Funding Your Investment Property: Strategies For Success

Investing in real estate is a popular way to build wealth and generate passive income. Financing an investment property can be done through various means, including conventional bank loans, hard money loans, private money loans, and tapping into home equity. When applying for a loan, lenders will typically consider the loan-to-value ratio, credit score, income, and assets. It's important to make a sizable down payment, be a strong borrower, and explore different financing options to secure the best deal.

Make a large down payment

Making a Large Down Payment for an Investment Property

When purchasing an investment property, lenders will often require a larger down payment than for a primary residence. This is because the property isn't your primary residence, so the likelihood of defaulting on the loan is higher. A larger down payment acts as an incentive for you to make the investment work, as you have more to lose if it doesn't. It also provides the lender with greater security.

The amount of the down payment varies depending on the type of loan. For a conventional bank loan, lenders often require 30% of the sale price as a down payment. However, this can be higher, with some sources suggesting that a down payment of 25% will help get you a better interest rate, and others stating that a minimum of 15% is required.

If you can make a down payment of 20%, you may be able to secure a conventional loan with a lower interest rate and a longer repayment period, which could result in lower monthly payments and improved cash flow.

A higher down payment can also give you access to better loan terms and interest rates. With a good credit score and a large down payment, you may find that more loan options become available to you.

Tips for Making a Large Down Payment

• If you have a primary residence with at least 20% equity, you can use a home equity loan or line of credit to fund your down payment.
• Consider using a private lender, who may be able to offer more flexible funding solutions.
• Look into government-backed loans, such as an FHA loan, which allows down payments as low as 3.5%.
• If you are a first-time homebuyer, consider a VA loan, which is backed by the U.S. Department of Veteran Affairs and offers financing with a 0% minimum down payment.
• Try "house hacking" by purchasing a multifamily property and renting out the other units. This can help you build up your down payment.

Be a strong borrower

Being a strong borrower is critical when it comes to securing funding for an investment property. Here are some key factors to consider:

Credit Score

First, check your credit score. While a higher score doesn't guarantee a loan, it can impact the interest rate and terms of the loan. A credit score below 740 may result in additional fees or a higher interest rate. Lenders typically require a minimum credit score of 620, but this may vary depending on the loan type. For example, a conventional loan often demands a score of 700 if you can't make a 25% down payment. FHA loans are more forgiving, with a minimum score of 500 for a 10% down payment or 580 for a 3.5% down payment.

Down Payment

A larger down payment not only improves your chances of securing a loan but also helps you qualify for a better interest rate. For conventional loans, a 20% down payment is standard, but lenders often require 30% for investment properties. Government-backed loans, such as FHA loans, may allow for lower down payments, even as low as 3.5%.

Debt-to-Income Ratio

Lenders will assess your debt-to-income ratio (DTI), which represents the percentage of your monthly income that goes towards debt payments. They will want to ensure that you can afford the loan payments along with your other financial obligations. The DTI requirements vary by loan type and lender, but it's generally recommended to keep your DTI below 45%.

Reserves

Having sufficient reserves is crucial. Lenders typically want to see that you have enough cash to cover mortgage payments and other expenses for at least six months. This demonstrates your ability to continue making payments even if your rental property is vacant or you encounter other financial setbacks.

Rental Income

If you already own rental properties, lenders may consider a portion of your rental income when evaluating your loan application. This can help improve your chances of qualifying for the loan and potentially secure better terms.

Property Management Experience

Some lenders may also consider your property management experience. If you have a track record of successfully managing rental properties, it can work in your favour when applying for an investment property loan.

Shop Around

Don't hesitate to shop around and compare offers from multiple lenders. Interest rates, fees, and requirements can vary significantly between lenders, so it's worth exploring your options to find the best deal.

Remember, being a strong borrower involves more than just a high credit score. Lenders will consider various factors, including your down payment, DTI, reserves, and property management experience. By demonstrating your financial strength and stability, you'll be well on your way to securing funding for your investment property.

