How to Finance Real Estate Investments for Beginners 

Understanding Real Estate Investment

Before you learn about financing a real estate investment, it’s crucial to know why people take the risk of buying property for profit and what they stand to gain.

What Is Real Estate Investment?

Real estate investing involves purchasing properties not for a place to live, but to generate profit through rental income, capital appreciation, flipping, or a combination of all three.

Real estate investors can work to grow their wealth through three avenues: 

• Residential real estate
• Commercial real estate
• Rental properties

Benefits of Investing in Real Estate

An investment in real estate offers the unique benefit of dual profit potential — investors can grow their wealth through passive income while also enjoying long-term capital appreciation. 

Real estate also diversifies portfolios by adding an asset class that is not tied to the stock or bond markets. Finally, real estate enjoys favorable tax treatment that the IRS does not extend to other asset classes.

Preparing for Your Investment

Real estate investing is not for everyone. Make sure you’re investing with a clear understanding of your capabilities and limitations, and that the time — and your financial profile — are suitable. 

Assessing Your Financial Health

Most real estate investors require ample cash and strong financial health. They typically don’t enjoy the many programs, benefits and offerings that are available to residential buyers, particularly first-time homeowners. 

Therefore, a thorough assessment of your financial profile is crucial. 

• Check in with your credit report, scour it for errors and get an updated credit score.
• Determine your budget and assess your cash savings — savings that you can stand to lose should your investment fail.
• Establish your investment goals — knowing why you’re investing in real estate will help you determine which avenue is right.

Researching the Market

Finding suitable locations and potentially profitable properties requires exhaustive market research, including: 

• Analyzing demographic and economic trends like population growth, income levels and employment prospects.
• Assessing market characteristics like appreciation levels, inventory and occupancy/vacancy rates.
• Understanding the neighborhood, its schools, amenities, services and crime rates.
• Gathering data on comparable properties.

Financing Options for Real Estate Investment

All the research in the world can’t get around the fact that in real estate, money talks — how are you going to finance your investment? 

Conventional Bank Loans

Investors can work with banks to secure conventional loans just like residential homebuyers, but the terms are rarely as forgiving. They typically require higher down payments of at least 20% to 30% with equally stringent standards for credit scores, debt-to-income ratios and income levels.

Conventional loans offer long terms, competitive interest rates, and a wide range of options with a familiar application process. However, they often require a larger down payment, excellent credit, and can take longer to approve.

Hard Money Loans

Flippers often pursue hard money loans, which can be useful for tight timelines. They are high-interest loans based on the property’s value, often issued by private lenders. The danger is in the clock. If the schedule drags out, hard money loans can quickly become too expensive to manage and the borrower can lose the property.

Private Money Loans

Many investors who enjoy a social network of people who are willing and able to help seek private money loans, often from family and friends. But money, of course, can strain relationships, so it’s crucial to have clear terms, written agreements and for the borrower to take the loan as seriously as they would had they borrowed from a bank.

Home Equity Loans and Lines of Credit (HELOC)

Some investors borrow against properties they already own to finance the purchase of investment properties. Tapping equity to purchase new assets can be a powerful tool — but one that comes with substantial risks.

Home Equity Loans

• Like personal loans, home equity loans provide a lump sum of cash that is repaid with agreed-upon interest charges through fixed monthly payments on a set schedule. 
• They’re often cheaper than personal loans, which are unsecured with rates tied to your income and credit — but there lies the danger. 
• Home equity loans are secured by your house, which becomes collateral that you can lose if you default. 

Home Equity Lines of Credit (HELOCs)

• HELOCs are more like credit cards than loans. They issue a line of credit that borrowers can tap, repay and then tap again throughout the HELOC’s term, which is typically five to 10 years. 
• They’re flexible and designed for ongoing projects with inexact costs, like renovations, perhaps for your new investment property. 
• Like home equity loans, HELOCs are secured by your home, which you could lose if you can’t repay what you borrow.

Government-Backed Loans

Qualified buyers can use certain government-backed loans to finance their real estate investments. 

FHA Loans

FHA loans are mainly for buyers who plan to live in the home and may not meet conventional loan requirements. Exceptions include buying a multi-unit property and living in one unit or renting out a home after a year due to a necessary move.

