The Complete Guide to Financing an Investment Property
The basic idea of financing an Investment Property
There are several motives and methods for investing in real estate. When equities fall, it may act as a hedge against market volatility, and there are other benefits to owning an investment property.
Purchasing an investment property is a great way to diversify your portfolio, whether you are buying and holding land for future development, flipping a property, purchasing a property for Renting the property to an older relative, and reaping the value when it sells or renting the home to create a passive income stream.
Unlike stock market trading, which may be done for very little money, real estate investing has a usually high start-up cost.
Once you’ve determined that investing in real estate is the correct choice for you, do your homework, and discover a decent offer, you’ll need to think about how to finance your investment property.
Investment property finance can take numerous forms, and borrowers must satisfy specific criteria. Choosing the incorrect type of loan can negatively influence the success of your investment, so it’s critical to understand the requirements of every kind of loan and how the various options function before approaching a lender.
Option 1: Conventional Bank Loans
You’re familiar with traditional finance if you currently own the main house. A conventional mortgage follows Fannie Mae or Freddie Mac’s criteria.
Unlike a Federal Home Administration, the Department of Veterans Affairs, or Department of Agriculture credit, is not backed by the federal government.
A down payment of 20% of the home’s purchase price is often expected with conventional financing. However, in the case of an investment property, the lender may request a down payment of 30%.
With a traditional loan, your credit score and credit history impact both your ability to get accepted and the mortgage’s interest rate.
Lenders examine borrowers’ income and assets as well. Borrowers must also demonstrate that they can afford their current mortgage and the monthly loan payments on an investment property.
Future rental revenue is not considered in debt-to-income calculations, and most lenders want borrowers to have at least six months of cash saved up to pay both mortgage commitments.
Option 2: Hard Money Loans
A hard money loan is a short-term loan that is best suited for flipping an investment property rather than buying and holding, renting it out, or building on it.
While it is feasible to utilize a hard money loan to acquire a property and then immediately pay it off with a conventional loan, private money loan, or home equity loan, starting with one of the other choices is more practical and cost-efficient if you do not intend to flip your property.
The advantage of choosing a hard money loan to fund a property flip over a standard loan is that it may be easier to qualify for. While lenders still take credit and revenue into account, the primary focus is on the property’s profitability.
The estimated after-repair value (ARV) of the home is used to determine whether you will be able to repay the loan. Loan money can also be obtained in a matter of days instead of weeks or months for a typical mortgage closing.
The main disadvantage of employing a fix-and-flip hard money loan is that it is not inexpensive. Depending on the lender, the interest rate on this type of loan can be as high as 18%, and the repayment period may be short.
Hard money loans with maturities of less than a year are not unusual. Origination and closing expenses may also be more significant than traditional finance, reducing returns.
Also Read: Top 5 Ways To Financing A Mobile Home With Land
Option 3: Private Money Loans
Private money loans are loans made from one person to another. Most private money loans are obtained from an investor’s friends and relatives.
If you don’t have any friends or relatives who can give you money for an investment property, going to local real estate investment networking events is a beautiful place to start looking for private money lenders.
BiggerPockets, a renowned real estate investing podcast, maintains a database of local real estate investment clubs where you may network.
Actual loan conditions and interest rates on private money loans can range from beneficial to predatory, depending on the borrower-lender relationship.
These loans are often secured by a formal contract that permits the lender to seize on the property if you fail to make payments. Before you sign an agreement with a loved one, consider how your relationship with the personal loan you private money may suffer if you default if you are new to real estate investment.
Option 4: Tapping Home Equity
A fourth option is to use your home equity to secure an investment property through a home equity loan, home equity line of credit, or cash-out refinance.
In most situations, you can borrow up to 80% of the equity worth of your house to go toward the acquisition, rehabilitation, and repair of an investment property.
Using equity to fund a real estate investment offers advantages and disadvantages depending on the type of loan you pick.
A HELOC, for example, works similarly to a credit card in that it allows you to borrow against the equity in your house, and the monthly payments are frequently interest-only. However, the rate is frequently variable, which might arise if the prime rate rises.
A cash-out would have a fixed rate, but it would potentially prolong your current mortgage term. A longer loan term may result in higher interest payments for the main house. This would have to be balanced against the expected earnings from an investment property.
What are the requirements for investment property loan approval?
The criteria will differ depending on the lender and the kind of financing. A relationship with the borrower may be all that is required for private lenders.
Hard money lenders may merely demand a thriving real estate market and a reasonably anticipated after-repair worth (ARV).
The income and credit score standards for home equity loans, home equity lines of credit, and conventional loans will be the most stringent.
Is it preferable to finance investment properties using a home equity loan or a home equity line of credit (HELOC)?
Home equity loans and HELOCs are highly similar products yet have significant variances. A home equity loan is a fantastic option if you want to acquire a single property and require a precise cash amount for the acquisition, repairs, and rehab.
Suppose you intend to buy and sell many homes in a short period. In that case, a HELOC will be more practical since you will have revolving access to cash as you draw from and pay down your credit line with each purchase and sale, as opposed to taking out and repaying multiple home equity loans.