Unlocking The No-Money-Down Approach: A Guide To Buying An Investment Home

Buying an Investment Home with No Down Payment

It is possible to buy an investment home with no down payment, and there are several ways to do it. The two extremes of buying investment property are buying outright for cash or buying using none of your own money. Most people's investment strategies fall somewhere between the two.

Using Other People's Money (OPM)

If you already own a primary residence, you can use the equity in your home to buy an investment property. You can apply for a home equity line of credit (HELOC) or do a cash-out refinance to use as a down payment on a new property. Alternatively, you can rent out your current home and purchase or rent another home to use as your primary residence.

Seller Financing

If you don't already own property, you can try seller financing, where the owner sells you the house directly and acts as the lender. Lease options are also available, where you rent a property from the owner with an option to buy. You can also try to negotiate the down payment with the seller, who may decline it in return for higher monthly payments or pay it on your behalf to sell the property faster.

Government-Backed Loans

Government-backed loans such as VA loans and USDA loans allow you to buy a home without a down payment if you meet specific criteria. For example, VA loans are available to active-duty service members, military veterans, and their spouses, while USDA loans are for borrowers in rural and suburban areas with low to moderate incomes.

Other Options

If you don't qualify for a government-backed loan, you may still be able to get a conventional loan with a low down payment or explore down payment assistance (DPA) programs. You can also try to find a co-borrower or partner who can provide the down payment, or exchange your skills or personal property for the down payment.

Rent out your current home

Renting out your current home is a viable option if you want to buy an investment property without a down payment. Here are some things to consider and steps to take if you're thinking of going down this route:

Weigh the Pros and Cons

Renting out your current home can provide additional cash flow and allow you to build equity through renter payments and increase your assets. It can also serve as a gateway to exploring real estate investing. However, there are some drawbacks, such as complex tax implications and the responsibilities of becoming a landlord.

Understand the Financial Requirements

Before renting out your current home, evaluate your finances to ensure you can handle the financial burden of two homes. Consider your budget, income, and any savings you have that can be used for a down payment on a second home. Keep in mind that you may need to cover two mortgage payments for a period of time.

Know the Lending Rules

If you have an existing mortgage on your current home, review the terms of your mortgage agreement. Lenders typically have rules regarding converting a primary residence into a rental property. They will want to ensure you can manage two homes financially and may require you to demonstrate landlord experience or have certain financial reserves.

Understand the Legal Requirements

Research the landlord-tenant laws in your state and local area. Understand your obligations and rights regarding security deposits, tenant screening, lease agreements, eviction rules, and fair housing laws. If your home is part of a homeowners association (HOA), check their rules and requirements regarding renting out your property.

Prepare Your Home for Renting

Get your home ready by making any necessary repairs or improvements. Consider hiring a property manager to handle the day-to-day tasks associated with renting out your property, such as screening tenants, collecting rent, and arranging maintenance.

Understand the Tax Implications

Consult with an accountant or tax advisor to understand the tax implications of renting out your current home. The rent you collect will be considered taxable income, and you will need to keep good records to comply with tax requirements.

Know Your Local Rental Market

Talk to a local real estate expert or realtor to understand the rental market in your area. They can provide insights on rental rates, demand, and what it takes to be a successful landlord.

Be Prepared for the Work Involved

Being a landlord comes with responsibilities and time commitments. You will need to be prepared to handle maintenance requests, repairs, tenant screening, lease agreements, and more. If this seems overwhelming, consider hiring a property management company to assist you.

Try house hacking

House hacking is a real estate strategy that involves renting out a part of your property while living there yourself. This can be anything from renting out a room in your house to purchasing a multifamily home and living in one of the units while renting out the rest.

• Choose the right property: Look for single-family homes with extra rooms or multi-family homes like duplexes or triplexes. You can also consider accessory dwelling units (ADUs), which are separate living units on your property that can be rented out.
• Calculate your potential income: Determine the potential profitability of your property by considering factors such as net operating income, cap rate, cash flow, and the 1% rule (where the monthly rent is at least 1% of the purchase price).
• Explore loan options: Owner-occupied mortgages, such as VA loans or FHA loans, can be advantageous as they often have lower down payment requirements (as low as 3.5% or even 0%) compared to investment property loans.
• Make any necessary renovations or repairs: It's best to do this before finding tenants. Ensure the rental space is functional and aesthetically pleasing to charge higher rent and attract long-term tenants.
• Find good tenants: Screen tenants thoroughly to ensure a good fit. Consider hiring an agency for background checks, running credit checks, and verifying income. Once you've found a suitable tenant, draft a lease agreement and have it signed before they move in.
• Be prepared for the responsibilities of being a landlord: Remember that being a landlord comes with additional responsibilities, such as maintenance, repairs, and responding promptly to tenant issues. You may also want to familiarise yourself with landlord-tenant laws and the Fair Housing Act to ensure you are compliant.

House hacking can be a great way to generate passive income, build wealth, and get started in real estate investing. It allows you to benefit from the tax advantages of homeownership while having your tenants help cover your mortgage and other expenses.

Tap into home equity

If you already own a home, you can tap into your home equity to cover the down payment for an investment property. Home equity is the difference between what you owe on your home and its market value. There are two ways to leverage home equity to buy an investment property: a home equity line of credit (HELOC) or cash-out refinancing.

