Real estate investing can be an excellent opportunity to make a substantial amount of money —if you know what you are doing.
Whether you’re a new or a seasoned real estate investor, one of the biggest roadblocks you might encounter is the inability to secure an investment loan due to bad credit or little to no cash reserves.
This doesn’t mean that your dreams of becoming a real estate investor have to come to an end; there are still ways that you can invest despite having bad credit or no money.
Why You Need Good Credit For Real Estate Loans
When qualifying a borrower for a loan, the first thing a lender considers is your credit score. A lender, such as a bank or credit union, will request your credit score from one or more credit bureaus that you have engaged with, and will use that information to determine whether or not you are “creditworthy.”
Credit scores are affected by a multitude of factors, including foreclosures, bankruptcies, late payments, unpaid debts, high debt, and more. It’s important that you understand the typical credit score requirements used by lenders.
If you have a low credit score, a lender will be less likely to approve your loan since there is a greater risk that you may default.
Conversely, the higher your credit score is, the less of a risk you present to the lender, and this could result in higher approval rate for loans.
Lenders will calculate the terms of the loan, such as the interest rate, using your credit score. It’s worth noting that there are ways that you can improve your credit score.
Because real estate investments require large loans, lenders tend to have stricter credit score requirements. If you default on a real estate investment loan, the lender must undergo the foreclosure process in an attempt to recoup their money. This process can be time-consuming and expensive, and most lenders will do whatever they can to avoid this.
If a real estate loan from a bank or a traditional lender is unobtainable because of your credit score or your limited cash reserves, then you can still consider the following alternatives as a way to finance your real estate investment.
1. Hard Money Loans
Hard money loans are commonly used by real estate investors who plan on flipping a property, but who may not have enough cash or good credit score. Although credit scores are not usually a factor in determining creditworthiness for these loans, borrowers must still be eligible for the loan based on the quality of the deal and any cash reserves.
If you apply for a hard money loan, you will also need to prove that you can afford the monthly payments. In addition, because there is a greater risk for the lender, interest rates tend to be much higher compared to conventional loans.
Moreover, the loan term tends to be much shorter, which means you have less time to pay it back.
2. Private Money Loans
A private money loan is a loan from a family member, friend, or other associate. Both parties in the arrangement must agree to the repayment terms—otherwise it can lead to problems down the road.
If you decide to secure a private money loan from someone you know, make sure they understand the risks and that all the terms are in writing. Commission a lawyer to draw up the contract—doing so will both protect you legally and also ensure that your relationship is not strained due to a misunderstanding over the loan.
3. Invest With A Partner
Investing with a partner can help you bypass your credit score issues. If your partner has excellent credit, then they can qualify for the loan on behalf of both of you.
If you or one of your other partners has bad credit, it will not affect the ability of the other to qualify for a loan to secure joint ownership of the real estate investment.
With that in mind, the following are two types of partnerships that you can enter into:
A limited liability company (LLC) is a business structure classified as its own legal entity. LLCs have the tax benefits of a partnership, but with greater protection from personal liability since it is treated as a corporation. In some states, a LLC can be formed by just one person.
Although lenders will still appraise personal credit, they do not calculate the credit of every member in the LLC. Therefore, as long as one of the members of your company has good credit, you should be able to secure a loan under your LLC.
A limited partnership cannot be formed by just one person. It must be formed by a general partner and a limited partner, where the general partner will be held personally liable.
A limited partnership can be useful in securing a loan if one partner has good credit, but the other partner has poor credit. The partner with good credit can become the general partner, and therefore secure the loan. Keep in mind, this partner will be held personally liable for all the debts and any other obligations in the partnership.
4. Use Seller Financing
If you are unable to secure financing from a bank or credit union, seller financing is an option. Seller financing allows you to cut out the middleman (the lender) and secure financing through the seller. Of course, the primary challenge with seller financing is finding a seller willing to do this.
First of all, the seller could end up facing foreclosure if the buyer defaults. Secondly, even if they don’t, they’ll have to go through the process of putting the house back on the market. This process is not only time-consuming, but costly as well. As a result, most sellers don’t want to take the chance to finance the buyer themselves.
With that in mind, the following are three types of seller financing options to consider:
Contract for Deed
A contract for deed is relatively simple. When the buyer agrees to purchase the property, they will acquire possession of the property right away. However, they will pay the seller in installments over a specified period of time.
Until the property is paid off, the seller will retain the legal title. You don’t need good credit for this seller financing option since you can bypass the lender; you’ll just need enough money to pay each installment when it’s due.
Subject-to financing is another option to circumvent the requirements for a good credit score when buying property. A subject-to contract allows the buyer to take over the seller’s existing mortgage. You would be paying off the seller’s mortgage for them until it is completely paid off. There are numerous advantages to such an agreement.
As the buyer, you wouldn’t have to worry about your credit score, nor would you have to pay any traditional closing costs. However, you would have to agree on how to pay the difference between the price of the house and the remaining balance on the existing mortgage.
For example, you could pay the difference in cash up front. Or you could pay the difference in an arranged installment plan with the seller once the mortgage has been paid off.
Seller Carry Notes
A seller carry note is a written agreement which dictates that the seller will finance the buyer. Essentially, you would borrow money from the seller to buy their property. The seller becomes the lender.
It’s important to understand that most sellers will require a higher down payment (often 25%) and charge a higher interest rate than traditional lenders would since they are taking on a greater risk.
5. Consider Wholesaling Investing
Wholesaling is all about finding multiple real estate investment opportunities. As a wholesale investor, you would look for owners who are motivated to sell. Once you identify a motivated seller, you would agree to a deal and lock them into a contract.
Once you obtain the contract, you can sell that contract to another investor for a profit. Essentially, you position yourself as a middleman by helping sellers find a buyer and providing investors with real estate investment opportunities.
Wholesale investing can be beneficial for several reasons:
- You don’t need a significant amount of money to invest
- You can find multiple deals at a time, which means you could potentially make a significant profit
- There’s less risk involved since you’re not buying the property yourself
The drawback is that you’ll likely have to offer the seller earnest money. Otherwise, the seller may see no reason to trust you to find a buyer.
Bird-dogging is similar to wholesaling. Like wholesaling, bird-dogging involves looking for real estate investment opportunities. The difference between the two is that with bird-dogging you don’t have to provide any cash to lock the seller into a contract.
Instead, you pass along any deals you find to other investors for a commission. You may not make as much money using this method, but it also doesn’t require any money up front, which means you don’t have to worry about securing any loans.
7. Lease Options
A lease option is a contract between a landlord and tenant, where the tenant can purchase the property at any time during their lease after they have lived there for a predetermined period of time.
Lease options are beneficial for credit-challenged borrowers because the borrower doesn’t need to buy the house right away. Essentially, you’ll rent the property until you are ready to purchase it, thereby giving you time to repair your bad credit score.
Don’t Let Bad Credit Prevent You From Investing In Real Estate!
Don’t let bad credit crush your dreams of investing in real estate. Just because a bad credit score keeps you from qualifying for a conventional real estate loan, it doesn’t mean that all hope is lost! You can always improve your credit score—and it is worthwhile working towards that over time.
In the meantime, there are plenty of other ways that you can secure financing for your investment property, despite your bad credit!
Here at Pine Financial Group, we understand real estate investors face unique and evolving challenges when it comes to financing their real estate investments. Having the money ready to fund your transaction is getting tougher and more important than ever, and because we only succeed when our clients do, we are dedicated to helping you make money.
Being in business since 2008 with thousands of completed transactions gives us the unique qualification of being your go-to hard money lender. We would love to help you get your next deal closed.