Various Real Estate Financing Options Explained

Are you considering the purchase of a new home? Perhaps you are interested in entering real estate investment for reasons such as buying a rental property or run down homes to fix and flip? In either of these situations, it is critical that you have a firm understanding of the different types of financing options available to you, and how each mortgage type suits certain types of real estate purchases. Knowing the difference and choosing a mortgage wisely can mean the difference of thousands of dollars in your pocket.

The mortgage world can seem very daunting even to seasoned real estate investors. I like to call it the "Mortgage Maze of Death" because it's confusing like a maze and if you make a wrong move it can really hurt you. To help sort through the mess I wrote this short article describing many of available real estate financing options available.

Pay attention! There's a test at the end!

Fixed-rate loan: Also known as a fixed rate mortgage (FRM), a fixed rate loan provides you with a predictable and stable mortgage repayment program. Mortgage payments are made monthly and the amount is the same each and every month. Because they offer a monthly payment that is known and does not change, fixed-rate mortgage loans remain the most popular type. Most fixed rate mortgages are terms of 15 or 30 years. If you choose a 30 year term, your monthly payments will be lower but you will pay a slightly higher interest rate. Also, some lenders do not allow for non-scheduled prepayments without charging you a ‘fine’. Check with your bank and make sure that the fixed rate loan you are considering allows you to make additional payments anytime and in any amount with no penalty.

Adjustable rate loans: Also known as an adjustable rate mortgage (ARM), an adjustable rate loan offers you a certain interest rate for a certain period of time from the date of loan signing. After this time, the rate will fluctuate based on the market and current interest rates. As an example, a 3/1 adjustable rate mortgage guarantees the initial interest rate for the first three years and then adjusts with the market after that, generally once a year. If interest rates are low at the time you are seeking a mortgage, an ARM always seems like the most attractive, and cost saving mortgage alternative. Be cautious though, because if you take out a 30 year mortgage, a lot can happen to interest rates and in the end, you may be paying more for your property than you anticipated.

Convertible mortgage loans: Put simply, a convertible mortgage is an adjustable rate loan that allows you to convert back to a fixed rate loan before a specified time. This is an ideal situation because you benefit from current low interest rates with the option to lock in a rate if the interest rates start rising drastically.

Balloon mortgage loans: With a balloon mortgage, you only make payments on the interest only. You do not have a loan that amortizes any of the principal amounts, and the entire loan is due at the end of the loan term. A balloon mortgage offers the benefit of really low monthly payments until you refinance the loan or pay it off in full. This method is great if you are buying and flipping properties for profit, keeping your payments low while you renovate the property and find a resale buyer.

Equity loan: If you are considering purchasing a second property, or an investment property, you can borrow on the equity of your own home to finance your new real estate purchase. Let’s say your current home is valued at $200,000, you may be eligible for up to 80% loan to value (LTV) or $160,000. The lender will factor your overall debt ratio as well as how you still owe on your current home to determine your eligibility. The interest rate on an equity loan will be higher than a conventional mortgage but much lower than an unsecured loan.

Bridge loan: Used as a short term solution only, a bridge loan is typically taken out for a period of a few weeks in order to get financing for a specific project. A bridge loan is frequently used in commercial real estate to expedite the closure of a property deal. Bridge loans are also used by those looking to purchase a home. For example, if you are purchasing a new home and need to make a down payment to close the deal, but you have not sold your current home yet, a bridge loan is the ideal financing option which secures the new property and can be paid off as soon as you sell your first property.

Ok, I lied. There's no test. I was just trying to get you to pay attention. Hopefully I have helped you with at least a dimly-lit map to navigate the mortgage maze of death.

Have a great day!

Matt