VA Loans

Veterans, active-duty service members, and surviving spouses can use VA loans for income-generating properties if the home is their primary residence. This includes renting out rooms, living in one unit of a multi-unit property, or renting out a single-family home after living in it for at least a year.

3 Steps to Secure Financing

Position yourself to secure favorable financing by following these steps.

Building a Strong Credit Profile

Your credit can make or break nearly any deal, so build your profile and increase your score by: 

• Paying all bills on time, every time
• Reducing existing debt
• Reducing your debt-to-income ratio
• Lowering your credit utilization

Saving for a Down Payment

The larger the down payment, the less risk you pose to lenders.

• Automate your savings to an FDIC-insured account — don’t invest it! 
• Create a specific bucket that is separate from your other savings
• Cut spending wherever possible and contribute the difference
• Explore down payment assistance programs

Gathering Necessary Documentation

While you’re saving, prepare for the tedious, intrusive and exhaustive underwriting process by getting your paperwork in order now, including:

• Proof of income
• Tax returns
• Bank statements
• Investment statements  
• Loan documents

Evaluating Potential Properties

With financing in place, it’s time to undertake the challenging yet necessary task of evaluating properties that may be worth investing in. 

Analyzing Property Value

Once you’ve used the previously covered market-analysis strategies to choose a few properties with strong potential, you must assess their value and that of the surrounding properties. 

This requires a comparative market analysis and a thorough examination of the property’s condition –how much will you have to spend to repair, renovate, and refurbish the property, and how much will that take from your overall budget? 

Calculating Expected Returns

If you’re pursuing passive income, it’s time to estimate the fair market value of your monthly rent and how much rental income you stand to earn. You must incorporate inevitable costs like: 

• Maintenance and repairs
• Taxes
• Advertising
• Utilities 
• Legal fees
• Property management
• Vacancies and tenant turnover

Managing Your Investment

When you buy a property, you have two options: Manage it yourself or hire someone else to do it for you. 

Property Management Options

Self Management

Self-managing landlords get to keep all of the profits and retain full control over the property, but must be qualified and willing to handle: 

• Being available 24/7 for tenant emergencies and maintenance issues
• Tenant communication
• Financial management 
• Advertising and marketing
• Legal compliance
• Nonpayment and evictions
• Tenant screening
• Competition

Professional Management

When you hire a professional management company, they share in the profits and assume a degree of control, but:

• You recover countless hours that active landlords lose.
• They bring expertise, connections and experience, which can prevent costly problems.
• They can reduce costly vacancies and limit turnover.
• You outsource the stress and worry that are inherent to the life of a landlord.

Legal Considerations

One of the primary reasons why investors hire professional property managers is that they bring institutional knowledge of the complex and potentially costly legal considerations that come with real estate investing, including: 

• Landlord-tenant laws
• Insurance coverage
• Ownership structures
• Financing
• Real estate laws
• Contract law

Challenges of Real Estate Investing

Just as real estate investing offers unique benefits, it also presents dangers and obstacles that other investors may avoid.

Market Fluctuations

Like the stock market, the housing market is subject to numerous influences that are beyond the investor’s control, including: 

• Fluctuating property values
• Changing economic conditions in the neighborhood, including incomes and job opportunities
• Under- or over-development
• Zoning changes
• Population decline

Dealing with Vacancies

Vacancies are the bane of passive-income real estate investors. Upon purchasing a property, it’s imperative to implement strategies for building tenant relationships, conducting proactive maintenance and attracting good tenants and screening them effectively.

Maintenance and Unexpected Expenses

The term “capital expenditure” refers to money set aside for inevitable but unpredictable expenses associated with owning property, and real estate investors must factor it into their budgets.

No investor will succeed in the long term without emergency reserves for maintenance, repairs, tax increases, legal fees and the many other fires that every property owner must use money to put out for as long as they own the structure.

Quick Tip: Steps to Start Investing in Real Estate

Thinking about buying property to build wealth? Here’s a simple breakdown to help you get started:

• Check your credit and overall financial health
• Save for a down payment and build an emergency fund
• Research different property types and investment strategies
• Explore your financing options (FHA, VA, conventional, etc.)
• Decide whether you’ll manage the property yourself or hire help
• Start small–consider house hacking or a single rental unit first

These steps can help you move from idea to action with more confidence.

Chris Seabury contributed to the reporting for this article.