Starter Guide for Aspiring Real Estate Investors

We wanted to share this very informative guide our friend Steph Young, interior designer and construction manager for Denver Life Design, sent to us for our blog. Hope this is helpful for all of you budding investors!

Real Estate Investing: Common Methods for Financing Rental Properties

Those considering investing in a rental property will quickly learn there is a big difference between getting funding for the purchase of a home they will live in and one that will be rented. There are a variety of reasons for this including the fact that financial institutions generally feel financing rental properties are a higher risk than owner-occupied properties. This often makes the terms of any mortgage to purchase an investment property less appealing. Real estate investors, however, are still able to acquire funding every day through a variety of traditional and non-traditional sources. Here are some of the common methods that are used to secure funding for rental properties.

Traditional Bank Mortgages

In many cases, with good credit, a borrower can acquire needed funding through a traditional bank. The bank, however, will likely require a larger down payment on an investment property, perhaps 20% or 25%. Traditional bank mortgages on investment properties will also probably mean you’ll be paying a higher interest rate throughout the term of a loan. This is particularly true if a property doesn’t qualify for an FHA mortgage. Some banks will shy entirely away from funding mortgages to purchase an investment or rental property.

Hard Money Loans

Hard money loans have found a place in the world of financing due to the tighter loan restrictions and regulations that resulted for the mortgage crisis of 2008-2009. They can be easier to acquire than traditional bank mortgages because they are privately funded by individuals. They also, however, can command much higher interest rates than traditional bank mortgages. These loans can frequently be negotiated in terms of rates and payment terms and are secured by the value of the property itself.

Private Loans

Private loans are similar to Hard Money loans in that they will generally carry higher interest rates and can be negotiated. They generally, however, are loaned from a person the borrower knows. This could be a friend or relative or someone the investor may feel may be interested in earning more than bank rates on their money. Private loans are also mostly secured by the property itself, along with perhaps, the sweat equity the investor may be willing to put into it.

Owner Financing

In some cases, investors may be fortunate enough to find a seller who is willing to finance all or at least a portion of the purchase price themselves. This can bypass banks and mortgage companies entirely. These deals are usually negotiated individually, and generally will have a balloon clause. This means, the owner will take payments from the investor for a period of years, usually three to five before a balloon payment of the remaining mortgage will be due. This often is long enough for the investor to build some equity in the property to seek other financing after the balloon period. These loans are also secured by the property are can have fairly restrictive allowances for late payments.

Home Equity Loan

If an investor has owned their own home for an extended period of years, they may qualify for a home equity loan or second mortgage to get needed funding for an investment property. These rates are usually fairly reasonable for the borrower and frequently carry flexible repayment plans. The other benefit is that because the loan is backed with the owner’s equity in their current property, there may be no mortgage on the investment property.

Cash

If an investor is in a good cash position or has other investments, they may be better served by using their own funds and other investments to finance an investment property. This is especially attractive if the return on investment (ROI) of a rental property projects higher than the earnings other investments may realize.

Other Options

There are other options for a motivated investor to consider, including living in a potential rental property themselves for a period of at least a year. This may qualify them for a lower rate, owner-occupied mortgage. It also has the added benefits of allowing the investor to become familiar with a property and to make needed repairs before offering it for rent.

Another option would be to purchase a duplex, multi-family or multi-use property and live in one of the units. This provides a financial institution with a bit more security, knowing the investor will be living on premises. This option will still likely mean higher interest rates and a larger down payment for investors.

The Key to Investing in Rental Properties

The key to investing in real estate is going into it with your eyes wide open. Know the pitfalls of being a landlord and how to explore the benefits of a property manager. Be realistic about vacancies and recognize the challenges of finding and keeping good tenants. Investigate likely maintenance expenses and seek advice of others. It starts by finding a property with potential and knowing all of the financing options available.

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