Most real estate investors don’t have enough money to buy properties with cash. Additionally, when you use debt as leverage, you can amplify returns. For both of these reasons, investors often ask me: what is the easiest mortgage to qualify for?
For investors, hard money loans are the easiest to qualify for, as the lender solely looks at the deal—not your personal finances. FHA loans are the best mortgage option for homeowners, as they have a lower down payment and credit requirements. Other mortgage options exist but have drawbacks.
But which should you use, and what are the criteria for getting approved? Let’s answer these and a few other questions that homeowners and real estate investors need to know.
EASIEST MORTGAGES FOR INVESTORS: HARD MONEY LOANS
Without a doubt, hard money loans serve as the absolute easiest mortgages for investors. And this easy-to-qualify nature comes from what hard money loans are.
What Is a Hard Money Loan?
When new real estate investors hear the term hard money, they often assume hard refers to difficult. In reality, a hard money loan uses the hard asset—the property—for lending criteria.
With your typical mortgage, lenders certainly look at the property itself. That’s why you need to complete an appraisal during the closing process. Lenders want to ensure that they can foreclose on the property and sell it to recoup the outstanding loan balance in the event of default. However, with these standard mortgages, lenders also look at all borrowers’ personal financial information. They’ll want to see credit scores, income verifications, debt-to-income (DTI), and anything else to feel comfortable lending money. Bottom line, these lenders look at all of your “soft” financial and credit qualifications in addition to the property itself.
When issuing loans, hard money lenders solely look at the property—the hard asset. As long as the borrower doesn’t have any bankruptcies or a criminal background, these lenders don’t worry about credit. Hard money lenders just want to know if it’ll be a good deal. As long as you have a suitable property, you can qualify for a hard money loan.
How Do Investors Qualify for Hard Money Loans?
House flippers primarily use hard money loans for short-term financing. Typically, investors use these loans for six months to three years, depending on the particular deal. But, regardless of the term, investors use hard money loans to finance the acquisition and rehab of a property that they plan to A) sell or B) refinance with a conventional mortgage and rent.
Every hard money lender uses a slightly different qualification process. But, they all share an emphasis on the quality of the actual property. For context, I’ll discuss how investors can qualify for our hard money loans:
- Step 1 – Determine the property’s ARV: The quality of the property drives hard money financing. As a result, we’ll want to see the after-repair value (ARV) first. We’ll use independent real estate professionals in your area and local comps to determine a property’s ARV.
- Step 2 – Determine the max hard money loan: We loan up to 70% of a property’s ARV. For example, if we assess ARV at $300,000, we’ll lend up to $210,000 in hard money ($300,000 ARV times 70%).
- Step 3 – Determine how much cash you’ll need out-of-pocket: Continuing the above example, if your property’s purchase price and total rehab costs are less than $210,000, you can finance 100% of this deal. However, say the total budgeted costs come out to $220,000. You’d need to commit $10,000 of your own cash to the deal ($220,000 total costs minus $210,000 total hard money funds).
As you can see, none of the above steps involve analyzing your credit and financials. As hard money lenders, we just want to make sure that the deal itself makes sense.
WHY DO HARD MONEY LOANS HAVE HIGHER INTEREST RATES?
Hard money interest rates exceed those of your standard 30-year mortgage. Hard money lenders charge higher rates for two main reasons:
- Risk: Hard money lenders assume far more risk than conventional lenders by not basing loan qualifications on borrower financials. Additionally, we base our loan on the future value of a property—the ARV. If you fail to complete the rehab as planned, we need to recoup our costs with a partially renovated property.
- Profit: Due to their short-term nature, hard money loans have a far shorter profit period. With a 30-year loan, lenders can view those interest payments as long-term income. Hard money lenders have a far briefer period to make money on each loan, meaning that they need to charge higher rates to justify the risk.
