How do I finance an investment property for the first time? Last week I offered a 5 step blueprint to help answer this question. Mortgage rates are still low and a lot of homeowners want to know the best way to access capital to expand their real estate portfolio.
What’s more, new legislation in California has opened the door to expand housing with SB 9. In short, housing restrictions are shifting across the state, allowing more homeowners to build ADUs, rental properties, duplexes, and even apartments on their land. Land that was previously zoned for single-family housing.
That said, financing an investment property is not without its own risk. Especially if your primary residence is used as collateral for the loan. Keep reading to weigh the benefits.
Here are the top five financing options to consider when financing an investment property.
1. Home equity line of credit
A home equity line of credit allows homeowners to tap into the equity in their home and use that cash without any restrictions. One benefit of a home equity line of credit is that you don’t pay any interest unless you use the funds. This allows homeowners to use the funds when they need them and pay the balance as quickly or slowly as they want (within the terms of the loan).
Often, homeowners will use a home equity line of credit to make a down payment on an investment property or use the funds to repair/restore an investment property. As with other home loan products, you’ll secure the best mortgage rate with a high credit score and low debt-to-income (DTI) ratio.
2. Home equity loan
A home equity loan is a common option for many homeowners. A home equity loan allows you to borrow against the equity in your home (maximum 80%) and use those funds as a down payment toward an investment property. Home equity loans are offered at a fixed rate and set term, often ten years. There is flexibility in terms, and the application process is similar to a home loan.
To get approved at the best mortgage rate, you’ll need substantial equity in your home, a high credit score and a low DTI (debt-to-income) ratio.
3. Conventional home loan
Conventional financing remains a common source of funding for an investment property. Applying for a conventional mortgage to finance a second home or investment property is similar to most home loans. Loan options include fixed-rate mortgages, adjustable-rate mortgages, the size of the down payment, and you’ll also have closing costs.
If the investment property is not also your primary residence, there will be an extra layer of documentation that is required to get approved. In addition, mortgage rates are often a bit higher for properties that are not defined as your primary residence. That said, mortgage rates are still extremely low, so a conventional home loan is definitely worth considering.
4. Personal loan
Peer-to-peer lending networks are a growing alternative to seek personal loans. Sources such as Lending Tree or Prosper offer a platform to match lenders and borrowers based on need and risk. There is often more flexibility attached to your use of funds with a personal loan. However, interest rates are determined solely by the lender. Rates are much higher than conventional loans but might be worth considering if you plan to borrow the funds for a very short time period.
5. Hard money loan
A hard money loan is a short-term loan ideally suited for fix-and-flips or when you plan to borrow the money for a short period of time. Interest rates are much higher than conventional loans (as high as 18% in some cases) and hard money loans also have a shorter payback period. The property is collateral for the loan, so the main focus is often the projected profitability of the property. There are greater risks with a hard money loan, but it can also be easier to qualify.
Here’s a refresher on the 5 step blueprint to finance an investment property.
Step 1. Understand your financing options.
The top five financing options above are the most popular for dozens of reasons. Depending on your goals, your vision, and borrower profile and how much equity you have in your home are all defining factors. An experienced mortgage broker can help you decide the best option for financing an investment property. One that secures the best mortgage rates with competitive loan terms that help grow your investment.
Step 2. Decide on the right type of investment property.
Choosing which type of property you want to finance is the first step. Do you want to generate passive income from a rental unit? Restore a fixer-upper and sell it for a profit? Buy a duplex and live in one of the units while you collect rent to cover the mortgage on the property?
Talk with a qualified mortgage broker to determine which type of property and financing fits your borrower profile.
Step 3. Build a strong borrower profile.
The two factors that will influence your financing the most are your credit score and your debt-to-income ratio. Whether you decide to work with a mortgage broker, a bank, or a private lender, every lender is in the business of determining risk. Pay down your consumer debt and credit cards so that your ratio is favorable, and fix any errors on your credit report.
Step 4. Prepare to make a large down payment toward your investment property.
Most lenders require a 20-30% down payment to finance an investment property. The higher your down payment, the better terms you’ll be able to secure for financing an investment property.
Step 5. Partner with a local mortgage broker.
Big banks, private lenders, and mortgage brokers are the main sources of funding when it comes to financing an investment property. Partnering with a local mortgage broker is the best decision for most homeowners financing an investment property for the first time. Why? A local mortgage broker is a wise partner when it comes to the local real estate market, home values, trends and risks. In addition, an experienced mortgage broker can leverage their partnerships with lenders across the nation so that you get the best financing available.
Contact us to get started and discuss your goals. We work with clients from California, Oregon, Washington, and Colorado and we partner with lenders across the country so we can get you the best financing, especially for an investment property on the west coast. Give us a call.