How to Finance Your Real Estate Investment
Buying your first real estate investment property? Here are some of the best ways to finance your purchase.
Financing investment property can get pretty creative. When taking on your first real estate investment, however, it’s best to keep your risk to a minimum. After taking a hard look at what you’ve got in the bank, how much you’re earning, and how much you can afford to spend, you are best served utilizing one of these more common approaches towards acquiring that first investment property.
Banks, credit unions, and smaller mortgage brokerage houses will assess your Adjusted Gross Income (AGI) and your existing debts, including the mortgage on your primary residence, credit cards, and any other loans you have. After reviewing your financial health, the bank or other financial institution will determine whether you can afford the investment property you wish to purchase. For all intents and purposes, this mortgage is viewed the same way as if you purchased a vacation home that you were not going to rent out. Now you’re carrying two mortgages and the assumption is that your income will cover both.
Income Property Consideration
In recent years, it has become common knowledge that national banks and credit unions have become very strict when it comes to accommodating loan requests. Often they will not consider anything but your AGI when looking at whether you can afford the property, even if you are going to use it for a second stream of income. If your AGI doesn’t meet a national financial institution's requirements, you will likely have to identify a local mortgage broker who works with a variety of smaller banks that will be more creative in their assessment, reviewing your AGI andthe income potential of the property.
These mortgages are exactly the same as the mortgages provided under the traditional approach, except they likely have a higher interest rate - typically between 25 and 100 basis points higher. Also, in order to obtain the mortgage, you will probably have to buy the property under your own name as opposed to an LLC or other corporate entity. The underwriter will want this personal guarantee to secure the loan.
The simplest approach of course is cash. The last several years have been heavy with cash buyers and if you’re lucky enough to have the capital to spend, having the full amount in cash will likely expedite the purchase. Cash buyers also have a better opportunity to negotiate a lower purchase price and leapfrog to the top of the offers considered. Sellers prefer buyers who have little or no contingency requirements, and a no-mortgage contingency is especially enticing.
Cash buyers who want to take advantage of current loan rates can still do so by buying the property in cash and then obtaining a loan after the closing. Just remember that if you use this approach and you originally buy the property under an LLC name, the mortgage lender will likely require the property be filed back under your personal name so that they gain access to your assets should you default on the loan.
Whether you are just starting out or you are an experienced investor, private loans are an excellent source of capital for acquiring investment property. You may have a family member, friend, or colleague, who appreciates your vision and is willing to provide you the loan to cover the balance you need. In this situation, you sign a promissory note, which details the loan amount, the interest rate to be paid, and the term of the loan.
The relationship you have with the private lender may determine the interest rate they charge you. Because a private lenders are taking on significant personal risk, they may charge you an interest rate higher than the prevailing interest rates. However, it’s also possible that someone close to you, like a family member, may give you an interest rate closer to the prevailing interest rate, or even the lowest interest rate available, knowing you are good for it. Whatever the interest rate is, private loans enable you to get the cash you need much faster, and with less red tape, than if you went through a bank.
If you are willing to co-own, a consortium is a great way to finance an investment property. In this scenario you pool your resources with other individuals (or businesses) and buy the property under a trust name or an LLC. The monthly returns you will get from the rental income will be reduced to your percentage of ownership, but if there is no other means available to you, this method gets you in the game.
More on Buying Investment Property
For a variety of useful articles on topics such as how to research investment properties before you buy, see the Buying Investment Real Estate section of Nolo.com