However, in exchange for these higher borrowing costs, investors gain the following benefits from hard money loans:
- Speed: Investors can close hard money loans within 10-15 days, far faster than the 30-45 days required to close a conventional mortgage.
- Flexibility: As private lenders, hard money lenders can offer borrowers far more flexible repayment options than traditional mortgage lenders.
- Reduced hassle: Due to the less stringent qualification requirements, hard money loans require far less administrative hassle to close. For investors completing multiple deals every year, this can add up to massive amounts of time and energy saved.
EASIEST MORTGAGES FOR HOMEOWNERS: FHA LOANS
If hard money loans are the easiest loans for investors to qualify for, FHA loans are absolutely the easiest for homeowners. By homeowner, I mean people looking to purchase a primary residence, not an investment property.
What are FHA Loans?
FHA stands for the Federal Housing Administration, a government agency designed to promote homeownership by insuring loans issued by private lenders. The FHA has a list of approved lenders, and these lenders offer FHA-insured loans. These loans are designed to provide low- to moderate-income Americans with an affordable mortgage option.
This FHA insurance reduces the risk for these lenders. If a borrower defaults on a loan, the FHA will reimburse the lender a portion of the outstanding loan balance. In return for this protection and reduced risk, FHA-approved lenders offer:
- Lower down payment: Conventional mortgages require a 20% down payment. Borrowers can qualify for FHA loans with as little as 3.5% down.
- Lower credit score: You only need a 580 credit score to qualify for an FHA loan—lower than most conventional requirements. And even if you have a score between 500 and 579, you can still be eligible, but you’ll need to increase your down payment to 10%.
- Sellers can cover closing costs: Closing costs can add up to thousands of dollars (or more). These costs can make home buying unaffordable for many Americans. As a result, the FHA permits sellers to cover closing costs in a home sale. This means that borrowers can save thousands of dollars in out-of-pocket cash at closing.
Drawbacks To FHA Loans
While FHA loans are easier to qualify for, they have one major drawback. Borrowers need to pay a mortgage insurance premium to the FHA. To protect lenders in case of default, the FHA requires to charge borrowers a premium. The FHA then uses these premium payments to fund payouts to lenders.
For borrowers, this annual payment is typically divided by 12 to determine the monthly pro-rata amount. The lender then applies that monthly premium to your mortgage payment each month. This means that you need to budget for higher monthly mortgage payments due to this added insurance expense.
HOW DO YOU APPLY FOR FHA LOANS?
First, you need to find an FHA-approved lender. If working with a local real estate agent, they can provide you with a list of reliable local lenders. Alternatively, a quick internet search will result in dozens of nationwide FHA-approved lenders.
Next, you’ll need to apply for the actual mortgage. This process entails submitting your financial and credit information to a lender. The lender will use this information to evaluate your application, just as it would for any other mortgage. For an FHA loan, lenders typically want to see DTIs of less than 43%. However, depending on the lender and the rest of your credit profile, you may be able to qualify with a DTI as high as 50%.
But, regardless of DTI and credit flexibility, FHA loans do not offer any flexibility on employment history. Lenders want to ensure that you can continue making mortgage payments. And, you can’t do this without reliable employment. As a result, most FHA-approved lenders will want to see at least two years of documented work history, preferably with the same employer. If self-employed, you’ll need at least two years of tax returns to prove self-employment income.
MORTGAGE ALTERNATIVES FOR INVESTORS WITH BAD CREDIT
As stated above, hard money lenders primarily concern themselves with the quality of the property. They will want to know if a borrower has filed for bankruptcy recently. Investors often will not qualify for a hard money loan in these situations. Accordingly, bad credit can prevent you from landing a hard money loan if that bad credit results from bankruptcy.
