decide to sell your home.
While there are many different types of rehab loans on the market, we’d like to point out three of the most popular and useful ones.
a. FHA 203(k) LoanExpected down payment: 3.5% down, depending on credit score
Like FHA Home Loans, FHA 203(k) loans are guaranteed by the Federal Housing Administration, which means they often have lower interest rates, smaller down payments, and more lenient qualification requirements. These loans are ideal for homeowners who want to buy a home that needs repairs or who want to upgrade or repair their current property.
There are two types of FHA 203K loans: Limited and Full. The main difference between the two is that Limited 203(k) loans do not allow funds to be used for structural changes (i.e., foundations, walls, etc.), and the maximum loan amount is capped at $35,000. The regular 203(k) loans do not include these stipulations.
Advantages• Simplifies the process of buying a fixer-upper by rolling everything into one loan• Reduces the need to utilize credit cards or standard home improvement loans for home repairs and upgrades• Allows you to perform repairs and upgrades quickly when compared to saving the money yourself• Fixer-upper homes may not meet the requirements for other home loans• Allows you to purchase low-cost homes• Allows you to customize your current or future house• Provides instant home equityDisadvantages• Only available through FHA-approved lenders• Credit score requirements• Only available for owner-occupants – investment properties are not eligible• Most adhere to a list of allowable and non-allowable repairs• Mortgage insurance is required• Higher interest rates than traditional FHA loans• The closing process typically takes longerb. VA Rehab and Renovation LoansExpected down payment: 0% down
Just as VA Home Loans are available to eligible military servicemen and servicewomen, so are VA Rehab Loans. These loans are intended to help military personnel repair and remodel their homes and often offer better terms than other home improvement loans (e.g., zero down payment and low interest rates).
There are several types of VA renovation loans available such as alteration and repair loans, energy-efficient mortgages, and supplemental VA loans, among others.
Advantages• May finance up to 100% of the home’s value• Can be issued at the same time as a standard VA home loan Disadvantages• Loan amounts vary from lender to lender• Third-party construction is required – no DIY projects are allowed• Not as useful for investment properties• Each loan type has additional requirementsc. Fannie Mae HomeStyle LoanExpected down payment: As low as 3% down
The Fannie Mae HomeStyle Loan makes it possible to combine your mortgage and remodeling costs into one loan. It’s perfect for homeowners who are looking at purchasing a house that needs work or for current homeowners that want to upgrade their property. One of the main stipulations of this loan is that any repairs or improvements must be affixed to the property and add real value.
This loan works by allowing borrowers to focus on the value of their home after repairs (ARV) rather than its current value, thus allowing you to borrow more than other loans might allow.
Advantages• Allows you to finance your home purchase and necessary remodeling with one loan• More cost-effective than using credit cards, personal loans, or other home improvement loans• Some DIY projects are allowed, though restrictions apply, and the lender must approve• Can apply to investment properties or secondary homes Disadvantages• The process can be more complicated than with other loans• Lenders must approve renovation projects• Not all lenders offer HomeStyle loans• Projects must be completed within 12 months of closing• Often requires higher credit scores than government-backed rehab loans• You must find contractors and plan projects• Some down payments may require MIP
7. Construction to Permanent Loan
Expected down payment: Average 10-20%; varies according to lender
This loan is intended for homeowners who want to build their home from the ground up. It greatly simplifies the process by rolling multiple loans into one, covering everything from construction to your final mortgage rate. Construction to Permanent loans take place in stages, often offering different rates and monthly payments before transforming into a standard mortgage rate. It’s ideal for homeowners who are seeking to build or renovate their homes and don’t want to go through the process of finding different financing options, obtaining multiple loans, and paying separate closing costs.
Advantages• Simplifies the process of building or renovating your home by mitigating paperwork, neutralizing extra closing costs, and reducing stress• Loan amounts may be as high as $2 million• Allows you to lock in low interest rates• One-time closing fees are often offered• Can be used for various purposes (e.g., lot loans, renovations, building on a currently owned lot, etc.)Disadvantages• Must be a one-unit, single-family home• Interest rates are often higher during construction• Higher monthly mortgage payments• Can be difficult to qualify for• Short-term loans offer additional risks for lenders and borrowers
The Next Step: Securing a Lender
Think the journey is over? Think again. Now that you’ve decided what financing option is right for you, your next step is to find a lender – and with thousands upon thousands of lenders out there, this can be a daunting task!
Locating a fair and professional lender is a time-consuming and often frustrating task, but we’d like to make it easier for you by recommending some great lenders that we’ve worked with over the years. Our experience with these individuals has been nothing short of spectacular. If you take the time to get in touch, you’ll be able to see what makes them so great as they help you secure your loan and take the next steps towards buying your dream home.
