The Full Guide to Property Mortgages Investments

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If the path to property riches was a simple one, then everyone would be a millionaire landlord or house-flipper.

Making big money from investment property (real estate purchased to receive rental income or a profit from reselling it) is never as easy as “buy low, sell high.” It takes meticulous study, preparation, hard work and a dollop of good luck.

But as long as you make decisions about real estate investment with your eyes wide open, the financial rewards could surprise and delight you.

In 2019, house flipping’s average gross return (profits before expenses) – of purchasing, renovating and reselling homes rapidly – was 39.9 percent.

In other words, for every $100,000 spent, the average house flipper had gained $39,900.

The average rental property return in 2019 was 15%. This means the average buyer of a $500,000 apartment building in a single year gained $75,000!

In comparison, the average return on the stock market over the last 50 years was around 8 percent, while the return on mutual funds for the average investor over the last 30 years was about 4-5 percent.

Busted Myths

Until we look at the advantages of buying investment property, let us bust two common myths:

Myth 1: Purchasing a primary residence is the same as purchasing an investment property.

Fact: While many people find their homes to be assets, a house is not an investment property unless you purchase it for the express purpose of producing rental income or a profit on resale.

Myth 2: Home prices have always risen, and if you own it long enough a primary residence can eventually become an investment property.

Fact: The home prices have not always risen, adjusted for inflation and local market conditions. Housing markets are subject to boom-and-bust cycles at both the national and local rates. Regardless of how long you have a house, when you resell it, there is no guarantee that you will be making a profit.

Buying Investment Property Pros & Cons

The most popular real-estate deals for small investors come in two flavors: (1) rental property acquisitions and (2) house flipping projects.

Here are each of the main advantages and drawbacks:

House Flipping Pros: Good money, delivered easily and in lump sums.

In principle, flipping a house is a short-term investment that offers outsized instant rewards.

You know the drill when you watch HGTV.

First, buy a slightly “distressed” property for less than market value in an up-and-coming neighborhood-or less than its near-future value. Next, restore this fixer-top to a decent home. The moment the facelift is done, find a buyer who can pay more for the property than you have spent.

Rinse and repeat.

House Flipping Cons: High rewards come with high risk.

Big yields can be deceptive. Often, they do not include all the purchase and maintenance costs of the house. Usually, these costs swallow 20 to 30 percent of earnings.

In addition to maintenance expenses, you must, among other items, pay closing costs, property taxes, premiums and (often) a realtor’s fee. When you pick up a mortgage and do not resell the land ASAP, the monthly payments will begin to gnaw at your earnings.

Most newbie house flippers make the biggest mistake, underestimating the cost of buying and repairing the home.

You are betting as a house flipper you will sell the renovated house at a substantial discount before ever-increasing costs ruin your profit margin.

It is not a naΓ―ve or impatient game.

A good flipper researches the local market extensively before buying an investment property. The perfect neighborhood is one where homes are still affordable, but are fast to appreciate. Good places to buy are areas with solid services (e.g. strong schools and employment opportunities) that are only beginning to “gentrify”.

If you don’t have much cash on hand, you’ll need a short-term loan to buy the house. Unfortunately the investment property loan conditions are more strict than those for primary residences. You would need to get a “hard-money loan” instead of a traditional mortgage to flip a home, and those loans are far more costly.

Finally, capital gains taxes must apply to your income.

Long-term capital gains (investments kept for a year or longer) are taxed at 10% to 15%, while short-term capital gains are taxed at the same rate as ordinary revenues. Since house-flipping gains typically rely on rapidly turning the investment over, you can pay rates as high as 20 percent unless you do an exchange under Section 1031 to delay the tax bill.

Rental Property Pros: The greatest advantage to rental property is the stable income stream it creates, whether you own an apartment complex or duplex.

