4 Ways To Invest With Other People's Money
Generally, you need to have money to make money. But wouldn’t it be great if you could simply borrow other people’s money to invest? Well, most of the time, you can’t just borrow money out of thin air. Someone who is willing to lend you money wants to have some assurances that you’re going to make good on your promise of paying them back entirely down the road, either in the form of monthly payments, collateral against your assets that they gain ownership of in the event you default on your loan, or both. But as soon as you start accumulating assets, you can start investing with other people’s money!
In this article, I will share 4 ways you can invest with other people’s money! If you don’t have assets to borrow against yet, learn these strategies anyways so you can learn which assets you’ll need to accumulate that are required for the borrowing strategies that are attractive to you.
Real estate loans
One of the most common ways to leverage your money is by buying real estate. Whether that be for your primary residence or a rental property, most people will borrow money from a bank to purchase the majority of the home.
As stated previously, the bank will not just lend to anyone. They’ll want to reduce their risk by:
Requiring you to put a down payment, usually 20-25% down.
Have you pay a monthly mortgage to (a) collect interest payments from you and (b) force you to pay down the loan and, therefore, own more of the home.
When you take a loan out from the bank, as part of your agreement, the bank will have the first priority to take ownership of the home if you were to default on the loan (i.e. be unable to pay the mortgage for an extended period of time). So if this were to happen, while not ideal for the bank, they still can recuperate some of their losses by taking ownership of the home and selling it.
That aside, as long as you have a down payment and pay your mortgage payments on time, the bank will leave you alone. And in your favor, since you don’t have to buy homes with 100% cash, you can leverage the bank’s money to own more homes.
For example, say you have $500K to invest in real estate. Instead of buying a single $500K home, you can buy 4 homes worth $500K each by putting 25% down into each one of them and borrowing the rest from a bank! Ultimately, if done right, you should end up with higher returns and cash flow by leveraging your money.
Hard money loans
Hard money loans are loans for those with a high risk appetite. These loans have way fewer requirements for people to qualify for them since these are not federally-backed loans. What a hard money lender cares about is that your plan for their money is sound, so that both you and they come out on top.
However, hard money loans come with high fees and sky high interest rates, usually in the 8-12% range. The point of leveraging hard money loans is not to hold onto them for long periods of time; doing so would make it nearly impossible to profit. Instead, hard money loans are usually used to purchase properties quickly to avoid the hassle of going through the traditional lending process that takes 40-50 days.
When it comes time to put together a purchase contract for a home using hard money, you actually put down that you’re paying “all cash.” And when a seller sees “all cash,” this tends to be attractive to them since they don’t have to wait as long for buyers to be approved for a loan by a traditional lender with lots of federal requirements. Hard money loans can be approved and funded within just a few days. But since the fees and interest rates are so high, you better be a savvy investor to make sure your deal absolutely makes financial sense.
All in all, hard money loans are almost always used for fix and flip deals. Ideally, you purchase the home quickly with the loan, borrow even more from your lender to fund the rehab project, then sell it within a few weeks or months to quickly pay off the loan and make a profit. You can see how I’ve flipped a home for over $100K in profit in under 4 months!
Home equity
The 2 main types of home equity loans are called HELOCs (home equity line of credit) and home equity loans.
HELOCs have variable interest rates, which makes them susceptible to rising interest rates. As we’ve seen over the past year, the Federal Reserve has raised rates at an unprecedented pace which has caused rates to skyrocket, including rates for HELOCs. On the flip side, when rates decline, so does the interest rate on your HELOC.
The nice thing about HELOCs is that you only pay interest on the amount you withdraw. You can think of a HELOC as a credit card, where you can withdraw as much (or as little) as you need up to a certain dollar limit (this limit is tied to a percentage of the amount of home equity you have). The main difference is that you begin owing interest as soon as you make any withdrawals. There is no grace period like you have with credit cards.
Home equity loans are essentially like another home loan. You receive a lump sum up front with a fixed interest rate, and you pay down the loan monthly, where part of your monthly payment is interest to the bank and the other part is principal that pays down your loan balance.
Borrowing against your investments
Many popular brokerage firms, like Fidelity, E-Trade, and M1 Finance, offer some sort of borrowing program. They’re usually called a line of credit or a margin loan. To enroll in these programs, these firms require you to pledge a certain amount of your equities as collateral. This means that if you borrow too much or if your investments go south, they can force you to pay them back by selling your investments for you.
These lines of credit work just like a HELOC. You can borrow as little or as much as you want, up to a certain dollar amount. As soon as you begin borrowing, you begin accruing interest rates. The nice thing about these loans, though, is that you don’t technically have to pay the interest right away. While the interest does accrue immediately, you can simply “pay” the interest by adding the interest amount to your outstanding loan balance.
Just like HELOCs, these loans are vulnerable to rising and falling interest rates. At the time of writing, many firms are offering rates that are in the 7-9% range. Just a year ago, when rates were near all-time lows, rates were in the 2-3% range! Take that as a big warning sign when you consider borrowing with variable interest rate loans!
Conclusion
All of the types of loans mentioned in this article will require a credit check. The better the credit score, the better odds you have of receiving a preferred interest rate. All lenders will require you to have some sort of cash on hand and/or collateral to borrow against. They want to see this to make sure you’re not going to be a problem down the road. After all, if they lend you money and you make good on your payments, they also win.
You don’t need to be rich to make a lot of money. But you do need to be willing to take on more risk, whether that means investing in riskier assets like stocks or real estate, borrowing people’s money to invest with higher dollar amounts, or both. However, please be wary about rising interest rates and borrowing more than you can handle! Borrowing can be tricky business, so only sign up for something you are absolutely sure about. If done right, hopefully you end up on top!
