As a startup or small business, it can be hard to decide where to get funding from and how to use the money to get the most on your return on investment(ROI). There are numerous lending companies out there trying to convince you to choose them.
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There are hard money lenders, which provide loans based upon your assets. You, the borrower, receive funds secured by real property. Hard money loans are typically issued by private investors or companies. For example if you are looking to flip a house, you can use that house as collateral to receive a loan and then use that funding to renovate the home for a bigger profit. Developers and flippers tend to use these lenders because you can borrow up to 100% of your purchase price. No matter how appealing this sounds, don’t get tricked into taking a hard money loan. The APR on these loans tends to be more than twice the average mortgage. If for some reason your flip doesn’t work out as planned, you can end up not only having to pay back the loan, but can also lose your investment property.
Bank loans are another option. These loans are solely based on your credit history and afford lower interest rates. However, these loans take time for approval, require an immense amount of paperwork and require having a FICO score of 700+.
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Some of the bank loans that are available come in the form of conventional mortgages and traditional loans as well as government backed mortgages. Most banks sell both kinds of loans, but they greatly differ for the investor and how they affect a short-term house flip vs. a buy and hold. In addition, they often take awhile to get approved and receive the funding. They also tend to have a lot of regulations associated with them.
Traditional bank loans are not backed by the government and the entire risk is put on you. A conventional mortgage can be either fixed-rate or an adjustable rate. The fixed-rate mortgage loan has the same interest rate for the entire payment term. This means that your monthly payment will stay the same, month after month, and year after year. It never changes. Adjustable rate mortgage loans (ARMs) have an interest rate that will change or adjust from time to time. The ARM will change every year after remaining fixed for a set period of time. Another type of ARM loan is one that starts off with a fixed interest rate and becomes an adjustable rate. An example of an ARM loan like this is the the 5/1 ARM loan which remains fixed for the first 5 years and then switches over to an adjustable rate and continues to adjust every year.
The ARM loan may sound appealing at first, but the uncertainty of the interest rates can catch you off guard later on. With an adjustable mortgage loan, the rate and monthly payment change over time, which can put you in the situation where you end up worse than you already were. The fixed rate mortgage offers the security knowing the interest rate remains the same the entire payment term. However, you pay for that stability with an above average interest rate.
A FHA or VA loan is very different from taking out a traditional mortgage on real estate. The FHA loan is government insured by the borrower paying mortgage insurance which protects the lender from losses that may occur from borrower default. A VA loan is a mortgage loan that is guaranteed by the Department of Veteran Affairs. This type of loan is for qualified eligible American Veterans or their spouses that want long-term financing.
Payday loans are short-term, high-interest loans designed to provide a person with extra money from one paycheck until the next. They are used predominantly by repeat borrowers living paycheck to paycheck. The government strongly discourages consumers from taking out payday loans because of their high costs and interest rates. Because their interest rates are so high, the next paycheck is often used to payback the initial loan and then the person is in need of extra money. The person then takes out another payday loan and it slowly turns into a never ending cycle.
A consolidated loan is simply a loan used to simplify your finances by consolidating your current debt. Simply put, a consolidated loan pays off all or some of your current debt, particularly credit card debt. This can be helpful as it means fewer monthly payments and potentially lower interest rates. Consolidated loans are typically in the form of second mortgages or personal loans.
A cash advance is a short-term loan against your credit card. Instead of using the credit card to make a purchase or pay for a service, you bring your card to the bank or ATM and receive cash to be used for whatever purpose you need. Cash advances are also available by writing a check to payday lenders.
Borrowing from friends or family is an informal type of loan. This isn’t always a good option as it may strain relationships. To protect both parties it is a good idea to make a promissory note.
Borrowing from retirement and life insurance is another type of loan. This option allows you to borrow from yourself, making repayment less stressful and easier. However, failing to repay can result in severe tax consequences or cause you to have less money when retiring as you already spent it.
