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5 Types of Business Loans for Real Estate Investors
There are business loans to finance any real estate investment project from commercial property purchases at a large scale to traditional small business loans that cover regular maintenance for a long-term holding. Hard money loans have specific uses like purchasing a property to flip, while other financing options can be tailored to smaller to-dos like replacing minor details.
Here are five types of business loans designed for real estate investors, the situations when they make sense, and when to find alternate solutions.
- Traditional mortgage
- Hard money loan
- Line of credit
- Bridge loan
- Real estate brokerage loan
Traditional Mortgages
Traditional residential and commercial mortgages are the best option to buy property as they tend to offer the lowest rates and longest payback periods. The longer payback period combined with lower interest helps you to maximize cash flow and profit.
Pros:
- The ability to reduce payments over time to free up cash flow or pay less in interest
- Longer payback periods
- Lower interest rates
Cons:
- Long approval times
- May not get approved for fix-and-flip strategies
As a bonus, you can refinance the loan if rates go down, recast for lower future payments if you have idle cash sitting around, or do a cash-out refinance to get money for other projects.
Traditional mortgages don’t work well when speed is important given the lengthy approval, appraisal, and escrow process. This makes the traditional mortgage from a large bank or lender a bad option for flips, foreclosure auctions, and similar time-limited opportunities.
Hard Money Loans
Hard money loans are private funding from individuals or investment groups specifically for real estate investment properties. These loans have higher interest rates than traditional mortgages, charge higher points up front, and require larger down payments.
Pros:
- Fast approval processes
- Perfect for most fix-and-flip situations
- Lenders are familiar with real estate investing so more projects may get approved
- Large amounts of financing
Cons:
- High interest rates
- Short payback periods
- More restrictions on uses as they may have a say in the projects
The benefit to a hard money loan for real estate investing is they’re fast and can provide large amounts of funding. Hard money lenders also understand the nuances of this investment strategy, so they are more likely to see why you want the property vs. a traditional lender that only looks at the paper in front of them.
They’ll loan money for properties that traditional mortgage lenders would likely not approve, like buying a less-than-stellar renovation project.
Hard money can still be affordable despite the fees and rates, given the short timeline for most flips, but they’ll erode profits for any buy-and-hold or for renovations where you can’t pay the loan off shortly thereafter.
Hard money lenders may require that you follow specific rules for the funding or may want a say in the project and what is done. Part of the thrill of being a real estate investor is being your own boss. When hard money loans feel like you must give up control, a short-term loan from an alternative lender like renovation financing can be used to upgrade individual systems like HVAC.
Pro-tip: Monitor rental comps in addition to sales during your renovation process. If rental prices take off, you can get a traditional mortgage to pay off the hard money loan and keep the property as a buy-and-hold.
Line of Credit
Business lines of credit help with day-to-day expenses like advertising a property for lease, surprise emergency costs like fixing hurricane damage, and simple upgrade costs like refurbishing a bathroom. You get approved upfront for a set dollar limit and fair interest rate like a regular loan, you use it as you need it, and you pay interest only on the outstanding balance like you do for a credit card.
Pros:
- Flexible funding to use as you see fit
- You can use the money as needed
- You only pay interest when you use the line of credit
Cons:
- Likely not enough to purchase properties
- The interest piles up fast if payments are missed
- You may be subject to variable interest rates
- Hidden fees could include inactivity and late payments
The versatility of a line of credit makes sense for most real estate investing situations that do not involve buying the property, as it gives you access to immediate cash when you need it for almost any reason. A business line of credit can be used to fix a broken fridge, put in new windows, or replace the roof on a rental. You can even use a business line of credit to build out a retail space for your new tenant if you rent space, clean up a hazmat spill, or add EV chargers to your parking lot.
About the only thing this loan type won’t make sense for is purchasing property, unless you have a very large limit. Most properties will cost too much for a line of credit, so use a traditional mortgage that also comes with a lower rate.
Bridge Loan
Bridge loans are short-term loans that cover cash flow needs while you wait for full financing options to come through. They have higher interest rates than other loan types, but they also have fast approvals for when you need money in a hurry.
Pros:
- Fast approvals to cover deposits when speed matters
- Large amounts can be approved
- Fast payback periods to clear debts off your business credit profile
Cons:
- High interest rates
- You may need to have a strong financial record
- Having a backup funding source coming to pay it off quickly is vital
Bridge loans are a good idea for real estate investors when you need a deposit fast in a foreclosure auction or are in a bidding situation in competitive markets. They can also be smart when you have other financing that is almost certainly coming, as you can pay the bridge loan off with the new loan and get a lower interest rate and a longer term.
Bridge loans are also good for emergencies like fixing damage from natural disasters while waiting for the insurance payments to come through.
Bridge loans are not good for speculative investments like signing a purchase agreement when you’re hoping to flip the contract before closing. Without a solid cancellation clause in the contract, you could face costly legal fees, be forced to buy the property, and possibly be forced into bankruptcy if you can’t get funding.
Also, avoid bridge loans for real estate investing when you don’t have another funding source lined up. For example, don’t use one for immediate cash to beat out competitors in a hot market before you have approval on a mortgage. This could make the price too high for traditional lenders that have strict loan-to-value requirements where they can’t lend more than a percentage of the property’s appraised value.
For these situations, try to find equity partners where you can use your sweat equity to cover your part of the deal while they fund most of the purchase price. If the property is a fix-and-flip, a hard money lender that offers a bridge loan for the deposit and a hard money loan after can be a good option too.
Pro-tip: A bridge loan can sometimes be used to fund a reverse 1031 exchange when you have to close on the replacement property before you can sell your current one. It is helpful in situations where you’re waiting for a renter’s lease to finish.
Real Estate Brokerage Loan
A real estate brokerage loan is a type of small business loan that can give you the funds needed to get your own broker license as well as start-up funds if you want to turn it into a secondary revenue source that complements your investing activities.
Pros:
- Great for beginner investors who also want to be real estate agents
- Ideal for investors who list multiple properties each year
- Perfect for DIYers who want to get their real estate license or access the MLS
Cons:
- You’re stuck in a buy-and-hold situation which is not ideal if you invest in multiple properties
- The loan agreements can be limiting for the use of funds
A real estate brokerage loan makes sense when you want to own your own brokerage and when you list more than a few deals each year. You get to keep the extra percentage points of profit you’re paying another broker when you buy and sell without a third party. Setting up your own independent brokerage also gets you access to MLS, which can be a good source of leads for future acquisitions and to bring awareness to your properties for sale.
Your brokerage can be turned into a secondary revenue source and a competitive advantage for acquiring properties. By having a brokerage, you can shift from real estate investing to being a real estate agency as the markets shift, keeping your business flexible and afloat.
If a potential seller is skeptical about selling you their house for cash because they think it can sell on the open market, you can beat out other brokers by offering to list it and then guarantee them your cash offer if it doesn’t sell.
Brokerage loans are not a good idea for real estate investors if they don’t do multiple transactions or if all of their investments are buy-and-hold. Buy-and-hold is where the real estate investor has to find renters and keep properties maintained vs. fixing and selling for profit. In these situations, you don’t need a special license or a brokerage as you’re a landlord and not buying and selling properties on your own. Because this is a business-specific loan, the other options above are better for purchases, renovations, and other needs.
There is no shortage of options for a real estate investor to get financing, including hard money and bridge loans for fix-and-flips or business lines of credit for maintenance and repairs. The options above can help you with your real estate business no matter how big or small your needs are. Learn more about our real estate financing options here.