Explore local lending options

When it comes to funding an investment property, exploring local lending options can be a great strategy. Here are some detailed tips to help you navigate this approach:

• Turn to Local Banks or Credit Unions: Consider approaching local banks or credit unions in your area for financing. These institutions often have a better understanding of the local real estate market and may be more willing to work with you. They typically have more flexibility regarding loan requirements and may be able to offer you more favourable terms, especially if you have a relationship with them.
• Compare Interest Rates and Terms: Don't settle for the first offer. Shop around and compare interest rates, down payment requirements, and loan terms among multiple local lenders. This will help you secure the best deal possible.
• Build Relationships: Developing relationships with local lenders can be advantageous. They may be more inclined to work with you if they know you and understand your investment goals. This could lead to faster loan processing, more flexible requirements, and potentially better interest rates.
• Explore Local Investment Clubs: Join local real estate investment clubs or networking events to connect with potential lenders and other investors. These events can provide valuable insights into the local market and introduce you to individuals who may be interested in partnering with you or offering loans.
• Consider Private Money Lenders: Private money lenders, often individuals like friends or family, can be a good option for securing funds. However, it's important to carefully consider the terms and potential consequences of defaulting on the loan to avoid souring personal relationships.
• Understand Local Market Trends: Familiarise yourself with the local real estate market trends, such as demand for rental properties, population growth, and economic development. This knowledge will help you make more informed decisions about where and when to invest, increasing your chances of securing favourable local financing.

Remember to do your due diligence when exploring local lending options, as interest rates, fees, and requirements can vary significantly between lenders.

Ask for owner financing

Owner financing is an alternative to traditional mortgage loans. It involves a direct agreement between the buyer/investor and the property seller, removing the need for third-party financial institutions. This option is particularly useful for buyers seeking quick fix-and-flip opportunities and more affordable terms and interest rates.

Under owner financing terms, the seller agrees to accept instalment payments for the sale of their property until the investor has paid the balance in full. Instead of giving the investor money, the seller issues a line of credit. This agreement tends to be more flexible than a traditional purchase agreement, with repayment periods ranging from five to thirty years.

When it comes to finding owner-financed homes, here are some tips:

• Retain a real estate agent
• Search for sellers on real estate websites
• Consult publicly accessible MLS websites
• Look for "For Sale By Owner" or "For Rent" signs
• Search through public eviction notices at a local courthouse
• Network at real estate events and conventions

It's important to note that owner financing works best when the seller owns the property outright, as a mortgage on the property can create complications. Additionally, in the case of a default, the seller retains the right to reclaim the property.

Advantages of Owner Financing:

• Easier and less stressful negotiations without banks
• A more accessible qualification process for buyers
• Shorter amortization periods
• Faster closing with fewer costs
• Higher interest rates for sellers
• Less expensive repairs or upgrades for sellers

Disadvantages of Owner Financing:

• More intensive paperwork
• Difficulty finding sellers who accept owner financing
• Sellers must manage loans themselves
• Sellers may face sizable down payments, higher interest rates, and shorter repayment periods
• Sellers receive less cash upfront and might have trouble collecting payments
• Homes with existing mortgages may not qualify for owner financing
• Sellers face higher foreclosure risks

Tap your home equity

If you have equity in your home, you can use it as a form of financing for an investment property. There are a few ways to go about it:

Home Equity Loan

Home equity loans are a type of second mortgage that allows you to borrow a fixed amount against the equity in your home. They are repaid over a set period, usually between five and 30 years. The interest rates are relatively low, and for those with good credit, they can be even lower. The loan is secured by the equity in your home, so if you default, you could lose your home.

Home Equity Line of Credit (HELOC)

A HELOC is another type of second mortgage, but it works more like a credit card. You can borrow multiple times against a line of credit up to a certain limit and then pay it off. HELOCs usually have no closing costs, and the interest rates are variable, which means they can go up or down over the life of the loan. Like a home equity loan, your home is at risk if you default.

Cash-Out Refinance

With a cash-out refinance, you replace your current mortgage with a new, larger one and take the difference in cash. This option can secure a lower interest rate or a shorter repayment term than your current mortgage. However, it will increase your overall debt burden, and you will have to pay closing costs.

Reverse Mortgage

A reverse mortgage is an option for seniors (62 or older). With this type of mortgage, the lender makes payments to you instead of you making payments to them. However, the most common type of reverse mortgage does not allow you to use the proceeds to buy a home that won't be your primary residence.

Before tapping into your home equity, it's important to consider the risks. Defaulting on these loans could result in the loss of your home. Additionally, there may be limits on how much equity you can access, typically between 80% and 85% of your available equity.

Frequently asked questions