Purchasing an investment property can be an exciting milestone for a would-be landlord or entrepreneur. The financing for investment properties, on the other hand, isn’t nearly as exciting. It can be a trouble spot, though. Investment property loans aren’t as easy to get as conventional home purchase financing.
If you don’t have the cash to make the purchase of your investment property, you’ll have to get financing, which isn’t as easy to get for an investment property as it is for a primary residence.
Still, the current low interest rates have enticed many people to consider pursuing investment property financing despite the potential hurdles that come with it. After all, there’s a pretty big payoff if you play your cards right, and that could be worth the hassle of obtaining an investment property mortgage loan.
How investment properties work
Investment properties are purchased to create income for the buyer, whether it’s a short-term or long-term gain. Property flippers, who are people purchasing a property to renovate or remodel for near-immediate resale, are looking for a short-term gain. Those who purchase investment properties with the goal to rent them out are looking for longer-term gain via the renter’s payment, which can generate income.
Either way, the profit is gained when you’re able to buy with enough potential sales or rental income to surpass the cost of the purchase price and renovation or remodeling costs. That could mean you buy at a low price and sell the home, post-renovations, for more money than you put into it. Or it could mean the rental yields surpass the monthly costs of the mortgage payments and cost of upkeep — which gives you a profit.
While you may envision an investment property as a single residence, there are other property types that can be purchased for profit. The types of investment properties you can opt for include:
- Residential: Residential properties are purchased to either resell after renovations or to rent to people. Investors interested in residential properties can purchase a single home, townhouse, duplex, triplex or multi-unit residence, like an apartment or condo building.
- Commercial property: Investment properties aren’t limited to residences. Some investors prefer to purchase commercial space and rent out the individual units for profit. This could include retail stores, warehouses or office buildings.
- Mixed-use: These types of properties contain commercial and residential space. Retail or other commercial businesses are generally housed on the first floor and residential units are on the second floor of the building.
[ Read: What I Wish I Knew Before Buying Rental Property ]
Should you get an investment property?
While property investment can be lucrative, investing in real estate is not for everyone. If you’re considering purchasing an investment property, weigh the advantages and disadvantages of doing so before you make a decision.
One main reason for owning property is the income stream it provides. As the owner, you get to set the monthly rent amount and then sit back and wait for rent checks to come in each month. If your investment was a smart one, the rent should cover the mortgage, taxes and insurance, with some left over to tuck away for future maintenance costs.
The return on investment can be pretty high, too. Real estate is considered to be a high-performing asset, which means there’s potential for a good return on the investment if you’re smart about your purchases.
For example, if your monthly mortgage loan payment, taxes and upkeep runs about $ 1,500 each month and you rent the unit for $ 2,000 per month, you are profiting $ 500 each month. That $ 500 can be saved for any maintenance costs that may arise without coming directly out of your pocket.
Another reason you may want to invest in property is that it offers you the ability to build equity. This is where the real passive income comes in, because the more you chip away at the mortgage, the more you’re essentially storing wealth in the home itself. Any renovations or updates done to the home can further increase the market value and, in turn, your equity. The increased equity provides leverage to purchase more properties if desired, or a source of money to tap into if unexpected costs come up.
[ Next: Should You Buy a Duplex, Rent Out One Unit, and Live in the Other? ]
Investing in property can also help cut down on your tax bill at the end of the year. There are tons of property-related credits, deductions and write-offs you can take advantage of when tax time rolls around. That includes depreciation, repairs, interest, insurance and other costs, all of which can cut your tax bill down significantly.
But as with any investment, there are some things that may deter you from being a property investor. One downside to financing an investment property is the amount of down payment required for the loan. Most lenders require at least 20% down, if not more, for an investment property purchase. On the flip side, the greater the down payment, the better the interest rate.
There’s also the risk you take in being a landlord. Even if you think you find a great tenant, you may find out that they’re anything but great once they’re in the home. They could cause thousands of dollars in damage, skip out on rent, break the lease clauses or cause other issues for you. That’s the gamble you take when you rent out a property. If you’ve got a tenant who’s chronically late or missing rent payments, it could cause serious financial issues for you.
Another potential pitfall of purchasing an investment property is the uncertainty of occupancy. If you had to get mortgage loan financing to purchase the investment property, you still have to pay the mortgage, taxes and insurance, even if there isn’t a tenant to pay rent. If you don’t have the funds to pay the property costs without a tenant year-round, it might be time to rethink an investment property purchase until you do.
The same goes for flipped investment properties. If the market takes a downturn when you’re listing the house, you may be waiting for a buyer for months or longer. That could put you in a serious financial bind, so make sure you’ve accounted for these possible issues before investing.
Tips for financing investment properties
The optimal way to purchase an investment property is to pay cash, but most people don’t have the funds lying around to do that. Luckily, you can fund the purchase of your investment property with a mortgage loan.
If you want to be successful at securing a mortgage loan for an investment property, you should try to:
- Make a large down payment. In most cases, you’ll be expected to put down a minimum of 20% on an investment property to obtain the loan since the risk of default is higher for the lender. If you can put down more, you should. It’s always wise to put down as much as you can to reduce the interest you’re paying on the loan and lower the monthly payments. This will be helpful if you have periods when the property is unoccupied. A larger down payment can also get you the best mortgage rates.
- Shop local lenders and credit unions. In some cases it pays to stick with a small local lender, like a credit union or private mortgage lender. Smaller lenders often have more flexibility than some of the national lenders, especially if you’re self-employed or have other unconventional methods of income. If you opt for a local lender, you might have a better chance at financing. You should also check with a mortgage broker that has access to a wide range of lenders. That can increase your odds of getting approved.
- Ask for owner financing. Another avenue that could prove successful is asking the current owner to finance the mortgage. To do this, you’ll need to come up with reasonable terms and present them in a way that shows the owner you’re serious. You’ll also need to prove you’re able to pay on time.
- Consider other forms of financing. If your credit isn’t great or you can’t get traditional financing, it’s time to get creative. Can you tap into the equity from your primary residence via a home equity loan or home equity line of credit? You’ll need to weigh the pros and cons carefully before going this route, but for the right property, it could be worth it.
[ Read: How to Finance a Duplex or Multifamily Home ]
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Too long, didn’t read?
Buying an investment property can be a good way to create passive income and grow wealth. However, investment properties are not for everyone. If you can’t make the mortgage without full occupancy or a quick sale of the home, you should really rethink this plan. You should also consider whether you’re really ready to be a landlord before you take the leap.
Once you’re ready to buy, make sure you’re well educated on financing for investment properties. This type of financing has higher down payments and tighter requirements for approval, so you may have to get creative with financing. This could mean taking a loan against the equity in your primary home, getting owner financing or waiting until you’re more financially stable to make the plunge. Whatever you do, make sure it’s the right move for your situation.
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