As you work to expand your real estate portfolio, it can be tough to find funding for your next property.
The best way to buy a property is with cash. But if that’s not an option, landlords should consider loans and other forms of financing, even if they only have $1000 to invest. If you’re buying a property with someone else, take the time to look at all your investment options.
Here are four ways to finance your next rental property.
1. Conventional financing
In conventional financing, the lender uses the property you hope to purchase as security for the loan.
With conventional loans, you secure a low monthly payment for the next 15 to 30 years. However, most lenders require a down payment of between 20 and 30% of the mortgage.
In many parts of the country, this means you still need to come up with $50,000 to $200,000 for the down payment. This requirement will sometimes have folks scrambling for other financing sources.
Further, gift funds are not allowed and you are not able to count “potential” rental income into your debt-to-income (DTI) calculation. Conventional financing often requires the borrower to afford the mortgage for both their primary residence and the new investment without the help of future rental income.
2. Private funding
Some lenders provide private financing with a secured interest in the home, which is similar to mortgage lending. This process can be faster than a conventional mortgage financing process.
Be prepared to pay a higher interest rate, but don’t let that deter you from considering this option. If the property is a good investment––that is, if the rental income has positive cash flow and there is the possibility of appreciation––you could get private funding for the short-term until conventional financing is available.
3. HELOC or home equity loan
A home equity line of credit (HELOC) exists when the lender uses an existing property that you already own as security for the loan. Typically, this loan is in addition to the primary loan that’s already in place.
A HELOC works like a credit card. The lender will give you a line amount, and you can charge or borrow funds from the line. You are billed monthly, and the minimum payment is typically interest only.
A home equity loan works differently. The lender will give you all the funds upfront, and you’re required to make a fixed payment each month that typically contains principal and interest. These loans are often amortized over a 15 or 20 year period. Home equity loans are “mini-versions” of a conventional mortgage.
Most lenders will allow you to borrow up to 90% of the value of the home on a primary residence and 80% on a second home. Some people don’t feel comfortable borrowing against their primary residence. But if you view your personal real estate and investment property portfolio as assets and liabilities that increase your net worth, this can help you come to terms with that issue.
4. Cash-out refinance on a primary or second home
A cash-out refinance is when the lender uses an existing property (primary or secondary home) that you own as security for the loan.
This process is identical to applying for a regular mortgage so it takes about 30 to 45 days to complete. Typically you can borrow up to 80% of the value of your home. A cash-out refinance pays off any existing debt on the property, then creates a new mortgage, and gives you the difference as a “cash out.”
Again, you must be comfortable using the equity from your personal property, which, since the housing collapse in 2008, has been difficult for many homeowners. There simply hasn’t been enough equity in their existing properties.
If you refinance on an investment property you already own, and which was not purchased within the prior six months, the max cash-out rule is 75% loan-to-value ratio (LTV) for a one-unit property and 70% for a property with two to four units. If you have four or more properties financed, the maximum LTV cash-out limit is 65%.
A cash-out refinance is allowed immediately if there was no financing for the purchase transaction and the following are guidelines are met:
The new mortgage can’t be for more than the initial investment that was used to purchase
Purchase was an arm’s length transaction
Provide the settlement statement which shows no financing
Title search must show there are no liens on the property
You need to be able to source the funds for the purchase via loan documents, bank statements, etc.
Loans used as a source of the down payment must be paid back on the new settlement statement
Remember, do you research on any potential investment property before seeking financing, whether you’re thinking of buying a rental in a college town and even if you’re mapping out when to sell existing investment properties.
Good luck expanding your portfolio!