If you’re thinking of applying for a real estate investment loan, then you need to have a down payment saved up. When buying a rental property, a 20% down payment is the norm. But do you have to put 20% down on a rental property? Is it worth putting 20% down?
Benefits of Paying 20% Down on a Rental Property
One of the main reasons why most real estate investors pay 20% down payments is the many benefits that come with them:
1. Lower Monthly Payments
Perhaps the most prominent benefit of 20% down payments is lower monthly mortgage payments. We’ll use a quick example to illustrate this point. Let’s say, for instance, you are buying a $300,000 single family home. A 20% down payment for the property would be $60,000. With an interest rate of around 3.19%, you would be paying $1,943 a month for a 15-year loan or about $1,300 for a 30-year loan. If, on the other hand, you were to pay a 10%, or $30,000, down payment, you would be paying $2,153 a month for a 15-year loan and $1,430 a month for a 30-year loan. You might be saving more in the short-term by paying 10% down, but it is definitely more affordable, in the long-term, to put 20% down.
2. Lower Interest Rates
Secondly, putting a higher down payment for an investment property can help you qualify for lower interest rates. Mortgage lenders look at your loan to value ratio (LTV ratio) to determine risk. A smaller down payment increases your LTV ratio which means you become a riskier borrower. Lenders balance higher risk with higher interest rates. A larger down payment lowers the LTV ratio and thus, lenders would be more willing to offer you lower interest rates.
3. Lenders Are More Willing to Work with You
Not only does 20% down on a rental property lead to lower mortgage payments and interest rates, but it also makes real estate investors more appealing to rental property lenders. A higher down payment shows lenders you have the means to pay for the investment property and can meet the necessary loan requirements. Even with substandard credit, you may be approved by lenders by exceeding the down payment requirements for rental property.
4. Edge Out the Competition
Finally, meeting or going beyond a property’s minimum down payment will put you ahead of other investors. If you have your eye on a high-demand property, having a large down payment offer will make you stand out to the seller.
Do You Have to Put 20% Down on a Rental Property?
With all that being said, do you have to put 20% down on a rental property? Even with all the benefits mentioned, a 20% down payment on rental property is not an absolute must. Instead, you can explore the many methods of buying an investment property with less than 20% down. The viability of each method will ultimately depend on a real estate investor’s goals and resources. Be sure to weigh the pros and cons of each method to see what best works for you.
How to Invest in Real Estate with Little Money Down
1. Owner-Occupied Loans
Arguably, the best way to buy a rental property with little money down is through federal loans. For starters, these loans have less strict credit requirements than those of conventional loans. They also have lower interest rates and, of course, lower down payments. The caveat with these loans, however, is that they must be used on a property that will be the buyer’s primary residence for the first year after purchase. Then, the property can be converted to a rental, without any changes to the loan terms. If you buy a small multi family home, live in one unit, and rent out the others, you can buy the rental property with a federal loan. What we described is actually a well-known rental strategy for beginner real estate investors, called house hacking.
FHA loans are the usual go-to for house hacking. They are renowned for their low credit requirements and down payments as low as 3.5%. Federal owner-occupied loans are also available through the USDA and the VA.
2. Private Money Loans and Partnerships
You can also get low down payment investment property loans through private money loans and real estate partnerships. Private money mortgages are loans financed by private individuals, such as friends and family. Through a real estate partnership, you and many other investors pool resources together to buy rental property. Both financing methods allow the investors themselves to set loan terms. As a result, you can agree to pay a low, or even no, down payment. In exchange, however, you may potentially pay higher interest or be responsible for managerial duties.
3. Hard Money Loans
Hard money loans are another method for securing low investment property down payments. They can even be used if you’re interested in how to invest in real estate with no money. Hard money lenders do not look at credit standing for qualification. Instead, they’ll judge the investment based on the market value of the property. For all the immediate financing they provide, hard money loans come with two main catches. For starters, hard money lenders require high interest rates. And you usually have to pay back the loan much faster than the typical 15 or 30-year loan. If a property is projected to be very profitable, however, hard money loans could be worth it.
4. Lease with Option to Buy
The last way to reduce down payments is through a lease with the option to buy. This option is excellent if you also need a place to rent out. By leasing a rental property with the option to buy, you and the landlord agree that a portion of the rent goes toward the property purchase. Both parties can also agree on a lower down payment. A timetable is then set for the tenant to purchase the property. Leasing with the option to buy gives real estate investors the perfect tenant perspective, as they will have lived in the property in question.
How Will Your Down Payment Affect Your Return on Investment?
All in all, 20% down on a rental property is worth it. Still, if you don’t have enough cash on hand, you have other options. Ultimately, what matters with down payments is how they impact your return on investment (ROI). To learn exactly how a down payment influences your investment property’s ROI, try Mashvisor’s real estate investment tools. With our calculator, you can enter your mortgage terms and the tool will automatically calculate your returns. Click here to try it for yourself.