Whereas a three-month house flip venture could produce a $50,000 gross profit on a $200,000 investment, a $200,000 rental property will produce $4,000 a month (assuming you set the rent using the 2 percent rule) at that rate, you’re going to reach $50,000 in 13 months, and the revenue does not end there. It will keep flowing in, year after year, month after month.

In addition to generating profit, rental income can help you pay off the loan you have secured for financing the house. And in some situations, your present and future rental income will help you qualify for more favorable terms on loans.

Tax advantages can be the greatest advantage of owning rental properties. Rental assets not only produce revenue and future gains from capital appreciation, but also include deductions that can reduce tax on your property.

Popular deductions include money spent on mortgage interest, repairs and maintenance, insurance, property taxes, transportation, lawn care, catastrophe losses (floods, hurricanes, etc.), as well as HOA charges and condo or co-op maintenance fees.

If net cash flow after deduction of expenses is not positive, then your rental income can also be tax-free!

Rental Property Cons: If you’ve ever spent time talking to a landlord, you know rental property ownership isn’t without worries and hassles.

In addition to revenue production, rental properties produce costs ranging from 35 percent to 80 percent of gross operating income. (Most properties range from 37% to 45%. If your estimates of costs fall well below this, double-check your calculations.) Many new homeowners underestimate the expense of owning and maintaining their property.

(Note: Expenses may not be completely tax deductible. It depends on whether the IRS classifies the rental income as “non-passive” or “passive.” If you do not spend at least 750 hours a year operating on your rental property, all losses are passive and only deductible up to $25,000 from the rental income. (Fortunately, losses over $25,000 may be shifted to the next year.)

So when things break β€” from refrigerators so ovens to water pipes and HVAC systems β€” you’re the one that has to repair it. If you’re not careful, or if you don’t want tenants to make midnight calls, you’ll need to contract a property management company to deal with these duties.

The good news is that some (or even all) unpleasant activities can be performed by property management companies – from holding units filled to managing repairs and maintenance, raising rents, attracting suitable new tenants and evicting deadbeats.

A successful management firm will also have all the leases, permits and other paperwork needed to make sure the building operates like a well-oiled income-producing machine. You should also be specialists on the city and state’s rules on landlord tenants.

Really bad news? Such facilities are not free of charge.

Expect to pay a monthly fee of 7 percent to 10 percent of the earned rentals to a management company. And this may only be the start.

Many property management companies have extra payments for maintenance or maintenance supervision, for finding new tenants, or even when a tenant renews the contract. Others often charge vacancy fees, which means you have to pay them even though no revenue is created by an asset.

Of course, one of the greatest landlord fears is the deadbeat tenant who is destroying the property and takes months to evict. Carefully screening prospective tenants – and buying property in stable, middle-class communities – may minimize the risk of long-term vacancies and non-paying tenants, but there’s no guarantee you won’t face these issues.

Loans Related to Investment Properties

It’s harder to get an investment property loan than to get one for an owner-occupied home. And typically, they’re more costly.

Many lenders want higher credit ratings, stronger debt-to-income ratios and rock-solid paperwork (W2s, paystubs, and tax returns) to show that tenants worked the same job for two years. (This last condition will make it complicated for retirees and self-employed people.) Moreover, most will insist on at least 20 percent down payment, and others will want you to have six months’ cash (or close cash) reserves available.

If you have four mortgages now, you’ll need some experience in getting a fifth. Many banks do not sell new mortgages to investors who already have four, except when a government entity insures the loans.

But just because getting investment property loans is harder doesn’t mean you shouldn’t try. While you might not qualify for a traditional mortgage, the Federal Housing Administration (FHA) or Veterans Administration (VA) may provide you with one. You may also apply for a hard money loan or a home equity line of credit (HELOC).

Many lenders do not really care about your background or job history, as long as they see plenty of future income in the investment property you are considering.

