What newbies need to know about investment property financing
Basic concepts for financing an investment property
You have big dreams of owning real estate and retiring the young. You just don’t have the funds to go out and buy the properties with cash (most of us don’t either). This takes you down the path of financing with your local bank. Perhaps you already own your own home and have gone through the mortgage signing and approval process. This should be easy then, right? Wrong, investment property loans are not like your traditional home loan.
Lenders are stricter with an investment property underwriting than with a personal home mortgage. You may be wondering, but why? It’s simple when you own an investment property and a personal residence and then you lose your job or things start to go south financially, you’ll pay off your personal mortgage before anything else in the worst case scenario. You don’t want to stop paying your mortgage, because that’s where you live!
The interest rate is going to be higher than your home mortgage, it just is. Add 1-3 percentage points more than the owner-occupied loan rate. That means if a lender charges 4.00% interest on homeowner loans, you’ll likely pay 5-7% interest on investment loans. That’s how it works friends. Loans are riskier, so banks want more for them.
As with any type of loan, your credit is important. It shows the bank a history of your past credit experiences and basically says why you should get a loan or why you shouldn’t get a loan. Working to make sure your credit is top notch is something you need to do long before you get into the real estate game.
With investment properties, your credit score doesn’t have as big of an impact as it does with home mortgages. You will still have options if your credit is less than perfect. If your score is below 740, you should expect to pay more in interest rate, lender fees, and lower LTVs. This doesn’t mean you shouldn’t invest with a credit score below 740, it just indicates what to expect.
20% learn it, love it, live it. That is the number the bank will want from you as a down payment on the purchase of your investment property. Of course, there are exceptions to the 20% down payment, however, that is what most banks require.
20% is a lot of money, right? Yes, I know, but the good news is that you won’t have to pay for mortgage insurance! Nobody likes mortgage insurance. The bad news is that that is the only good news. Also 20% down is the best case scenario, if you have bad credit expect the bank to wait longer or don’t even look at your offer. As a final note, plan on needing at least three months’ worth of payments as a reserve of liquid cash. Cash reserve is important, yes you may have finally saved that 20%, but if you don’t have more than 20% in working capital by the time the furnace shuts down in the first month, the bank will question again whether to give you a loan. .
House hacking to get started
The idea behind home hacking is to simply decrease or minimize your own expenses and use the margin (money you are saving) to invest in purchasing rental properties. Living in a nice house with an indoor pool and a movie theater is great and all, but that house isn’t making you a monthly cash flow, it’s costing you a monthly cash flow.
The basic idea behind this “hack the house” mentality is to simply rent out part of your home to someone else, or co-exist with someone else as a roommate in your own home. It can also mean selling your primary residence now and buying a multi-family property and living in one of the units while renting out the rest. Basically, when all is said and done, you are renting out what you already live in, to lower your monthly expense and save capital for your dreams of real estate glory!
If you have yet to purchase your first home, or want to sell your home now to get into real estate, a multi-unit property might be the right option for you. By purchasing a multi-family home, you can live in one of the units and have your tenants pay all of your expenses. This is generally more attractive to most people than having someone else live in your house.
For example, if you buy unit 4, live in one unit, and rent each of the other units for $600 per month, that would mean you are making $1800 per month in rents. If your loan, security deposit (taxes + insurance), utilities, and other expenses amount to just $1600, you could get paid $200/mo just for living in the house. Even better when it’s time to move into your future home, you can rent out that fourth unit for even more income. Sounds like a great idea, right?
Investment properties have higher interest rates
Lenders are a little more lenient with credit score
You will need 20% for the initial payment (there are exceptions)
Try house hacking to get started in real estate
The Little Time Investor