Getting financing for your first property can be a real pain.
Buying a rental property comes with a pretty high monetary barrier which makes the process difficult – and it can be especially difficult for first time buyers as they often have more to prove and less money on hand to prove it.
What you need to know:
1) Big down payments
Mortgage insurance doesn’t cover investment properties. What this means in practical terms is that your lender is assuming more ‘risk’ when giving you a loan for a property investment. The result is that you will likely need to put down at least a 20% deposit to secure traditional financing.
We will explore methods of how to get around this monetary barrier later in the article. The more money you can put down though, the more likely you are to get a loan, and the better interest rate you will be able to find.
2) More loans could make it tough
The more loans that you already have the harder it becomes to get another. Most lenders won’t even consider you for a loan if you already have 4 or more.
There are some that will allow you up to as many as 10 loans though, so it is worth doing some research.
The reason it becomes harder to get a new loan is simply that the more debt you have the more likely you are (on paper at least) to default on that debt. So, the further you stretch your finances the harder and, ironically, more expensive it becomes to stretch them more.
3) Strong Credit
There are many factors that will affect the terms of a loan, amongst them the independent policies of the firm you are dealing with. But a major one you will want to check before you start dealing, is your credit score.It is suggested that ideally your credit score exceeds 740, though it depends on who you are dealing with.
A lower credit score, whilst it may not stop you from getting the loan it could hurt you interest rates and even incur some extra upfront fees.
4) Backup Cash
It’s not just an excellent credit score that you will need, but some decent reserves in the bank to pay any and all potential upcoming expenses. These are both personal and investment related, having six months worth of payments in the bank has become part and parcel of the process of lending.
Lenders want to know that a sudden or unexpected expense won’t cause you to default.
This means in terms of practicality, they will want to see you have six months worth of mortgage payments available per property, at the very least.
5) Choose your Lender
The big banks are pretty strict and getting a loan from one of them is often harder, simply because you have to very stringently adhere to all their financial demands. And even if you do, well, you still might not get the loan, or the terms may not be as favourable as if you went elsewhere. There’s also an element of impersonality from a big bank. You are one of hundreds of thousands of customers.
When purchasing a rental property, an important aspect of your long-term success is developing a strong, reliable team—and your lender is actually one of the first parts of that equation.
If your down payment isn’t quite as big as it should be or if you have other extenuating circumstances, consider going to a neighborhood bank for financing rather than a large national financial institution as they will likely have a little more flexibility, be more interested in local investments, and a better understanding of the local area.
Alternatively, you could explore the route of mortgage brokers or direct lenders. Though you will want to do some dues diligence if you plan to approach one of these.
A few questions to consider include:
- What’s their background?
- Do they belong to a professional organisation?
- Do they currently work with active property investors?
The main difference between a broker and a lender is that a broker has a selected list of lenders they call upon for investment. Whereas a direct lender is the institution actually lending you the loan.
What if you don’t have a lot of cash? Can you still invest in property?
Not everyone has the cash to be able to secure a loan in traditional manners. A credit score of 740, a 20% down payment, and 6 months worth of mortgage payments in the bank on top of that?
On a $250,000 property, that would be $50k for the down payment with a further $6,714 in the bank. (We worked this out with a 5% interest rate and a fixed 25 year payment period.)
And let’s not forget the cash for renovations which could number in the tens of thousands. It’s a lot.
So, here are a couple of slightly more creative ideas to get you around that need for up front cash.
Who says you have to use a loan programme? Seller financing, whilst not all that common does happen and work out well for both parties involved.
This is when the sellers themselves finance the property for you, allowing you to negotiate any terms you want! This works best with sellers who have no mortgage. Maybe the property needs work and they don’t have the time or money to do it themselves.
Often in these cases they are happy to accept monthly payments for the property, this helps everyone avoid the hassle of selling through realtors, the commission and all the other middlemen who get involved along the way.
It’s often an avenue worth exploring with sellers, it can prove an effective way to sell and a cost efficient way to buy your first property.
The seller might be another property investor – or they might be the property’s live-in owner.
The key to success is to ensure you agree on a fair interest rate. Regardless of how much experience you have, be sure to get the terms of the loan in writing, with signatures.
If your retirement money is in an self-directed IRA, you’re allowed to invest it in non-traditional assets, meaning something other than stocks or mutual funds. Real estate is an approved investment category meaning yes, you guessed it, you can invest it in property.
If you are thinking about going this route, talk it through with your CPA first. Landlording can be a hands on kind of investment, even with great software and automation tools out there and not everyone has the time or energy to make a successful investment out of it. isn’t for everyone.
We have outlined a number of things that you need to be aware of when going to get your loan for a rental property. However, there are other even less traditional methods that are possible, and they may even be worth researching.
A word of caution though, make sure all deals you do are documented properly and those documents are legally binding.
Do not end up over-leveraging and if in doubt about cashflow or profitability, err on the side of caution. No investment is free of risk, and often the case with property is the less money you come to the investment with the riskier it could be.
Whatever you decide, whether you go for more traditional routes or explore less traditional loan options or seller financing avenues, we always advise discussing your options with a professional.
We hope you found this blog interesting! However, do note that it should not be used as a substitute for competent legal and/or other advice from a licensed professional.