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The 4 Types of Financing for Real Estate Investors

The 4 Types of Financing for Real Estate Investors

I’ve talked with lenders and potential financiers of my transactions for many hours over the course of my real estate investing career. With so many different loan and equity financing options accessible to investors today, it’s critical to understand the advantages and disadvantages of each so you can select the best financing solution for your unique situation.

Naturally, options are not only more limited than they were a few years ago given the state of the credit market, but the notion of a “good bargain” from a lender has also changed. It’s important to understand not only the different types of financing that are available, but also which types are most common and easiest to obtain. When I first started looking at financing for single family homes, I passed on a few potential options that in retrospect were pretty good given today’s tight credit market.

While there are, of course, more than four ways to finance real estate investments, most are a derivative — or mix of the four we will describe here — and the purpose of this article is to define the four most popular types of financing available to real estate investors.

Traditional Financing


The lender for this form of loan is typically a bank or mortgage broker, although it could also be a quasi-government agency or a huge banking institution (Freddie Mac, Fannie Mae, etc). The borrower’s present financial condition, including credit score, income, assets, and debt, is the only factor taken into consideration when determining eligibility for a loan. You probably won’t be eligible for traditional financing if you don’t have decent credit, a reasonable salary, and a low debt-to-income ratio (that is, you make a lot of money relative to your monthly responsibilities).


  • Benefits: Minimal interest rates, low loan expenses (or points), and lengthy loan terms are all advantages of traditional finance (generally at least 30 years). It’s a fantastic option if you are eligible for conventional finance.
  • Drawbacks: There are a few drawbacks to traditional financing for investors, some major:
  1. As I mentioned above, the main disadvantage of traditional financing is how tough it is to qualify for loans these days. When it comes to income and credit, you could have qualified for traditional lending’s “sub-prime” variant just a year or two ago, but these sub-prime options are no longer available due to the sub-prime meltdown (many of these borrowers defaulted on their loans). Therefore, it would be best to avoid trying to obtain traditional finance in the present day unless you have good credit, a stable salary, and little debt.
  2. The minimum down payment required by traditional lenders is often 20%. Investor loans with less than 20% down can be difficult to find via standard finance these days, yet this isn’t always the case.
  3. Dealing with conventional lenders who may not fully comprehend your firm might be challenging for investors. For instance, the lender almost prevented me from closing on a home with standard financing last week because they would not release the money until the hot water heater in the investment property was operational. As an investor, it’s typical for me to purchase homes that, among other things, have faulty hot water heaters. Since my sellers are mostly banks, I can’t usually expect them to remedy these issues for me. Before I even acquired the house in this situation, I had to fix the hot water heater, which is not something I want to do frequently.
  4. Traditional lenders take their time when it comes to appraisals and pushing loans through their process. It’s best to allow for at least 21 days between contract acceptance and close. As an investor, you often want to incent the seller to accept your offer by offering to close quickly; with traditional lending, that can often be impossible.
  5. There is a cap on the number of loans you can have at once if the lender will be financing through Freddie Mac or Fannie Mae, which is the case for most lenders. You will eventually come into this issue with traditional lending if you plan to be an active investor going after more than 5 or 10 properties at once because there is now a cap of either 4 or 10 loans (depending on whether it’s Freddie or Fannie).
  6. No conventional loans exist that will include the cost of rehab in the loan. If you want to spend $100,000 on a house and $30,000 on repairs, you will have to pay that out of your own pocket because the lender won’t include it in the loan.


Portfolio/Investor Lending


Smaller banks occasionally lend their own funds (as opposed to getting the money from Freddie, Fannie, or some other large institution). These banks typically have the freedom to set their own lending standards and are not restricted to relying solely on the borrower’s financial status. One or two of the portfolio lenders, for instance, will consider both the borrower’s financial status and the specific investment being considered.

Because some portfolio lenders (also called “investment lenders”) have the expertise to actually evaluate investment deals, if they are confident that the investment is solid, they will be a bit less concerned about the borrower defaulting on the loan, because they have already verified that the property value will cover the balance of the loan. That said, portfolio lenders aren’t in the business of investing in real estate, so they aren’t hoping for the borrower to default; given that, they do care that the borrower has at least decent credit, good income and/or cash reserves. While I haven’t been able to qualify for traditional financing on my own due to my lack of income, portfolio lenders tend to be very excited about working with me because of my good credit and cash reserves.


