Investing in a rental property is a smart move — we can all mostly agree on that. But, how should we go about financing a rental property? That’s the tricky part we may not all agree on.
Once you understand all the available options for financing a rental property and become equipped in knowing how to choose the best way given your resources and time, you’ll realize that it’s not difficult to finance a rental property. So, we want you to be aware of the different options available for financing a rental property and when it’s best to use each of them.
1. Cash
This is the simplest way of financing a rental property, if you have the money obviously. Using all cash is when you buy and close the deal using cash from your own pocket. If you have the money, it’s a great way to finance a rental property because the risk to cover any loans or payments is zilch. But with using cash, you’re missing out on the advantages of leveraging. When you’re not leveraging (using other people’s money to finance your rental property), your return on investment, cash on cash return, etc., are somewhat diminished.
It’s the best way for financing a rental property if…you have a high income; are looking to make small purchases per year; are not bankable at the moment; want to park your money somewhere without being overly concerned about the returns.
Related: What is a Good Cash on Cash Return?
2. Buy As an Owner-Occupant
When you buy a rental home as an owner-occupant, you’re able to get the best financing deals! You can get a homeowner grade mortgage locked for 30 years with as little as 3.5% down payment. The bank will typically pay your taxes and insurance out of an escrow account, which you pay into monthly as a part of your payment deal. As long as you live in the property for the minimum of the 12 month requirement and the loan stays in place, even when you move out and turn it into a rental property. You can then buy another property as an owner occupant and repeat the process again and again.
With that being said, be careful with overusing this process because it shows up on your credit, and since you can only get so many of these loans, you might hit a wall and have to look for other options.
It’s the best way for financing a rental property if…you’re just getting started in the business; you’re looking to hold only a few rentals as a side job.
3. Conventional Bank Loan
You might be familiar with a conventional bank loan. It conforms with the guidelines set by Fannie Mae or Freddie Mac, which isn’t backed by the federal government. With an investment property, the down payment may go up to 30%. But a nice perk that comes along with this is that the bank may include an estimated net rental income from the property to help your debt-to-income ratios (especially if a tenant is already in the rental property). So, make sure you discuss this with your lender.
With that being said, your credit score, credit history, and income are important for a conventional bank loan. They determine your ability to be approved and the interest rate for the mortgage. You may have the best investment property calculator or Airbnb calculator in all existence but if you cannot sustain an investment financially, it won’t do you any good. You must be able to afford the mortgage; and the future rental income from the property is not calculated in the equation.
It’s the best way for financing a rental property if…you have a good credit score and credit history; have high income.
Related: Buy a rental property using a mortgage or cash?
4. Small Community Bank Financing
This is different than the conventional bank loan. Unlike large banks that operate in all 50 states and internationally, small banks operate in small communities. Large banks conform to guidelines like Fannie Mae and Freddie Mac as mentioned above. But when it comes to small banks, they keep the loans in-house rather than sell them off to investors. They’ll want to get to know you better. So, expect some face-time visits and be prepared to network! Once they approve, they’ll be pretty easy to work with.
Small banks also love it when your deals are in their area (if not, they might pass). And perhaps the best part about small banks is that they understand equity partnerships because they make deals in other business fields, not just real estate. So, if you’re looking to raise investors to buy larger properties with you, small banks can help you structure the loans for such deals.
It’s the best way for financing a rental property if…you are looking at real estate investments as a full-time job; are good at networking and building relationships.
5. Private Lender
Whether be it a family friend or a full-time private lender, sometimes having a private lender rather than a bank lender comes with advantages. You’re able to negotiate the deal freely because there are no set landing requirements. The loan qualification process is often less time consuming and complex. And you’ll probably spend less money on closing costs associated with the loan.
With that being said, the interest rates are usually higher and most private loans are short-term. So, you might want to check in to a private lender/bank combo, where you can you can go to a bank and get that private lender refinanced out. But regardless, make sure you know you’re able to negotiate a fair deal with the private lender. Also, meet with multiple lenders before choosing who to close the deal with.
It’s the best way for financing a rental property if…you’re not bankable at the moment; are a good negotiator; confident that the rental property will be profitable (since the interest rates are higher).
Related: 9 Ways To Invest If You’re Not Rich (Yet)
The Bottom Line…
There are so many options out there for financing a rental property. It’s never set in stone if an option is right or wrong; it simply depends on your resources, time, and why you are investing. We’ve outlined the most popular options for you in this article, but make sure you dig deeper into the option you think is most suitable for you before going for it. Also, click here to learn about more options on investing with little or no money.
We hope that this has given you the right idea on how to choose the best method to financing a rental property that suits you. Start finding rental properties today with Mashvisor!