Investor Financing Options

September 1, 2008 · 21 comments

Now that I’ve spent many dozens of hours talking to lenders and potential financiers of my deals, I’m starting to gain some insight into the different types of loans and equity financing available to real estate investors, and the benefits and drawbacks of each. Of course, given today’s credit situation, options are not only more limited than they were a couple years ago, but the definition of a “good deal” from a lender has changed as well. When I first started looking at financing for single family houses, I passed on a couple potential options that in hindsight were pretty good; if I had realized how bad the lending landscape was, I might have jumped on some of those sooner.

Anyway, the point of this post is to discuss some of the various types of financing I’ve seen. I’m not a financing expert, so don’t take my word for anything you read below; I’m just relaying my experiences to date. I’ll be sure to add updates to this post in the future.

So let’s get to it:

Traditional Financing

This type of loan is generally done through a mortgage broker or bank, and the lender may be a large banking institution or a quasi-government institution (Freddie Mac, Fannie Mae, etc). The requirements to qualify for a loan are based strictly on the borrower’s current financial situation — credit score, income, assets, and debt. If you don’t have good credit, reasonable income, and a low debt-to-income ratio (i.e., you earn a lot compared to your monthly obligations), you likely won’t qualify for traditional financing.

Benefits: The benefits of traditional financing are low-interest rates (generally), low loan costs (or points), and long loan durations (generally at least 30 years). If you can qualify for traditional financing, it’s a great choice.

Drawbacks: There are a few drawbacks to traditional financing for investors, some major:

  • The biggest drawback to tradition financing is what I stated above — it’s difficult to qualify these days. Just a year or two ago, you could have qualified under a “sub-prime” variation of traditional lending, where income and credit were less of an issue; but given the sub-prime meltdown (many of these borrowers defaulting on their loans), these sub-prime options have gone away. So, unless you have good credit, income, and small debt, you’re better off not even bothering with trying to get traditional financing these days.
  • Traditional lenders generally require that at least 20% be put down as a down payment. While this isn’t always true, investor loans with less than 20% down can be tough to find via traditional lending these days.
  • As an investor, it can be difficult to deal with traditional lenders who don’t necessarily understand your business. For example, a house I closed on last week with traditional financing almost fell-through because the lender wouldn’t provide the funds until the hot water heater in the investment property was working. As an investor, it’s common that I’ll buy houses with broken hot water heaters (among other things), and I can’t generally expect the seller to fix this for me, especially when my seller’s are usually banks. In this case, I had to fix the hot water heater before I even owned the house, which is not something I want to do on a regular basis.
  • 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.
  • If the lender will be financing through Freddie Mac or Fannie Mae (and most will), there will be a limit to the number of loans you can have at one time. Currently, that limit is either 4 or 10 loans (depending on whether it’s Freddie or Fannie), so if you plan to be an active investor going after more than 5 or 10 properties simultaneously, you’ll run into this problem with traditional lending at some point.
  • There are no traditional loans that will cover the cost of rehab in the loan. If you plan to buy a $100K property and spend $30K in rehab costs, that $30K will have to come out of your pocket; the lender won’t put that money into the loan.

Portfolio/Investor Lending

Some smaller banks will lend their own money (as opposed to getting the money from Freddie, Fannie, or some other large institution). These banks generally have the ability to make their own lending criteria, and don’t necessarily have to go just on the borrower’s financial situation. For example, a couple of the portfolio lenders I’ve spoken with will use a combination of the borrower’s financial situation and the actual investment being pursued.

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:

  • Some portfolio lenders will offer “rehab loans” that will roll the rehab costs into the loan, essentially allowing the investor to cover the entire cost of the rehab through the loan (with a down-payment based on the full amount).
  • Portfolio loans often require less than 20% down payment, and 90% LTV is not uncommon.
  • 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!
  • 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:

  • 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.
  • 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).
  • 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.
  • 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:

  • 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.
  • 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.

21 responses to “Investor Financing Options”

  1. Calla Gold says:

    I liked the clearly stated descriptions of each of these borrowing options. In the lending world I’ve experienced the truth of what the author says.

    It’s nice to read a non-gobble-de-goop write up of an area that can be so confusing. This is simple and full of helpful data.


  2. The third and largely overlooked downside to equity partners is securities law. By promising to profit share with a largely passive investor, you’ve created a security, and may be subject to SEC rules and guidelines. Most equity investor seekers miss this, because the system is such that the SEC doesn’t come hunting around, and thus many are unaware of what lurks. Everything might be going fine, but if the deal goes sour, investor money is lost and they talk to an attorney, one of the first things the attorney is where the Private Placement Memorandum or other offering docs are. All of a sudden you (the person who offered the equity security) may now owe them the full amount of their investment immediately, even if it lost value and they were aware of this possiblity.

    Making sure people are aware of this!


  3. mo says:

    Interesting. I’d like to hear how one goes about getting a portolio lender. I’m currently going about seeking financing right now.

  4. Aly L. says:

    Thanks for such an informative blog! The information is very helpful.

    I have 2 rental properties, one purchased with cash, the other with a conventional mortgage. I’m now looking into rehab/resale properties. It looks like portfolio lenders or HMLs are the way to go. Have you used either one? Can I ask how you generally finance your flips? Thank you.

  5. J Scott says:

    Hi Aly –

    I currently use a “rehab lender” (a small bank that makes loans specifically for the purpose of acquisition and rehab of properties) for all my purchases. All loans are short-term (12 months, interest-only), with decent terms (1.25 points upfront and 6.75% interest), and requires 20% down from me on each property.

