Creative financing is a term used widely amongst real estate investors to refer to non-traditional means of real estate financing, or financing techniques not commonly used. The goal of creative financing is generally to purchase, or finance a property, with the buyer/investor using as little of his own money as possible, otherwise known as leveraging, OPM (Other People’s Money). Using these techniques an investor may be able to purchase multiple properties using little, or none, of his “own money”.
Types of creative financing:
Hard money loans (abbreviated as HML) are made through a hard money lender which is similar to private mortgages. A HML may get his financing either from his own contacts with private lenders, or financial institutions with whom he has established his own lines of credit. Hard money becomes a last resort when borrowers cannot meet the lending standards set by banks or government sponsored enterprises such as Fannie Mae and Freddie Mac. Hard money loans are made to real estate investors for the purpose of investing in and rehabbing real estate. The hard money lender will also charge points of 3% to 6% or more. These points are often paid up front, but a few lenders may roll these into the loan. Rates are a little higher than borrowing directly from a private lender, as the hard money lender may also be collecting yield spread.
Hard money loans are high-interest mortgages available from private investors. Desperate borrowers with poor credit scores, bankruptcies, no verifiable income, or too much debt often take out hard money loans when they are unable to qualify for traditional mortgages.
A private mortgage is a loan secured by real estate that is made by a private lender, instead of a traditional lender, financial institution, or government institution. Interest rates on these loans are considerably higher than traditional loans and may range from 12% to 18%, with points sometimes being required as well These loans are most commonly short term and last anywhere from 6 months to three years. These are asset based loans made for the purchase and rehabilitation of real estate. Because the loans are asset based, the decision to loan is based on the criteria of the property and not usually the qualifications, or credit of the borrower.
A Simultaneous closing allows a home seller to offer owner financing on a property without having to hold any mortgage. On closing day, the property title is transferred to the buyer and the newly created (owner-financed) mortgage is sold to a note investor for cash, simultaneously.
A subject-to transaction is a creative finance technique where a buyer is able to take title to property without procuring a note of his or her own. The transaction usually involves the seller of the property leaving his or her existing financing in place so that the buyer does not need to pay transaction costs associated with obtaining a traditional loan. This process is similar to assuming a loan, but differs because it usually takes place without the consent of the original lending institution and violates the terms of the loan. This technique is useful because it affords the buyer the ability to obtain financing without the need for transaction costs and does not tie up capital to procure a new note. The technique also allows the buyer to purchase property quickly without going through the arduous loan process
A land trust is an agreement whereby one party (the trustee) agrees to hold ownership of a piece of real property for the benefit of another party (the beneficiary). Land trusts are used by nonprofit organizations to hold conservation easements, by corporations and investment groups to compile large tracts of land, and by individuals to keep their real estate ownership private, avoid probate and provide several other benefits.
In this scenario, the seller is often several payments behind and may even be close to foreclosure, the seller can also show significant hardships that have led them to being unable to continue making payments on this property. The seller will give the short sale investor a contract to purchase the property, a deed that will probably be placed in escrow, power of attorney and a number of other documents that will give them full control of the property. The investor will then present a case to the bank holding the mortgage, that the seller is no longer able to make payments, is having to relinquish control of the property and that the loan on the property must be reduced in order for the investor to purchase the property.
Creative financing techniques:
1. Hard money lenders. You can ask around or find these online. They specialize in short-term loans at high interest. You typically use this type of financing for a “fix and flip.” You can often get the money fast, and if you make $60,000 on a project, who cares if you paid $20,000 interest in six months.
2. No-doc and low-doc loans. No (or low) documentation of your income or credit required. Again, you can find banks that do these online now. The catch is that you will only be able to borrow up to 80% of the purchase price or property value. If you have 10% in cash, you might be able to borrow the other 10% from a friend or the seller.
3. Seller-carried second mortgages. Sometimes a bank will loan you 90%, and allow the seller to take back a second mortgage from you for 5%, leaving you needing only 5% for a down-payment.
4. Land contract. Called “contract for sale” or other names as well, this just means the seller lets you make payments, and delivers the title upon payment in full. I sold a rental this way for $1,000 down, because I wanted the 9% interest, and the higher price I got this way.
5. Credit cards. If a seller will take $20,000 down on a fixer-upper that you expect to make $40,000 on, why not use credit cards? This is a true 0-down deal for you, and if you turn the project in six months, you will have paid $1000 in interest on an 18% credit card. Don’t let $1000 get in the way of making $40,000.
6. Retirement accounts. The laws get pretty complex in this area, but you can check with a tax attorney to see how you might borrow from your own retirement account to finance real estate investments.
7. Friends and family. Keep it all business, if you use this source, but loaning you money at 7% isn’t a gift if their money is getting 2% in the bank.
8. Note buyers. The seller needs cash. He raises the price, and sells to you for $100,000 with no money down, taking back two mortgages from you for $90,000 and $10,000. He arranged (or you did) for a note buyer to pay him $80,000 cash for the first mortgage at closing, getting him the cash he wanted. You pay two payments now, one to each note holder.
9. Get a loan on other property. Interestingly, if you take out a home equity loan for a vacation, and then forget to use it for that, you can use it for the down-payment on an investment property, without violating the rules of the bank that gives you the primary mortgage. In other words, you got in with no cash of your own.
10. Partnerships. For bigger projects, you could arrange for five investors to each put money into a partnership, with your share being the management responsibility instead of cash.
With the current economic downturn in credit market, banking, etc., it may be very difficult to virtually impossible to accomplish some of the creative financing techniques discussed above.
Originally posted 2009-04-10 06:23:36. Republished by Blog Post Promoter