Updated October 14th, 2020
Owning a rental property can be a great investment, but you need to consider the financial side of things before you start house shopping. All the different options can seem overwhelming, and it's always good to keep in mind that one person's ideal solution might not fit you.
These are some of the more popular financing avenues that can help you begin your journey towards becoming a real estate tycoon:
Go the traditional mortgage route
Most lenders will ask for a 20% down payment to secure traditional financing to go down this route. This is because investment properties aren't covered by mortgage insurance. A 25% down payment may even qualify you for a better interest rate, which pays off in the long run if you have the money. As with many loans, you'll need to have a good credit score and undergo the bank's qualifying process. There are also some additional fees for a mortgage – around 2% to 5% of the average purchase price.
Take it slow as an owner-occupant
This is one of the best financing routes, especially for someone starting. Look for the perfect rental property, then use it as a personal residence for the 12 months that an owner-occupant loan requires.
For example, the Federal Housing Administration (FHA loans) loans are very popular as they can go as low as 3.5% for a down payment. This rate then stays the same when you move out and turn it into a rental. Other benefits of this include taking your time fixing up the property and learning the specifics of it.
Look for an investment partner
The down payment on a traditional mortgage means you'll need to have quite a bit of saving upfront. An option is to find someone to partner with who can make up what you lack with the down payment. Of course, this will end up meaning a split in the profits, so you'll have to weigh the pros and cons and see where your priorities are. In the end, it can lead to you gaining your first investment property even sooner.
Consider a home equity loan
A home equity loan is a second mortgage which allows a homeowner to borrow money using their home's equity as collateral. To break it down, the equity is the difference between what you owe on the mortgage of your home and how much the home is worth.
Using this kind of loan can let you tap into up to 80% of your existing home's value and use that to finance your investment property. The repayment period, like a typical mortgage, is usually around 20 to 30 years.
Tips to help the financing process
Look into buying an investment property with a tenant already in place – there are some serious advantages to this! Since the tenant would still pay the same rent, you will most likely end up with a month's rent before the first mortgage payment is even due. Plus, you probably won't have to worry about fixing up or renovating the place until the renter leaves.
Of course, you'll have to look into if the tenant is paying market rent. If the rent the tenant is paying is quite a way under market, you may be able to get a discount off the property's sale price. Check out rental evaluation calculators like Rentometer to determine a reasonable rent amount for the property.
Before beginning to look for finance options, it's important to pay down any existing personal or business debt you might have. This gives you the best chance possible for a reasonable rate if you're going to a lender.
How do you get started?
The best option is to gather as many options as possible and compare them. Meet with several lenders who can show you what mortgage programs they offer and check-in with a bank or two. You can also try mortgage brokers or even an online lender. They will likely each have different programs, so it's good to shop around to find the best one for your situation.
About the Author: Jennifer McDermott is the Consumer Advocate at personal finance comparison website finder.com. She has more than 12 years' experience under her belt, where she's analyzed consumer trends in the finance, lifestyle, and travel industries. Jennifer loves to uncover interesting insights and issues to help people make better decisions with their money.
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