    So, for a typical property of mine that I purchase for $50K and expect to put $30K of rehab into it, I will need total funding of $80K. The rehab lender will provide 80% of that ($64K), I’ll provide 20% ($16K), and I’ll pay 1.25 points upfront ($800) and 6.75% interest for 12 months.

    I’m not sure where you live, but I’m guessing there are small banks (literally one or two branches) that would provide these types of loans in your area. Feel free to shoot me an email if you’d like more detailed info (

  6. FigenM says:

    Hi Scott:

    I have been visiting your web site on and off for almost a year. It is always like a fresh air when I stressed out with my rentals and rehabs. Thank you so much for tremendous info that you are providing for all of us.
    I have a question about financing your flips considering the everchanging lending market. Are you still using rehab lenders ? How are you financing nowadays ?

    Thank you so much
    Figen M.

  7. J Scott says:

    Figen –

    I’m still using one specific rehab lender. They’ve provided me a “line of credit” where I basically have a fixed amount of money that I can use to purchase rehab properties. Each purchase is treated as a separate loan, and I’m required to come to the table with 20% of the total acquisition plus rehab cost. In other words, if I buy a $50K property that needs $30K of work, I come to the table with $16K (20%) and they finance the other $64K (80%).

    Each loan is 12-months interest only, with a rate of Prime + 1.25% (and a minimum 6.75%). So, these days I’m pretty much just paying 6.75% on the loans, as Prime is still well below 5%.

    My line of credit is enough that I can essentially do about 4-5 properties at once, strictly using the rehab financing.

  8. Mark L. says:

    J Scott, The info you provide is very insightful and excactly what novice investors need. I know you mentioned you were not a guru, however the specific details far outweigh what some so called gurus provide. I must imagine the time it must take to maintain this website and run your business,WOW… I want to thank you!

  9. J Scott says:

    Thanks Mark,

    I always appreciate the kind words!

  10. SheMor says:

    Ditto what Mark L said! I am totally impressed by all of your write ups. I love that you are so straightforward and aren’t trying to “Sell” a gimmick. You seem to be the most down to earth Flipper/Real Estate Investor out there! Great information.

    Thank you,
    from a semi-novice real estate investor

  11. J Scott says:

    Shelina –

    Thank you for the kind words!

  12. Tomas Janik says:

    J. Scott,
    as most people here, I also do appreciate all the hardwork you put to maintain this website for us and to share your every experience with all of us!
    Tremendous source of information!!! Very admiring.

    Wish I could find partner like you to team up here in Bay area:))

    Wish you best of luck!!!

  13. Pat Tompkins says:

    J. Scott

    I can’t thank you enough for all the resources you provide on this site. I’m just getting into the game, and I’m talking with a couple equity investors to get myself started, as I don’t have a down payment available for a conventional loan but your site has been an invaluable wealth of information. Thanks again for your commitment, I’ll be posting much more in the near future I’m sure.


  14. J Scott says:

    Good luck, Pat! Let us know how it goes…

  15. Patti says:

    I am getting my foot in the door, so to speak and I have a question. I do have good credit however, I don’t have a down payment. What do you think of using a hard money lender for the first few deals and then using a rehab loan?

    Thanks for the great site!!!


  16. mark says:

    my wife and I are looking into flipping homes as well , but we have very little funding.
    when seeing that there is other option , such as Portfolio/Investor Lending . my wife lost her job with A.I.G and just gets unemployment and I have my own Drywall and Painting business but things have been very slow. So if anyone out there may know an investor that would be willing to look at my Ideas please drop me an e-mail I’m looking to make lots of money and go half on profits ..

  17. Skye Smith says:

    With portfolio rehab loans, Is the money disbursed in several increments, only AFTER a certain amount of work is completed? A friend of mine claims that she mistakenly took out this type of loan in the past, without understanding that she had to spend her own money upfront.

  18. Skye Smith says:

    And a second question, she also said her money draws were disbursed directly to the contractor, even though it was her loan. Is this how all of them work?

  19. J Scott says:

    Hi Skye,

    Yes, the banks are going to want to protect their investment, which means they’re not going to release the rehab funds until they’ve verified that the work was successfully completed (they’ll send someone to do a visual inspection).

    While one option is to pay out-of-pocket for the work and then be reimbursed by the bank, the other option is to negotiate with your contractors to pay them after the work is done (and after the bank pays you). Oftentimes, the banks will be willing to do several inspections and release funds over several draws, so you’d be getting money every week or two (or three); if your contractors know this, they may be willing to wait a week or so after the job is completed to get paid. This is the way that many rehabbers do it with their contractors.

  20. J Scott says:

    Hi Skye,

    With respect to the second question, it really depends on the bank. Many will give the money directly to you (to pay the contractors), but I imagine that there are some that will want to pay the contractors directly, based on invoices you’ve received. This is something you should discuss with your bank upfront to make sure everyone is on the same page. Also, if the bank is to pay the contractor directly, this may be an incentive for a contractor to work with your payment schedule, as they are getting their money directly from the bank, which means they should have less concern about not getting paid.

  21. Michael L says:

    Hi J Scott,
    Really appreciate the time and effort you put forth for all of us to enjoy and benefit from. I just started doing research about keeping our current house as a rental, while purchasing a new primary residence. Your page has opened up a lot of possibilities in my mind. Thank you!


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