The first step in buying your dream home is learning about the ins and outs of real estate loans. 

A real estate loan, which is also referred to as a mortgage, is commonly used by homebuyers to finance real estate. When approved, borrowers sign a legal document (known as a mortgage note) that promises to repay the loan, with interest and other costs over a period. A real estate loan is generally one of the least expensive ways to finance a home, but it can also be one of the more intimidating processes a beginner homebuyer undertakes.

Even when seeking real estate investment loans, it is crucial to understand the importance of preparation. The process of applying (and being approved) for a mortgage loan can be both time-consuming and complex, as it requires an immense amount of time, paperwork, and patience to complete. However, there are a few preliminary tasks homebuyers can do to make the process smoother. Read through our guide below to learn how to get a real estate loan today.

What Is A Real Estate Loan

A real estate loan is financing used to purchase a property, and there are several types available to aspiring homeowners and real estate investors alike. Each loan type will come with different approval requirements, interest rates, and terms. It is crucial to investigate the options available to you before deciding on one. Pay attention to the terms of each loan type to make sure you choose the right one for your situation. While real estate loans most commonly refer to traditional mortgages, there are several ways to finance a property.

Real Estate Investment Loans

A real estate investment loan simply refers to financing that is used to purchase an investment property, rather than a primary residence. While there are a few loans that cannot be applied to investment properties, investors have access to many financing options. Additionally, investors may have more freedom to choose options with higher interest rates or shorter loan terms, depending on the performance of a given deal. Here are a few types of real estate investment loans to investigate:

Traditional Loans: Traditional loans, or mortgages, are granted by banks and other lending institutions. These loans typically have approval standards based on your personal financial history, and they often fail to take future rental income into account. With traditional loans, investors are also required to put 20 percent down on a property (or pay private mortgage insurance).

Private Money: This loan type refers to investors lending capital to other investors. The incentive for providing a private money loan is to earn money through interest as it is paid back. This setup is common among real estate investors because the approval timeline is often quicker (and in some cases more relaxed) than other financing options.

Existing Home Equity: Another option available to investors is to tap into their existing home equity. This can be done through a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance. Each of these three options has slightly different approval requirements and loan stipulations but they essentially operate the same. Investors who use these loan types are essentially able to tap into their existing equity to purchase another property.

Qualifying Investment Loans: There are also financing options available to investors who meet certain requirements, or who are willing to purchase property in certain areas. These loan types include the VA loan, USDA loan, 203k loans, and more. While these options are not available to everyone, there are certainly worth looking into as they can offer several favorable loan terms.

Hard Money Loans For Real Estate

Hard money loans in Arizona real estate are a good option for investors hoping to secure access to financing without going through a lengthy approval process. Unlike a traditional real estate loan, hard money loans are secured by collateral (rather than a borrower’s ability to repay). This means if the borrower were to default on loan payments the lender would sell the asset—in this case, a property. Hard money loans are known to have high interest rates and typically only last from one to five years. However, they remain an attractive option for real estate investors hoping to secure short term real estate loans.

Crowdfunding Real Estate Loans

Crowdfunding real estate loans allow investors to finance deals using smaller contributions from multiple potential lenders. Crowdfunding transactions are typically completed online and can be done using several social media platforms. The appeal of crowdfunding a deal is that it allows real estate investors to expand their network while also utilizing a nontraditional finance option. Crowdfunding real estate loans also allow investors to promote their businesses, as they are marketing the success of given deals.

Real Estate Bridge Loans

Bridge loans, otherwise known as gap funding, are temporary financing options secured by an investor’s existing property. They can be used to buy new real estate before the previous property sells. This set up allows investors or homebuyers to “bridge” the gap from one property to another without worrying about simultaneously selling and buying. There are a few drawbacks to bridge loans, particularly the fact that they can be more expensive than utilizing other loan options. Borrowers will also be responsible for payments on their existing mortgage or loan, in addition to the bridge loan.

How To Qualify For A Real Estate Loan In 10 Steps

The road to homeownership starts with financing, as this will determine everything from your budget to timeline when it comes to buying a home. Luckily, there are a few steps aspiring homeowners can take in advance to get the process started. Read through the steps below to learn how to qualify for a real estate loan:

1. Check Your Credit

The first step to obtaining a real estate loan begins with checking your credit. The process includes pulling your credit report to evaluate where your credit score stands, as this three-digit number is a necessary ingredient to borrow money from a traditional lender.

“Credit scores are a crucial component of the home buying process, impacting everything from the size of a mortgage payment to the interest rate on a home loan,” said Senior Vice President for TransUnion, Ken Chaplin. “People with subprime credit may face financial barriers to homeownership, making it difficult for their dream home to become a reality.”

Several credit scoring models have their own evaluation systems. FICO, the most common scoring model, will analyze a credit score in points, with a range of credit scores: bad credit (300 – 600), poor credit (600 – 649), fair credit (650 – 699), good credit (700 -749), excellent credit (750 – 850). The calculation of a credit score will typically consist of five major factors:

Payment History = 35 percent

Outstanding Balances = 30 percent

Length of Credit History = 15 percent

Types of Accounts = 10 percent

Credit Inquiries = 10 percent

A low credit score won’t automatically disqualify you from a home loan or real estate deal, but it will affect several key factors of your loan, including the size, mortgage rate, and access to certain loan programs. A quality credit score is a great asset for homebuyers and one they can continuously work to improve.

