Real Estate

What Beginners Should Know About Investment Property Financing

Basic concepts for financing an investment property

You have big dreams of owning a real estate property and retiring young. You just don’t have the funds to go out and buy the properties for cash (most of us don’t either). This gets 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, right? Investment property loans are not like traditional home loans.

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

Interest rate

The interest rate will 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 homeowners loans, they will likely pay 5-7% interest on investment loans. This is 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 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 well before you get into the real estate game.

With investment properties, your credit score doesn’t have as much of an impact as it does with home mortgages. You will still have options if your credit is not perfect. If your score is less than 740, you should expect to pay more in lower interest rate, lender fees, and LTV. This doesn’t mean you shouldn’t invest with a credit score lower than 740, it just tells you what to expect.

Lower LTV

20% learn, love it, live it. That is the number the bank will want from you as a down payment for the purchase of your investment property. Of course, there are exceptions to the 20% discount, 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 this is the only good news. Also, 20% down payment is the best, if you have very bad credit, expect the bank to wait longer or not even look at your deal at all. As a final note, plan for the need for payments of at least three months 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 oven shuts down in the first month, the bank will again question the possibility of granting you a loan. .

Hacking houses to start

The idea behind house hacking is to simply decrease or minimize your own expenses and use the margin (money you are saving) to invest in acquiring rental properties. Living in a nice house with an indoor pool and a movie theater is great and all, but that house is not generating monthly cash flow for you, it is costing you monthly cash flow.

The basic idea behind this “house hacking” mentality is to simply rent part of your home to someone else, or coexist 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 the rest. Basically, when all is said and done, you are renting what you already live in, to lower your monthly expenses 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. When buying a multi-family home, you can live in one of the units and have your tenants pay all your expenses. This is generally more attractive to most people than having someone live in your home.

For example, if you buy a unit of 4, live in one unit, and rent each of the other units for $ 600 a month, that would mean you earn $ 1800 a month in rents. If your loan, escrow (taxes + insurance), utilities, and other expenses amount to just $ 1,600, you could get paid $ 200 a month just to live in the house. Even better when it’s time to move into your future home, you can rent that fourth unit for even more income. Sounds like a great idea, right?

Key takeaway:

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 investor

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