There are several reasons for investing in real estate. This may be a hedge against market fluctuations as stocks are down, and there are also other advantages involved with the purchase of investment properties.
Becoming a landlord can be a good way to produce a steady passive income stream, but it takes a certain amount of cash to get going. And if you don’t have a big bankroll, taking out an investment property loan might be the best way to close the deal.
Investment property lending will take a variety of forms and there are clear requirements that lenders need to be able to follow. Choosing the wrong form of loan may have an effect on the viability of the project, and it is important to consider the criteria of each type of loan and how the various options operate before contacting the lender.
Note: Three types of loans that can be used for investment properties are: traditional bank loans, hard money loans, and home equity loans.
- There are a few options to fund investment property, including the use of equity in your personal estate.
- If you do not have the cash to finance a down payment yourself, it may be possible to use gifted money, but the cash donations must be reported.
- Buying property and renovating it for profit is called flipping in real estate jargon.
- Hard money loans serve as short-term lending, and most often have a shorter payback period than traditional mortgages.
- Banks don’t give hard money loans, only traditional mortgages.
Option #1: Conventional Bank Loans
If you already own a house that is your primary residence, you may be comfortable with conventional financing. The traditional mortgage conforms to the requirements set out by Fannie Mae or Freddie Mac and, unlike the FHA, VA or USDA loans, is not subsidized by the federal government.
For conventional lending, the usual expectation of a down payment is 20% of the selling price of the home, but for an investment property, the developer can need 30% of the funds as a down payment.
With a conventional loan, your personal credit score and credit history will decide your ability to get accepted, and what kind of interest rate applies to the mortgage. Lenders also check the profits and assets of lenders. And, of course, lenders need to be able to prove that they can cover their current mortgage and annual debt payments on investment properties.
Initial rental income is not counted in the debt-to-income ratios, so most lenders expect homeowners to have at least six months of cash put aside to meet all mortgage commitments.
Choice #2: Fix-and-Flip Loans
Though being a homeowner has its perks, it also has some headaches. For certain owners, flipping houses is a more appealing option, as it helps them to collect their money as a lump sum when the house is sold, rather than waiting for a monthly rent check.
A fix-and-flip loan is a form of short-term loan that helps the borrower to finish repairs so that the house can be put back on the market as soon as possible. Fix-and-flip loans are simply hard money loans, which ensures that the debt is backed by the house itself. Hard money borrowers specialize in these types of loans, but some crowdfunding sites sell them as well.
The upside to using a hard money loan to fund a house swap is that it could be easier to apply than a traditional loan. While borrowers do regard factors like credit and profits, the primary emphasis is on the viability of the land.
The approximate valuation of the home after restoration, aka the after-repair value (ARV) is used to gauge if you will be able to repay the loan. It is also easy to get loan approval in a matter of days rather than taking weeks or months for a traditional mortgage completion.
The only downside to having a fix-and-flip loan is that it’s not going to come cheap. Interest rates on this form of debt can be as high as 18 percent, depending on the provider, so the timeline on paying it back may be limited. It is not uncommon for hard money loans to have conditions that last less than a year. Originating fees and closure expenses could also be higher relative to traditional lending, which may eat away at returns.
Choice #3: Tapping Home Equity
Banking from your home equity, either through a home equity loan, HELOC or cash-out refinancing, is the third way to buy investment properties for long-term renting or flip funding. For most cases, it is possible to borrow up to 80% of the home’s equity to be used for the purchase of a second house.
Using equity to fund an investment in real estate has its pros and cons, depending on the form of loan you want. For example, with a HELOC, you can invest on equity the same way you can on a credit card, and regular fees are also interest-only. The rate is normally variable; however, this means that it can rise if the premium rate increases.
A cash-out refinancing would come at a set cost, so it could extend the life of the current mortgage. A longer loan period may mean charging more interest for primary residence. It will have to be measured against the anticipated returns it investment properties will offer.
Investing in a rental property or undertaking a house-flipping scheme are risky projects, but they provide the opportunity for a big payout. Seeking capital to take advantage of an investing opportunity doesn’t have to be a hindrance if you know where to look. When you compare various borrowing choices, bear in mind what the short-and long-term costs are and how they can impact you.