Purchasing an investment property is a great way to build your real estate portfolio, turn a quick profit, or create a reoccurring income. However, many people face challenges when it comes to financing the purchase when they are first getting started.
Whether you have a great credit score and are ready to buy or are just curious about what it takes to purchase investment real estate, this guide will help you understand the basics. Here are five tips to consider when financing investment property.
#1: Have a Sizeable Down Payment
The first step to financing an investment property is to be prepared to make a sizeable down payment. In most cases, lenders will require you to have at least twenty percent of the purchase price. Some even require first-time investors to have more—as high as forty or fifty percent!
The reason? Lenders want to make sure you have enough, so-called, skin in the game. In their eyes, if you come into the deal with no upfront cash, there’s a good chance you won’t take the investment as seriously and could default on the loan. This is their way of ensuring they aren’t putting themselves at risk for foreclosure and all the necessary steps that go along with that process.
If you aren’t sure you can come up with this kind of money, then it might be time to get a little creative. Find other ways to finance that portion of the purchase, including taking out a home equity loan against your primary residence or borrowing from family members.
#2: Make Sure You Have a Strong Credit Score
Before purchasing a new investment property, you also need to make sure you have a strong credit score. The common threshold is a 740 or higher, but each lender has their own set of requirements to follow.
What if your credit score is below 740? Can you still get funding? If you have at least a 620, you can generally still secure some sort of financing. However, it won’t be nearly as easy to do, and you could end up paying more in interest in the long haul. Thus, it is essential to try to focus on cleaning up your credit and raising your overall score before attempting to secure funding for an investment property.
#3: Try Local Banks or Credit Unions
If you’re having a hard time getting financing, consider talking to local banks or credit unions. In many cases, they have much more pull and flexibility in helping you achieve the funding you need to purchase an investment property.
They are also generally familiar with the area or neighborhood where you intend to purchase. This can help give them a much clearer picture of what you’re trying to achieve and whether or not you’ll actually make a profit—which can mean getting a yes instead of a no when it comes to manually underwritten loan approval.
#4: Ask for Owner Financing
Another option is to ask for owner financing. In some cases, the current owner of a property might be moved to finance the transaction themselves and effectively act as the bank. This usually requires a property that has been on the market for a longer period of time and a seller who needs something to happen soon. Instead of making a mortgage payment to a bank each month, you make the payment directly to the seller. Eventually, you will either secure other financing and pay off the remainder of the purchase price or sell the property for a profit.
There is a downside to this. Getting into business with someone you don’t know or barely know can be risky. If there’s an issue in the future and you aren’t able to make the payments, the original owner could foreclose on the property. For many new investors, this is a shaky way to start the footing for an investment business, which is why most avoid it.
#5: Understand Other Available Financing Options
Still stuck on how to move forward in financing your new investment property? There are also other available options to consider. A few of the most common methods include:
- Hard Money Loans: Companies that give out hard money loans are not banks. Instead, they are a group of investors who choose to invest in real estate projects specifically. These are usually short-term in nature and do not typically exceed three years.
- Private Money Loans: These are individuals who have a bit of extra cash and want to get involved in the real estate investment business. These deals do not include bank involvement and can sometimes be a bit risky.
- Fix-and-Flip Loans: These loans are designed for situations when you want to purchase an investment property, renovate it, and try to resell it for a substantial profit. Banks do not offer this type of funding, but most hard money and private money lenders will work with you.
- Home Equity Loans: As mentioned above, you can take out a home equity loan on your primary residence to help secure funding for an investment property. The practicality of this depends on your personal finances and ability to make money on either the sale of the property or monthly reoccurring income from tenants so that you can pay off the balance of the loan without losing your home.
- Commercial Investment Loans: If you aren’t looking into purchasing residential property and want to buy a business building or shopping center, you’ll want to consider a commercial investment loan from a bank instead of a conventional loan. The terms and processes are slightly different, so make sure to do your homework before taking this route.
Before seeking out any non-conventional process for funding an investment property purchase, you’ll need to be prepared. Have a solid plan for how you intend on either selling the investment or finding tenants. If you are turning the property into a rental, you also need to show how you intend to handle issues like maintenance, screening, collection of rents—and if you plan on doing these things yourself or hiring a property management company. The more detailed you can be, the higher your chances of securing alternative financing.
Bottom Line? Don’t Be Afraid to Get Creative!
While these are just a few of the various options available, they aren’t the only ones. Get creative and start thinking of ways to fund your new investment property—selling that old stack of baseball cards in the attic to help fund a portion of the down payment, asking a family member for help, and more. The possibilities really are out there if you get creative!