Hard Cash Loans

Often house flippers and serious real estate investors use those loans. These are also known as commercial property loans and “patch and flip” loans, which have three primary advantages:

  1. Approval and financing is faster. In some situations, on the same day the application is submitted loans will be accepted, and funding can take as little as three days. Thanks to this speed, hard money loans are perfect for buyers who want to buy a property quickly – before it can be scooped up by the competition.
  2. Easier to qualify. When you make a down payment of 25 to 30 percent, have ample cash reserves and a strong track record as an investor in real estate, many lenders can overlook a subpar credit score. And they may not know you have 4 + mortgages already.
  3. They’re short-term loans. Most hard money loans have periods of one to two years or three to five years. That would be a deal killer for anyone buying a rental house. Few (sane) buyers of rental properties tend to pay back the loan within one or two years. But those words are ideal for house flippers, this is good, because there is no such thing as a 12-month mortgage. Even if banks wrote short-term mortgages, most would never loan money for a property that required major renovations – one that could not be deemed uninhabitable.

The expense is the greatest drawback to a hard money loan other than the 25 percent to 30 percent equity threshold. Usually, interest rates vary from 9% to 14%, and others bear initial charges (in the form of “points”) from 2% to 4% of the overall loan.

Conventional Mortgages

Conventional mortgages are fairly cheap compared with hard-money loans. In general, with an investment property mortgage, you would usually pay one to three percentage points more in interest.

According to an article in The Mortgage Reports from November 2017, a borrower with a 720 credit score financing a 20 percent down personal residence will qualify for an APR of 3,875 percent.

Add a risk-based price change for Fannie Mae of .75 percent to this. (The surcharge applies -75% of the loan sum to the fee, not the rate.) If the same borrower purchased a rental house instead of a primary residence, there will be an additional surcharge. The size of the surcharge will depend on the mortgage’s loan-to-value (LTV).

If the LTV were 80%, the extra charge would be 3,375%. Therefore the buyer of the rental property will also pay an extra charge of 4.125 percent.

Nonetheless, the issue with traditional mortgages is not their expense but getting accepted for some potential real estate moguls.

When you don’t own a unit in a building, most banks may want to see the following to authorize a rental property mortgage:

  • A down payment of 20 percent at least. If you want a lower rate, make an even bigger down payment. (On the positive side, investment property mortgage insurance does not apply.)
  • A minimum 80 percent LTV ratio.
  • A credit score greater than or equal to 740. Scores below 740 won’t doom your application (necessarily) but will cause higher interest rates, higher fees and lower LTVs.
  • Six months of “money funds” (cash, or assets easily convertible into cash).

When you have four mortgages on your account, there will not be many traditional lenders getting close to you.

While a policy launched by Fannie Mae in 2009 requires 5-10 mortgages to be on a borrower’s record, it can be difficult to locate a bank that will provide you with a mortgage, even with Fannie Mae’s guarantee.

The program requires payments of six months, held at the time of settlement as a liquid reserve. For single-family homes it takes at least 25 percent down, while 2-4 unit properties need 30 percent down. When you have six mortgages or more, a credit score of 720 or more is required. There are no exceptions.

FHA Mortgages

A FHA mortgage can be the ideal ‘starter kit’ for first-time buyers to fund a rental house.

There’s a catch though. To qualify for an FHA mortgage’s generous rates and terms, you’ll need to occupy a building unit. The property then counts as “occupied holders.”

Agencies do not grant FHA mortgages. Instead, private lenders make the loans, and the FHA insures those lenders for losses. This offers further motivation for banks to lend to borrowers who may otherwise be perceived as too risky.

Thanks to government backing, FHA mortgage lenders are lenient regarding minimum credit ratings, down payment amounts, and prior knowledge of the borrower’s real estate.

For buildings with one to four apartments, the down payment threshold for FHA mortgages is just 3.5 percent. In comparison, a traditional loan might allow 20 percent down on a two-unit purchase and 25 percent down on a 3-unit or 4-unit home purchase.

Since the FHA provides cash incentives for down payments and the use of a municipality’s down payment funds, it’s even possible to get an FHA-funded home with no money of your own.

