Real estate can be purchased for a variety of reasons and in a variety of ways. When stocks fall, they can act as a hedge against market volatility, and there are other benefits to owning an investment property.
Buying the investment property is a great way to broaden your portfolio if you are purchasing and holding land for flipping a property, future development, or making a passive income by renting the property.
Unlike stock market trading, which may be done for very little money, investing in property has a significant initial investment cost. After you’ve determined that real estate investing is suitable for you, do your homework, and discover a good deal, you’ll need to think about how to finance your investment property.
Borrowers must meet particular conditions for real estate financing that can take various forms. Because getting the wrong type of loan might have a negative impact on your investment’s success, it’s critical to understand the criteria of each type of loan and how the different options function before approaching a lender.
Should You Become A Landlord?
Being a landlord entails a wide range of responsibilities. Vacancies must be advertised, tenants must be screened, rental properties must be evaluated and purchased, and routine maintenance and repairs must be performed.
A landlord must also be skilled at collecting rents, keeping books, dealing with taxes, according to local regulations, creating and enforcing rules, and occasionally evicting non-compliant tenants on a financial level. Before you invest, make sure you’re aware of the advantages and disadvantages.
The pros and cons of being a landlord
Pros
- Income. Rentals can provide a consistent monthly income stream that tends to grow over time.
- Possibilities for wealth Because property values rise over time, real estate is typically seen as a safe investment.
- There are tax advantages. You can deduct depreciation and other costs as a property owner. Expenses can also be deducted from other income for active investors.
- Ability to make use of existing assets. Few investments provide similar prospects for obtaining finance of up to 80%.
Cons
- Concerns with the law. Running afoul of local landlord-tenant rules can land you in court and jeopardize your financial security.
- Vacancies. Every year, 41% of properties are empty for a period of time.
- The Obstacle. Almost half of all landlords have had to evict a tenant at some point. Evictions can cost up to $10,000 in some cases.
- Time constraints. Even for a single home, landlord responsibilities can be time-consuming. Landlords, for example, get an average of six calls per year for repairs.
4 Landlord Loan Options
Option 1: Obtaining a loan from a traditional bank
You’re definitely familiar with conventional finance if you already own a property that serves as your primary residence. A conventional mortgage follows Freddie Mac or Fannie Mae criteria and is not backed by the federal government, unlike a Department of Veterans Affairs (VA), Federal Housing Administration (FHA), or Department of Agriculture (USDA) credit.
The standard down payment requirement for conventional financing is 20% of the home’s buying price. On the other hand, a down payment of 30% on an investment property may be required by the lender.
With a traditional loan, your personal credit history and credit score impact your ability to get authorized as well as the mortgage’s interest rate. Lenders also scrutinize borrowers’ income and assets. Borrowers must also demonstrate that they can afford their current mortgage as well as the payments of monthly loans on an investment property.
Future rental revenue isn’t considered when calculating debt-to-income (DTI). Most lenders predict borrowers to have a minimum of six months’ worth set aside to fulfill both mortgage commitments.
Option 2: Hard money loans
Hard money loan is a short-term loan designed for flipping an investment property rather than buying and holding, developing it, or renting it out.
If you are not planning to flip your property, it is feasible to utilize a hard money loan to buy a property and subsequently pay it off with a traditional loan, home equity, or private loan.
The advantage of choosing a hard money loan to fund a property flip over a standard loan is that it may be likely to succeed. While credit and income are still taken into account by lenders, the value of the property is the primary consideration.
The property’s estimated ARV (after-repair value) is utilized to determine if you can repay the loan. In addition, instead of waiting weeks or months for a traditional mortgage closing, you can acquire loan money in a matter of days.
The cost is the most significant disadvantage of employing a fix-and-flip hard money loan. The rate of interest on this type of loan can be as high as 18%, based on the lender, and the repayment period may be short.
Hard money loans or in this context, landlord loans frequently have periods of shorter than a year. In addition, compared to traditional finance, service charges and closing costs may be greater, reducing returns.
Option 3: Private Money Loans
Loans from one person to another are known as private money loans. Most private money loans are obtained from an investor’s relatives and family.
If you don’t have any friends or family who can give you money for an investment property, going to local property investment networking events is a wonderful place to start looking for private money lenders.
The interest rates and actual loan terms on private money loans might range from exceedingly favorable to predatory. These loans are usually secured by a formal contract that gives the lender the right to foreclose on your home if you don’t pay.
Before you sign an agreement with a loved one, if you are new to the field of real estate investment, think about how your association with the lender would suffer if you default before the agreement.
