Investing in real estate helps you avoid the market volatility common in the stock market. Plus, rental properties make a great source of passive income.
However, investment properties require more capital to buy than stocks. For most investors, that means figuring out how to finance as much of the cost as possible.
Don't be scared away by the gurus who make it sound complicated, though. Try these options to fund your first investment property, rather than coughing up the whole purchase price in cash.
1. Conventional Mortgage
Anyone who owns a primary residence will be familiar with this financing option. Whereas lenders as little as a 3% down payment for primary home purchases, a 20-30% down payment or more will be required when buying an investment property. Unless you house hack — more on that later.
The approval of a conventional mortgage, the interest rates, and loan limit will be determined by your credit history as well as your personal credit score. Lenders will also review your assets and income to establish whether you can afford any existing mortgage payments and also the monthly loan payments you will be taking on once you buy the investment property.
Ensure you have enough cash to cover mortgage obligations for the first 6 months, as most conventional lenders require cash reserves. However you can use future rental income to help you qualify for the loan, with your debt-to-income ratio.
A conventional mortgage is one of the easiest and best ways to finance your first investment property purchase. Thus, it should be your first option.
2. House Hack
Owning a home is one of the best ways to build wealth since it frees up the money you would have been spending on renting. For those who are willing to "house hack," owning a home can tremendously increase your net worth within a short period.
In multifamily house hacking, you occupy one unit and rent out the others. The rental income generated will be used to pay your monthly mortgage payments, and there will be a surplus at times. Since you’ll be purchasing the property with the intent to live in it you will qualify for low down payment required for owner-occupied mortgage loans. Some options, such as FHA loans, allow you to put down only 3.5%.
You can also house hack by buying a single-family home then adding an ADU, renting out bedrooms, or even renting out the storage space you are not using!
This is the easiest way to get into real estate investing if you are open to sharing your living space with other people. Nevertheless, you will be assuming landlord duties hence the need to be prepared for such if you are not planning to hire a property manager.
3. Portfolio Loan
A portfolio loan is different from a conventional mortgage in that the lender not only originates but also retains it rather than offloading on the secondary market. Since it remains in the lender's portfolio, the lender has the freedom to set the standards.
Portfolio lender financing doesn't follow the rules of the other conventional loans which makes it a more flexible option for borrowers who are having a difficult time securing financing. In portfolio loans, you don't have to pay PMI, which saves you money every month. Additionally, it is the lender who sets down payment requirements.
Portfolio lenders don’t report to the credit bureaus, and don’t put a limit on how many mortgages can appear on your credit report (unlike conventional mortgage lenders). They make a great option for investment property loans once you reach the limit of how many mortgages you can have appearing on your credit report.
Finally, portfolio lenders tend to move much faster than conventional lenders. You can typically settle within 10-20 days with a portfolio lender, compared to 30-60 days with conforming lenders.
4. Hard Money Loan with the BRRRR Method
This is usually a short-term loan with fewer hindrances and requirements compared to the other financing options. Even though considered a last resort by many investors, a hard money loan may be your key to real estate investing — at least for acquisition.
These loans are designed for buying and renovating properties. They come with short loan terms (usually 6-24 months), and the lender expects you to pay them back by either selling the property (flipping it) or renting it out and refinancing it (the BRRRR method).
It's the value of the property you are purchasing that will be used in making a lending decision rather than your credit history or credit score. The property will be used as collateral should you fail to repay the loan.
However, traditional lenders don't offer hard money loans. You'll have to seek out private lenders to get hard money loans. Also, the interest rates are usually higher given how risky such a loan is. It is your best bet if you want to act fast in purchasing a prime investment property or your credit isn't perfect.
5. Tap Your Home Equity
For most people, the most valuable asset is their primary residence. Capitalizing on your home equity might be the answer to your real estate investment dreams. You can borrow up to 80% of the equity you have in your home.
When drawing on your home equity you can opt for a home equity loan (usually a cash-out refinance) or a home equity line of credit (HELOC). With a HELOC, you can borrow against your home equity just like you would with a credit card. The monthly payments are interest-only. However, the interest rate is variable based on prime rate changes but some lenders offer fixed interest rates for some years.
6. Seller Financing
Don’t want to borrow from a bank?
The seller, in this case, lends you the money to buy an investment property without getting the banks involved. You'll still have to make the down payment and the rest of the amount will be paid in installments.
It is a much more flexible financing option compared to the other options but you'll have to find a willing seller. The terms depend entirely on what you agree upon with the seller.
Final Thoughts
Investment properties can open up countless opportunities for you hence the need to get started early. However, securing a great financing package should be a top priority for anyone purchasing an investment property. For first-time real estate investors, financing can be an intimidating step but once you understand your options everything becomes easier. You should take your time in learning about the financing methods you can take advantage of since different situations will call for different financing. You just need a bit of financial ingenuity to turn what you already have into great prosperity.
