5 Tips for Financing Your First Rental Property

A good number of the wealthiest people in the world ascribe their success to real estate, and with good reason. According to billionaire Andrew Carnegie, 90% of millionaires became wealthy by investing in real estate. Real estate is a good investment opportunity as it provides a hedge against inflation, offers long-term rewards of equity growth and appreciation, and delivers considerable tax breaks.

  • Tuesday, March 10, 2020

  Matt Angerer

  Financials   Mortgage   

A good number of the wealthiest people in the world ascribe their success to real estate, and with good reason. According to billionaire Andrew Carnegie, 90% of millionaires became wealthy by investing in real estate. Real estate is a good investment opportunity as it provides a hedge against inflation, offers long-term rewards of equity growth and appreciation, and delivers considerable tax breaks.

Nevertheless, getting started with real estate investments is not easy. Buying your first rental property can be overwhelming. First, you have to familiarize yourself with the ins and outs of real estate investing. Second, you have to secure financing for your project.

As it gets more difficult to secure traditional financing, you can feel like your dream of becoming a landlord is far-fetched. Luckily, numerous financing options can make it easy for you to fund your first rental property. This article outlines five tips to finance your first rental property and help you find the best financing option.        

1. Consider Paying Your Debt before Purchase

Before you think about financing your first rental property, consider paying down your personal debt. It is best practice to pay down any student loans, personal loans, and unpaid medical bills before you make this great move.

Also, examine your debt-to-income ratio (DTI) because it may affect your ability to obtain financing from banks and other sources. You can calculate your DTI by dividing your recurring monthly debt by your monthly income and multiplying the resulting figure by 100. If you have a high DTI, it shows that you have a considerable debt compared to your monthly earnings. A high DTI may compromise your ability to secure funding at favorable interest. Most financial institutions prefer a DTI of 36% or lower.

2. Secure a Down Payment

Investment properties require more significant down payment than owner-occupied properties. If you paid a 3% down payment for your current home, do not expect to pay the same for your rental property. You will need at least a 20% down payment.  If you are considering a conventional loan, a sizeable down payment will help you get competitive interest rates.

3. Maintain Good Credit Ratings

When financing your first rental property, your credit score is crucial, especially if you want bank financing. For example, your credit score affects the amount a bank can loan you as well as the interest rate.

A high credit score qualifies you for a considerable amount coupled with a low-interest rate. If you have a poor credit score, you may get a high-interest rate or required to pay a fee to qualify for a low-interest rate.   

You can maintain a high credit score by regularly monitoring it, making timely loan payments, and refraining from over-utilizing your credit card –maintain a balance of more than 30% always. 

4. Consider a Fixed Rate Mortgage

Financial institutions offer fixed and adjustable-rate mortgages. A fixed-rate mortgage means that you lock an interest rate for the duration of your loan. With adjustable-rate, the interest rates keep fluctuating based on market conditions and other factors.

Although adjustable-rate mortgage offers low introductory rates, you should note that the rates may go up in the future, and consequently, your monthly payments. Therefore, a fixed-rate mortgage may be great because you lock your interest, and your monthly payments are constant throughout your loan.

5. Financing Options

There are numerous financing options for your first rental property. The secret is to choose one that meets your needs and maximizes your returns.

  • Buy as an Owner Occupant

One feasible way of financing your first rental property is purchasing the property as your primary residence. This way, you can access a lower down payment than investor loans and lower interests. As opposed to the typical 20% down payment for investor loans, an owner-occupant loan requires a lower down payment –as low as 3.5-5% for FHA loans.

However, ensure that you check the rules and regulations on owner-occupied property. The majority of banks require that you reside in the home for one year before you sell or rent it to generate income. Once the one year is over, you can rent the property, and say hello to being a landlord.

  • Obtain Home Equity Line of Credit

If you already have a home and equity, you can use the equity to finance your rental property. A home equity line of credit will help you finance your investment property without much struggle. You can borrow between 80-90% of the home's total equity.

Just like the mortgage process, when applying for a line of credit the bank examines your credit score and monthly income. With a home equity line of credit, your home becomes the security for your new loan.

  • Try an Online Lender

Forget about local banks and credit unions and their plethora of requirements for loans. Instead, you can try online lenders to finance your rental property. The primary advantage of online lenders is that you don't have to drive from one bank to another and sit in long and tedious meetings only to be told you don't qualify for a loan. With plenty of online loan marketplaces, you can compare loan options and get the right partner to meet your financial needs.

  • Gather a Group of Investors

If you can't buy a property alone, you can gather a group of investors and buy the rental property together. If you want to purchase a rental property costing $600,000, you gather three more investors who contribute $150,000 each. This way, you buy the property quicker while spreading out the risk.

  • Use Seller Financing

With seller financing, the seller of a rental property serves as a bank and allows you to negotiate the terms you would like. The seller gives you the title of the house but keeps the security deed and note to the house. You make monthly payments to the seller. In the event you default, he can foreclose on you.

Although seller financing is an excellent option to finance your first rental property, it can be difficult to locate a seller willing to seller finance. Difficult does not mean impossible, and you can get a seller who inherited a property and is unsure what to do with it. Also, you may get a seller with a property that needs minor repairs but does not have the cash for them. Such sellers can be willing to seller finance.  

  • Consider Private Funding

Private money lending can provide you the much-needed money for your first rental property. You can get money from a friend, family member, or acquaintance.

  • Find a Rent-to-Own Property

This form of financing is excellent for first-time buyers in real estate. You get to rent a property for some time -may two or three years then buy it. Rent-to-own has numerous benefits, including giving you time to secure financing and improve credit score. 

Buying your first rental property can be your highway to success. However, you must take time to gather your finances and research on ideal rental properties. Even with the required finances, it would be catastrophic to choose the wrong property, or let the wrong tenants into your property. However, you need not worry about that thanks to our tenant screening software.

About the author

Matt Angerer is the Founder and President of VerticalRent. He enjoys writing on a variety of topics that help Landlords, Property Managers, and Renters across America. He is particularly interested in helping renters understand their local marketplace, pick the best places to live, and find an awesome roommate. Since 2011, VerticalRent has grown to service over 100,000 landlords and renters across America. 

Read more articles from Matt Angerer

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