Saturday May 28, 2022

What newbies need to know about investment property financing

Basics for financing an investment property

You have big dreams of owning real estate and retiring young people. You just don’t have the funds to go out and buy the properties in cash (most of us don’t either). This leads you down the path of financing with your local bank. Perhaps you already own your own home and have gone through the mortgage approval and signing process. This should be easy then, right? Wrong, investment property loans are not like your traditional home loan.

Lenders are stricter with the underwriting of an investment property than they are with the mortgage on a personal home. You may be wondering, but why? It’s simple when you own an investment property and a personal residence and then lose your job or things start going south financially, you’ll pay off your personal mortgage before anything else at worst. You won’t want to default on your mortgage, because that’s where you live!

Interest rate

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 folks. Loans are riskier, so banks want more for them.

credit score

As with any type of loan, your credit is important. It shows the bank a history of your past credit experiences and basically tells you 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 should 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’ll still have options if your credit isn’t 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 simply indicates what to expect.

Lowest LTV

20% learn it, love it, live it. That’s the number the bank will want from you as a down payment on 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’s the only good news. Also, 20% down is the best case scenario, if you have bad credit expect the bank to wait longer or not even look at your offer. As a final note, plan on needing at least three months’ payments as a liquid cash reserve. The 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 goes out in the first month, then the bank will question again if you grant a loan. .

House Hacking to start

The idea behind home hacking is to simply lower 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 generating you monthly cash flow, it’s costing you monthly cash flow.

The basic idea behind this “house hack” mentality is to simply rent part of your house to someone else, or co-exist with someone else as a roommate in your own house. 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 buy your first home, or if you 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 appealing to most people than having someone live in their home.

For example, if you buy a 4 unit, live in one unit, and rent each of the other units for $600 per month, that would mean you are earning $1800 per month in rents. If your loan, escrow (taxes + insurance), utilities, and other expenses come to just $1600, you could be paid $200/month 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?

Main point:

Investment properties have higher interest rates

Lenders are a bit more lenient on credit scores

You will need 20% for the initial payment (there are exceptions)

Try house hacking to get started in real estate

America’s Favorite,

The little time investor

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