Buying an Investment Property: Common Financing Options

Unless you’ve inherited a rental property or have enough liquidity to pay cash, acquiring an investment property is going to take some sort form of financing. Since such a purchase is, in fact, an “investment”, buyers will want to look closely at their options and their impact on the bottom line. Before choosing a financing option, a buyer should be clear on their financial goals. Do they want to be able to produce the highest net income per month possible, get the real estate property paid off as quickly as possible, or somewhere in between?

Any person contemplating the purchase of a rental a property should be well aware of the costs associated with such an investment. These include the mortgage, taxes, insurance, and maintenance. One should also be realistic about financially enduring vacancies. If you’ve considered the financial aspects of owning an investment property and have a desire to purchase one in the future, it’s time to think about your financing options.

Owner Financing

There are a variety of reasons a rental property owner may be willing to finance your loan to buy their investment property. They may be tired of performing the duties of a landlord, want to move on to a different revenue stream, or may have other personal reasons why financing your loan may make sense for them.

An owner will usually only finance a purchase for a relatively short period, however normally three to five years. Following this period a “balloon” payment will often come due, meaning by then, the purchaser will need to secure other financing to pay the original private lender the balance due. If the buyer can’t secure financing in this balloon period they will lose their down payment, any payments made and the property will revert to the original seller. Owner financing can be advantageous for a seller because terms are totally negotiable and it can help a buyer who may otherwise not qualify for traditional financing to purchase an investment property.

Friends or Relatives

In some cases, friends and relatives can be a source of financing an investment property. This can work in several ways. The person buying the property could simply borrow the money from friends and relatives at an agreed rate using the property as collateral. A buyer could also become a “partner” with friends and relatives in the purchase of an investment, agreeing to perform all the duties of the landlord in part, to serve as “sweat equity” in the project. Any partnership should be well thought out and documented in legal terms even one forged between friends or family. Having everything in writing will ensure there are no surprises and that everyone understands their role and what it entails financially.

Conventional Loans

Investment property loans are treated differently than a mortgage for a primary residence. This is because lenders see these investments as riskier than private homes. This means higher down payments, higher interest rates and may even take a better credit rating to get approval. One can expect a 20% down payment as a minimum. On the other hand, banks and mortgage companies will often consider the investment potential in approving such loans. If the rental property can be purchased at a good price (low Loan to Value (LTV) ratio) and shows potential for a solid income, a good business plan might help persuade lenders into more favorable terms.

Private Lending

Secondary and private lenders appreciate the security of real estate but have little interest in owning a property or managing properties. They instead would prefer to lend money to those who will seek out and manage these properties while getting a solid return on their investment. Generally, these lenders will charge higher interest rates but will be more lenient on who they lend money to because their loans are secured by the property.

A Second Mortgage

If you have a large amount of equity in your primary residence, that equity can serve to completely fund an investment property. A home with a large amount of equity may serve to totally finance a smaller rental property at very favorable terms. Depending on your financial goals this could serve, and perhaps should serve, help you reach them.

Other Options

One popular option is buying a multi family building (such as a duplex) that you can live in while collecting rent from the other units on the property. This can count as a “primary residence” while getting help paying mortgage payments/housing costs, and gives owners access to options like the FHA loan and potentially securing an FHA 203K loan that provides funding for major renovations.

The key is always knowing what is involved and fully understanding the terms of the loan you’re considering. If your goals are long-term, you are best served securing financing that helps you reach those goals. If the goals are short-term in an effort to “flip” a property, a whole different set of guidelines will apply.  Take at least as much time in choosing financing as you did in locating an investment property. Your diligence is sure to pay dividends.