Acquaint yourself with the various financing strategies and options for investment properties. One of the most popular ways for Americans to put their money to work is traditionally and currently still in real estate. Real estate was chosen as the best long-term investment by a greater percentage of American respondents to an annual poll conducted by Gallup than stocks or gold. However, it is common knowledge that real estate can be quite pricey, and a large number of people do not have the financial resources necessary to purchase investment properties outright. The acquisition of an investment property can be financed in a variety of ways, including the use of conventional loans and the sale of assets that the investor already possesses.
Key Takeaways
- A piece of real estate that is purchased with the intention of earning a return on the investment, either in the form of a capital gain or a monthly cash flow, is referred to as an investment property.
- Conventional loans, which are typically reserved for one's primary residence, are also available for investment properties; however, the requirements for the down payment and the reserve may be more stringent.
- A short-term fix-and-flip loan can offer larger loan-to-value amounts and more flexible repayment terms to investors who intend to buy a property with the intention of quickly selling it for a profit.
- If you already own property, you may be able to leverage your existing assets by borrowing against your existing equity to finance the purchase of an additional property. This will allow you to take advantage of a potentially lower interest rate.
What Exactly Is a Real Estate Investment?
A piece of real estate that is purchased with the intention of generating a return on the original investment or serving as a source of income for the buyer is known as an investment property. Single-family homes and multi-family homes with features like duplexes and apartment buildings are common examples of well-liked real estate investments. Investing in real estate typically results in a profitable return thanks to the regular flow of cash that is generated by the property. Your monthly profit will be the amount of rent that is in excess of what it will cost you to own and maintain the home if you buy a property for investment purposes and then rent it out to a tenant. Having an investment property that appreciates in value while you own it can also result in a capital gain for you. One of the key distinctions that can be made between investment property, a primary residence, and a secondary or vacation home is that a primary residence is the one in which you spend the majority of the year and does not typically serve as a source of ongoing monthly revenue. In the case of a multi-family dwelling, an investor's primary residence and investment property can be located on the same piece of real estate at the same time. IMPORTANT: When it comes to the requirements for borrowing money, investment properties and primary residences are treated very differently. While you may be able to purchase a home with a down payment of as little as a few per cent (or even none at all, in the case of certain specialised loans), purchasing investment property typically calls for a down payment of closer to 15 to 20 per cent as well as larger cash reserves.Loans from Conventional Banks
Conventional loans for investment properties can be obtained from lenders in a manner very similar to that of conventional mortgages for primary residences. These loans are subject to a significant number of the requirements that are imposed by Fannie Mae and Freddie Mac on other conventional loans. The requirement for a larger down payment is one of the most significant distinctions that can be made between loans for primary residences and loans for investment properties. In many cases, a down payment of only three per cent is required to purchase a primary residence. Loans for investment properties that are backed by Fannie Mae typically require a down payment of 15 per cent for single-family units and up to 30 per cent for multi-family units, although the exact amount varies depending on the type of loan. Another point of differentiation is the amount of qualifying income required for a conventional loan when purchasing an investment property. In the same way that you would use your personal debt-to-income ratio when purchasing your primary residence, you can use it to determine whether or not you are qualified for a mortgage. To qualify, however, you can also use the anticipated future rental income from investment properties. This is another way to meet the requirements. IMPORTANT: If you want to qualify for a mortgage with rental income, the income must generally be verifiable in some way, such as through the seller's tax returns or a signed lease for the property.Real estate investors who want to quickly renovate and resell a property can take advantage of a loan product called a fix-and-flip loan. Because an investor who buys a property to rent it out for many years has very different needs than one who flips homes, the type of loan that each of these investors might require is also very different. First, unlike traditional mortgages, which are intended to cover the cost of the home minus the down payment, fix-and-flip loans take into account the expenses that will be incurred by the investors for the cost of making repairs to the property. As a consequence of this, it is possible that they have borrowed more money than the property is currently worth. Fix-and-flip loans, on the other hand, typically come with interest rates that are significantly higher than those of conventional loans. This rate takes into consideration both the fact that the lending institution is providing more money than the actual value of the property warrants and the likelihood that the borrower will repay the loan in a shorter amount of time than originally anticipated. For instance, the term of a loan for a fix-and-flip project might only be between 12 and 18 months. TIP: Some loans for property flipping and renovation come with interest-only repayment periods. During these periods, the investor is exempt from making payments that go toward paying off the loan's principal. It is essential to keep in mind that although these loans include a number of advantages, such as the fact that they are designed specifically for real estate investors, there are also a number of potential drawbacks. In the event that you are unable to sell the property as quickly or for as much as you had hoped, you may find that you are "underwater" on a loan that has a high-interest rate and monthly payments that are unaffordable for you.Loans for Renovating and Selling
