Purchasing investment property is a great way to generate income. There are many types of loans that can be used to purchase investment properties. However, some lenders have stricter eligibility requirements than others.
It is recommended to seek professional advice from a financial advisor or mortgage broker before applying for an investment property loan. They can provide expert guidance on different loan programs available and help you select the best one for your situation.
Getting a Loan
If you want to purchase a property and generate rental income or buy a fixer-upper that you can flip for profit, investing in real estate is a great way to diversify your portfolio. However, it’s important to understand the financing process to ensure you can qualify for an investment property mortgage. The requirements differ from a conventional mortgage for a primary residence, including higher credit scores and debt-to-income ratios, higher down payments and stricter underwriting guidelines.
Conventional mortgages require you to fill out an application, which the lender will use to review your personal credit history and determine your eligibility for a loan. This includes reviewing your debt-to-income ratio, assessing your employment and income, and checking on your assets. The lender may also ask questions about your previous real estate investments and how you plan to manage the new property.
Investment property loans require a higher debt-to-income ratio than traditional mortgages and usually have a higher minimum down payment. This is because lenders assume more risk when lending to investors than borrowers purchasing a primary residence.
Some lenders may require you to provide a track record of successful property management, which can be difficult for first-time investors. Others may expect you to have reserves in the bank for both your personal and investment-related expenses, while still others might ask that you attend local real estate investment networking events before providing financing.
Down Payment
The amount of money needed to make a down payment on an investment property depends on the lender and loan type. For instance, conventional mortgages require a minimum down payment of 20%. However, borrowers can qualify for mortgage loans with smaller down payments and lower interest rates if they have an excellent credit score.
Investors can also use home equity to pay for a down payment on an investment property. However, lenders may limit the maximum amount of home equity that can be borrowed. Borrowers should check with their primary mortgage lender before considering this option to understand the restrictions and requirements.
Other financing options for investment properties include hard money loans, which are typically short term and have higher interest rates than traditional mortgages. These loans are often used by investors who want to purchase a distressed property and fix it up quickly. They may require larger down payments than rental loans and can be closed in 30 days or less.
Lastly, investors may be able to obtain a non-owner-occupied mortgage by using the property as collateral on another existing loan. This strategy is called cross collateralization and can reduce down payments or eliminate them altogether for investment properties. To qualify, borrowers must be able to prove that they can repay the debt on all of their properties in the event that one of them defaults.
Interest Rates
When you get a mortgage for investment property, you can expect higher rates and fees than you would on a primary residence. This is because real estate investors are considered higher risk by banks. They are more likely to walk away from a failed property, than the owner-occupier who is emotionally attached to his or her home and may work harder to make it a success.
One way to mitigate these higher costs is to put a larger down payment down on the property, which will lower the loan-to-value ratio and reduce your interest rate. However, that also reduces your equity stake in the property, which may not be a good idea if you are a new investor who could experience a financial setback.
The other major factor in investment property mortgage rates is the borrower’s credit score. The higher a person’s credit score, the more likely they are to qualify for a low interest rate, and vice versa.
If you have a high credit score, you might be able to secure financing through conventional mortgage loan programs, which have low down payments and low interest rates. Other options include using a home equity loan or line of credit, or borrowing from your retirement account. Another option is to use a hard money lender, which offers shorter-term bridge loans for investment properties with more flexible terms and qualification requirements than traditional lending sources.
Taxes
Investing in real estate can be lucrative, but it’s also expensive. Depending on the type of real estate purchased, it can require maintenance and repair costs, insurance, and utility expenses. If the property is being rented out, it may require a lot of time and effort to find and screen tenants and to handle tenant complaints, evictions, and other issues that can arise.
Using borrowed money to purchase a real estate investment can also have tax implications. For example, mortgage interest on residential rental properties is typically deductible. In addition, owners can deduct the cost of certain rental property expenses such as depreciation and repairs. However, it’s important for real estate investors to consult with their tax professionals before taking out a loan to learn about the specifics of these deductions.
Real estate investors must maintain records substantiating deductible expenses. This includes records such as rent collection and payment, property expense receipts, and monthly mortgage payments. Having this documentation can come in handy if the investor is audited by the IRS.
Leverage is a common strategy used by real estate investors to increase their returns. The use of debt can magnify an investment’s gains if the value of the property appreciates, but it can also magnify losses if the property declines in value or the borrower defaults on the loan.