Alternative 1: Wholesaling
Mortgage alternatives do exist for these types of investors. The first option involves wholesaling properties. Wholesaling doesn’t require investors to purchase properties, so they don’t need to qualify for loans. Instead, they find off-market properties, and they enter contracts to buy these properties. However, rather than close on the properties, they assign the contracts to a third party, typically a fix & flip investor, for a fee. As such, wholesalers find deals, connect the sellers with investors, and collect a fee in the process without dealing with the headaches, risk, and credit requirements of qualifying for a loan.
Pursuing this strategy has a two-fold advantage for investors. First, you can wholesale properties to build capital for future investments. If you earmark a portion of the profit from every deal, you can build up the seed capital for future investments. Second, you can use your wholesaling period to rebuild your credit. While bankruptcies may seem like the end of your financial life, they don’t remain on your record forever.
Depending on what chapter you file, your bankruptcy will be removed from the public record either seven or ten years after filing.
Alternative 2: Find a Partner
The next alternative to personally qualifying for a mortgage entails finding a partner. Many real estate (and essentially all commercial real estate) deals involve partnerships. People pool their resources and/or skills under the umbrella of a separate legal entity, typically an LLC. For example, if an investment requires $100,000, but you only have $50,000, you may bring in another partner to contribute the other $50,000. Or, you may contribute your time by managing the property while another partner contributes the actual capital.
NOTE: The IRS does not recognize LLCs. A multi-member LLC is treated as a partnership (or S Corp, if elected) for tax purposes, and a single-member LLC is treated as a sole proprietorship.
You can also form an LLC with someone for mortgage purposes. If you can’t personally qualify for a mortgage, the other LLC member can apply in their name. But, investors need to understand that most residential mortgage lenders will not lend to LLCs—they want to lend to individual borrowers. Once again, this is where the flexibility of hard money lenders comes into play. Most hard money lenders have no issues loaning to an LLC. As long as they have the property itself as collateral, it doesn’t matter whether they lend to Joe Smith or Joe Smith, LLC, so long as one of the LLC members has a credit history without a bankruptcy.
MORTGAGE ALTERNATIVES FOR HOMEOWNERS WITH BAD CREDIT
As outlined above, FHA loans offer extremely flexible credit requirements. With a 10% down payment, borrowers can qualify with a score as low as 500. But what if you have a credit score lower than 500? Unfortunately, you likely won’t be eligible for any mortgages with credit scores that low, but alternatives still exist.
While rare, some sellers may be willing to provide you with financing directly. The buyer wouldn’t receive a loan from a bank or other mortgage lender in these situations. Instead, the seller would act as the lender. You’d agree to loan terms, and each month you’d pay the seller the agreed-upon monthly payment. This may work in related-party situations. For example, if a friend or family member wants to sell you a home, they may trust you enough to accept loan payments directly, regardless of your credit score.
This deal is somewhat similar to seller financing. However, sellers in this scenario retain the title, that is, ownership, of the house. Every month, the tenants pay rent, but the landlord applies a portion of every rent payment to the purchase price. Eventually, the tenant/buyer has the option—but not a requirement—to formally purchase the house.
For buyers with poor credit, this lease-to-own period has two benefits. First, it gives you time to rebuild your credit score. By the time you’re ready to execute the purchase option, you’ll have a better chance of qualifying for a mortgage. Second, you gradually build equity in the property so that by the time you need to apply for a mortgage, you’ll have a smaller down payment requirement. Unfortunately, it can be extremely difficult to find a seller willing to agree to this arrangement.
Before asking about the easiest mortgage to qualify for, borrowers need to ask why they seek a mortgage. For investors, hard money loans offer the easiest qualification terms. The speed you can close on one allows you to move on a deal quickly. For primary home buyers, FHA loans represent the best option. In addition to having lower credit requirements, these loans also require far less cash-to-close. You can use a lower down payment and ask sellers to cover closing costs.
Investors and homebuyers should recognize that alternatives exist to both mortgage options. While these alternatives may pose some obstacles, it may be worth the added hassle to purchase a property, depending on your unique situation.