Short summary: Getting loans for investment properties is different from loans for private homes. There are a few requirements that every lender will request. They include making a decent down payment, having cash reserves, maintaining a good credit score, shopping around for the most suitable lender, and securing a loan through other means. No matter what type of loan you decide to get for a rental property, you must first understand the market, have a clear idea of your financial situation, understand the risks involved, and then decide.
Thinking about getting a loan to buy a rental property? There are a number of things you should know when it comes to loans. Lack of knowledge about the financial aspect of things is often a recipe for disaster for some people and can lead to unnecessary stress and in some cases, financial ruin.
While interest rates remain low, the finance market has tightened up on giving out loans to people who want to buy a property. Therefore, before you rush and buy your first rental property, Rogue Real Estate shares a few things about loans that you should be aware of.
Buying a property is usually expensive. It is important to make a decent down payment, otherwise, your monthly mortgage premiums will be quite high. Experts in the loan industry suggest that one should put down at least 20% to secure a loan.
If you make a higher down payment in the range of 25-30%, you can get much more favorable interest rates. If you do not have adequate money for a down payment, the best advice is to wait until you have accumulated at least 20%.
Some people get a second mortgage on a property they own as another option, but this is an extremely risky venture which can lead to severe financial stress if you are unable to come up with the monthly premiums.
In such a situation, you can end up losing both properties. Therefore, the first rule of getting a loan for a rental property is to know your limit and know how much you can afford without risking your financial stability.
2. Having cash reserves is essential
In addition to the down payment, lenders will require you to have liquid assets in reserve. While most require six months of cash reserves per property (including taxes and insurance), some might require four. Banks usually require between six and twelve months of cash reserve.
Cash reserves are a safety net in case you go through a rough patch regarding money that lasts a month or more than that. It includes principal, interest, taxes, insurance and homeowners association dues.
The mortgage lender will let you know an estimated monthly payment for your investment property. Knowing this information, you can save accordingly.
3. Maintain a good credit score
In order to secure a financial loan at low-interest rates, you need to be a strong and reliable borrower. This can only happen if you have a good credit rating.
In general, people who have poor or low credit scores not only fail to get loans but even if they do get approved, it is at a very high interest rate. If you have a solid credit score, you can have more control, and you can get a loan at good interest rates, making your monthly premiums more affordable.
4. Don’t take the traditional route
Many people first turn to their bank when applying for a loan for a rental property, but experts recommend keeping away from these traditional lenders. The reason is that banks have rigid guidelines, and they offer much higher rates than other financial institutions.
There are many small financial institutions that are more flexible and also offer free advice on investing locally. Furthermore, there are mortgage brokers who also offer a wide range of loan products, but it is vital that you know about these companies.
You need to do some research to know about their reputation, longevity, and reliability before you even walk into their office. A bit of research can help you make the right choice. This does not mean you should never go for a bank; it just means you should evaluate all your options. Or get a mortgage broker do it for you.
5. Be creative
If the rental property you are looking at has good profit potential, you could secure a loan through a life insurance policy or through a home equity line of credit. However, to get personal loans from peer to peer lending sites like the lending club, you must have a solid history in real estate investment.
As a reminder, before you choose this option, do your homework, know your financial status and your ability to meet the expected costs; and then decide what you should do.
No matter what type of loan you decide to get for a rental property, you must first understand the market, have a clear idea of your financial situation, understand the risks involved, and then decide.
You should ideally be debt-free before you get a loan for a rental property. Remember, while the cost of borrowing is cheap today, the financial market can change anytime, and an increase in interest rate can quickly eat into your profits.
Finally, if you are a first-timer, go for a smaller property as that would be more affordable for you and will require a lower initial investment from your side. If this property is in the right location, where you can quickly find tenants, you might be able to get a steady rental income. With time, you can revolve this mortgage and buy a bigger property.
The best thing to do if you are seriously considering buying a rental property is to speak to a mortgage company as they can guide you in terms of the cost of the property, the potential market value of that property in case you decide to sell in future, the location, the rental attractiveness, etc. Gather all the information and understand what you’re getting into before signing any papers or agreeing to any terms.