1. Debt Financing

What It Is:
Debt financing involves borrowing money from a bank or institutional lender to purchase real estate. The investor repays the loan over time with interest, typically using rental income from the property.

Example:
Sarah wants to buy a rental property for $300,000 but only has $60,000 for a down payment. She applies for a mortgage and borrows the remaining $240,000 from a bank. The monthly rental income from tenants covers her mortgage payments, taxes, and other property expenses.

Why It Works:

• Allows investors to acquire properties without needing the full purchase price upfront.
• Helps scale a real estate portfolio by leveraging borrowed capital.
• Mortgage interest may be tax-deductible, reducing taxable income.

Key Considerations:

• Banks typically require a 20-25% down payment for investment properties.
• Credit score and debt-to-income ratio impact loan eligibility and interest rates.
• Fixed-rate loans provide stable payments, while adjustable-rate mortgages (ARMs) may fluctuate.

2. Private Lenders

What It Is:
Private lenders are individuals or companies that provide real estate loans outside of traditional banks. These loans are often short-term, with higher interest rates and flexible approval processes.

Example:
Mike wants to buy a fixer-upper for $150,000, but the bank rejects his loan due to his low credit score. Instead, he secures financing from a private lender, who provides the full amount within a week, but at a higher interest rate than a bank loan.

Why It Works:

• Faster approval and funding compared to banks.
• Flexible loan terms for borrowers who may not meet traditional bank criteria.
• Suitable for short-term investors, such as house flippers.

Key Considerations:

• Interest rates are typically higher than traditional bank loans.
• Loan terms are often shorter, requiring repayment or refinancing within a set period.
• Private lenders may require additional collateral or guarantees.

3. Hard Money Loans

What It Is:
A hard money loan is a short-term, high-interest loan from private investors or specialized lenders, secured by the property rather than the borrower’s credit. These loans are common for house flipping and bridge financing.

Example:
Anna finds a distressed home selling for $100,000. She borrows the full amount from a hard money lender, renovates the property over three months, and sells it for $200,000. After repaying the loan and covering renovation costs, she makes a profit.

Why It Works:

• Fast approval and funding compared to traditional bank loans.
• Focus on property value rather than the borrower’s credit score.
• Ideal for short-term investments like fix-and-flip projects.

Key Considerations:

• Loan amounts are typically based on a percentage of the property’s value.
• Higher interest rates and additional fees apply.
• Short repayment periods require a clear exit strategy.
• Failure to repay on time can result in foreclosure.

4. Seller Financing

What It Is:
Seller financing occurs when the seller provides financing to the buyer instead of requiring a traditional bank loan. Payments are made directly to the seller based on agreed terms.

Example:
John wants to buy a property for $250,000 but doesn’t qualify for a bank loan. The seller agrees to finance the deal, so John makes a $25,000 down payment and pays the remaining balance in monthly installments over several years.

Why It Works:

• Avoids traditional loan approval processes.
• Provides flexibility in structuring payment terms.
• Can benefit sellers by creating an additional income stream.

Key Considerations:

• Interest rates may be higher than conventional bank loans.
• Some agreements require a final large payment (balloon payment) after a few years.
• Proper legal documentation is necessary to protect both parties.

5. 1031 Exchange

What It Is:
A 1031 exchange, named after Section 1031 of the IRS tax code, allows real estate investors to defer capital gains taxes by reinvesting proceeds from a sold property into another investment property.

Example:
Lisa sells her rental property for $500,000 and reinvests the proceeds into a new rental property worth $600,000. Since she follows the 1031 exchange process, she defers paying capital gains taxes on the profit from the first sale.

Why It Works:

• Defers capital gains taxes, allowing for reinvestment of full profits.
• Facilitates portfolio growth without immediate tax liabilities.
• Enables diversification by exchanging different types of investment properties.

Key Considerations:

• Only applies to investment properties, not primary residences.
• The replacement property must be identified within 45 days and acquired within 180 days.
• A qualified intermediary must handle the transaction to ensure compliance.
• Taxes are deferred but not eliminated—capital gains taxes apply if the new property is later sold without another 1031 exchange.