Top 6 Ways to Finance Your Rental Property
Posted on Friday March 12, 2021 at 03:18PM in General
Top 6 Ways to Finance Your Rental Property
Purchasing real estate can be a great investment and update to your financial portfolio, for a variety of reasons. Real estate is one of the primary investment categories, which also includes stocks, bonds, gold/commodities, and cash. Real estate often gives you an advantage against market volatility if stocks go down, and being a landlord allows you to have a steady stream of passive income. When buying a rental property, you need to have a certain amount of cash in order to get started and enjoy the perks. It can be challenging to discover the right way to fund your property purchase. Most investors use a combination of cash and loans to purchase a property to increase the leverage which increases the return on the cash that is used. While a loan can increase your return rate in good times, it can also decrease your return rate in bad times. Even if you decide to buy a property with another person, it is important to know all your investing options. We have provided you with the top six ways to finance your next property.
Loan optionsWhen financing your rental property, it is important to choose the right loan for you. Some loans have very specific criteria that needs to be met and if you choose the wrong type of loan, you could set back your success in financing your real estate.
- Conventional Bank Loans You are probably familiar with conventional financing if you already own your own home (that is your primary residence). This type of loan is not backed by the federal government and instead conforms to guidelines set by other parties. The typical down payment for this loan is around 20% of the purchase price of the home, but in the case of an investment property, you may need to provide a down payment of 30% of the funds.
- Tapping Home Equity - HELOC Another way to secure your investment property is through drawing on your home equity (through a home equity loan (HELOC), or cash-out refinance). Generally, you are able to borrow up to 80% of your home’s equity value in order to use it for the purchase of a second home.
- Fix-and-flip Loans If you would like another option that doesn’t include becoming a landlord, you should consider flipping houses as an alternative. You are able to receive a lump sum of profits when the house is sold, instead of waiting for rent checks each month for your return on investment.
- Private Funding Private funding is similar to mortgage lending in the aspect that some lenders can provide secured interest in the home or rental property. This process can be faster than the route of conventional mortgage financing. When considering this option, keep in mind that you may pay a higher interest rate. If the property is a good investment (if there is a positive cash flow through rental income) you can use the option of private funding until conventional financing is available for you.
- Insurance Company or Specialized Lender Insurance companies need a stable return and often use real estate loans. Because they are custom loans, these loans are typically for one million dollars or higher. You would contract directly with the insurance company or specialized lender that facilitates the loan. Most terms can be negotiated, including the term, interest rate, ability to pre-pay or no ability to prepay without a penalty, covenants, etc. Unlike a conventional loan, there are typically yearly reporting requirements where you need to provide a rent-roll, profit and loss statement, and there may be annual inspections of the property where an inspector reviews the inside and outside of a property to ensure it is properly maintained. Using rental property management software like Schedule My Rent helps you create a rent-roll report and track expenses. The interest rates are often similar or lower than a conventional loan.
- Cash-Out Refinance on a Primary or Secondary Home A cash-out refinance is when your lender uses one of your existing properties, a primary or secondary home, as security for your new loan. This process is the exact same as applying for a standard mortgage and takes around 30 to 45 days. You are typically able to borrow up to 80% of your home value. Through cash-out refinance, any existing debt on the property will be paid off and a new mortgage will be created. Then you will receive the difference as “cash out”.
- You provide the settlement statement indicating no financing
- A title search shows there are no liens on your property
- Any loans used as a source of your down payment must be paid back on your new settlement statement
- Your purchase was an arm’s length transaction
- Your new mortgage cannot be more than the initial investment that was used to purchase
- You must be able to source the funds for your purchase through bank statements, loan documents, etc.
Your personal credit score and credit history play a determining role in if you get approved for this loan, and how high the interest rate on your mortgage will be. Since you are renting this property and don't plan on living in it, it is not an "owner occupied" property your interest rate is typically .5% higher than a loan that is "owner occupied" where you live in the property. Your lenders will also review your income and assets and you must be able to prove that you can afford your current mortgage along with the loan payments on your investment property. You may have to have at least six months of funds for both of your mortgages. When your debt-to-income calculations are made, your future rental income from the property may not be included, depending how conservative the bank loan officer is.
This method has its pros and cons which can depend on what type of loan you decide to choose.
If you choose the HELOC option, you are able to borrow against the equity. This is the same concept you would use with a credit card, and your monthly payments would often be interest-only. The rate is variable in most situations (meaning it can increase if the prime rate also changes).
If you decide on the cash-out refinance method, you would pay a fixed rate, but it could extend your current mortgage. If you have a longer loan term, you are also paying more interest on your current residence. It is important to keep in mind that you will have returns on investment when you rent out the property.
This short term loan called a fix-and-flip loan allows you to renovate a property and put it back on the market as quickly as possible. These loans are essentially hard money loans. This means that the loan is secured by your property.
The benefit of this type of loan is that it might be easier for you to qualify for a house flip loan instead of a conventional loan. While your credit score and income are still considered, the primary concern is the profitability of your property. Your property’s estimated after-repair value (ARV) is used in calculating if you are going to be able to repay the loan. Another advantage is that you might be able to get loan funding in days instead of weeks or months when applying for this loan.
The largest disadvantage that is important to think about is that your interest rates can go as high as 18%, and you might have a small timeframe for paying back the loan. It is not uncommon for these types of hard money loans to have time frames of less than a year. It is also important to consider the origination fees and closing costs that could take out part of your returns.
Since this option has home owners using the equity from their personal properties, it may not be an option for you if there is simply not enough equity in your existing properties to finance the cash-out.
The maximum cash-out available to you if you refinance on a property you own (that was not purchased in the last six months) is 75% loan-to-value ratio (LVT) for one property, and 70% if you have a property with two to four units.
You are able to pursue a cash-out refinance immediately if these guidelines are met and if there was no financing for the purchase transaction.