If you’re ready to step into the waters of investment property financing, this guide is here to help. You need to have your money and credit in order and know what your options are for loans. After all, purchasing an investment property is a big step. You need to know what to expect and ways you can make it more affordable.
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What’s an Investment Property?
An investment property is a piece of real estate you purchase with the sole reason of profiting off of it. These can be properties you hold for a short period, like you’re house flipping, or they can be long-held, like with rental properties.
Investment properties make money by balancing the purchase price and further investment while maintaining cash flow. This can be with a specific goal in sight, like with flipping a house, or it could be with several smaller goals, such as making improvements while maintaining renters.
How to Prepare for Investment Property Financing
As with any real estate purchase, you need to have your finances in order. That’s especially true with financing investment properties. Lenders have higher requirements for investors than they do for those looking to fund their primary residence. Here are a few ways you can be prepared.
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1. Build Your Credit
Many lenders are going to require you to have good or excellent credit to finance an investment property. In general, expect lenders to require a credit score of 680 or better. There are some ways around this (more on that later). But, the better your credit score, the more likely your loan application is accepted and you’re offered a more favorable interest rate.
2. Have a Sizable Down Payment
Financing an investment property requires you to already have a good chunk of money toward the purchase. This can vary depending on the loan type, but for a conventional mortgage, you’ll likely need 15% down.
3. Have Extra Cash Reserves
Along with your down payment, you’ll need extra cash in reserve. This may or may not be required by your lender. However, if you’re buying an investment property, you’ll need to put money into the property. Even the most turnkey of rental properties will need funding in case of a major appliance failure or to cover things like landscaping.
4 Investment Property Financing Methods
There are four primary investment property financing methods that you can take advantage of.
1. Using Your Own Home Equity
If you own your current home or have a large chunk of equity, you can use the equity in it to finance your investment property purchase. There are three ways to do this:
Cash-out refinance: With this product, you dip into your equity, replacing your old mortgage, or, if you own the home outright, starting a new mortgage. You can get up to 80% of your equity as a lump sum.
Home equity loan: Similar to a cash-out refinance, you will need to leave some equity in the home and you’ll be paid in a lump sum. But, a home equity loan lets you keep your original mortgage (if you still have it) and start a second loan. This can be beneficial if your original mortgage has a low rate.
Home equity line of credit (HELOC): A HELOC is a line of credit, like a credit card, that taps into your home equity. It works on two time periods: a draw and a repayment period. People often use HELOCs when they don’t know how much they need exactly and would rather not take out a lump sum.
Let’s go over how you can use your home equity. For example, let’s say you own a home appraised at $350,000. You decide to take out a home equity loan for 80% of your equity. That’s $280,000. You can then use that lump sum to purchase and update an investment property.
2. Getting a Mortgage
There are a few ways you can get investment property financing with a mortgage. The main way is through a conventional mortgage. Conventional mortgages aren’t part of a government-sponsored program, which makes them harder to get, especially for investment properties. For a conventional mortgage on an investment property, you’ll likely need a credit score of 680+ with at least a 15% down payment.
Another way you could get a mortgage for an investment property is through a government-sponsored mortgage, like an FHA loan. FHA loans can be attained with lower credit scores and down payments, making them much more flexible. You may have to jump through other hoops, though. For instance, you can buy a multifamily property with up to four units with an FHA loan, but you will need to live in one of the units as your primary residence for at least a year. FHA also offers financing for non-owner-occupied properties, but they come with specific requirements around the condition and age of the property.
3. Private Money Loans
Private money loans are especially common in real estate investment. They are what they sound like: loans from wealthy individuals or organizations made to other individuals. Often times they’re from a family member or close friend. If they’re from an organization, it’s not an accredited one, like a bank or credit union.
If you know the lender well, you may get a low interest rate. However, if the loan is coming from someone you don’t know, private money loans tend to have higher rates. The repayment terms are often much shorter than with a conventional mortgage too.
4. Hard Money Loans
Hard money loans are similar to private money loans in that they’re short-term mortgages offered at a higher interest rate. The difference here is that hard money loans often come with higher fees. You attain one through a hard money lender and they’re usually funded by investors.
The Bottom Line
Getting the right investment property financing is a big piece of the puzzle when it comes to purchasing an investment property. Before you make a decision, you need to be aware of your finances and your options. Research lenders before contacting them and read carefully over the terms of their loan offer. Strong financing can be the foundation for your real estate investment.
Real Estate Investing Tips
Investing in real estate means you’ll have to do a lot of juggling. Having a financial advisor in your corner gives you one less thing to worry about. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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