We’re taught from a young age that going into debt is generally a bad idea. However, when it comes to buying a rental property, avoiding debt is extremely difficult for most investors because coming up with hundreds of thousands of dollars in cash is no easy feat! So, if you haven’t come into a large windfall of money or have had decades to save money, taking out a loan is probably your best option for purchasing a rental property. It’s important to note that financing options for primary residences are unlike investment properties because banks and financial institutions view them differently.
There are several different ways to invest in rental property; some of the most popular are conventional mortgages, private money lenders, and home equity loans. If you want to explore financing options further, take a deeper dive into rental property financing. There are a few factors you should consider when choosing a financing option for your investment property:
- Investment Goals
- Liquidity
- Down Payment and Fees
Investment Goals
Before you make your first (or next) investment, it’s essential to consider your goals. Some investors are content with owning and managing one property, while others want to build a rental empire. Which one are you?
If you want to own a single rental property to bring in some extra cash every month and work towards building long term wealth, that’s a very achievable goal for any investor. In addition, you can easily manage a single property yourself and help cut down on your operating costs.
If your goal is to build a portfolio of rental properties, it can be a great way to diversify your investments. The more properties you own, the less reliant you are on income from any one source. Something to keep in mind is that opting for financing instead of paying cash for properties with this goal would be the smartest play. Tying up all your money on the first property will keep you from being able to buy more properties as quickly as possible. Another factor to consider with multiple investment properties is the time commitment. It takes a lot to manage one property, let alone multiple! Consider interviewing several property managers to find the best one to oversee the properties for you.
Liquidity
We’re talking about financing here, but an important decision to consider when acquiring any real estate is the cash vs. financing option. For many investors, paying for rental properties in money isn’t a realistic option, but for some, it is. So the question to ask is: Is paying cash for a rental property an intelligent move? It’s difficult to answer that question, but the idea of liquidity (your readily available cash) can help make the answer clearer.
Even the most cash-rich real estate investors would have to spend a large chunk of their cash to acquire new rental property without financing, tying up most of their funds in one investment. Depending on your investment strategy, this isn’t always a bad thing, but it generally hurts your ability to diversify your portfolio. Many investors prefer to finance their properties because it allows them to scale up their portfolios quicker than investors who have less cash on hand.
Down Payment and Fees
Assuming you plan on going the financing route, you’re going to need some cash ready upfront for either a down payment or fees incurred from financing.
With conventional mortgages, you’re required to come up with a down payment and closing costs when purchasing your rental property. These loans are the same as what banks and financial institutions use to finance primary residences but have stricter requirements for investors. For example, lenders will generally require a 20% down payment and a solid credit score. For many investors, the 20% can be daunting, but the lower interest rates on conventional mortgages can be worth the down payment. If you’re trying to save up for a down payment on a rental property, check out these valuable tips to reach your savings goal.
With other financing options, you can avoid large down payments and strict credit requirements altogether, but it comes at a different expense. If your credit score isn’t the strongest, private money lenders are a good financing route. They are used to working with investors with lower credit scores, but they’ll charge higher interest rates and loan fees for the risk they’re taking.
If you’re a current homeowner, a home equity loan could be a viable financing option for you. You can borrow up to 90% of your home’s value by basically taking out a second mortgage on your home, and the bank will use your primary residence as collateral for your rental property.
Final Thoughts
Whether you’re a new or seasoned investor, there are several ways you can finance a rental investment property. It’s essential to weigh all the options available to you and your current financial situation. If you get clear on your investment goals, finding a financing solution that works well for you becomes much more manageable.