Equally significant, the organization says it will guarantee loans to credit-scoring borrowers as small as 500. This is more than 100 points below the traditional mortgage and VA mortgage minimum.

The FHA often provides exceptions for home owners that have experienced a recent sale, short selling, or bankruptcy due to “extenuating circumstances,” such as sickness or job loss.

The FHA needs home buyers to wait only 12 months following a significant credit incident before re-applying for a mortgage via its Back to Work programme. The standard of the industry is nearer to four years.

FHA mortgage lenders would like to see a minimum credit score of 620 for applicants.

VA Mortgages

A 16 percent amount of active duty military personnel own investment assets compared to 9 percent of the general population, according to a 2016 report by the National Association of Realtors.

For that there are two reasons:

  1. Since active duty workers are frequently forced to relocate, they are often unable to sell their original homes at a price that would allow them to recoup their investments. So, they become absentee tenants instead of selling the houses.
  2. VA mortgages allow veterans, members of the active duty service and their surviving spouses to receive investment property loans with no down payment and low mortgage rates. As with FHA loans, the only condition is for the borrower to stay in one of the units of the building (in this case, for at least a year). They can rent out the entire building after that, and move somewhere else.

Rental properties can have up to four apartments, or they can be a duplex or triplex. The property may also be a home that rents a room, or a home on the property with a separate apartment.

Borrowers may also purchase one home, stay there for a year, and then repeat the multi-building cycle until they meet the maximum financing known as the entitlement limit.

Yet another advantage of VA mortgages: borrowers can take advantage of rentals from other housing units to qualify for the loan by including the rent as revenue. Usually they will add up to their qualifying income 75 percent of market rentals.

On the other hand, the rental property must be in moving condition and be approved by a VA home assessor before the loan can be accepted.

Home Equity Lines of Credit (HELOCs)

HELOCs are revolving lines of credit which usually come with variable rates. Your monthly payment is contingent on the current rate and balance of the loans.

HELOCS are similar to credit cards. You can remove any amount up to your cap, whatever the time. You are entitled to pay down or cancel the loan at will.

There are two stages of HELOCs. You use the line of credit whenever you want during the draw period and your minimum payment will cover only the interest due. But the HELOC draw period ends at some moment (usually after 10 years), and your loan enters the repayment process. You can no longer draw funds at this stage, and the loan will be completely amortized for the remainder of its years.

HELOCs deliver greater flexibility and less monthly payments across the draw cycle relative to traditional mortgages. You can borrow as much as you need – when you need it.

The possible disadvantages are the variable interest rates (which rise in conjunction with the prime rate of the Federal Reserve) and the risk that monthly payments may spike as soon as the repayment process begins.

A HELOC may be a lower-cost option to a hard-money loan in some house flipping circumstances.

But unlike a hard money loan, a HELOC may have more risk attached: if you don’t already own an investment property, with your primary residence, you’ll secure the HELOC. When you default on the loan, the lender will foreclose your home, not the property for investment.

When you already own an investment property, this dilemma can be solved by applying for a HELOC on one or more of those properties. The only trick here is to locate a lender.

Since many property investors failed after the 2008 housing crash, many banks would not allow credit home equity lines backed by investment assets. The few banks that do provide such HELOCs make it far more difficult to apply for them than before.

In certain cases, lenders set the ratio of LTV at or below 75 percent. They’ll also need a minimum credit score of 680 (compared to 620 for a borrower living in the building).

Lenders would require lower debt-to-income ratios (30 percent to 35 percent for borrowers on investment properties, versus 40 percent for anyone borrowing against a primary home). And, to the surprise of no one, they’ll even charge higher interest rates or allow you to pay 2-3 “points” in advance.

Expect to make an at least 25 percent down payment.

