Start-up capital is money people use before they start a business. It's used to pay for business-related expenses like hiring and paying staff, buying or renting office space, paying for a license or permit, marketing, and more.
The beauty of investing in real estate and starting a real estate business is that you typically don't have all those expenses to get in the game -- but you do need money (usually) to acquire the investment property and renovate or make repairs. So what's the best way of getting investment capital for real estate?
How to get start-up capital for your real estate business
The most basic way of getting start-up capital for your real estate business is to save it or maybe obtain it through an inheritance. If you have enough cash, you might be able to buy a property outright without needing to rely on any other financing method. If you can do that, besides typical expenses and carrying costs related to holding or flipping property, all the money you earn through the property is profit.
If you don't have that kind of money lying around, there are other ways of getting the capital you need for your real estate business. In real estate investing lingo, this is called using OPM, which stands for "other people's money."
Different sources of start-up capital
If you need start-up capital for your real estate business, you have several options. Below is a discussion of your options and the pros and cons of each.
Bank or credit union mortgage
Just as you might take out a mortgage to buy a primary residence, you can take one out for real estate investment property. If you're already a homeowner, you're probably familiar with this process, which is a plus.
You'll need to qualify for an investment property mortgage, though, and the requirements can be tough. You'll typically need a higher credit score and a lower debt-to-income ratio than for a primary home mortgage. You also might need to put down a larger down payment, and lenders might want to see a pretty significant sum of money in savings, such as 6 to 12 months of mortgage payments. Plus, after making it through all those hoops, you'll likely pay a higher interest rate than people with primary residence mortgages do.
If you own a home, you might be able to take out a home equity line of credit (HELOC). This allows you to use a percentage of your home's equity for whatever you like, including buying an investment property. Once you have a HELOC, you can use it whenever an investment property comes up without the sometimes-long wait that can happen when you apply for a mortgage.
The interest rate on a HELOC is adjustable, which is great when interest rates are low. You need to prepare for them to rise, though. If you miss your HELOC payment, you could lose your primary residence.
An FHA loan
An FHA loan is an option you have, but it comes with strings attached. The good thing about an FHA loan is the qualifications for a real estate investor are the same as they are for a primary homebuyer, unlike a regular mortgage. So you'd enjoy the relaxed qualifications of a lower baseline credit score and a low down payment.
The caveat is that you need to live in the property. The way investors do this is to buy a duplex, triplex, or quadplex and live in one of the units, renting out the other or others. (Note that if the property has more than four units, it's categorized as commercial real estate instead of residential real estate.) You need to live in this property for 12 months, after which time you can move, rent out your space, and then have the property as a purely investment vehicle.
Peer-to-peer lending lets you borrow money, typically up to $40,000, from people who sign up with a peer-to-peer lending site. These private money lenders are called investors. There are several peer-to-peer lenders, which you can find from conducting an online search. Prosper Marketplace is a big name, but there are more.
If you have bad credit, expect your interest rate to be high, about the same rate you would pay from using a credit card.
Hard money loan
Lots of investors use hard money lenders since the loan is not based on the borrower's financial picture; rather, a hard money lender uses the property as collateral. Hard money loans are also popular because the funds are typically available fast.
If you don't pay back the loan, the hard money lender takes the investment property. These types of loans are usually only for the short term. Flippers often use this vehicle to obtain and renovate a property and then pay back the lender after the sale. If you plan to hold the property, say as a rental property, for more than a year, you would probably need to refinance the loan.
Borrow from friends and family
If you have friends or family that would lend you money, you might consider this route. You'll probably not need to go through a credit check, and the process should be easy. The consequences if the deal goes bad and you can't pay back the loan, however, might be too great: You could alienate someone dear to you.
If you do borrow from friends or family, treat this as any other financial transaction by putting the deal in writing, and offer to pay the loan back with interest. That way, you both gain, and it levels the psychological playing field.
The Millionacres bottom line
Even if you don't have enough cash on hand to start real estate investing, you can still invest in real estate. You have options on obtaining start-up capital for your real estate business. Evaluate your options, choose the one that suits you best, and get in the game.