Your path as a real estate investor may take various routes, depending on your resources and goals. Many people begin when they decide to change their primary residence. Instead of selling their current home when they acquire another, they may repurpose the initial residence into a rental property. Similarly, when your equity in a home increases, you may use that appreciation as a down payment on an investment property. Whether starting from scratch or with a saved down payment, you will probably need financing at some point.
As a real estate investor, you have some financing options, again depending on your resources and goals. Because lenders typically consider investment property loans riskier than a loan for a primary residence, you can expect to pay higher rates and fees, even with a conventional loan from your bank. The good news is that some potential tax advantages may moderate the impact of those higher costs. You will also probably need to commit a higher down payment and demonstrate excellent creditworthiness.
What kinds of loans should I consider for a rental property?
Conventional or conforming loans are the closest match to the loan for a home you intend to occupy rather than rent out. Ordinary banks, credit unions, and mortgage brokers can lead you to the relevant products. Like owner-occupied mortgages, these loans are frequently eligible for guarantees by Fannie Mae or Freddie Mac if the loan and loan amount meets the guidelines.
Even if you have a good credit score, you may need to make a down payment of as much as 30 percent. You will also likely pay a higher interest rate than you would for a primary residence. Fortunately, the interest you pay is deductible from your rental income, along with other business costs (like repairs, maintenance, and advertising).
Other costs of obtaining a loan for your investment property (like the commission on the purchase, appraisal, and title insurance) are not deductible from income. However, they are part of the cost basis, which means that you may benefit down the line with respect to calculating capital gains.
FHA and VA multi-unit financing may be a potential solution if you qualify and intend to live in one of the units. For example, suppose that you are buying a four-plex. With FHA or VA multi-unit financing, you can rent out three of the units and live in the fourth. After a year, the residency requirement expires, and you can move out and use all four as rentals. In addition, these loans have federal guarantees, which allows the lender to offer more attractive terms for those who qualify.
Private money or hard money loans can be attractive or not, depending on the relationship between the borrower and the lender. Many private money loans are made between relatives or friends so that they may have generous terms. That’s not always the case, so be sure that you carefully review the loan contract.
In contrast, hard money loans are often only available at a very high cost. As a result, these loans are best used for short-term purposes like flipping real estate or as a bridge until you can obtain more attractive financing.
Portfolio loans are typically more suitable for investors holding multiple properties because this loan allows you to finance several assets using the same lender. As a result, you may be able to negotiate a lower down payment or provide a less-than-stellar credit score, but your overall costs may be higher.
Seller financing is an option in some cases. This loan involves the buyer making payments directly to the seller over an agreed-upon period. Sellers may consider this option if they want income or prefer to spread out their capital gains.
No matter which form of mortgage loan you decide to pursue to finance your investment property, your creditworthiness will affect the terms you can get. Maintaining a good credit score will always help you find a lower rate. It also helps to develop a relationship with one or more lenders. In addition, maintain excellent income and expense records to document your ability to repay the loan.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
The income stream and depreciation schedule for any investment property may affect the property owner's income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Programs that depend on tenants for their revenue may suffer adverse consequences because of any financial difficulties, bankruptcy or insolvency of their tenants.