Utilizing the Equity in Your Primary Residence or Another Property You Own is Another Way to Finance an Investment Property
You also have the option of using the equity that you have accumulated in either your primary residence or another property that you own in order to finance an investment property. Lenders will typically permit you to use the equity in your home for other things if you take out a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance.A Loan on the Home's Equity
A home equity loan is a one-time lump sum that you borrow from a financial institution. The loan comes with a set interest rate and a predetermined time period for repayment. It is common practice to be able to borrow up to 85 per cent of the equity in your home for any reason.Line of Credit-Based on the Value of the Home
A home equity line of credit, also known as a HELOC, is a revolving line of credit that allows homeowners to borrow against the equity in their home whenever they require additional funding. HELOCs come with a maximum amount that you can borrow, but as long as you continue to make payments on the loan, you can continue to borrow up to that maximum amount. HELOCs typically have a "draw" period at the beginning, during which you are allowed to borrow against your equity, followed by a "repayment" period, during which you are required to make fixed payments. During the draw period of your line of credit, you might be required to pay nothing more than the interest, which is calculated at a variable interest rate.Refinancing with Cash Out
One type of mortgage refinancing is known as a cash-out refinance, and it involves taking out a new loan for an amount that is greater than the mortgage that is being refinanced. You will receive a cash payment equal to the difference between your old mortgage and your new one. This money is yours to spend however you like. When it comes to making payments on the loan, a cash-out refinance operates the same way as any other kind of mortgage refinance the loan does; the only difference is that you take out a larger loan. After that, you will be able to put the additional cash toward the financing of your investment property.The Pros and Cons of Getting a Loan Based on Your Equity
The ability to leverage an asset that you already own is one of the primary benefits of using the equity in your home to finance the purchase of an investment property. However, there is a significant drawback that should not be ignored. Your primary residence acts as collateral when you take out a home equity loan to pay for the acquisition of a second property. If the return on the investment property is lower than you anticipated and you are unable to keep up with the payments on your mortgage, you run the risk of losing your primary residence. Another danger associated with HELOCs is the fact that the interest rate is frequently subject to change. As a result, monthly payment for a loan that appears manageable today could quickly become unmanageable if interest rates were to significantly increase.Advice on Obtaining a Loan for an Investment Property
If you are aware of how to properly prepare yourself in advance, there are a few obstacles that you will be able to overcome on your way to obtaining financing for an investment property.Consider making a sizable initial payment
Conventional loans for investment properties typically require a down payment of anywhere from 15 per cent to 30 per cent, with the exact amount needing to be determined by the number of units in the home as well as the type of loan. The more money you can put away, the more options you'll have when it comes to purchasing real estate, so try to save as much as you can.If at all possible, pay with cash
Even though there are opportunities for financing, there are certain benefits that come with making a cash payment instead. First, you lower the possibility of losing your home to foreclosure in the event that you are unable to collect the amount of rent you had anticipated. When it comes to finding investment properties, you are also a more competitive bidder, and this is especially true in a market that favours sellers. In point of fact, research conducted by Realtor.com in December 2020 found that all-cash deals accounted for approximately 36 per cent of real estate transactions across the country. This is due to the fact that these offers can be more appealing to the seller.Increase Your Personal Credit Score
When determining whether or not you are qualified for a home loan, how much of a loan you are eligible for, and what interest rate you will be offered, your credit score plays a significant role. If you have a good credit score, you might be able to buy a home with a smaller down payment and a lower interest rate, which can save you tens of thousands of dollars in interest over the course of the loan's lifetime.Questions That Are Typically Asked (FAQs)
When is the appropriate time to start planning for the financing of an investment property?
Prospective buyers of investment properties should start saving as soon as possible to give themselves enough time to amass the necessary funds. Larger down payments are typically required for investment properties.Is it difficult to get a loan for a property that will be used for investment?
It's actually quite similar to the process of getting a loan for your primary residence when you're trying to get a conventional loan for an investment property. You will need a credit score that is satisfactory, sufficient cash reserves, and a down payment that is in accordance with the requirements of the lender.Is it possible to obtain a loan on an investment property with a term of thirty years?
Loan products such as 30-year fixed-rate and variable-rate mortgages, which are also offered for primary residences, are also offered for investment properties. This is true of the majority of the loan products.