Many real estate investors are searching for additional ways to create passive income. The market in South Florida is a lucrative locale for creating this kind of residual income. One of the most common barriers to entry with rental property acquisition can be that a significant amount of capital needs to be available for a down payment. In this blog post, we are going to cover some of the different ways that investors can finance investment properties.
The most common types of loans for the acquisition of rental homes are Home Equity Loans, Hard Money Loans and Conventional Loans. Investors need to research and understand the differences between these three different kinds of loans. Using the wrong one for a specific investment property can jeopardize the potential for the transaction to be profitable, especially in the short term.
Home Equity Loans
In 2021, most homeowners have a decent amount of equity available in their properties. This equity can be used to further their real estate goals by acquiring additional properties. One way to access this equity is by applying for a Home Equity Line of Credit (HELOC). The equity can also be tapped into through completing a cash-out refinance transaction on the home. A property owner can typically borrow up to 80 percent of their equity in order to purchase a second property. Depending on which type of loan they decide to use, there may be a different list of pros and cons. If you choose to get a HELOC, it will essentially function as a high limit credit card. The monthly payments will most likely be interest only. However, a HELOC usually means a variable interest rate. If the prime interest rate the loan is tied to increases, the rate and payment on the loan will also increase. Conversely, a cash-out refinance comes with the stability that a fixed rate brings. However, one potential drawback is that it will often extend the duration of your current mortgage.
Hard Money Loans
These loans make the most financial sense when your goal is to purchase a property, make repairs and/or additions, and then flip the property by quickly reselling it for a profit. A hard money loan will most often be significantly more expensive than the other types of loans. It will also need to be repaid in full within a year or less in most instances. A hard money lender will be primarily focused on how much potential profit is wrapped up in the property. They are much less concerned with things like the credit score of the prospective borrower, or what their credit payment history actually looks like. The terms that come along with hard money loans are usually quite stringent, and you should be prepared to have interest rates climb up to 18% or higher. Any penalties for missed payments will also be quite painful financially for the borrower. However, these types of loans can be of tremendous value to an investor and sometimes the only way to get the property. This is due to the fact that they are much easier to qualify for than home equity lines of credit or conventional loans. Another huge plus is that they will typically fund very quickly, comparatively speaking (days instead of weeks), to the other options. This allows the construction on the project to begin almost immediately.
Conventional loan products are governed by the standards set forth by Fannie Mae and Freddie Mac. In today’s marketplace, conventional lenders generally require a 20% down payment on most deals. If the property involved in the transaction is an investment property however, the lender may require as much as 30% of the purchase price as a down payment. For conventional loans, things like whether or not an investor qualifies for a loan, and what interest rate they will be required to pay will depend on the investor’s personal financial situation. A borrower will be asked to provide documentation showing that they can afford the monthly payments on the new loan in addition to their existing monthly financial obligations. Their debt-to-income ratio will be reviewed prior to factoring in the rental income they are expecting to garner from the property, and approval or denial of the loan application is based on this figure.
As you are choosing the best type of loan for your investment property, be sure to consider both the short and long-term implications of each type of loan to ensure that your venture will be as profitable as possible! As always, please don’t hesitate to reach out to PMI Key Partner with questions about any aspect of acquiring and managing rental property.