Investing in real estate has continually been a popular way for many people to generate a passive income and start building up their wealth. In today’s market, seasoned as well as brand new investors are incorporating rental properties within their portfolio. And it’s not hard to see why – interest rates continue to remain low and young people nowadays are purposely choosing to rent versus own.
While seeing the benefits of purchasing an investment property is easy; finding a way to finance it tends to be more challenging. Only a few investors, especially when they are first starting, can buy investment properties outright with cash.
When you start exploring the financing options available for investment properties, you will see that some choices have stringent requirements, while others tend to be more flexible. Each option has its pros and cons, so you need to be sure the one you choose is in line with your short-term and long-term investment goals.
Think you are ready to take the plunge? Getting a mortgage for your investment property is different than securing one for your primary residence, and the requirements can vary per lender. The more you know about each financing option out there, the better equipped you will be to choose the right one. In this article, we will cover four tips to keep in mind when financing your investment property.
1. Explore Different Loan Types
There are different kinds of investment property loans available. The three most common and well-known are conventional mortgage loans, hard money loans, and home equity loans.
Conventional Mortgage Loans
The requirements and processes for obtaining this type of loan do vary. However, according to Quicken Loans, most lenders require at least a 20% down payment since there is no mortgage insurance available for investment properties. As stated by Wells Fargo, this requirement vastly differs from the 3% you can put down when purchasing a primary residence. Plus, to get a conventional loan, you need a good credit score and enough money to afford your other mortgages. If you plan on keeping your investment property long-term and you meet all the qualifications, these loans can be a great choice for financing.
Hard Money Loans
If you don’t meet the qualification for a conventional mortgage loan, hard money loans are another option. A hard money loan is procured from individuals or companies that lend money to people investing in properties. These individuals or companies are less interested in your credit score, and they are more interested in your property investment’s value when making their lending decision. A hard money loan is faster to get than a conventional loan, but they usually come with higher interest rates and must be paid off in a shorter term. However, if you do not plan to keep your investment property in your portfolio for a long time, or you are looking to fix and flip it, hard money loans could be the way to go.
Home Equity Loans
When you have sizeable equity in your primary residence, you may have the option of taking a home equity loan to finance your investment property. One of the reasons that this is a popular choice for investors is the interest paid on home equity loans is tax-deductible. If you decide to pursue this type of loan, the process is simple – lenders appraise your primary residence’s value and check your credit to determine if you qualify. One thing to keep in mind when it comes to home equity loans is that interest rates tend to be higher than your first mortgage.
2. Plan on Making a Sizable Down Payment
Since the entire goal of purchasing an investment property is to make money, ideally, you want to owe as little as possible on your mortgage if you can. Plus, putting a sizable down payment can help boost your monthly income in the long run. If you intend to go the traditional route for financing, you know lenders require at least 20% down to secure a loan. Therefore, it is best to starting planning for it before looking at properties. Sizable down payments demonstrate your commitment to the bank, and it provides them with more security should you default on your loan.
3. Don’t Limit Your Banking Options
Even though big banks and conventional mortgage loans are the most common way to secure financing, there are also other alternatives for funding your investment property that is worth considering – especially if you do not meet their strict qualifications. Local, small community banks tend to be more flexible in the requirements needed for securing investment property loans. These banks also know and understand their surrounding area well, and they like to invest in their neighborhood. Additionally, community banks enjoy building relationships with their investors, and that can prove to be valuable as you expand your portfolio.
4. Get Creative When Necessary
When you have explored various banking options to obtain financing for your investment property, but nothing pans out, it’s time to get creative (if it makes financial sense). Here are some ideas.
Ask the Seller to Consider Financing
If your credit isn’t great or you don’t meet all the requirements necessary for traditional financing, consider asking the seller if they are willing to finance it. In owner funding, the seller extends you the credit you need to purchase their property. Terms are usually flexible, and you can close your deal quickly. However, interest rates are generally higher, and they sometimes require the loan to be paid back faster.
Buy a Multi-Family Property
A multi-family property has between two and four units. If you want to invest in this sort of property, consider living in one unit while renting out the rest. Your investment property then becomes your primary residence, so you can take advantage of lower interest rates and fees since it is much cheaper to finance a primary home. Plus, your rental income can lower or erase your mortgage payment and help you pay down your loan.
Gather a Group of Investors
When you gather a small group of real estate investors together, you can each invest money to purchase an investment property in cash. With this method, there is no loan, so your group quickly generates income. You won’t have as much risk when investing as a group, but you’ll also have to share the profits. Property management companies can help your investment group handle tenant issues as well as fill vacancies so that you don’t have to worry about it.
Deciding on how to finance your investment property involves making smart decisions and evaluating your goals. When you choose carefully and correctly, you’ll help set yourself up for financial success.