After choosing the right location for your investment property, the type of financing you use is easily the second most important factor for the success of your investments. The loan terms contribute to the relative ease or difficulty with which you will be able to make the investment profitable.
This is why when looking for financing for an investment property you should look far and wide, advises Upkeep Media. The more you know about available financing, the more options you give yourself. Having more options means you will be more confident going into negotiations with prospective lenders.
How do you give yourself this edge at the beginning of your property investment journey? You must know what lenders want from you and be ready with those things before you send in an application. This way, you will be the one choosing which lender to deal with, rather than the other way round.
What are some of the important things you should know about financing an investment property?
1. Fix your credit
The starting point is your credit; it tells lenders how trustworthy and financially capable you are. For the best loan terms, your credit score should be above 740. Also, there should be no history of delinquencies in your credit history. If you currently don’t have these, you should start working on ways to improve your credit.
2. Your personal debts matters
How much debt you owe determines how much you will have at your disposal to make the mortgage payments. Lenders look at your debt-to-income ratio (DTI); the proportion of your monthly income that goes to debt repayment. For the most favorable outcomes, this should be less than 45%. To make it easier for yourself, lower your DTI to 35%.
3. Plan to make a bigger down payment
The down payment on an investment property loan is going to be higher than what you paid down on your home. You should expect to pay 20% down, but if you can make a bigger down payment than this, go for it. Making a large down payment will get you the easiest loan terms possible.
4. Have your paperwork ready
Important documents a lender will ask from you include proof of stable and sufficient income. This will often mean showing a recent letter of employment from your employer and tax records. For business owners and self-employed individuals, proof of business registration, and two years’ financial statements will be required.
5. Avoid high interest rates
Newbie investors often make the mistake of letting themselves get pressed into accepting high-interest loans. If the rate you are being offered is high, it is better to defer your investment or look for other ways to finance the property. Interest rates go a long way to determine the potential profits you can make from an investment.
6. Choose a fixed-rate mortgage
One important thing about interest rates is they fluctuate, and these changes will affect the performance of your investments. To protect your assets, find a low-interest loan, and make sure the interest rate on that loan is fixed; that it is a fixed-rate mortgage. These are usually more expensive than adjustable-rate mortgages, but better in the long run.
7. Buy a low-cost home
This is your first investment property; do not over-reach yourself. By targeting a low-cost home, you limit both you and the lender’s risks. Lenders are happier with first-time landlords who follow this path because they know the investor will be more responsible. Furthermore, buying a cheaper home will minimize the extent of your exposure if something unexpected happens.
8. Buy an owner-occupier
Lenders view rentals where the landlord lives in one of the units as less risky because people often do their best to protect the homes they live in. Buying as an owner-occupant will let you take advantage of lower down payments; as little as 5%. Furthermore, after living in the home for one year, you are allowed to rent it out.
9. Look for properties with “Subject-To” financing
With this option, the existing mortgage remains in place even after you have bought the home. The title of the home transfers to you and you assume responsibility for paying the mortgage. This lets you avoid the burden of coming up with a down payment for the property. But this financing option is harder to come by.
10. Negotiate the closing costs
Closing costs come to 3%-6% of the purchase price for a property, which is a lot of money. Most new property investors do not know they can negotiate the closing cost. A good way to do this is to ask the seller for concessions by having them pay some of the closing costs for the purchase.
11. Consider other funding sources
In addition to conventional loans, other ways to finance an investment property include private lenders and partnerships. You can also use more creative financing options, such as looking for seller financing, using a self-directed IRA, getting a 203K loan, or leasing a home with the option to buy it.
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