3 Things to Know About Financing a Rental

Real estate investors today are expanding their portfolios to include investment real estate. Residential real estate is the only investment asset class that both appreciates in value while simultaneously providing monthly cash flow. As property values increase so too do rental rates. If you’re been seriously considering buying a rental property, there are three things you can expect.

Interest Rates are Higher.
Investment real estate is considered a greater risk for investors compared to someone buying and financing a primary residence. The thinking is simply that if someone gets into some degree of financial stress, the primary residence will be kept while selling the investment properties or otherwise letting them go into foreclosure. Rates are higher but not alarmingly so. One can expect to see rates anywhere from 0.50 to 1.00 percent higher compared to rates for a primary residence.

Down Payment.
Again with a nod toward risk, you can expect to make a down payment of at least 20 percent of the sales price. If you make a down payment of 25 percent or more you’ll get slightly better terms. With a primary residence, your down payment can be as little as 5.0 percent or even 3.0 percent with certain first-time buyer programs. Down payment funds must come from accounts that you own and have access to.

Qualifying Income.
One of the main considerations for investing in real estate is cash flow. If a property doesn’t produce cash flow, investors won’t likely consider it for a purchase. But using that additional income from the rental to help qualify comes with strings attached. First, a lender won’t use the full amount of the rental income to help qualify.

Instead, the lender will consider a vacancy factor of approximately 25 percent. Even if the unit is occupied full time, there will be occasions when the property is vacant and being prepared for the next tenant. If the rental is $2,000, qualifying income would then be $1,500. Second, even if the rental income is discounted for a vacancy, unless you have had two years of experience being a landlord, the income won’t be counted regardless.

However, once the two-year history has passed, the income can be used to help qualify. This is one of the reasons why it’s not uncommon for real estate investors to own multiple properties because the new mortgage, taxes, and insurance is no longer an expense because the rent covers these charges.

Your loan officer can explain these and other items such as rates and fees and what your monthly payments will be. Investment real estate is an asset class all on its own. You just need to know what to look out for before you jump in.

 


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