Option 4: Borrowing against your home’s equity
A fourth approach to acquiring an investment property is to use your home equity by a home equity loan, cash-out refinance, or home equity line of credit (HELOC). In most situations, you can borrow up to 80% of the equity worth of your house to put toward the purchase, rehab, and repair of an investment property.
Using equity to finance a property transaction offers advantages and disadvantages depending on the sort of loan you pick. A HELOC, for example, allows you to borrow against your home’s equity in the same way that a credit card does, and the monthly payments are generally interest-only. However, because the rate is frequently flexible, it can rise if the prime rate rises.
A cash-out will have a fixed rate, but it will likely lengthen the duration of your current loan. For the primary residence, a longer loan duration means you have to pay more in interest. This would have to be balanced against the expected returns on an investment property.
Creating A Financial Plan
Underestimating expenses or overestimating income is one of the new landlords’ most common mistakes. Your budget is just as good as the data you use to create it. You’ll need accurate rental income and vacancy projections.
Before you buy a house, you should get prices from insurance companies, property managers, gardeners, and other service providers. Your rented property will require homeowners insurance.
Step 1: Calculate your investment’s return on investment.
A rental ROI calculator can help you calculate the cap rate, cash-on-cash, and annual gross rent multiplier of a property, all of which are return on investment (ROI) indicators. The cap rate is calculated by dividing the net operating income (NOI) by the property value, and it should be between 5% and 15%. Your net operating income divided by the cash you’ve invested is
cash-on-cash. The annual gross rent multiplier is calculated by dividing your annual rental income by dividing the purchase price.
Record your outgoing expense
To figure up a rental’s net operating income and return on investment, you’ll need the following information:
- The cost of your purchase (repairs, purchase price, and closing costs.
- Details on the funding
- Taxes on real estate
- Repairs, management, upkeep, utilities paid by you,
- Insurance and HOA dues are all estimated monthly costs.
Consider the costs of vacancies as well. According to the US Census, the average vacancy rate in the United States is roughly 7%, and you’ll have to pay for advertising whenever there are openings.
Work out how much you are going to charge for rent
There are a variety of resources available to help you figure out what the market rate is for homes similar to yours. Because you’ll be competing with other people, look online for available rentals in your neighborhood. You may also get comparables (“comps”) for your property by using rent estimator services like Rentometer or Redfin’s free rental calculator.
Order an income property appraisal if you plan to buy the property as a rental. For you, the appraiser will compute market rent.
Determine what to do if you don’t have a tenant
If you don’t buy a rental property with a current tenant, plan to spend weeks, if not months, preparing the property for tenants, promoting, and screening candidates before collecting a single rent check.
Also, keep in mind that there will be vacancies in the future. According to Foremost Insurance Group, renters leaving, violating a lease, or being evicted cause 41% of homes to be vacant each year.
Step 2: Put money aside for maintenance and unexpected expenses.
Every year, expect to spend 1% to 3% of the value of your home on maintenance and repairs. If your home is older or in poor condition, you may need to put away even more money.
New properties with outstanding tenants may be fine with a 1% budget, so you can save money by accepting just the best renters who will look after the property.
Step 3: Take into account additional costs
You may need to budget for additional costs such as insurance, screening, and background checks, marketing your rental property, and possibly legal fees if concerns emerge, in addition to your return on investment and maintenance costs.
What are the requirements for investment property loan approval?
The requirements for each lender and type of financing will differ. A relationship with the borrower may be all that is required for private lenders. A hot real estate market and a solid anticipated after-repair value or ARV may be all that is required for hard money lenders.
Lenders of home equity loans, home equity lines of credit (HELOCs), and conventional loans will have the strictest income and credit score restrictions.
Is it better to finance investment properties using a home equity loan or a home equity line of credit (HELOC)?
HELOCs and home equity loans are relatively similar products with some key variations. A home equity loan is a suitable option if you want to acquire a single property and require a certain cash amount for the acquisition, repairs, and rehab.
Suppose you plan on purchasing and selling many properties in a short time. In that case, a HELOC is a better option because you’ll have continuous access to money as you withdraw from and pay to your credit line for each sale or purchase, rather than taking out and repaying multiple home equity loans.
Final Thoughts
Investing in a rental property or taking on a house-flipping project are both hazardous investments, but they can pay off handsomely.
Finding the money to take advantage of an investment opportunity shouldn’t be a problem if you know where to look. Keep that in mind the long-term and short-term costs when you analyze alternative financing options and how each can affect the investment’s bottom line.