You can pay cash for your Sonoma County investment property.
However, you’ll have to come to the table with a lot of cash. Properties in Sonoma County are expensive. Cash offers are often preferred by sellers, but they’re not ideal when you’re investing.
Which means, you’ll have to finance your investment property.
Leveraging your purchase with a loan is a great way to kick off a successful and lucrative investment experience. But, you’ll have to choose what type of financing is best for your purchase. There are several different avenues you can choose.
Here are some of the most common ways to finance a property purchase – and some that require a bit of creative thinking and planning. Choose what’s going to work best for your current financial situation, your investment goals, and your ability to repay the money you’re borrowing.
Traditional Mortgage Loans
Let’s start with the most common and perhaps the most basic of all financing options: a mortgage.
A traditional home loan is provided by banks, credit unions, or other financial institutions, and the money you borrow is secured by the property you purchase. It’s probably the way you financed the home you’re living in, and real estate investors can also utilize the traditional mortgage when acquiring investment properties.
Advantages include:
- Lower and fixed interest rates
- Repayment periods that extend up to 30 years
- Regulations imposed by the government provides security
This is a safe method for financing your property; you’ll have more than enough time to recoup the initial investment and pay off your loan, especially if you keep the property occupied with stable tenants who contribute to those payments.
There are some disadvantages, however, especially:
- Lengthy approval processes
- Lots of required documentation
- Strict qualification standards
- Down payment requirements
You’ll have to document and verify your income and credit, and expect your lender to take a detailed look at your financials.
Hard Money Loans
Hard money loans are a form of asset-based lending where the loan is secured by the real property itself. These loans are not issued by traditional financial institutions but rather by private investors or companies. These are especially popular among investors who flip their properties.
You’ll appreciate fast approval and funding if you go with a hard money loan.
There’s also less of an interest in your own financial position. Investors care more about the property you’re buying and the money that can be made there.
Prepare for higher costs with this type of loan. Interest rates and fees are typically higher than traditional loans, affecting the overall cost of borrowing. Also, you’re not likely to spend 15 or 30 years repaying a hard money loan. They’ll have to be paid off quickly, which means this will only work for you if you’re planning to sell the property or refinance into a different loan within a few years.
Multifamily Investors Can Leverage FHA Loans
Planning to live in one of the units you buy in a multifamily property? That’s going to give you a very impressive option. Federal Housing Administration or FHA loans are designed for investors who will buy a multi-unit property (up to four units) while living in one of the units.
If you’re going to occupy one of your rental units, this is the best way to finance your investment. These FHA loans require a lower down payment (as low as 3.5 percent), consider borrowers with lower credit scores, and offer better interest rates.
These loans also come with mortgage insurance, which can increase the monthly payments but offers some protection against default. It’s a specific investor who will benefit from an FHA loan, but if you’re looking for a multifamily property that includes a home for yourself, this is an inexpensive way to finance your investment.
Is a Portfolio Loan Right for You?
You’ll pay more in interest, but you’ll get funded fast and efficiently with a portfolio loan. A portfolio loan is a type of mortgage that a lender originates and retains instead of selling on the secondary mortgage market. The lender will instead keep that loan within their own portfolio. Usually, these are more flexible for borrowers than traditional loans.
They can also provide a range of financing options that go well beyond financing the purchase of a property. You can also use this type of loan for a line of credit, refinancing, and cash-out refinancing. Portfolio loans are ideal for investors with multiple properties who want to streamline their financing and payment processes.
Seller Financing for Sonoma County Investments
There are specific markets for buyers who want to invest with seller financing. This is for you when you cannot find other lending options that will work. Seller financing is a great option if you can’t get a loan from a traditional lender or need more flexible repayment terms.
With this financing option, the seller agrees to finance the purchase directly. The terms of the loan, including interest rates and repayment terms, are negotiated between the buyer and the seller. However, not all sellers are willing to offer seller financing, and it may come with higher interest rates and stricter repayment terms than traditional loans.
Pay for an Investment Property by Leveraging your Home Equity
Those are some of the most common ways to finance an investment property.
If you already own a home, you can also use that asset to finance your future properties. How much equity do you have in your own home, or in some other investment property that you might own? You can leverage the value of your existing investments to fund the purchase of your next investment.
There are two ways to do this. A home equity loan or a home equity line of credit can help investors finance their acquisition. Those two options look like this:
- Home equity loan
A home equity loan offers you a lump sum of money that’s borrowed with an interest rate that is fixed but tends to be higher than the interest rate you’d get with a line of credit.
- Home equity line of credit (HELOC)
A HELOC provides you with only the cash that you need, and while the interest rate you get is likely to be lower, it can also fluctuate. The cost of your line of credit won’t be fixed.
Which is better when you are buying an investment property? It really depends. You’ll be able to get all the money you need at once with a home equity loan, but the HELOC gives you more flexibility when it comes to repayment and typically a lower interest rate.
Tapping Into Your Retiremen
If you’ve been saving diligently for retirement and there’s a nice sum of money sitting in a self-directed IRA, you can use the money you have vested to fund the purchase of an investment property. This has become more common than it once was, but there are some pretty strict IRS rules and restrictions.
If you want to pursue this, make sure you have a self-directed IRA that allows for real estate investments. You also want to follow these important steps:
- Identify the Investment Property
Decide what you’re going to buy. A property manager and a real estate agent can help you choose a potentially profitable investment property.
- Conduct Due Diligence
Perform due diligence on the property, such as an inspection. When you need additional financing beyond your retirement savings, you’ll need to secure a non-recourse loan. Not all lenders offer non-recourse loans, and the ones that do might require a larger down payment and charge higher interest rates.
- Purchase the Property
The investment property will be owned by your IRA or 401K, not you personally. All documents must reflect this, and all transactions must be made directly from your retirement account.
- Management of the Property
Buying with retirement funds means you need to have the property professionally managed and maintained; you cannot perform maintenance yourself. All expenses must be paid from the IRA, and all income must return to it.
Consult with a tax advisor to understand the implications of this type of investment purchase.
You’ll also need to plan how real estate assets will be handled once you reach the age for required minimum distributions (RMDs). Real estate cannot be divided in the same way as stocks, so you’ll need a strategy.
How Will You Choose the Best Financing Option?
With all the options that are available, how will you know which financing option is best for you and your investment goals?
When financing your Sonoma County real estate investment, remember to research and compare different loan options and lenders. Consider all associated costs, not just the purchase price – including renovation, maintenance, insurance, and taxes.
It’s always important to plan for your expenses, especially vacancies and turnovers.
Talk through the options with a broker you trust, a CPA, or your local property manager. We love helping investors work through their options, so don’t hesitate to contact us at Redwood Residential Property Management if you have any questions about how to finance your investment property wisely.