Home Equity Line of Credit (HELOC)

A HELOC is a line of credit that is backed by your home equity. It works similarly to a credit card, giving you flexible access to funds with a credit limit based on your property's equity. During the draw period, you can make interest-only payments, which can be helpful for managing the varying costs of purchasing an investment property. Once the draw period ends, you will need to start repaying the principal balance and interest in full. A significant advantage of a HELOC is that you can use the line of credit multiple times, making it a good option if you plan to make multiple purchases. However, a potential drawback is that HELOCs typically have variable interest rates, which can be stressful for borrowers who prefer the stability of a fixed-rate loan.

Cash-Out Refinancing

With cash-out refinancing, you replace your current home loan with a new mortgage for a higher amount. The difference between the new loan and what you currently owe is paid out in cash, which you can then use for the down payment on an investment property. This option typically offers the lowest interest rates compared to other equity-tapping loans. However, it is important to consider the cash-out refinance closing costs and the impact on your overall debt burden. Additionally, beginning in May 2023, conventional cash-out refinances became more expensive, with higher interest rates or extra fees if you borrow more than 30% of your home's value.

When deciding whether to tap into your home equity to buy an investment property, it is important to consider the potential benefits and drawbacks. On the one hand, leveraging your home equity can help you secure the down payment, possibly leading to better financing terms. It can also allow you to build wealth over time through an extra income source and property appreciation. However, there are risks to consider, such as the impact of shifts in the housing market and the possibility of ending up underwater on your loan if the property loses value. Therefore, it is crucial to carefully assess your financial situation and goals before making a decision.

Use the BRRRR method

The BRRRR method is a popular strategy for investing in real estate. It is a five-step process that can help you build a portfolio of rental properties and generate consistent income. Here's a detailed guide on how to use the BRRRR method to buy an investment home with no down payment:

Buy a Distressed Property:

The first step is to find and purchase a distressed property, such as a foreclosed home or a property in need of repair. These properties are often sold below market value, allowing you to maximize profits by making repairs and renting. Look for run-down properties, homes with overgrown yards or broken windows, or properties with notices posted on the doors.

Renovate and Rehab:

Once you've purchased the property, it's time to renovate and bring it up to code. Focus on making necessary repairs and upgrades that increase the home's market value. This could include a kitchen makeover, bathroom remodels, or other improvements. It's important to work with a trusted contractor and set a reasonable budget for the renovations.

Rent to Tenants:

After the renovations are complete, find a carefully screened tenant to rent the property. It's crucial to have someone living on the property, as most lenders won't agree to refinance an unoccupied home. Screen prospective tenants thoroughly by running a credit check, conducting background checks, and verifying rental history.

Refinance the Property:

The next step is to refinance the property and pull out cash through a cash-out refinance. Work with a professional broker or bank to refinance based on the increased market value of the renovated property. Most lenders will allow an 80% loan-to-value (LTV) ratio, so you'll need to leave a 20% margin of equity in the property.

Repeat the Process:

Use the cash you earned from the cash-out refinance to buy another distressed property and start the cycle again. The key to the BRRRR method is to repeat these steps and build a portfolio of rental properties over time. By doing so, you can generate passive income and increase your real estate holdings.

The BRRRR method requires careful planning, budgeting, and patience. It may not be suitable for investors looking for quick returns, but it can be a powerful strategy for those willing to put in the work and build a long-term passive income stream.

Opt for seller financing

Opting for seller financing is a viable option for those looking to buy an investment property with no down payment. This type of arrangement is also known as a purchase-money mortgage or owner financing, and it involves the property seller providing financing for the buyer, eliminating the need for a traditional lender.

Advantages for Buyers:

• Greater access to financing opportunities: Seller financing can be especially beneficial for low-income buyers or those with poor credit who may not qualify for traditional mortgages.
• Lower closing costs: Buyers may be able to negotiate more flexible terms with the seller, resulting in lower expenses associated with closing costs.
• No private mortgage insurance (PMI) premiums: In some cases, seller financing agreements may not require PMI premiums, reducing the overall cost of the loan.

Advantages for Sellers:

• Saving on closing costs: Sellers can save on closing costs by providing financing directly to the buyer.
• Capital gains tax savings: Over time, seller financing can result in significant capital gains tax savings for the seller.
• Faster sale and ability to sell as-is: By offering seller financing, the seller may be able to sell the property faster and without the need for repairs.
• Release from property tax, insurance, and maintenance expenses: The seller no longer has to worry about ongoing property-related expenses.
• Option to sell the promissory note: The seller has the option to sell the promissory note to an investor, providing additional financial flexibility.

Disadvantages of Seller Financing:

• Fewer regulations protecting buyers: Seller financing agreements may have fewer regulatory protections in place compared to traditional mortgages.
• Risk of foreclosure: Buyers are still vulnerable to foreclosure if the seller does not make mortgage payments to senior financing.
• No home inspection/PMI may result in overpaying: Without a home inspection or PMI, buyers may end up paying more than the property is worth.
• Higher interest rates and larger down payment: In some cases, seller financing may come with higher interest rates and require a larger down payment than traditional mortgages.
• Risk of default for the seller: If the buyer defaults on payments, the seller faces financial risk.

When considering seller financing, it is important to carefully review the terms of the agreement and consult with a qualified professional to ensure that it aligns with your personal financial situation and goals.

Frequently asked questions