2. Perform A Credit Audit

Once you have pulled your credit report and confirmed your credit score, it’s now time to perform a credit examination. This process is essentially taking a highlighter to your credit report to outline what you did right, where you went wrong, and noting how you can improve. This step is commonly carried out in the beginning stages of applying for a home loan, as it can sometimes take weeks, months, and even years to make the necessary adjustments.

3. Dispute Inaccuracies, Late Charges & Negative Information

Now comes the time to fight inaccuracies on your credit report. Because negative information can adversely affect your chances of securing a real estate loan, it’s critical that homebuyers not only review their credit report but examine and verify everything is correct.

Homebuyers seeking to dispute inaccuracies are recommended to contact both the credit bureau and the company that provided the information to the bureau. Under the Fair Credit Reporting Act, these two entities are responsible for rectifying inaccurate or incomplete information on your credit report. In most cases, this can be completed in two steps:

Step One: Contact the credit bureau and inform them of the information you believe to be incorrect. Along with providing your complete name and address, this should include identifying each item in your credit report you dispute, an explanation of why you dispute the information, and a request for correction. This should also include copies of any related information to your dispute.

Step Two: Contact the appropriate creditors and explain you are disputing the information they provided the bureau. This also includes sending copies of documents that support your position.

4. Pay Off Debt

Another element to obtaining a real estate loan is debt-to-income. Lenders will compare how much you make versus how much you spend, to determine how much you can reasonably afford. In most cases, lenders will not approve a homebuyer if their debt is more than 36 percent of their income, with some lenders requiring more stringent debt-to-income ratios. There are generally two types of debt-to-income ratios that lenders look for:

Front-End Ratio: This relates to housing costs, including the percentage of income that goes towards the expense.

Back-End Ratio: This ratio reveals how much a potential homebuyer’s income goes to debts, such as credit card bills, car payment, child support, student loans, and other debt.

When preparing to apply for a real estate loan, the best thing a homebuyer can do is reduce the amount of money they owe. Reducing the balances on credit cards or other financial obligations will help to lower the percentage of your income that goes towards paying monthly debt. In essence, this will help to free up credit, including the amount of money you can borrow.

5. Determine What You Can Afford

A common mistake homebuyer make in the beginning stages is looking for the home they desire, rather than what they can comfortably afford. While lenders will have lending guidelines in place to determine the amount of money you can borrow, it’s also important that buying a house makes financial sense for you and your family. That said, potential homebuyers must consider both their current (and future) finances when getting started. In some cases, renting may be a better option compared to buying, so it’s important to compare the costs of renting vs buying to gain a better understanding of where you stand.

6. Gather Work History

Employment history is another important factor in obtaining a real estate loan. Lenders will want homebuyers to have at least two years’ history with a company, but it’s not an absolute. Lenders will consider several factors, including if you were in school, military service, or switching career fields.

The purpose of gathering work history is to verify you have a reliable source of money coming. Lenders are essentially determining your risk level, including whether you have the ability to make your monthly payments.

7. Assemble Income Information

Like work history, another component to securing a real estate loan is verifying your income. Homebuyers should assemble their income information, including pay stubs, tax returns, bank statements, brokerage statements, work contracts, and other documentation to verify their source of income. This step is crucial to not only determining how much you can afford but confirming that you can make your monthly payments.

8. Down Payment

The next step in applying for a real estate loan is the down payment. The amount a homebuyer pays⁠—somewhere between three percent and 20 percent of the home’s price⁠—will depend on a combination of factors, including credit and financing. Loan-to-value ratio (LTV) is another aspect that lenders look at. This ratio, which compares the value of the home with the value of the loan, is used by lenders to assess the amount of exposed risk they are taking on with the mortgage. For example, a low LTV ratio would create higher mortgage payments each month, as you have less equity ownership in your home.

Aside from the down payment, homebuyers will also need extra funds to pay for closing costs and other obligations in the home buying process. Additionally, it is important that potential homebuyers avoid opening up any new lines of credit during this process, as it can affect your chances of being approved.

9. Compare Lenders

The second-to-final step in securing a real estate loan comes down to simply comparing your options. Whether that entails researching lenders or asking friends and family, you must take the time to examine your choices, as each lender will handle different types of loans. Remember, not all lenders offer the same loans, so homeowners need to conduct their due diligence when buying a home, especially when finding a lender.

10. Get Pre-approved, Not Pre-Qualified

The last step to obtaining a real estate loan is getting pre-approved. This process differs from getting pre-qualified, which does not require access to your financial information. Getting pre-approved lets lenders run your credit and review your finances.  Its important potential homebuyers understand the difference between pre-approval and pre-qualified, as one will provide a much more accurate estimate of your potential loan amount. By taking the time to meet with lenders and review your personal finances, you can increase your chances of landing your dream home (or investment property).

Summary

The road to securing real estate loans is no easy task. That said, arming yourself with the necessary information and knowledge, as well as preparing your documentation in advance, will help assist potential homebuyers in homeownership. Pay attention to the different options available to you, and then follow the steps above. If it seems intimidating right now, do not worry: the process will get easier with each deal you land.