Real estate investing gets more exciting and potentially more rewarding when you make money with other peoples’ money. Borrowing money to buy and own rental properties increases your risk, but when invested wisely, it increases your profits. Leveraged real estate investing works best when rents and home values are rising. As rents and the value of their real estate holdings rise, their monthly mortgage for rental property remain constant, creating instant larger and larger profits. Today’s rents and property values are appreciating handsomely—an ideal environment for the investor who knows how to leverage his investments with borrowed money.
Financing a Rental Property
Typical Home Mortgage
An easy way to get started is with a mortgage that is secure by the equity in the home you are buying. This is just like the mortgage you may have taken out to buy the house that you live in. However, mortgage rates for rental properties are sometimes higher, require larger down payments, and have different approval requirements than properties occupied by their owners. You will need to have funds available to cover the down payment and closing costs to purchase your investment property. Typically, loans for rental properties require a minimum 20% down payment, since mortgage insurance is not available on investment properties. You can actually use the rental income of your current investment property to qualify for a new loan. However, if you plan on going this route, you must document property management experience for at least two years.
Some investors begin with HomePath financing, available only on a limited number of Fannie Mae-owned properties that are sold at auction. It requires only a 5% down payment, no mortgage insurance, expanded seller contributions, and expanded financing for renovation. HomePath Mortgage Individual investors may finance up to 20 properties on Fannie Mae–owned properties only. Other loan programs typically allow just four financed properties per borrower. HomePath Mortgages are available for move-in ready properties for both owner occupants and investors — one HomePath lender also now offers HomePath Mortgage for the LLC borrower. A companion mortgage product, the HomePath Renovation Mortgage provides both the funds to purchase and to renovate up to four properties for investors. Prospect Mortgage is the program’s financing partner.
Home Equity Line of Credit
Did you know that you can use your existing home to get a loan for a rental property! Many beginning investors use money from a secured line of credit on their existing home as a down payment for their first or second investment property. A secured line of credit, also known as HELOC (home equity line of credit) is a line of credit secured by the equity in the house you live. Typical interest rates on these lines of credit run around 3 to 4%, thus making them an affordable option to get started in leveraged investing. Once you purchase a property that cash-flows positive every month, you have a couple options. You can either pay the minimum (usually interest only) on your line of credit and keep the rest in your pocket, or pay the principal down as well. This entirely depends on your objective for the property, your exit strategy and how the property performs.
Some things to consider when getting a loan for a rental property
Your monthly cash-flow and what you do with it. If the positive cash-flow covers all expenses and you have enough left over to pay down the principal on the Line of Credit, then why not? Some investors rely on cash-flow to cover their living expenses, i.e. full-time investors.
- Taxation – Interest is often a landlord’s single biggest deductible expense. However, expenses that landlords can deduct include mortgage interest payments on loans used to acquire or improve rental property. Check with your tax professional for more information on all the tax benefits of real estate investing.
- Your long term and short term objectives. Are you planning to retire in a few short years? You may want to “just pay everything off,” and live off the rental income in retirement. In this case, paying down debt may be right for you.
Perhaps you can split your profits. Use some to pay down debt (mortgages, Lines of Credit, credit cards), use some to re-invest, and use some to have fun. After all, you should reward yourself for working hard and creating income streams that work. Eventually after 25-35 years the mortgage will be paid off and hopefully the value will be significantly higher, which will more than cover your original down payment.
What to Look for
Right now money is still “cheap”. Borrowing costs are still low. However, you still have to be very careful to get into the right properties, in the right locations. These are the type of properties that give you:
The highest possible monthly cash-flow
- Excellent potential for Equity appreciation
- And solid tenants that pay your mortgage every month
Remember, the lower the amount of cash invested, the higher your return (from value appreciation and/or rental income). On the other hand, the larger your cash investment, the lower your return. Also, remember, a higher appreciation will greatly increase earnings on your leveraged investment.