Buying an investment property can be one of the keys to financial freedom and generational wealth. Whether you want to enjoy rental income, tax benefits, or both, owning an investment property can help you achieve your long-term goals in less time.
The actual process of financing and buying an investment property does require careful planning and consideration, though. You also have to think about the different types of investment properties available to you.
Before we get into all that, let’s look at a few reasons why buying an investment property could be a smart move for you:
- Rental income: Earn consistent cash flow and generate passive income by renting out your asset.
- Appreciation: When you invest in real estate, it has the potential to appreciate over time, increasing the property’s value and your overall investment. You can accelerate this appreciation by making improvements to your property that can command higher rents.
- Diversification: Buying an investment property adds to your investment portfolio, which spreads out your risk and reduces your portfolio’s overall volatility.
- Tax benefits: We weren’t just going to leave you with a teaser. Real estate investments can come with many tax benefits, including mortgage loan interest deduction, operating expenses, property taxes, insurance, and depreciation.
- Inflation hedge: An investment property—most home purchases, really—will tend to not only hold steady price-wise, but many increase their value over time, allowing you to hedge against inflation.
How to Finance and Buy an Investment Property
Financing is the hardest part of any home purchase for most homebuyers. This period can be fraught with stress-inducing paperwork as you gather documents, consider your income and debts, and calculate how additional mortgage payments may impact your monthly budget.
But that’s where mortgage lenders and experts like APM come in. We’re always happy to sit down with you and go over your specific financial situation, goals, and options.
For those of you considering whether to invest in real estate, here are a few steps to get you started.
1. Set clear investment goals.
Define your investment goals, including the type of property, location, budget, expected returns, and timeline.
2. Assess your finances.
Evaluate your credit score, calculate your savings for a down payment, and get your documents in order for pre-approval on a home loan. Though every lender is different, many mortgage lenders require a minimum 620 credit score when buying an investment property. On the down payment side, APM can work with as little as 15% down on a single-family investment property and 25% down on a multifamily investment property.
Keep in mind that many mortgage lenders will also want to see six months’ cash reserves before financing an investment property. Private mortgage insurance (PMI) may also be required if you’re putting less than 20% down.
3. Consider interest rates.
Interest rates for investment properties are generally higher than those for primary residences. The increased rate reflects the higher risk perceived by lenders due to the property not being occupied by the owner.
4. Learn loan to value (LTV).
The loan-to-value ratio compares the loan amount to the property’s appraised value. Investment properties often have stricter LTV requirements. This means you may need to have more equity or a larger down payment to meet the LTV ratio requirements. APM can offer up to 80% LTV.
5. Analyze your debt-to-income (DTI) ratio
Mortgage lenders will look at your debt-to-income ratio, which compares your monthly debt obligations to your monthly income. For investment properties, there may be more stringent DTI requirements, but lenders can usually consider rental income when calculating your ratio.
6. Compare financing options.
Many of the same types of loans you can use to obtain a mortgage loan on your primary residence can be used when buying an investment property. These include conventional loans, FHA loans, VA loans, or jumbo loans.
7. Do the math.
Calculate the potential return on investment (ROI) by factoring in rental income, expenses, mortgage payments, and vacancy rates. You also need to consider the monthly mortgage payments over the life of the loan, which can be up to 40 years if you finance through APM. You want to make sure you have the bandwidth to stay on top of tenant turnover, general maintenance, updates, and both expected and unexpected repairs.
8. Think through maintenance and property management.
Speaking of repairs, think about whether you want to hire a property manager to handle tenant screening, rent collection, and property maintenance. These people and companies can be lifesavers, but it is a cost you’ll need to factor into your monthly budget.
Types of Investment Properties
You might be sold on the idea of buying an investment property, but did you know there are a few options to choose from?
First, there are single-family homes, which are great for securing long-term renters. They can also be used for short-term rentals, depending on your area’s laws and any HOA rules, and whether demand exists in that market for short-term housing (more on this later).
Second, multifamily properties, which can consist of two to four units or even entire apartment buildings, are great because you can house numerous renters. More renters equals more monthly rent payments.
Here’s a fun fact you may not know about multifamily properties: If you live in one of the units, then you can finance the property as a primary residence instead of an investment property. This generally buys you a more flexible set of mortgage loan requirements, not to mention a lower interest rate.
Finally, you can buy in a condominium complex, which is essentially like purchasing an apartment unit in a building where everyone else also owns their unit (or rents it out like you do!). Once again, you have to consider the building’s bylaws, but the condo rental market is very robust.
A Little Info on Airbnb
Before you invest in real estate with the explicit goal of throwing it up on Airbnb or other home-share sites, you want to make sure you know what you’re getting into. Familiarize yourself with the local regulations governing short-term rentals. Some cities have specific rules, permits, or restrictions regarding Airbnb rentals. Ensure that you understand the legal requirements and any potential limitations in your desired location to avoid legal complications or unexpected surprises.
You also want to look for properties with features that appeal to travelers, such as proximity to attractions, ample space, desirable amenities, and a welcoming ambiance. Consider the property’s layout, number of bedrooms, parking availability, and outdoor spaces. The property should offer a unique and comfortable experience for guests.
Owning an Airbnb can be a lucrative investment, but don’t forget to consider the long-term sustainability of your property. Look for areas with economic stability, diverse tourism sources, and potential for growth. Anticipate any changes in the market or regulations that could impact your business, and evaluate whether you can adapt.
Second Home vs. Investment Property
Many people confuse investment properties and second homes, since an investment property may literally be the second home purchase you make. There is a clear difference between the two, however. The financial requirements are different for each, as these two purchases function differently.
A second home is really a dwelling for you and your family to use. It’s like a vacation home in the sense that you live in it for part of the year. A second home also needs to be located at least 50 miles away from your primary residence. While you can rent out a second home, you can only do so for two weeks or less per year.
As you can imagine, these parameters change not only the type of financing, but the potential for cash flow and tax benefits as well.
When you’re thinking about buying an investment property, the best part is how exciting it can be. Though there are financial requirements, obtaining a mortgage loan on an investment property doesn’t need to be hard, especially with APM by your side.
We can walk you through all the guidelines, options, and ways to position yourself for the best chance of success. Give us a call today to find out more.