Seller Financing

Once every third “blue moon,” you will be able to secure funding from sellers for an investment property. Often known as owner financing, land contract or deed contract, this is an agreement under which the seller functions as the creditor, giving you private mortgage.

Instead of having a conventional loan from a mortgage firm or bank, you are funding the purchase with the house’s current owner.

Financing for sellers is not easy to come by. The overwhelming majority of buyers want to see their own mortgages paid out in full at the closing.

A house can’t be financed legally by a seller unless it’s purchased free and clear. Relatively few homes are safe and simple to buy. Most owners have some kind of mortgage.

Owner-financed land contracts are mostly based on a ballon mortgage of 5 years. This ensures that they are due in full in just five years, no matter how much the buyer has paid off or how little.

Some come with 10-year amortization, meaning a payment plan that will completely pay off the loan within 10 years. This alternative leads to incredibly high mortgage payments.

Seller financing can, in some cases, make sense for a house flipper. But this form of loan is in most cases neither necessary nor desirable.

Getting the Best Property Investment Loan

We don’t know much about your personal finances or the assets that you might consider, so we can’t provide detailed advice about how to fund your purchases or arrange your offers. That said, these are some easy tips for financing more property for less money:

  • Always buy at the best prices available! To compare the interest rates and conditions, as well as to compare closing costs and other expenses, contact several lenders, beginning with the bank that issued your first mortgage.
  • Read the “fine print” to discover any big fees and hidden costs, including increased costs caused by the amount of current loans/mortgages you have already.
  • Reduce the interest rate in return for a greater down payment, whenever feasible. In certain situations, charging up front fees (“points”) can also make sense to lower the cost. If you apply for a large loan and plan to keep the property for a long time, paying upfront fees and/or a higher down payment will reduce your overall repayment by thousands of dollars.
  • Consult your credit report in the months before you begin your property hunt to find out what types of loans you qualify for. When the score is very anemic, take action to raise the score – e.g. by paying down as much debt as possible (or paying off completely).
  • Make sure you have plenty of cash savings or other liquid assets. Cash reserves of six months are typically needed to qualify for mortgages on investment properties.
  • Consider your long-term objectives to decide what form of loan will fit best in your current situation, and a potential future. What would you do for example if your company made you move when you were in the midst of a fix-and-flip venture? Did you invested enough to recruit contractors to get the job done? (If so, how much it will lower the earnings – and the ability to repay the loan?)
  • Figure out how much land you can afford, and stick to your schedule. First-time investors in real estate underestimate its prices a lot. When you purchase only those assets that you can afford, cost overruns can lead to frustration and a small reduction of your profit margins. If you fall in love with a property and surpass your price limits, catastrophe in the form of additional expenses will occur.

Flip or Rent?

This choice depends on your ambitions and to what degree your talents, experience (construction talents are really helpful) and your current financial position can be leveraged.

In general, house flipping is typically the bigger risk, as such deals depend on how property prices in the near future can increase. Although price depreciation is never good for property owners, rising and/or declining prices have less effect on someone whose main source of income comes from rents than a fast resale of a property.

The highest flipping returns were at 146.6% in Pittsburgh in mid-2017; at 120.3% in Baton Rouge, LA; at 114% in Philadelphia; at 103.3% in Harrisburg, PA; and at 101.8% in Cleveland, according to ATTOM Data Solutions. These cities were top of the list because they had plenty of inexpensive, older homes that could be renovated quickly. At the same time there were also rising house prices.

The strongest markets for rental property in early 2017 were Cleveland, with an annual return of 11.5%; Cincinnati, 9.8%; Columbia, SC, 8.6%; Memphis, TN, 8.5%; and Richmond, VA, 8.2%. The poorest markets were usually situated on either coast in the main cities, where the prices of real estate had long been sky high.

But local markets are still evolving, and these figures can soon be out of date – unless they are already outdated.

Like with every other form of property, real estate brings risks as well as rewards. By carefully analyzing markets and funding options, you can lower risks but you can never fully eradicate them.