Rental properties can be an ideal investment, thanks to the fact that they can provide immediate cash flow and long-term capital growth. They also provide an opportunity for tax benefits. However, many beginner real estate investors struggle to get into the business. One of the main reasons is because most of them find it difficult to finance rental properties. Getting rental property financing is rarely a smooth ride if you don’t know some basic principles. If you are looking to buy your first rental property or want to learn how to finance multiple rental properties, this blog is for you.
Here are some tips on how to finance a rental property to help you get started:
8 Tips on How to Finance Rental Properties
1. Make sure you can afford the monthly payments
When financing rental property, you should make sure that you can afford the monthly payments of the loan. You will be paying down the loan over a long time and if your monthly obligation is too high, you may find it hard to live with. Budget yourself accordingly, taking into account the fact that rental rates can fall depending on the economy. You may also experience vacancies or tenants failing to pay rent. If you are unable to pay your mortgage, you risk your rental property being foreclosed upon.
2. Explore different financing options
There are many ways you can finance rental properties, each with its own pros and cons. Make sure you look at different financing options before making a decision on which one to take. When it comes to real estate investment financing, what worked for others might not necessarily work for you. Therefore, carefully assess your financial situation and take into account all variables before securing a loan. Consider mortgage rates and other investment property loan requirements.
Doing your research will help you pick a financing method that will help you to fulfill your investment goals. Familiarize yourself with the real estate financing methods available to you. Also, consider working with a financial advisor who can guide you through the process.
Here are some of the options to consider:
- Conventional Loans
- FHA Loans
- Hard Money Loans
- Private Money Loans
- Seller Financing
- Home Equity Loans and Lines of Credit (HELOC)
3. Make a sizable down payment
When it comes to investment loans, you will typically be required to put a down payment of at least 20% of the property’s value. If you pay down at least 20%, you won’t have to pay for mortgage insurance on your loan. However, if you can put even more down, you will be able to secure better investment property mortgage rates. A substantial down payment on rental property shows mortgage lenders that you are financially stable.
4. Lower your debt-to-income ratio
When looking to finance rental properties, one crucial thing to take into account is DTI. Mortgage lenders usually use DTI to estimate your ability to pay them back. DTI is calculated by diving your recurring monthly debt with your gross monthly income. A high DTI shows that your debt is too much for your income level. This could affect your ability to qualify for the loan or get a favorable interest rate from the bank. Before you begin shopping for mortgage lenders, consider paying down your debt first and avoid taking any more debt.
5. Boost your credit score
You also have to check your credit score before getting a loan for a rental property. Your credit score will greatly influence the terms of the loan. If you have a low credit score (below 740), your interest rate will be higher. You will be required to pay a fee to keep the interest rate down. To maintain good credit, always make your loan payments on time and don’t use all of your credit limit. If there are any errors or discrepancies in your credit report, try to handle them as soon as possible.
6. Consider a local bank
If you can’t raise the full down payment or don’t meet some of the investment property loan requirements, consider turning to a local bank or broker for financing investment property instead of a large lending institution. Smaller banks are usually a little more flexible. They will often work closely with local investors to help them finance rental properties. Local mortgage brokers are also a good option because they can access a wide range of loan products. Just make sure you do your research before you pick one.
7. Opt for a fixed-rate mortgage
Banks usually give two types of real estate investment loans to investors looking to finance rental properties. These are fixed-rate mortgages and adjustable-rate mortgages. With a fixed-rate mortgage, you will have the same interest rate for the whole duration of your loan. On the other hand, the interest rate of adjustable-rate mortgages usually starts low but could fluctuate in the future.
You should consider investment property loans with a fixed-rate mortgage to protect yourself from an increase in monthly payment when interest rates rise. An unstable interest rate will affect your cash flow.
8. Prepare your paperwork early
An important part of learning how to get a mortgage for a rental property is knowing the documents that are required and lining them up early. You will be required to prove your financial situation and prepare some crucial documents before you are given a loan.
Acquisition of investment property loans may sometimes experience delays. To expedite the process, be proactive and gather the necessary documents early. Getting an early start helps to reduce stress and last-minute rush. Some of these documents include financial statements, rent rolls, social security cards, divorce papers (if applicable), etc. Inquire with your lending institution what documentation you’re required to give.
The Bottom Line
Finding that perfect rental property won’t mean much if you don’t know how best to finance a rental property. With a little research and creativity, you can bring real estate investor financing within reach. The above tips will help you finance rental properties more effectively and bring you closer to achieving your investment goals.
However, before considering how to finance investment properties, make sure you find an investment property with a good return on investment. With Mashvisor’s rental property calculator, you will able to find and analyze a profitable property in minutes.