  • Benefits: As mentioned, the major benefit of portfolio lending is that (sometimes) the financial requirements on the borrower can be relaxed a bit, allowing borrowers with less than stellar credit or low income to qualify for loans. Here are some other benefits:
  1. Some portfolio lenders will provide “rehab loans” that effectively let the investor borrow enough money to pay for the entire cost of the renovation (with a down-payment based on the full amount).
  2. Portfolio loans often require less than 20% down payment, and 90% LTV is not uncommon.
  3. Portfolio lenders will verify that the investment the borrower wants to make is a sound one. This provides an extra layer of checks and balances to the investor about whether the deal they are pursuing is a good one. For new investors, this can be a very good thing!
  4. Portfolio lenders are often used to dealing with investors, and can many times close loans in 7-10 days, especially with investors who they are familiar with and trust.


  • Drawbacks: Of course, there are drawbacks to portfolio loans as well:
  1. Some portfolio loans are short-term — even as low as 6-12 months. If you get short-term financing, you need to either be confident that you can turn around and sell the property in that amount of time, or you need to be confident that you can refinance to get out of the loan prior to its expiration.
  2. Portfolio loans generally have higher interest rates and “points” (loan costs) associated with them. It’s not uncommon for portfolio loans to run from 9-14% interest and 2-5% of the total loan in up-front fees (2-5 points).
  3. Portfolio lenders may seriously scrutinize your deals, and if you are trying to make a deal where the value is obvious to you but not your lender, you may find yourself in a situation where they won’t give you the money.
  4. Because portfolio lenders often care about the deal as much as the borrower, they often want to see that the borrower has real estate experience. If you go to a lender with no experience, you might find yourself paying higher rates, more points, or having to provide additional personal guarantees. That said, once you prove yourself to the lender by selling a couple houses and repaying a couple loans, things will get a lot easier.


Hard Money


Hard money is so-called because the loan is provided more against the hard asset (in this case Real Estate) than it is against the borrower. Hard money lenders are often wealthy business people (either investors themselves, or professionals such as doctors and lawyers who are looking for a good return on their saved cash).

Hard money lenders often don’t care about the financial situation of the borrower, as long as they are confident that the loan is being used to finance a great deal. If the deal is great — and the borrower has the experience to execute — hard money lenders will often lend to those with poor credit, no income, and even high debt. That said, the worse the financial situation of the borrower, the better the deal needs to be.


  • Benefits: The obvious benefit of hard money is that even if you have a very poor financial situation, you may be able to a loan. Again, the loan is more against the deal than it is against the deal-maker. And, hard money lenders can often make quick lending decisions, providing turn-around times of just a couple days on loans when necessary. Also, hard money lenders — because they are lending their own money — have the option to finance up to 100% of the deal, if they think it makes sense.
  • Drawbacks: As you can imagine, hard money isn’t always the magic bullet for investors with bad finances. Because hard money is often a last resort for borrowers who can’t qualify for other types of loans, hard money lenders will often impose very high costs on their loans. Interest rates upwards of 15% are not uncommon, and the upfront fees can often total 7-10% of the entire loan amount (7-10 points). This makes hard money very expensive, and unless the deal is fantastic, hard money can easily eat much of your profit before the deal is even made.


Equity Investments


Equity Investment is just a fancy name for “partner.” An equity investor will lend you money in return for some fixed percentage of the investment and profit. A common scenario is that an equity investor will front all the money for a deal, but do none of the work. The borrower will do 100% of the work, and then at the end, the lender and the borrower will split the profit 50/50. Sometimes the equity investor will be involved in the actual deal, and oftentimes the split isn’t 50/50, but the gist of the equity investment is the same — a partner injects money to get a portion of the profits.


  • Benefits: The biggest benefit to an equity partner is that there are no “requirements” that the borrower needs to fulfill to get the loan. If the partner chooses to invest and take (generally) equal or greater risk than the borrower, they can do so. Oftentimes, the equity investor is a friend or family member, and the deal is more a partnership in the eyes of both parties, as opposed to a lender/borrower relationship.
  • Drawbacks: There are two drawbacks to equity partnership:
  1. Equity partners are generally entitled to a piece of the profits, maybe even 50% or more. While the investor doesn’t generally need to pay anything upfront (or even any interest on the money), they will have to fork over a large percentage of the profits to the partner. This can mean even smaller profit than if the investor went with hard money or some other type of high-interest loan.
  2. Equity partners may want to play an active role in the investment. While this can be a good thing if the partner is experienced and has the same vision as the investor, when that’s not the case, this can be a recipe for disaster.