Investment properties are great investments for the long haul, but with today’s economy and the tightened lending standards, it can be hard to figure out how to buy a rental property. Financing a rental property can be tough business, and paying all cash can seem daunting because of the amount of the investment. Here is a breakdown of the ways to buy and finance a rental property.
Paying Cash
The first alternative to buying a rental property is to pay all cash. This requires having a large sum of money, because most rental properties are more expensive than traditional homes. However, if you have the cash, this could be a good option. If you are going to use all cash, you should look at the return you’re going to get on your investment.
For example, if you pay $500,000 in cash, and the free cash flow after paying expenses is $50,000, you would effectively earn a 10% return, which is great. However, if you only are earning a free cash flow of, say, $5,000, putting your money in a CD is probably a better investment.
Hard Money
Hard money lending is a form of lending where you as the buyer get a private lender (or hard money) up front, and then pay all cash for the property. Typically, hard money lenders require several points up front, as well as higher interest rates than traditional mortgages. If you are planning on holding the property for a long time, this probably isn’t the best option.
Using an Existing Property
If you already own a property, like a single family home, and have a lot of equity in it, you may consider taking out a home equity line of credit, or even a mortgage against it, and then use the proceeds to buy the rental property. This will let you take advantage of the low rates, while using the money for a rental.
Mortgage Financing
Finally, you can always get a mortgage on your property. Since it is an investment property, you usually can’t get the lowest rates in the market – you will usually be about 1% higher than the best rate – which still isn’t a bad interest rate. If you are planning on getting a mortgage, you must be a very qualified buyer:
- You must put at least 20% down payment, but most likely 25% or more down
- You will most likely need a credit score higher than 750
- Your lender may require you to get mortgage insurance unless you are putting 30% down (and the mortgage insurance premium may be more like 3%, instead of 1% like a owner-occupied home)
- You must maintain a least 6 months reserves for all properties, including the one you are looking to purchase
- If you have any other rental properties, you must provide at least two years of documented tax returns proving the income
While difficult, it is not impossible to get a loan for an investment property – you will just need to work hard at securing it.