Another type of loan is a home equity loan. If you have equity in your home - the house is worth more than you owe on it - you can use that equity to help pay for big projects. Home equity loans are useful for renovating the house whether for personal or for flipping. They are also useful for consolidating credit card debt, paying off student loans, etc.
Home equity loans and home equity lines of credit (HELOC) use the borrower’s home as a source of collateral so interest rates are considerably lower than credit cards. The major difference between the two is that the home equity loan has a fixed interest rate and a home equity line of credit (HELOC) has variable rates and offers a flexible payment schedule. Home equity loans and HELOCs are used for home renovations, credit and debt consolidation, major medical bills, education expenses, and retirement income supplements. These loans must be repaid in full if and when the home is sold.
Auto loans are collateral based which means they are tied to your property. They help you finance a car and repay it slowly. However, if you miss a payment you are at risk for the car be repossessed. In addition, if you choose to finance the car through the dealership, they charge you a convenience fee with higher interest rates than a bank. In the end the car may end up costing you much more than it is worth.
Student loans are offered to college students and their families to cover the costs of higher education. There are two major types of student loans; federal and private student loans. Federal student loans are better as they tend to have lower interest rates and more borrower friendly repayment terms. Student loans usually afford no interest while in college, but as soon as you graduate you are expected to pay it back. Unlike most loans, student loans stay with you for life. They can not be defaulted on.
Peer to peer lending or P2P is a newer type of loan. This involves the practice of lending money to individuals or businesses through online services that match lenders directly with borrowers. The interest rates and payment terms vary greatly from lending group. Most of these lending groups determine your eligibility based upon your monthly revenue or by monthly income. The interest rate then varies according to your FICO credit score. If you have a lower than average FICO credit score, your interest rate will be high and can be as much as 70%! If you have an above average FICO credit score, your interest rate can be as low as 3%. The repayment terms also vary from lending group to group, but generally deduct an agreed upon repayment amount either daily, weekly or sometimes monthly from your bank account. This amount is automatically deducted without you having to lift a finger. With P2P lending, you can get your money as fast as 24 hours or as slow as 2 weeks. It all depends on how fast you can hand in your paperwork, are matched to a lender and agree to the repayment terms.
Crowdfunding is the practice of funding by raising capital through numerous sources. Crowdfunding is often done through the internet and done on specific websites that are used to promote ideas, ventures or projects. Often, musicians, filmmakers, artists and people who need money that do not want to take out a loan, use crowdfunding. The repayment terms vary from venture to venture. For example, if the funding is needed for a business, the business may give out promotional items for the donation or give shares of the company. If it is for a personal project, the person may send people a simple thank you note or create something related to the project. Crowdfunding is tricky as you can wait months or even years to obtain the money you need to start your project. In addition, some websites that offer crowdfunding, set a specific time frame in which you have to obtain all the funding. If you do not reach your goal, the money is then returned to the people who donated and you are back to where you started.
The final option for loans are lines of credit (LOCs). However, this is not a loan. Instead it is a non-collateral line(s) of credit (LOCs) that your property is not at stake. You agree to repay the money at low or no interest. In addition you only have to pay back the money you use. For example, you may be approved to borrow $500,000, but only choose to use $5,000. You would only be responsible to pay back $5,000. Lines of credit are determined by your FICO credit score. If you have an average credit score or higher you are eligible for money. This is an excellent option for small businesses or for personal expenses. In addition, even if your credit score is lower than average, you can still be approved depending on the funding group you choose. Some can repair your credit and then get you approved for funding.
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Whenever and however you decide to borrow money it is always best to research your options and fully understand the agreement. Whether it is to pay for luxury items, consolidate credit card debt, obtain funding for flipping, renovate your home, pay medical expenses, etc. you should know what type of loan you are receiving and if any of your belongings are tied to it as collateral. It is also a good idea to familiarize yourself with the repayment terms: what your monthly obligation will be, how long you have to repay the loan and the consequences of missing a payment. If any part of the agreement is unclear to you, don’t hesitate to ask for clarifications or adjustments.
Which funding solution have you decided on? Are you happy with your choice? Do you recommend it to others?