Creative Financing
Business owners and investors alike are always looking for ways to fund their endeavours. From executing a business plan and scaling an existing company to acquiring funds for an investment deal, the answer to the finance question is not always found at a traditional banking institution. The savvy investor or entrepreneur may look for opportunities to take advantage of creative financing options.
What is creative financing?
Creative financing is a term commonly used in real estate investment circles to describe methods and strategies to secure deals, outside of traditional methods common to the majority of people. Regardless of the benefits available in real estate, there are processes to creatively fund other types of businesses as well. You may be looking to launch a startup venture, or grow an existing business to new heights. Keep reading below for some examples of how to secure funding or a loan for various types of opportunities.
Strategies for Real Estate
Hard Money Loans
For the purpose of funding the rehab of a property, hard money is a common choice for many real estate investors who are looking for financial means outside of a bank. Lenders for these types of loans are typically a person or a company, who will secure funds against the real property. The loan can be similar in structure to a private mortgage, however typically carries shorter term lengths and higher interest rates. This is not always the most ideal way to finance a project and in most cases would be considered as a last resort or a bridge loan. For individuals with less than ideal credit, this method can help get an investment project off the ground and progress towards better opportunities with preferred terms and rates in the future.
Private Mortgages
Similar to the aforementioned hard money loan, a private mortgage is a loan that is secured against a real estate property. The funding is provided by a private lender, rather than a traditional institution and could be made up of multiple investors pooling their money and participating in the collective gains. The benefit of choosing this type of financing is the qualifications for the loan are based on the asset itself, rather than an individuals credit score. This type of mortgage is typically short term and high interest as well, yet for a house flipper it provides quick access to cash as long as you’ve done your due diligence. Private lenders may require a down payment and limit the loan to value (LTV) percentage for the loan to keep equity in the property and manage risk.
Home Equity Lines of Credit
Home ownership comes with many benefits, one of them being the ability to borrow funds against the equity you have built in your home over the years. Not to be confused with mortgage loans, a Home Equity Line of Credit or HELOC is a credit line secured against the property. It is similar to taking a second mortgage on a house but allowing you to use the funds as needed. This is a great option for accessing financing to help cover the cost of a down payment on another home or renovations on an investment property. When applying for a HELOC, the bank will need to know the appraised value of the house you will be borrowing against, your current equity in the home, your income, the debt you are servicing and your current credit score. The pros of using a HELOC include lower interest rates, the ability to avoid mortgage insurance costs by having a 20% or greater downpayment, and having flexible access to funds.
Cash Out Refinancing
Now that you understand how to borrow against the equity in your home, you may also want to consider a cash out refinance strategy. The popular BRRRR method is one of the best ways for investors to succeed in real estate. To execute a cash out refinance, there must be enough equity in the property for the numbers to make sense. But for the sake of this example we’ll make it easy by assuming the property has been acquired with cash, whether it be savings or a short term loan. If you did your due diligence and acquired the property at a discount and forced appreciation through renovating, you would be able to approach a conventional lender and secure a loan against the property for 80% LTV (loan to value). Let’s assume you purchased a property for $70,000, that would be worth $100,000 after renovation. You spend an additional $10,000 in renovations and holding costs. Now you’ve spent a total of $80,000 when you approach a lender to mortgage your property at 80% LTV, based on the new value of $100,000. The lender cuts you a cheque for $80,000 to cash out of your investment the amount you put into it. You now benefit from having an asset, that has $20,000 of equity, which you can cashflow and continue to build on said equity, and at the end of the day you’ve essentially acquired for $0. This strategy requires having the funds up front, or having a financial backer to help acquire the property for cash. A good amount of due diligence is also necessary to understand the total amount you need to invest up front, as well as being able to predict a legitimate after-repair value. With that said, many investors use this strategy to scale their portfolios quickly. Click here for more details on the BRRRR method and how it can be used in conjunction with cash out refinancing.
Personal Loans
A personal loan, also known as a consumer loan, can be a convenient way to access a fixed amount of money to achieve real estate investment goals or to kick start a new business venture, especially when a business loan is not a viable option. With fewer qualification requirements, multiple repayment options and that they can be unsecured or secured, personal loans are used by many investors. These loans are offered by most major banks, alternative lending funds, and online personal loan companies. To qualify, lenders will examine your credit score, current debt, employment status and income, as well as any other financial commitments or assets held. The amount of financing available for unsecured loans can be up to $10,000 and for secured loans as much as $30,000 or higher depending on your financial situation. It is important when using personal credit for business purposes to always have a repayment strategy in place, remember personal loans affect your personal credit.
Strategies for Business Owners
Merchant Cash Advances
As stated above regarding the many creative options you have for financing, a loan does not always have to come from your typical banking institution. Merchant cash advances are one such example that is designed to help provide capital to business owners who commonly collect revenue via debit or credit transactions. The lender leverages your point of sale transactions to pay back the loan they provide to you. Keep in mind that this is not always the most optimal way to get a loan, as it carries high interest rates and can stack the odds against your business if you’re not careful. But if you are in a jam waiting on the approval of financing through another method and need access to cash quickly, you may be able to leverage your transactions for a fast cash infusion and bridge the gap until you are able to close a more favourable deal from another lender.
Equipment Financing
If you require the use of equipment to generate revenue for your business, lenders will treat such items as assets rather than a simple business expense. There are quite a few industries for which equipment is considered an income earning asset, and you can leverage this equipment to gain access to capital. Financing equipment can be done either up front when you need new items, but it can also be done using existing items that you already own outright; this is called a lease buy back. In this case the lender would purchase your existing equipment from you for a lump sum, and lease it back to your business to continue using for generating an income. You receive the cash you need, and in turn make a monthly payment to the lender, stretching out the payment over an agreed term length. Talk to your accountant about some of the benefits to doing this in regards to your business taxes.
Invoice Factoring
As mentioned above, you may have assets in your business that can be collateralized to obtain funding. One of those assets that is commonly overlooked could be your outstanding invoices with customers who pay on a revolving credit with your business. Invoice factoring leverages your accounts receivable invoices to give you immediate deposits of cash as opposed to waiting 30, 60, or 90 days before your customer actually pays you. There are plenty of invoice factoring companies and lenders that are happy to take ownership of your aging accounts in exchange for a percentage of the invoice values. You as the business owner would have to give up some of that revenue, sometimes as low as 5%, but it could be as high as 30% as well. The benefit is in getting paid right away. And in a harsh marketplace that could mean the difference between paying your employees and expenses versus having to scale back due to a lack of cashflow.